Sample Chapter

 

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Financial Accounting Tools for Business Decision Making, 6th Canadian Edition By Paul D. Kimmel, Jerry J. Weygandt, Donald E. Kieso, – 
Solution Manual 
SAMPLE QUESTIONS

 

 

 

CHAPTER 1 Th e Purpose and Use of Financial Statements

 

Questions

  1. What is accounting?

(SO 1) 2. Distinguish between internal and external users

of accounting information.

(SO 1) 3. What kinds of questions might internal users of

accounting information want answered? External

users?

(SO 1) 4. Why is ethics as important to accountants as it

is to the decision makers who rely on fi nancial

information?

(SO 2) 5. Identify the advantages and disadvantages of

each of the following forms of business organization:

(a) proprietorship, (b) partnership,

(c) private corporation, and (d) public corporation.

(SO 2) 6. Identify the similarities and diff erences between

a public corporation and a private corporation.

(SO 2) 7. (a) Identify the fi nancial reporting standards a

public and a private corporation may use.

(b) Why do you think they diff er?

(SO 2) 8. Explain how the reporting entity concept applies

to business organizations.

(SO 3) 9. Explain the following terms and give an example

of each: (a) asset, (b) liability, (c) shareholders’

equity, (d) revenues, and (e) expenses.

(SO 3) 10. Distinguish between operating, investing, and

fi nancing activities.

(SO 3) 11. Give two examples of each kind of business

activity: (a) operating, (b) investing, and

(c) fi nancing.

(SO 3) 12. Name two local companies that provide services

and generate service revenue. Name two local

companies that sell products and generate sales

revenue.

(SO 4) 13. What is a fi scal year end? Why does a company’s

fi scal year not always end on December 31?

(SO 4) 14. André is puzzled reading Air Canada’s fi nancial

statements. He notices that the numbers have all

been rounded to the nearest million. He thought

fi nancial statements were supposed to be accurate

and wonders what happened to the rest of

the money. Respond to André’s concern.

(SO 4) 15. Th e basic accounting equation is Assets 5

Liabilities 1 Shareholders’ Equity. Replacing

words with dollar amounts, what is Shoppers

Drug Mart’s accounting equation at

December 29, 2012? Shoppers’ simplifi ed

fi nancial statements can be found in

Illustration 1-9 within this chapter.

(SO 4) 16. What are the primary components explained

in a statement of changes in equity? What types

of items generally increase each component?

What types of items generally decrease each

component?

(SO 4) 17. (a) What is the purpose of the statement of cash

fl ows? (b) What are the three main categories of

activities included in the statement?

(SO 4) 18. Why is a statement of fi nancial position prepared

as at a specifi c point in time, while the other

fi nancial statements cover a period of time?

(SO 4) 19. How are each of the following pairs of fi nancial

statements related?

(a) Income statement and statement of changes

in equity

(b) Statement of changes in equity and statement

of fi nancial position

(c) Statement of fi nancial position and statement

of cash fl ows

(SO 4) 20. Identify the four fi nancial statements used by

corporations using (a) IFRS and (b) ASPE.

Brief Exercises

BE1–1 Th e following list presents diff erent types of evaluations made by various users of accounting information:

  1. Determining if the company respected income tax regulations
  2. Determining if the company pays reasonable salaries
  3. Determining if the company can pay for purchases made on account
  4. Determining if a marketing proposal will be cost-eff ective
  5. Determining if the company’s profi t will result in a share price increase
  6. Determining if the company should use debt or equity fi nancing

(a) Beside each user of accounting information listed in the left -hand column of the table that follows, write the

number of the evaluation above (1 to 6) that the user would most likely make.

(b) Indicate if the user is internal or external. Th e fi rst item has been done for you as an example.

(a)

Type of Evaluation

(b)

Type of User

Investor 5 External

Marketing manager

Creditor

Chief fi nancial offi cer

Canada Revenue Agency

Labour union

BE1–2 Match each of the following forms of business organization—(1) proprietorship, (2) partnership, (3) public

corporation, or (4) private corporation—with the set of characteristics that best describes it.

(a) ________ Simple to set up; founder retains control

(b) ________ Separate legal entity; shares closely held

(c) ________ Easier to transfer ownership and raise funds; no personal liability

(d) ________ Shared control; increased skills and resources

(e) ________ Issues shares; can choose to follow IFRS or ASPE accounting standards

BE1–3 Classify each item by type of business activity—operating (O), investing (I), or fi nancing (F).

(a) ________ Cash received from customers

(b) ________ Dividends paid to shareholders

(c) ________ Common shares issued to investors

(d) ________ Money borrowed from a bank

(e) ________ Purchase of an offi ce building

(f) ________ Salaries paid

BE1–4 For each of the following items, indicate (a) the type of business activity—operating (O), investing (I), or fi nancing

(F)—and (b) whether it increased (1), decreased (–), or had no eff ect (NE) on cash. Th e fi rst one has been done for

you as an example.

(a)

Type of Activity

(b)

Cash Eff ect

  1. Sold goods on account. O NE
  2. Borrowed money from a bank.
  3. Purchased inventory for cash.
  4. Provided a service for cash.
  5. Paid salaries in cash.
  6. Purchased a delivery truck for cash.

BE1–5 Use the accounting equation to answer these independent questions:

(a) Th e shareholders’ equity of Sansom Corporation is $120,000. Its total liabilities are $55,000. What is the amount of

Sansom’s total assets?

(b) Th e liabilities of Houle Corporation are $170,000. Houle’s share capital is $100,000 and its retained earnings are

$90,000. What is the amount of Houle’s total assets?

(c) Th e total assets of Pitre Limited are $150,000. Its share capital is $50,000 and its retained earnings are $25,000. What

is the amount of its total liabilities?

(d) Th e total assets of Budovitch Inc. are $500,000 and its liabilities are equal to half its total assets. What is the amount of

Budovitch’s shareholders’ equity?

BE1–6 At the beginning of the year, Lam Ltd. had total assets of $800,000 and total liabilities of $500,000. Use this information

to answer each of the following independent questions.

(a) If Lam’s total assets increased by $150,000 during the year and total liabilities decreased by $80,000, what is the amount

of shareholders’ equity at the end of the year?

(b) During the year, Lam’s total liabilities decreased by $50,000. Th e company reported a profi t of $50,000, sold additional

shares for $75,000, and paid no dividends during the year. What is the amount of total assets at the end of the year?

(c) If Lam’s total assets decreased by $80,000 during the year and shareholders’ equity increased by $110,000, what is the

amount of total liabilities at the end of the year?

BE1–7 Indicate which statement—income statement (IS), statement of fi nancial position (SFP), statement of changes in

equity (SCE), or statement of cash fl ows (SCF)—you would examine to fi nd each of the following items:

(a) _______ Sales revenue

(b) _______ Supplies

(c) _______ Dividends

(d) _______ Cash provided by operating activities

(e) _______ Total liabilities

(f) _______ Cash used for fi nancing activities

(g) _______ Salaries expense

(h) _______ Common shares issued during the year

BE1–8 Indicate whether each of these items is an asset (A), a liability (L), or shareholders’ equity (SE):

(a) ______ Accounts receivable

(b) ______ Salaries payable

(c) ______ Equipment

(d) ______ Offi ce supplies

(e) ______ Common shares

(f) ______ Bank loan payable

(g) ______ Retained earnings

(h) ______ Cash

BE1–9 Determine whether each transaction would increase (1), decrease (2), or have no eff ect (NE) on each the following

components found in the statement of changes in equity: share capital, retained earnings, and total shareholders’

equity. Th e fi rst one has been done for you as an example.

Share Capital

Retained

Earnings

Total

Shareholders’

Equity

(a) Profi t NE + +

(b) Issue of common shares

(c) Dividends paid to shareholders

(d) Cash

(e) Loss

(f) Issue of long-term debt

BE1–10 Go-Ahead Limited began the year with common shares of $100,000 and retained earnings of $350,000. During

the year, it issued an additional $25,000 of common shares, reported a profi t of $75,000, and paid dividends of $5,000.

(a) Calculate the ending balances of (1) common shares, (2) retained earnings, and (3) total shareholders’ equity.

(b) Explain how your answer would change if the company had reported a loss of $75,000 rather than a profi t.

Exercises

E1–1 Facebook, Inc. is a public corporation and has been one of the world’s most active social networking sites. Its

revenue is generated primarily from advertising.

Instructions

(a) Identify two internal users of Facebook’s accounting information. Write a question that each user might try to answer

by using accounting information.

(b) Identify two external users of Facebook’s accounting information. Write a question that each user might try to answer

by using accounting information.

E1–2 Consider the following statements.

Proprietorship Partnership

Public

Corporation

Private

Corporation

  1. No personal liability F F T T
  2. Owner(s) pay(s) personal income tax on

company profi ts

  1. Generally easiest form of organization to

raise capital

  1. Ownership indicated by shares
  2. Required to issue quarterly fi nancial

statements

  1. Owned by one person
  2. Limited life
  3. Usually easiest form of organization

to set up

  1. Required to use IFRS as its accounting

standards

  1. Shares are closely held

Instructions

Indicate if each of the statements listed in the left -hand column of the table above is normally true (T) or false (F) for each

of the following types of business organization: proprietorship, partnership, public corporation, and private corporation.

