Modern Advanced Accounting in Canada 7th edition by Hilton – Solution Manual
CHAPTER 1 A Survey of International Accounting
R EVIEW Q UESTIONS
- Explain if and when it may be appropriate for an accountant to prepare
financial statements that are not in accordance with GAAP.
- Why is it important to supplement studies of Canadian accounting principles
with studies of the accounting practices used in other countries?
- In what manner has there been a shift toward a global capital market in
- List the factors that have influenced the accounting standards used in a particular
- What role does the stage of development of a country’s capital markets have
on the direction taken by the country’s accounting standards?
- In what way has the level of inflation influenced the accounting standards of
a particular country?
- In what manner does the balance-sheet format used by companies in other
countries differ from the format used by Canadian companies?
- Identify some of the financial statement items where U.S. GAAP is different
- What is the goal of the IASB?
- What does the FASB-IASB convergence project expect to achieve? How will
it be carried out?
- What evidence is there that IASB pronouncements are becoming acceptable
throughout the world?
- Describe the extent of harmonization or convergence of accounting standards
for publicly accountable enterprises in Canada with the standards
published by the IASB.
- Explain why complete comparability on a worldwide basis is going to be difficult
to achieve despite a switchover to IFRSs.
- Briefly explain why the Canadian AcSB decided to create a separate section
of the CICA Handbook for private enterprises.
- Briefly explain why a Canadian private company may decide to follow IFRSs
for public companies, even though it could follow GAAP for private companies.
- 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.
- (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
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
(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?
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:
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.
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. GAAP IFRSs
U.S. dollars U.S. dollars
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
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
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.
NOTES FROM THE INTERIM AUDIT
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
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
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.
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.
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
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
LO1, 5, 6
42 CHAPTER 1 A Survey of International Accounting
HIGHLIGHTS OF NEW LEGISLATION ON EMISSIONS
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.
LETTER CONCERNING SALE OF LADIUM PROCESSING DIVISION
May 2, Year 4
Mr. I. P. Labigne
President and Chief Executive Officer
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
- 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.
Ms. S.N. Wong, CA
Vice-President, Finance and Chief Financial Officer
Donaz Integrated Limited
CHAPTER 1 A Survey of International Accounting 43
LADIUM PROCESSING DIVISION BALANCE SHEET
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
LADIUM EXTRACTION DIVISION
(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
- This budget was prepared on the basis that the Extraction Division would sell its
ladium to the Processing Division.
- 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.
- 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.
NOTES FROM DISCUSSIONS WITH ML’S CFO
- 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.
- 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.
- Selling costs for the disposal of Processing are expected to amount to $6.7 million.
- 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.
- 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%
- 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.
- 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.
LO4, 5, 6
LO4, 5, 6
46 CHAPTER 1 A Survey of International Accounting
- 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.
(ii) Research and development
(iii) Deferred gain on lease
(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:
- Impaired loans—original versus market rate of interest
- Interest costs—capitalize versus expense
- Actuarial gains/losses—recognize immediately or defer and amortize
- Compound financial instrument—debt versus equity components
- Income taxes—future income tax method or taxes payable method
Harmandeep provides the following information with respect to each of these
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
LO5, 6, 7
CHAPTER 1 A Survey of International Accounting 47
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.
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.
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.
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
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