Th e fi rst one has been done for you as an example.

E1–3 Consider the following business activities.

Type of Activity

  1. Cash receipts from customers paying for daily ski passes O
  2. Payments made to purchase additional snow-making equipment
  3. Payments made to repair the grooming machines
  4. Receipt of funds from the bank to fi nance the purchase of the additional snow-making equipment
  5. Issue of shares to raise funds for a planned expansion
  6. Repayment of a portion of the loan from the bank (see #4)
  7. Payment of interest on the bank loan
  8. Payment of salaries to the employees who operate the ski lift s
  9. Receipt of a grant from the government for training a group of disabled skiers
  10. Payment of dividend to shareholders

Instructions

Classify each of the above items by type of business activity: operating (O), investing (I), or fi nancing (F). Th e fi rst one has

been done for you as an example.

E1–4 Consider the following business activities.

(a) (b)

Type of Activity Cash Eff ect

  1. Purchase of goods for resale O –
  2. Purchase of equipment
  3. Borrowed money from a bank
  4. Purchase of long-term investment
  5. Sale of merchandise to customers
  6. Issue of common shares
  7. Sale of long-term investment
  8. Payment of dividends
  9. Repayment of money owed to bank
  10. Payment of interest on money borrowed from bank

Instructions

(a) For each of the above items, indicate the type of business activity—operating (O), investing (I), or fi nancing (F).

(b) Indicate whether each of the above items would increase (1) or decrease (−) cash. Assume all items are cash transactions.

Th e fi rst one has been done for you as an example.

E1–5 Consider the following typical accounts and statement items.

Classify business

activities.

(SO 3)

Identify business

activity and eff ect

on cash.

(SO 3)

Identify fi nancial

statement.

(SO 4)

Calculate accounting

equation and profi t.

(SO 4)

  1. _______ Cash
  2. _______ Profi t
  3. _______ Service revenue
  4. _______ Common shares
  5. _______ Sales
  6. _______ Dividends
  7. _______ Merchandise inventory
  8. _______ Income tax expense
  9. _______ Accounts receivable
  10. _______ Interest expense
  11. _______ Cash provided by operating activities
  12. _______ Cash used by investing activities
  13. _______ Bank loan payable
  14. _______ Equipment
  15. _______ Retained earnings

Instructions

Indicate on which statement(s)—income statement (IS), statement of fi nancial position (SFP), statement of changes in

equity (SCE), and/or statement of cash fl ows (SCF)—you would fi nd each of the above accounts or items. Note that there

may be more than one correct statement for some of the above.

E1–6 K-Os Corporation reported the following selected information for the two years ended December 31:

2015 2014

Total assets $520,000 $440,000

Total liabilities 350,000 290,000

Instructions

(a) Calculate total shareholders’ equity at December 31, 2014 and 2015.

(b) Calculate the change in total shareholders’ equity for the year ended December 31, 2015.

(c) K-Os’s shareholders’ equity consists only of common shares and retained earnings. Using the change in total shareholders’

equity calculated in (b) above, calculate the profi t or loss for the year ended December 31, 2015, assuming:

  1. K-Os issued no common shares during the year and paid no dividends.
  2. K-Os issued no common shares during the year and paid dividends of $5,000.
  3. K-Os issued $25,000 of additional common shares during the year and paid no dividends.
  4. K-Os issued $10,000 of additional common shares during the year and paid dividends of $5,000.

E1–7 Summaries of selected data from the fi nancial statements of two corporations follow. Both companies have just

completed their fi rst year of operations.

Instructions

Determine the missing amounts for [1] to [12]. Note that you may not be able to solve each item in numerical order.

E1–8 Th e following amounts (in thousands) were taken from the December 31 statements of fi nancial position of Maple

Leaf Foods Inc.:

Instructions

(a) How much is Maple Leaf Foods’ shareholders’ equity at December 31, 2012 and 2011?

(b) Write Maple Leaf Foods’ accounting equation for each year.

(c) Calculate the change in total shareholders’ equity for the year ended December 31, 2012.

(d) Assume that Maple Leaf Foods had the following changes to its shareholders’ equity in 2012: dividends of $22,229

thousand, and other shareholders’ equity items of $(65,181) thousand. How much profi t did it report in 2012?

E1–9 Th e following list of accounts, in alphabetical order, is for Aventura Inc. at November 30, 2015:

Instructions

(a) For each of the above accounts, identify whether it is an asset (A), liability (L), or shareholders’ equity (SE) item.

(b) Prepare a statement of fi nancial position at November 30.

E1–10 Th e following selected accounts and amounts (in millions) were taken from the February 2, 2013, fi nancial statements

of Reitmans (Canada) Limited.

______________ Administrative expenses $ 47.4

______________ Cost of goods sold 372.1

______________ Dividends 52.1

______________ Finance expenses 1.3

______________ Finance income 5.6

______________ Income tax expense 8.5

______________ Selling and distribution expenses 550.2

______________ Sales 1,000.5

Instructions

(a) For each of the above accounts, identify whether it is a revenue (R) or expense (E) account or an account that is not

reported on the income statement (NR).

(b) Prepare an income statement for the year.

E1–11 Th e following information is for Kon Inc. for the year ended December 31, 2015:

Common shares, Jan. 1 $20,000

Common shares issued during year 10,000

Retained earnings, Jan. 1 58,000

Offi ce expense 1,600

Dividends 5,000

Rent expense 12,400

Service revenue 61,000

Utilities expense 2,400

Salaries expense 30,000

Income tax expense 3,000

Instructions

Prepare an income statement and statement of changes in equity for the year.

E1–12 Sea Surf Campground, Inc. is a public camping ground in Ocean National Park. It has the following fi nancial

information as at December 31, 2015:

Camping revenue $168,000

Accounts payable 5,000

Bank loan payable 50,000

Cash 7,500

Equipment 119,000

Income tax expense 10,000

Dividends 12,000

Operating expenses 130,000

Supplies 2,500

Common shares, Jan. 1 30,000

Common shares issued during year 10,000

Retained earnings, Jan. 1 18,000

Instructions

(a) Determine profi t for the year.

(b) Prepare a statement of changes in equity and a statement of fi nancial position for the year.

E1–13 Consider each of the following independent situations:

  1. Th e statement of changes in equity of Yu Corporation shows dividends of $70,000, while profi t for the year was

$75,000.

  1. Th e statement of cash fl ows for Surya Corporation shows that cash provided by operating activities was $10,000; cash

used by investing activities was $100,000; and cash provided by fi nancing activities was $120,000.

  1. Naguib Ltd.’s statement of fi nancial position reports $200,000 of total liabilities and $250,000 of shareholders’ equity.
  2. Rijo Inc. has total assets of $100,000 and no liabilities.

Instructions

For each company, write a brief interpretation of these fi nancial facts. For example, you might discuss the company’s fi nancial

health or what seems to be its growth philosophy.

Problems: Set A

P1–1A Financial decisions made by users oft en depend on one fi nancial statement more than the others. Consider each

of the following independent, hypothetical situations:

  1. Th e South Face Inc. is considering extending credit to a new customer. Th e credit terms would require the customer

to pay within 30 days of receiving goods.

  1. An investor is considering purchasing the common shares of Orbite Online, Inc. Th e investor plans on holding the

investment for at least fi ve years.

  1. Caisse d’Économie Base Montréal is thinking about extending a loan to a small company. Th e company would be

required to make interest payments at the end of each month for three years, and to repay the loan at the end of the

third year.

  1. Th e chief fi nancial offi cer of Tech Toy Limited is trying to determine whether the company is generating enough cash

to increase the amount of dividends paid to shareholders in this, and future, years. He needs to be sure that Tech Toy

will still have enough cash to expand operations when needed.

Instructions

(a) Identify the key user(s) in each situation and determine whether they are internal or external users.

(b) State whether the user(s) you identifi ed in (a) would be most interested in the income statement, statement of fi nancial

position, or statement of cash fl ows to make their decision. Choose only one fi nancial statement in each case, and

briefl y give reasons for your choice.

P1–2A Five independent situations follow:

  1. Th ree computer science professors have formed a business to expand wireless access for computers. Each has contributed

an equal amount of cash and knowledge to the venture. While their plans look promising, they are concerned

about the legal liabilities that their business might confront.

  1. Joseph LeBlanc, a student looking for summer work, has opened a bicycle rental shop in a small shed on the Trans

Canada Trail system.

  1. Robert Steven and Tom Cheng each owned a snowboard manufacturing business and have now decided to combine

their businesses. Th ey expect that in the coming year they will need to raise funds to expand their operations.

  1. Darcy Becker, Ellen Sweet, and Meg Dwyer recently graduated with business degrees, with majors in accounting.

Friends since childhood, they have decided to start an accounting practice.

  1. Hervé Gaudet wants to rent storage lockers in airports across the country. His idea is that customers will be able to

leave their luggage at the airport if they have a long layover so they can explore the local surroundings without being

burdened with luggage. Th is will require the rental of space in each airport as well as the hiring of employees and

other operating costs.

Instructions

(a) In each of the above situations, explain what form of organization the business is likely to take: proprietorship, partnership,

public corporation, or private corporation. Give reasons for your choice.

(b) Indicate which type of accounting standards—IFRS or ASPE—each of the business organizations you identifi ed in (a)

is most likely to use for external reporting purposes.

P1–3A All companies are involved in three types of activities: operating, investing, and fi nancing. Th e names and

descriptions of corporations in several diff erent industries follow:

Indigo Books & Music—book retailer

High Liner Foods—processor and distributor of seafood products

Mountain Equipment Co-op—outdoor equipment retailer

Ganong Bros. —maker of candy

Royal Bank—banking and fi nancial service provider

Instructions

(a) For each of the above corporations, provide a likely example of (1) one of its operating activities, (2) one of its investing

activities, and (3) one of its fi nancing activities.

(b) Which of the activities that you identifi ed in (a) are common to most corporations? Which activities are not?

P1–4A Slipstream Ltd. reports the following list of accounts, in alphabetical order:

________(_a_)________ ________(_b_)________

Accounts payable _________L_________ ________S_F_P________

Accounts receivable __________________ __________________

Bank loan payable __________________ __________________

Cash __________________ __________________

Common shares __________________ __________________

Equipment __________________ __________________

Income tax expense __________________ __________________

Income tax payable __________________ __________________

Interest expense __________________ __________________

Offi ce expense __________________ __________________

Prepaid insurance __________________ __________________

Rent expense __________________ __________________

Repair and maintenance expense __________________ __________________

Salaries payable __________________ __________________

Service revenue __________________ __________________

Vehicles __________________ __________________

Instructions

(a) Classify each account as an asset (A), liability (L), share capital (SC), revenue (R), or expense (E) item. Th e fi rst one

has been done for you as an example.

(b) Identify on which fi nancial statement(s)—income statement (IS), statement of changes in equity (SCE), and/or statement

of fi nancial position (SFP)—each account would be reported. Note that there may be more than one correct

statement for some of the above. Th e fi rst one has been done for you as an example.

P1–5A Craft Carpentry Limited reports the following statement of fi nancial position accounts, in alphabetical order:

Accounts payable $ 6,400

Accounts receivable 10,800

Bank loan payable 9,000

Cash 1,250

Common shares 1,000

Equipment 19,400

Income tax payable 2,000

Interest payable 100

Prepaid insurance 600

Retained earnings 12,250

Salaries payable 1,000

Supplies 1,200

Unearned revenue 1,500

Instructions

(a) Classify each account as an asset (A), liability (L), or shareholders’ equity (SE) item.

(b) Calculate total assets, total liabilities, and total shareholders’ equity and prepare Craft Carpentry’s accounting

equation.

(c) Craft Carpentry’s retained earnings was $2,250 at the beginning of the year. Th e company reported revenues of $72,000,

expenses of $50,000, and dividends of $12,000 during the year. Prepare a calculation that proves how retained earnings

of $12,250 at the end of the year were determined.

P1–6A Selected information (in millions) is available for Sears Canada Inc. and Canadian Tire Corporation, Limited

for a recent fi scal year:

Sears Canadian Tire

Beginning of year

Total assets $ [1] $12,338.8

Total liabilities 1,638.7 [4]

Total shareholders’ equity 1,092.0 4,409.0

End of year

Total assets 2,479.1 [5]

Total liabilities [2] 8,417.8

Total shareholders’ equity 1,076.4 [6]

Changes during year in shareholders’ equity – –

Repurchase of shares 0.1 225.0

Dividends 101.9 97.7

Total revenues 4,511.1 11,451.0

Total expenses [3] 10,951.8

Other decreases in shareholders’ equity 14.8 10.9

Instructions

(a) Determine the missing amounts for [1] to [6].

(b) Which company has a higher proportion of debt fi nancing at the end of its fi scal year? Of equity fi nancing?

(c) Sears’s year end is the last Saturday in January. Canadian Tire’s year end is the last Saturday in December. How might

these diff ering year-end dates aff ect your comparison in (b)?

P1–7A On June 1, 2015, One Planet Cosmetics Corp. was formed. Its assets, liabilities, share capital, revenues, expenses,

and dividends as at June 30 follow:

Cash $ 6,000

Accounts receivable 4,000

Supplies 1,400

Equipment 32,000

Accounts payable 2,300

Bank loan payable 14,000

Common shares 25,000

Dividends 1,000

Service revenue $12,000

Supplies expense 1,200

Interest expense 800

Offi ce expense 1,500

Utilities expense 1,300

Income tax expense 700

Salaries expense 3,400

Instructions

(a) Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the month.

(b) Explain why it is necessary to prepare the fi nancial statements in the order listed in (a).

P1–8A Selected fi nancial information follows for Maison Corporation for the year ended December 31, 2015:

Cash, Jan. 1 $ 12,000

Cash dividends paid 10,000

Cash paid to purchase equipment 35,000

Cash payments for operating activities 120,000

Cash receipts from operating activities 140,000

Cash received from issue of long-term debt 20,000

Cash received from issue of shares 20,000

Instructions

(a) Classify each of the above items, except for cash at the beginning of the year, as an operating, investing, or fi nancing

activity.

(b) Prepare a statement of cash fl ows for Maison Corporation for the year.

(c) Comment on the adequacy of cash provided by operating activities to fund the company’s investing activities.

P1–9A Incomplete fi nancial statements for Baxter, Inc. follow.

BAXTER, INC.

Income Statement

Year Ended November 30, 2015

Revenues $90,000

Operating expenses [1]

Profi t before income tax 30,000

Income tax expense 6,000

Profi t $ [2]

Instructions

(a) Calculate the missing amounts for [1] to [13]. Note that you may not be able to solve each item in numerical order.

(b) Explain (1) the sequence for preparing the fi nancial statements, and (2) the interrelationships between the income

statement, statement of changes in equity, and statement of fi nancial position.

P1–10A GG Corporation, a private corporation, was formed on July 1, 2015. On July 31, Guy Gélinas, the company’s

president, prepared the following statement of fi nancial position:

GG CORPORATION

Statement of Financial Position

July 31, 2015

Assets Liabilities and Shareholders’ Equity

Cash $ 20,000 Accounts payable $ 34,000

Accounts receivable 50,000 Boat loan payable 40,000

Merchandise inventory 36,000 Common shares 50,000

Boat 24,000 Retained earnings 6,000

$130,000 $130,000

Guy admits that his knowledge of accounting is somewhat limited and is concerned that his statement of fi nancial position

might not be correct. He gives you the following additional information:

  1. Th e boat actually belongs to Guy Gélinas, not to GG Corporation. However, because Guy thinks he might take customers

out on the boat occasionally, he decided to list it as an asset of the company. To be consistent, he also included

as a liability of the company the personal bank loan that he took out to buy the boat.

  1. Included in the accounts receivable balance is $10,000 that Guy personally loaned to his brother fi ve years ago. Guy

included this in the receivables of GG Corporation so that he wouldn’t forget that his brother owes him money.

  1. Guy’s statements didn’t balance. To make them balance, he adjusted the Common Shares account until assets equalled

liabilities and shareholders’ equity.

Instructions

(a) Identify any corrections that should be made to the statement of fi nancial position and explain why.

(b) Prepare a corrected statement of fi nancial position. (Hint: To get the balance sheet to balance, adjust Common Shares).

(c) What other fi nancial statements should GG Corporation prepare, assuming it follows Accounting Standards for

Private Enterprises?

Problems: Set B

P1–1B Financial decisions made by users oft en depend on one fi nancial statement more than the others. Consider each

of the following independent, hypothetical situations:

  1. An Ontario investor is considering purchasing the common shares of Fight Fat Ltd., which operates 13 fi tness centres

in the Toronto area. Th e investor plans on holding the investment for at least three years.

  1. Comeau Ltée is considering extending credit to a new customer. Th e terms of the credit would require the customer

to pay within 45 days of receipt of the goods.

  1. Th e chief fi nancial offi cer of Private Label Corporation is trying to determine whether the company is generating

enough cash to increase the amount of dividends paid to shareholders in this, and future, years. She needs to ensure

that there will still be enough cash to expand operations when needed.

  1. Drummond Bank is considering extending a loan to a small company. Th e company would be required to make interest

payments at the end of each month for fi ve years, and to repay the loan at the end of the fi ft h year.

Instructions

(a) Identify the key user(s) in each situation and determine whether they are internal or external users.

(b) State whether the user(s) you identifi ed in (a) would be most interested in the income statement, statement of fi nancial

position, or statement of cash fl ows. Choose only one fi nancial statement in each case, and briefl y give reasons for your

choice.

P1–2B Five independent situations follow:

  1. Dawn Addington, a student looking for summer work, has opened a vegetable stand along a busy local highway.

Each morning, she buys produce from local farmers, then sells it in the aft ernoon as people return home from

work.

  1. Joseph Counsell and Sabra Surkis each own a bike shop. Th ey have decided to combine their businesses and try to

expand their operations to include skis and snowboards. Th ey expect that in the coming year they will need funds to

expand their operations.

  1. Th ree chemistry professors have formed a business that uses bacteria to clean up toxic waste sites. Each has contributed

an equal amount of cash and knowledge to the venture. Th e use of bacteria in this situation is experimental, and

legal obligations could result.

  1. Abdul Rahim has run a successful but small cooperative health and organic food store for over fi ve years. Th e increased

sales at his store have made him believe that the time is right to open a chain of health and organic food stores

across the country. Of course, this will require a substantial investment for inventory and property, plant, and equipment,

as well as for employees and other resources. Abdul has no savings or personal assets.

  1. Mary Emery, Richard Goedde, and Jigme Tshering recently graduated with law degrees. Th ey have decided to start a

law practice in their hometown.

Instructions

(a) In each of the above situations, explain what form of organization the business is likely to take: proprietorship, partnership,

public corporation, or private corporation. Give reasons for your choice.

(b) Indicate which type of accounting standards—IFRS or ASPE—that each of the business organizations you identifi ed

in (a) is most likely to use for external reporting purposes.

P1–3B All companies are involved in three types of activities: operating, investing, and fi nancing. Th e names and

descriptions of corporations in several diff erent industries follow:

WestJet Airlines—airline

University of Calgary Students’ Union—university student union

GlaxoSmithKline— pharmaceutical manufacturer

Maple Leaf Sports & Entertainment—professional sports company (including ownership of the Toronto Maple

Leafs hockey team and Raptors basketball team)

Empire Company—food retailer and real estate investments (including ownership of Sobeys)

Instructions

(a) For each of the above corporations, provide a likely example of (1) one of its operating activities, (2) one of its investing

activities, and (3) one of its fi nancing activities.

(b) Which of the activities that you identifi ed in (a) are common to most corporations? Which activities are not?

P1–4B Gulfstream Inc. reports the following list of accounts, in alphabetical order:

________(_a_)________ ________(_b_)________

Accounts payable _________L_________ ________S_F_P________

Accounts receivable __________________ __________________

Bank loan payable __________________ __________________

Buildings __________________ __________________

Cash __________________ __________________

Common shares __________________ __________________

Cost of goods sold __________________ __________________

Equipment __________________ __________________

Income tax expense __________________ __________________

Income tax payable __________________ __________________

Interest expense __________________ __________________

Land __________________ __________________

Merchandise inventory __________________ __________________

Mortgage payable __________________ __________________

Offi ce expense __________________ __________________

Prepaid insurance __________________ __________________

Salaries payable __________________ __________________

Sales __________________ __________________

Instructions

(a) Classify each account as an asset (A), liability (L), share capital (SC), revenue (R), or expense (E) item. Th e fi rst one

has been done for you as an example.

(b) Identify on which fi nancial statement(s)—income statement (IS), statement of changes in equity (SCE), and/or statement

of fi nancial position (SFP)—each account would be reported. Note that there may be more than one correct

statement for some of the above. Th e fi rst one has been done for you as an example.

P1–5B D&K Delivery Limited reports the following statement of fi nancial position accounts, in alphabetical order:

Accounts payable $10,800

Accounts receivable 16,400

Bank loan payable 40,000

Cash 11,250

Common shares 5,000

Income tax payable 2,000

Interest payable 400

Prepaid insurance 700

Retained earnings 42,250

Salaries payable 2,050

Supplies 1,250

Unearned revenue 2,500

Vehicles 75,400

Instructions

(a) Classify each account as an asset (A), liability (L), or shareholders’ equity (SE) item.

(b) Calculate total assets, total liabilities, and total shareholders’ equity and prepare D&K Delivery’s accounting equation.

(c) D&K Delivery’s retained earnings were $22,250 at the beginning of the year. Th e company reported revenues of

$172,000, expenses of $140,000, and dividends of $12,000 during the year. Prepare a calculation that proves how

retained earnings of $42,250 at the end of the year were determined.

P1–6B Selected information is available for Tim Hortons Inc. and Starbucks Corporation for a recent fi scal year:

Tim Hortons

(in CAD millions)

Starbucks

(in USD millions)

Beginning of year

Total assets $2,204.0 $ [4]

Total liabilities [1] 2,973.1

Total shareholders’ equity 1,154.4 4,

End of year

Total assets 2,284.2 [5]

Total liabilities 1,094.1 3,104.7

Total shareholders’ equity [2] [6]

Changes during year in shareholders’ equity –

Repurchase of shares 18.7 1.1

Dividends [3] 543.7

Total revenues 3,123.8 13,604.6

Total expenses 2,716.0 12,219.9

Other decreases in shareholders’ equity 222.9 112.7

Instructions

(a) Determine the missing amounts for [1] to [6].

(b) Which company has the higher proportion of debt fi nancing at the end of its fi scal year? Of equity fi nancing?

(c) Tim Hortons’ year end is the Sunday nearest to the end of December. Starbucks’ year end is the last Sunday in

September. In addition, Tim Hortons reports its fi nancial results in Canadian dollars and Starbucks reports in U.S.

dollars. Is it appropriate to compare these two companies in (b)?

P1–7B On May 1, 2015, Aero Flying School Ltd. was formed. Its assets, liabilities, share capital, revenues, expenses, and

dividends as at May 31 follow:

Cash $ 5,300

Accounts receivable 10,200

Equipment 60,300

Accounts payable 2,200

Bank loan payable 22,000

Service revenue 12,600

Interest expense 100

Common shares 50,000

Rent expense $2,200

Repair and maintenance expense 700

Fuel expense 3,300

Offi ce expense 2,300

Salaries expense 1,000

Income tax expense 600

Dividends 800

Instructions

(a) Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the month of May.

(b) Explain why it is necessary to prepare the fi nancial statements in the order listed in (a).

P1–8B Selected fi nancial information follows for Furlotte Corporation for the year ended June 30, 2015:

Cash, July 1 $ 40,000

Cash payments for operating activities 109,000

Cash paid for equipment 40,000

Repayment of long-term debt 15,000

Cash dividends paid 13,000

Cash receipts from operating activities 158,000

Instructions

(a) Classify each of the above items, except for cash at the beginning of the year, as an operating, investing, or fi nancing

activity.

(b) Prepare a statement of cash fl ows for Furlotte Corporation for the year.

(c) Comment on the adequacy of cash provided by operating activities to fund the company’s investing activities.

P1–9B Incomplete fi nancial statements for Wu, Inc. follow:

WU, INC.

Income Statement

Year Ended August 31, 2015

Service revenue $85,000

Operating expenses [1]

Profi t before income tax 35,000

Income tax expense 9,000

Profi t $ [2]

Instructions

(a) Calculate the missing amounts [1] to [13]. Note that you may not be able to solve each item in numerical order.

(b) Explain (1) the sequence for preparing and presenting the fi nancial statements, and (2) the interrelationships between

the income statement, statement of changes in equity, and statement of fi nancial position.

P1–10B Th e Independent Book Shop Ltd. was formed on April 1, 2014. It is a small private corporation, run by Joanna

Kay. On March 31, 2015, Joanna prepared the following income statement:

INDEPENDENT BOOK SHOP LTD.

Income Statement

Year Ended March 31, 2015

Revenues

Accounts receivable $23,000

Service revenue 41,000

Total revenues $64,000

Expenses

Rent expense $12,000

Offi ce expense 5,000

Vacation expense 4,000

Total expenses 21,000

Profi t before income tax 85,000

Income tax expense 5,000

Profi t $90,000

Joanna admits that her knowledge of accounting is somewhat limited and is concerned that her income statement might

not be correct. She gives you the following additional information:

  1. Included in the Service Revenue account is $3,000 of revenue that the company expects to earn in April 2015. Joanna

included it in this year’s statement so she wouldn’t forget about it.

  1. Joanna operates her business in a converted carriage house attached to her parents’ downtown home. Th ey do not

charge her anything for the use of this building, but she thinks that if she paid rent it would have cost her about

$12,000 a year. She included this amount in the income statement as Rent Expense because of the “opportunity

cost.”

  1. To reward herself aft er a year of hard work, Joanna took a vacation to Greece. She used personal funds to pay for the

trip, but she reported it as an expense on the income statement since it was her job that made her need the vacation.

Instructions

(a) Identify any corrections that should be made to the income statement and explain why.

(b) Prepare a corrected income statement.

(c) What other fi nancial statements should the Independent Book Shop prepare, assuming it follows Accounting Standards

for Private Enterprises?

 

 

CHAPTER 2 A Further Look at Financial Statements

 

Questions

  1. What are current assets? Give four examples of

current assets a company might have.

(SO 1) 2. What is meant by the term operating cycle?

(SO 1) 3. (a) Distinguish between current assets and noncurrent

assets. (b) Distinguish between current

assets and current liabilities. Why does showing

these items as current in nature matter?

(SO 1) 4. (a) What are current liabilities? (b) Give four

examples of current liabilities a company might

have.

(SO 1) 5. (a) Distinguish between current liabilities and

non-current liabilities. (b) Explain how a bank

loan can sometimes be classifi ed as both a current

liability and a non-current liability.

(SO 1) 6. Identify the two components of shareholders’

equity normally found in a corporation and

indicate the purpose of each.

(SO 1) 7. Explain what it means to present a statement of

fi nancial position in order of liquidity, as is done

by many North American companies, compared

with presenting it in an order of reverse liquidity,

as is done by many international companies.

(SO 2) 8. Explain what each of the following classes of

ratios measures and give an example of each:

(a) liquidity ratios, (b) solvency ratios, and

(c) profi tability ratios.

(SO 2) 9. Why is the current ratio a better measure of

liquidity than working capital?

(SO 2) 10. “Th e current ratio should not be used as the only

measure of liquidity, because it does not take into

account the composition of the current assets.”

Explain what this statement means.

(SO 2) 11. Dong Corporation has a debt to total assets ratio

of 45%, while its competitor, Du Ltd., has a debt

to total assets ratio of 55%. Based on this information,

which company is more solvent? Why?

(SO 2) 12. Jonathan Baird, the founder of Waterboots Inc.,

needs to raise $500,000 to expand his company’s

operations. He has been told that raising the

money through debt by obtaining a bank loan

will increase the riskiness of his company much

more than by raising the money by issuing

common shares. He doesn’t understand why this

is true. Explain it to him.

(SO 2) 13. Why can you compare the price-earnings ratio

among diff erent companies but not earnings per

share?

(SO 2) 14. Th e TD Bank has a price-earnings ratio of

12 times, while CIBC has a price-earnings ratio

of 10 times. Which company do investors appear

to favour?

(SO 2) 15. Explain why increases in earnings per share,

price-earnings, and current ratios are considered

to be signs of improvement in a company’s

fi nancial health, but an increase in the debt to

total assets ratio is considered to be a sign of

deterioration.

(SO 3) 16. (a) Describe the conceptual framework and

explain how it helps fi nancial reporting.

(b) Is the conceptual framework applicable

to publicly traded companies reporting using

IFRS, to private companies using ASPE, or to

both?

(SO 3) 17. (a) What is the objective of fi nancial reporting?

(b) Who are the main users that rely on this

objective?

(SO 3) 18. Explain how the going concern assumption supports

the classifi cation of assets and liabilities as

current and non-current.

(SO 3) 19. Identify and explain the two fundamental

qualitative characteristics of useful fi nancial

information.

(SO 3) 20. How is materiality related to the fundamental

qualitative characteristic of relevance?

(SO 3) 21. Identify and explain the four enhancing

qualitative characteristics of useful fi nancial

information. Is there a prescribed order for

applying these enhancing characteristics?

(SO 3) 22. Explain how the cost constraint relates to the

quality of completeness.

(SO 3) 23. What are the elements of fi nancial statements?

(SO 3) 24. Identify and explain the two bases used to measure

the elements of fi nancial statements.

(SO 3) 25. Explain how the qualitative characteristics of

relevance and faithful representation relate to the

cost and fair value bases of accounting.

Brief Exercises

BE2–1 Th e following are the major statement of fi nancial position classifi cations:

  1. Current assets 5. Current liabilities
  2. Long-term investments 6. Non-current liabilities
  3. Property, plant, and equipment 7. Share capital
  4. Intangible assets 8. Retained earnings

Classify each of the following selected accounts by writing in the number of its appropriate classifi cation above:

(a) ______ Accounts payable (j) ______ Land

(b) ______ Accounts receivable (k) ______ Merchandise inventory

(c) ______ Accumulated depreciation (l) ______ Common shares

(d) ______ Buildings (m) ______ Supplies

(e) ______ Cash (n) ______ Mortgage payable, due in 20 years

(f) ______ Patents (o) ______ Current portion of mortgage payable

(g) ______ Dividends (p) ______ Prepaid insurance

(h) ______ Income tax payable (q) ______ Unearned revenue

(i) ______ Long-term investments

BE2–2 A list of current assets for Swann Limited includes the following: accounts receivable $14,500; cash $16,400;

merchandise inventory $9,000; supplies $4,200; and prepaid insurance $3,900. Prepare the current assets section of the

statement of fi nancial position.

BE2–3 A list of fi nancial statement items for Shum Corporation includes the following: accumulated depreciation—

buildings $33,000; accumulated depreciation—equipment $25,000; buildings $110,000; equipment $70,000; and land

$65,000. Prepare the property, plant, and equipment section of the statement of fi nancial position.

BE2–4 Hirjikaka Inc. reports the following current and non-current liabilities: accounts payable $22,500; salaries payable

$3,900; interest payable $5,200; unearned revenue $900; income tax payable $6,400; mortgage payable (due within the

year) $5,000; mortgage payable (due in more than one year) $50,000. Prepare the current liabilities section of the statement

of fi nancial position.

BE2–5 Indigo Books & Music Inc. reported the following selected information for the years ended March 31, 2012, and

April 2, 2011 (in thousands):

2012 2011

Total current assets $453,629 $336,980

Total current liabilities 229,503 235,365

(a) Calculate the working capital and current ratio for each year.

(b) Was Indigo’s liquidity stronger or weaker in 2012 compared with 2011?

BE2–6 Convenience store operator Alimentation Couche-Tard Inc. reported the following selected information for the

years ended April 29, 2012, and April 24, 2011 (in U.S. $ millions):

2012 2011

Current assets $1,337.4 $1,242.2

Non-current assets 3,115.8 2,684.0

Current liabilities 1,566.8 977.4

Non-current liabilities 711.8 969.4

(a) Calculate the debt to total assets ratio for each year.

(b) Was the company’s solvency stronger or weaker in 2012 compared with 2011?

BE2–7 Th e following information is available for Leon’s Furniture Limited for the years ended December 31 (in thousands,

except for share price):

2012 2011

Profi t available to common shareholders $46,782 $56,666

Weighted average number of common shares 70,033 69,969

Share price $12.99 $12.40

(a) Calculate the earnings per share and the price-earnings ratio for each year.

(b) Indicate whether profi tability improved or deteriorated in 2012.

BE2–8 Presented below is a chart showing selected portions of the conceptual framework. Fill in the blanks from (a)

to (f).

this chapter:

  1. Comparability 8. Neutrality
  2. Completeness 9. Predictive value
  3. Confi rmatory value 10. Relevance
  4. Cost constraint 11. Timeliness
  5. Faithful representation 12. Understandability
  6. Freedom from error or bias 13. Verifi ability
  7. Materiality

Match each characteristic to one of the statements below:

(a) ________ Information that has predictive value, confi rmatory value, and is material is said to have this fundamental

qualitative characteristic.

(b) ________ Information that is complete, neutral, and reasonably free of error is said to have this fundamental qualitative

characteristic.

(c) ________ Th is enhancing qualitative characteristic requires that similar companies should apply the same accounting

principles to similar events for successive accounting periods.

(d) ________ Th is quality results in information that has nothing important omitted.

(e) ________ Th is constraint requires that the value of the information presented should be greater than the cost of providing

it.

(f) ________ Public accountants perform audits to determine this enhancing qualitative characteristic.

(g) ________ Th is quality requires that information cannot be selected to favour one position over another.

(h) ________ Th is enhancing qualitative characteristic describes information that a reasonably informed user can interpret

and comprehend.

(i) ________ When information provides a basis for forecasting profi ts for future periods, it is said to have this quality.

(j) ________ Th is quality describes information that confi rms or corrects users’ prior expectations.

(k) ________ Th is enhancing qualitative characteristic requires that information be available to decision makers before it

loses its ability to infl uence their decisions.

(l) ________ Faithful representation means that information is complete, neutral, and this third quality.

(m) ________ Th is quality allows items of insignifi cance that would not likely infl uence a decision not to be disclosed.

BE2–10 For each of the situations discussed below, choose a basis of measurement to use and explain why.

(a) Sosa Ltd. is a real estate company that purchases and holds land for eventual sale to developers.

(b) Mohawk Inc. is a manufacturing company that purchased land on which it plans to construct a new plant next year. It

expects the value of the land to rise rapidly over the next few years.

 

Exercises

E2–1 Th e following are the major statement of fi nancial position classifi cations:

  1. Current assets 5. Current liabilities
  2. Long-term investments 6. Non-current liabilities
  3. Property, plant, and equipment 7. Shareholders’ equity
  4. Intangible assets

Instructions

Classify each of the following selected accounts taken from TELUS Corporation’s statement of fi nancial position by writing

in the number of the appropriate classifi cation above:

(a) ________ Accounts payable and accrued liabilities

(b) ________ Accounts receivable

(c) ________ Accumulated depreciation

(d) ________ Buildings and leasehold improvements

(e) ________ Common shares

(f) ________ Current maturities of long-term debt

(g) ________ Dividends payable

(h) ________ Goodwill

(i) ________ Income and other taxes payable

(j) ________ Income and other taxes receivable

(k) ________ Inventories

(l) ________ Land

(m) ________ Long-term debt

(n) ________ Prepaid expenses

E2–2 Th e assets (in thousands) that follow were taken from the December 31, 2012, balance sheet for Big Rock Brewery

Inc.:

Accounts receivable $ 2,358 Intangible assets $ 128

Accumulated depreciation—buildings 827 Inventories 3,892

Accumulated depreciation—machinery and equipment 6,480 Land 2,516

Accumulated depreciation—mobile equipment 149 Machinery and equipment 20,800

Accumulated depreciation—offi ce furniture 140 Mobile equipment 645

Buildings 11,070 Offi ce furniture 310

Cash 4,281 Prepaid expenses and other 364

Instructions

Prepare the assets section of the statement of fi nancial position.

E2–3 Th e liabilities and shareholders’ equity items (in thousands) that follow were taken from the March 31, 2012,

balance sheet for Saputo Inc.:

Accounts payable and accrued liabilities $ 571,814

Bank loans payable (current) 166,631

Common shares 629,606

Deferred income taxes payable (non-current) 156,632

Income taxes payable 163,996

Long-term debt 379,875

Other long-term liabilities 54,486

Retained earnings 1,467,108

Instructions

Prepare the liabilities and shareholders’ equity sections of the statement of fi nancial position.

E2–4 Th ese items are taken from the fi nancial statements of Summit Ltd. at December 31, 2015:

Accounts payable $ 14,050 Interest expense $ 4,750

Accounts receivable 13,780 Interest payable 1,600

Accumulated depreciation—buildings 45,600 Land 54,000

Accumulated depreciation—equipment 17,770 Long-term investments 30,000

Service revenue 73,040 Mortgage payable 95,000

Buildings 128,800 Operating expenses 48,680

Cash 15,040 Prepaid insurance 390

Common shares 50,000 Retained earnings, Jan. 1 66,520

Equipment 62,400 Supplies 740

Income tax expense 5,000

Instructions

(a) Calculate profi t and the ending balance of retained earnings at December 31, 2015. It is not necessary to prepare a

formal income statement or statement of changes in equity.

(b) Prepare a statement of fi nancial position. Assume that $13,600 of the mortgage payable will be paid in 2016.

E2–5 Th ese fi nancial statement items are for Batra Corporation at year end, July 31, 2015:

Salaries expense $44,700 Supplies expense $ 900

Utilities expense 2,600 Dividends 12,000

Equipment 35,900 Depreciation expense 3,000

Accounts payable 4,220 Retained earnings, Aug. 1, 2014 17,940

Service revenue 81,100 Rent expense 10,800

Rent revenue 18,500 Income tax expense 5,000

Common shares 10,000 Supplies 1,500

Cash 5,060 Trading investments 20,000

Accounts receivable 17,100 Bank loan payable (due Dec. 31, 2015) 21,800

Accumulated depreciation—equipment 6,000 Interest expense 2,000

Interest payable 1,000

Additional information:

Batra started the year with $6,000 of common shares and issued additional shares for $4,000 during the year.

Instructions

Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the year.

E2–6 Th e chief fi nancial offi cer (CFO) of Padilla Corporation requested that the accounting department prepare a preliminary

statement of fi nancial position on December 20, 2015. He knows that certain debt agreements with its lenders

require the company to maintain a current ratio of at least 2:1 and wants to know how the company is doing. Th e preliminary

statement of fi nancial position follows:

Prepare fi nancial

statements.

(SO 1)

Calculate ratios and

evaluate liquidity.

(SO 2)

PADILLA CORPORATION

Statement of Financial Position

December 20, 2015

Assets Liabilities

Current assets Current liabilities

Cash $ 25,000 Accounts payable $20,000

Accounts receivable 30,000 Salaries payable 20,000 $ 40,000

Prepaid insurance 5,000 Non-current liabilities

Total current assets 60,000 Bank loan payable 80,000

Equipment 200,000 Total liabilities 120,000

Total assets $260,000 Shareholders’ equity

Common shares $90,000

Retained earnings 50,000 140,000

Total liabilities and shareholders’ equity $260,000

Instructions

(a) Calculate the current ratio based on the data in the preliminary statement of fi nancial position.

(b) Based on the results in part (a), the CFO requested that $20,000 of the cash be used to pay off the balance of the

accounts payable account on December 21. Calculate the current ratio aft er this payment is made, assuming there are

no further changes to current assets and current liabilities.

(c) Is it ethical for the CFO to recommend this action?

E2–7 Huntingdon Capital Corp. is a competitor of Plazacorp and First Capital Realty. Huntingdon reported the following

selected information (in millions):

2012 2011

Current assets $103.5 $ 77.3

Non-current assets 217.8 422.5

Current liabilities 30.8 78.0

Non-current liabilities 114.8 218.2

Instructions

(a) Calculate the working capital, current ratio, and debt to total assets ratio for each year.

(b) Did Huntingdon’s liquidity and solvency improve or worsen during 2012?

(c) Using the data in the chapter, compare Huntingdon’s liquidity and solvency with that of Plazacorp, First Capital Realty,

and the industry for 2012 and 2011.

E2–8 Th e following information is available for Cameco Corporation for the year ended December 31 (in thousands,

except share price):

2012 2011

Profi t available for common shareholders $264,583 $449,844

Weighted average number of common shares 395,234 394,662

Share price $19.59 $18.41

Instructions

(a) Calculate the earnings per share and price-earnings ratio for each year.

(b) Based on your calculations above, how did the company’s profi tability change from 2012 to 2011?

E2–9 Here are some fundamental and enhancing qualitative characteristics of useful fi nancial information:

  1. Comparability 7. Neutrality
  2. Completeness 8. Predictive value
  3. Confi rmatory value 9. Relevance
  4. Faithful representation 10. Timeliness
  5. Freedom from error or bias 11. Understandability
  6. Materiality 12. Verifi ability

Instructions

Match each characteristic to one of the following statements, using the numbers 1 to 12.

(a) _______ Accounting information cannot be selected, prepared, or presented to favour one set of interested users over

another.

(b) _______ Accounting information must be available to decision makers before it loses its ability to infl uence their

decisions.

(c) _______ Accounting information is prepared on the assumption that users have a reasonable understanding of accounting

and general business and economic conditions.

(d) _______ Accounting information provides a basis to evaluate a previously made decision.

(e) _______ Accounting information includes everything it needs to and nothing important is omitted. Th is is an important

component of faithful representation.

(f) _______ Accounting information helps users make predictions about the outcome of past, present, and future events.

(g) _______ Accounting information about one company can be evaluated against the accounting information from

another company.

(h) _______ Accounting information is included if its omission or misstatement could infl uence the economic decisions

of users. Th is is an important component of relevance.

(i) _______ All the accounting information that is necessary to faithfully represent economic reality is included.

(j) _______ Accounting information can be determined to be free of material error.

(k) _______ Accounting information is included if it will make a diff erence in users’ decisions.

(l) _______ Accounting information about a company can be confi rmed by two or more users to be a faithful representation.

E2–10 Marietta Corp. had the following reporting issues during the year:

  1. Land with a cost of $208,000 that is intended to be used by the company as a building site was reported at its fair value

of $260,000.

  1. A surplus parcel of land with a cost of $150,000 intended for resale in the near future is reported at its fair value of

$160,000.

  1. Th e president of Marietta, Deanna Durnford, decided it wasn’t necessary to classify assets and liabilities as current and

non-current as she expects to operate the company only for another 10 years.

Instructions

For each of the above situations, identify (a) the assumption or principle involved, and (b) whether it is being followed

correctly or has been violated.

 

Problems: Set A

P2–1A You are provided with the following selected balance sheet accounts for entertainment retailer HMV Group plc:

Accumulated depreciation

Cash

Common (ordinary) shares

Current income tax payable

Current income tax recoverable

Interest-bearing loans and borrowings (current)

Interest-bearing loans and borrowings (non-current)

Inventories

Investments

Plant, equipment, and vehicles

Trade and other payables

Trade and other receivables

Trademarks

Instructions

Identify the balance sheet (statement of fi nancial position) category for classifying each account. For example, accumulated

depreciation should be classifi ed as a contra asset in the property, plant, and equipment section of HMV’s balance

sheet.

P2–2A Th e following items are from the assets section of WestJet Airlines Ltd.’s December 31, 2012, statement of

fi nancial position (in thousands):

Accounts receivable $ 37,576

Accumulated depreciation—aircraft 1,127,889

Accumulated depreciation—buildings 20,025

Accumulated depreciation—ground property and equipment 79,052

Accumulated depreciation—leasehold improvements 5,536

Accumulated depreciation—spare engines and parts 44,713

Aircraft 2,605,277

Buildings 135,924

Cash 1,459,822

Ground property and equipment 136,167

Inventory 35,595

Intangible assets 50,808

Leasehold improvements 16,538

Other assets 297,899

Prepaid expenses, deposits, and other 101,802

Spare engines and parts 146,422

Instructions

(a) Identify the statement of fi nancial position category in which each of the above items should be classifi ed.

(b) Prepare the assets section of the statement of fi nancial position.

P2–3A Th e following items are from the liability and shareholders’ equity sections of WestJet Airlines Ltd.’s December

31, 2012, statement of fi nancial position (in thousands):

Accounts payable and accrued liabilities $460,003

Advance ticket sales 480,947

Current portion of long-term debt 199,044

Deferred income tax (long-term) 356,748

Long-term debt 574,139

Other current liabilities 47,859

Other long-term liabilities 155,570

Other shareholders’ equity items 64,110

Retained earnings 793,296

Share capital 614,899

Instructions

(a) Identify the statement of fi nancial position category in which each of the above items should be classifi ed.

(b) Prepare the liabilities and equity sections of the statement of fi nancial position.

(c) If you completed P2–2A, compare the total assets in P2–2A with the total liabilities and shareholders’ equity in P2–3A.

Do these two amounts agree?

P2–4A Th ese items are taken from the fi nancial statements of Mbong Corporation for the year ended December 31, 2015:

Retained earnings, Jan. 1 $105,000 Depreciation expense $ 6,200

Utilities expense 2,000 Accounts receivable 14,200

Equipment 66,000 Insurance expense 2,200

Accounts payable 8,300 Salaries expense 37,000

Buildings 72,000 Accumulated depreciation—equipment 17,600

Cash 5,200 Income tax expense 6,000

Salaries payable 3,000 Supplies 200

Common shares 34,200 Supplies expense 1,000

Dividends 5,000 Bank loan payable, due 2018 15,000

Service revenue 81,700 Trading investments 20,000

Prepaid insurance 2,000 Accumulated depreciation—buildings 18,000

Repair and maintenance expense 2,800 Interest expense 1,500

Land 40,000 Interest revenue 500

Additional information:

  1. Mbong started the year with $30,000 of common shares and issued $4,200 more during the year.
  2. $1,500 of the bank loan payable is due to be repaid within the next year.

Instructions

(a) Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the year.

(b) Explain how each fi nancial statement is related to the others.

P2–5A Th e fi nancial statements of Johanssen Inc. are presented here:

Prepare fi nancial

statements; discuss

relationships.

(SO 1)

Calculate ratios and

comment on liquidity,

solvency, and

profi tability.

(SO 2)

JOHANSSEN INC.

Income Statement

Year Ended December 31, 2015

Sales $2,218,500

Expenses

Cost of goods sold $1,012,500

Operating expenses 906,000

Interest expense 98,000 2,016,500

Profi t before income tax 202,000

Income tax expense 42,000

Profi t $ 160,000

JOHANNSSEN INC.

Statement of Financial Position

December 31, 2015

Assets

Current assets

Cash $ 60,100

Trading investments 54,000

Accounts receivable 207,800

Merchandise inventory 125,000 $ 446,900

Property, plant, and equipment 625,300

Total assets $1,072,200

Liabilities and Shareholders’ Equity

Current liabilities

Accounts payable $100,000

Income tax payable 15,000

Current portion of mortgage payable 27,500 $ 142,500

Mortgage payable 310,000

Total liabilities 452,500

Shareholders’ equity

Common shares $307,630

Retained earnings 312,070 619,700

Total liabilities and shareholders’ equity $1,072,200

Additional information:

  1. Profi t available to common shareholders was $160,000.
  2. Th e weighted average number of common shares was 40,000.
  3. Th e share price at December 31 was $35.

Instructions

(a) Calculate the following values and ratios for 2015. We provide the results for 2014 for comparative purposes.

  1. Working capital (2014: $260,500)
  2. Current ratio (2014: 1.6:1)
  3. Debt to total assets (2014: 31.5%)
  4. Earnings per share (2014: $3.15)
  5. Price-earnings ratio (2014: 7.5 times)

(b) Using the information in part (a), discuss the changes in liquidity, solvency, and profi tability between 2015 and 2014.

P2–6A Selected fi nancial statement data for a recent year for Chen Corporation and Caissie Corporation, two competitors,

are as follows:

Chen Caissie

Sales revenue $1,800,000 $620,000

Cost of goods sold 1,175,000 340,000

Operating expenses 283,000 98,000

Interest expense 10,000 4,000

Income tax expense 85,000 35,400

Current assets 407,200 190,400

Non-current assets 532,000 139,700

Current liabilities 166,325 133,700

Non-current liabilities 108,500 40,700

Share price 25 15

Weighted average number of common shares 76,000 62,000

Instructions

(a) Calculate working capital and the current ratio for each company. Comment on their relative liquidity.

(b) Calculate the debt to total assets ratio for each company. Comment on their relative solvency.

(c) Calculate the profi t, earnings per share, and price-earnings ratio for each company. Assume that the profi t you calculate

equals the profi t available to common shareholders. Comment on the two companies’ relative profi tability.

P2–7A Selected fi nancial data for a recent year for two clothing competitors, Le Château Inc. and Reitmans (Canada)

Limited, are presented here (in thousands, except share price):

Le Château Reitmans

Current assets $132,223 $301,374

Total assets 220,210 594,555

Current liabilities 47,382 86,914

Total liabilities 80,412 139,537

Profi t (loss) available to common shareholders (8,717) 26,619

Share price $4.08 $12.39

Weighted average number of common shares 25,659 65,188

Instructions

(a) For each company, calculate the following values and ratios. Where available, industry averages are included in parentheses.

  1. Working capital (n/a)
  2. Current ratio (2.0:1)
  3. Debt to total assets (24.0%)
  4. Earnings per share (n/a)
  5. Price-earnings ratio (19.3 times)

(b) Compare the liquidity, solvency, and profi tability of the two companies and their industry.

P2–8A Selected ratios for Pitka Corporation are as follows:

2015 2014 2013

Working capital $10,000 $25,000 $35,000

Current ratio 1.1:1 1.2:1 1.2:1

Debt to total assets 34.2% 42.3% 40.0%

Earnings per share $3.50 $3.15 $3.40

Price-earnings ratio 5.7 times 5.1 times 5.5 times

Instructions

(a) Identify if the change in each value or ratio is an improvement or deterioration between (1) 2013 and 2014, and

(2) 2014 and 2015.

(b) Briefl y discuss the change in Pitka’s liquidity, solvency, and profi tability over the three-year period.

P2–9A Bobby Young is the accountant for the Blazers, a new professional hockey team. He has just fi nished preparing

the fi nancial statements for the team’s fi rst year end, which falls on December 31, 2015. Th e chief fi nancial offi cer (CFO)

of the team is Bucky Ryan and he has just reviewed the fi nancial statements and made the following requests of Bobby:

  1. Because the team’s bank has asked to have a fi nal copy of the fi nancial statements by January 15, 2016, Bobby recorded

the utilities expense for December 2015 based on an estimate because he normally receives the utility bill three weeks

aft er the month the bill pertains to. Bucky wants this removed from the fi nancial statements because it is not a “solid”

number based on an invoice.

  1. Th e team has bought a small building near the arena. Th e area has recently been selected by the city for some signifi –

cant development and consequently the value of the property has risen 15% in the past year. Bobby has not shown this

increase in value on the fi nancial statements but Bucky would like him to do so.

  1. Th e team recently signed Wayne Crosby to play next year. Upon signing, the team paid Wayne a “no strings attached”

signing bonus. Bobby recorded this as an expense but Bucky would like him to record it as an asset since it relates to

a future period.

Instructions

(a) What is the objective of fi nancial reporting? Do Bucky’s suggestions for what should be reported on the fi nancial statements

meet the objective of fi nancial reporting? Explain.

(b) For each of the items covered above, determine if the proposed changes enhance or diminish the qualitative characteristics

of the team’s fi nancial statements and whether it is dealing with these items in a manner that is consistent with

the defi nitions for elements of fi nancial statements.

P2–10A In 2011, when publicly traded companies in Canada adopted IFRS, real estate companies were given the choice

of using cost or fair value to account for their real estate portfolios. Th is was not an easy decision for real estate companies

to make as there were advantages and disadvantages to each choice. In the end, while many companies chose to revalue

their real estate portfolios to fair value, others chose cost.

Instructions

(a) Identify the advantages and disadvantages of each of the two bases of measurement: cost and fair value.

(b) Speculate as to why a company might choose to adopt the fair value basis of accounting for its real estate portfolio.

What impact do you think this will have on the elements of its fi nancial statements?

(c) Speculate as to why a company might choose to adopt the cost basis of accounting for its real estate portfolio. What

impact do you think this will have on the elements of its fi nancial statements?

(d) Do you believe you could eff ectively compare the fi nancial statements of two competing companies using diff erent

bases of measurement?

 

Problems: Set B

P2–1B You are provided with the following selected balance sheet accounts for L’Oréal Group SA, the world’s largest

beauty products company:

Classify accounts.

(SO 1)

Accumulated amortization—patents and trademarks Inventories

Accumulated depreciation—industrial machinery and equipment Investments

Bank overdraft Land

Cash Non-current borrowings and debts

Common (ordinary) shares Patents and trademarks

Current borrowings and debts Prepaid expenses

Income tax payable (current) Trade accounts payable

Industrial machinery and equipment Trade accounts receivable

Instructions

Identify the balance sheet (statement of fi nancial position) category for classifying each account. For example, accumulated

amortizationpatents and trademarks should be classifi ed as a contra asset in the intangible assets section of L’Oreal’s

balance sheet.

P2–2B Th e following items are from the assets section of Devon Limited’s December 31, 2015, statement of fi nancial position:

Accounts receivable $ 4,145

Accumulated amortization—patents 10,190

Accumulated depreciation—buildings 22,470

Accumulated depreciation—equipment 85,900

Buildings 53,150

Cash 97,625

Equipment 166,750

Goodwill 42,425

Patent 29,415

Land 5,860

Trading investments 71,630

Merchandise inventory 93,320

Prepaid expenses 25,950

Instructions

(a) Identify the statement of fi nancial position category in which each of the above assets should be classifi ed.

(b) Prepare the assets section of the statement of fi nancial position.

P2–3B Th e following items are from the liability and shareholders’ equity sections of Devon Limited’s December 31,

2015, statement of fi nancial position:

Accounts payable $ 2,900

Current portion of mortgage payable 3,570

Mortgage payable 71,430

Retained earnings 338,290

Common shares 39,225

Unearned revenue 16,295

Instructions

(a) Identify the statement of fi nancial position category in which each of the above items should be classifi ed.

(b) Prepare the liabilities and equity sections of the statement of fi nancial position.

(c) If you completed P2–2B, compare the total assets in P2–2B with the total liabilities and shareholders’ equity in P2–3B.

Do these two amounts agree?

P2–4B Th ese items are taken from fi nancial statements of Beaulieu Limited for the year ended December 31, 2015:

Cash $ 8,000

Buildings 80,000

Accumulated depreciation—buildings 12,000

Accounts receivable 7,500

Prepaid insurance 250

Equipment 32,000

Accumulated depreciation—equipment 19,200

Accounts payable 9,550

Salaries payable 3,000

Common shares 20,000

Income tax expense 5,000

Long-term investments 20,000

Retained earnings, Jan. 1 34,000

Dividends 3,500

Service revenue 80,500

Depreciation expense 5,400

Insurance expense 2,400

Salaries expense 33,000

Utilities expense 3,700

Interest expense 8,000

Interest revenue 500

Land 50,000

Mortgage payable 80,000

Additional information:

  1. Beaulieu started the year with $15,000 of common shares and issued $5,000 more during the year.
  2. $10,000 of the mortgage payable is due to be repaid within the next year.

Instructions

(a) Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the year.

(b) Explain how each fi nancial statement is related to the others.

P2–5B Th e fi nancial statements of Fast C Calculate ratios and orporation are presented here:

comment on liquidity,

solvency, and

profi tability.

(SO 2) FAST CORPORATION

Income Statement

Year Ended December 31, 2015

Sales $706,000

Expenses

Cost of goods sold $420,000

Operating expenses 144,000

Interest expense 10,000 574,000

Profi t before income taxes 132,000

Income tax expense 35,400

Profi t $ 96,600

FAST CORPORATION

Statement of Financial Position

December 31, 2015

Assets

Current assets

Cash $ 23,100

Trading investments 34,800

Accounts receivable 86,200

Merchandise inventory 109,750 $253,850

Property, plant, and equipment 465,300

Total assets $719,150

Liabilities and Shareholders’ Equity

Current liabilities

Accounts payable $134,200

Income tax payable 10,350

Current portion of mortgage payable 12,000 $156,550

Mortgage payable 132,000

Total liabilities 288,550

Shareholders’ equity

Common shares $100,000

Retained earnings 330,600 430,600

Total liabilities and shareholders’ equity $719,150

Additional information:

  1. Profi t available to common shareholders was $96,600.
  2. Th e weighted average number of common shares was 40,000.
  3. Th e share price at December 31 was $30.

Instructions

(a) Calculate the following values and ratios for 2015. Th e results for 2014 are provided for comparative purposes.

  1. Working capital (2014: $78,000)
  2. Current ratio (2014: 1.4:1)
  3. Debt to total assets (2014: 51.5%)
  4. Earnings per share (2014: $1.35)
  5. Price-earnings ratio (2014: 10.8 times)

(b) Using the information in part (a), discuss the changes in liquidity, solvency, and profi tability between 2014 and

2015.

P2–6B Selected fi nancial statement data for a recent year for Belliveau Corporation and Shields Corporation, two competitors,

are as follows:

Belliveau Shields

Sales revenue $450,000 $890,000

Cost of goods sold 260,000 620,000

Operating expenses 130,000 59,000

Interest expense 6,000 10,000

Income tax expense 10,000 65,000

Current assets 180,000 700,000

Non-current assets 600,000 800,000

Current liabilities 75,000 300,000

Non-current liabilities 190,000 200,000

Share price 2.50 6.00

Weighted average number of common shares 200,000 200,000

Instructions

(a) Calculate working capital and the current ratio for each company. Comment on their relative liquidity.

(b) Calculate the debt to total assets ratio for each company. Comment on their relative solvency.

(c) Calculate the profi t, earnings per share, and price-earnings ratio for each company. Assume that the profi t you calculate

equals the profi t available to common shareholders. Comment on the two companies’ relative profi tability.

P2–7B Selected fi nancial data for a recent year for two discount retail chains, Walmart Stores, Inc. and Target Corporation,

are presented here (in U.S. $ millions, except for share price):

Walmart Target

Current assets $ 59,940 $16,388

Total assets 203,105 48,163

Current liabilities 71,818 14,031

Total liabilities 121,367 31,605

Profi t available to common shareholders 16,999 2,999

Share price 69.95 61.15

Weighted average number of common shares 3,374 657

Instructions

(a) For each company, calculate the following values and ratios. Where available, industry averages have been included

in parentheses.

  1. Working capital (n/a)
  2. Current ratio (1.8:1)
  3. Debt to total assets (16.9%)
  4. Earnings per share (n/a)
  5. Price-earnings ratio (18.6 times)

(b) Compare the liquidity, solvency, and profi tability of the two companies and their industry.

P2–8B Selected ratios for Giasson Corporation are as follows:

2015 2014 2013

Working capital $47,000 $53,000 $50,000

Current ratio 1.5:1 1.7:1 2.0:1

Debt to total assets 25.4% 25.5% 20.0%

Earnings per share $0.86 $1.29 $1.00

Price-earnings ratio 4.7 times 5.1 times 5.5 times

Instructions

(a) Identify if the change in each value or ratio is an improvement or deterioration between (1) 2013 and 2014, and

(2) 2014 and 2015.

(b) Briefl y discuss the change in Giasson’s liquidity, solvency, and profi tability over the three-year period.

P2–9B Brenda Chan is the new accountant for a small private company called Ace Construction Limited. She has recently

prepared the year-end fi nancial statements for the company. Brenda’s boss, Virginia Schwirtz, who is the chief executive

offi cer (CEO), has asked her to make three changes to the fi nancial statements as follows:

  1. Remove an expense and its related liability that Brenda recorded for damages expected to be paid from a lawsuit due

to a poorly done construction job a few months ago. Virginia believes that, although it is highly likely that Ace will

have to pay for these damages, because a fi nal agreement about the exact amount of these damages will not be agreed

to until next month, nothing relating to this issue should be recorded in the fi nancial statements or disclosed in the

notes to the fi nancial statements.

  1. Just prior to the end of the year, Ace signed a contract to build a new arena for the city for a fi xed fee of $80 million. As

long as the company can build the facility for less than this amount, the company will make a profi t. Since the value of

the contract is fi xed and because the city has always paid its bills on time, Virginia wants the revenue for this contract

to be recorded in the current year because that was when the contract was signed.

  1. Th e company has a chequing account that is allowed to go into an overdraft (negative) position. When the balance

falls into an overdraft , the bank begins to charge interest on that amount as if it were a bank loan, which in essence it

  1. Since there is no due date on such a balance, Virginia would like the loan to be reported as a non-current liability.

Instructions

(a) What is the objective of fi nancial reporting? Are Brenda’s or Virginia’s actions consistent with these objectives? Explain.

(b) For each of the items covered above, determine if the proposed changes enhance or diminish the qualitative characteristics

of the company’s fi nancial statements and whether the company is dealing with these items in a manner that

is consistent with the defi nitions for elements of fi nancial statements.

P2–10B Th e following are hypothetical situations that require the choice of one of the two bases of measurement: cost

or fair value.

  1. You purchase your textbooks at the university bookstore to use during the term, but plan on selling them at the end

of the term.

  1. You purchase a new iPad and plan on never parting with it, at least not until a new model comes out.
  2. You purchase soft ware for your computer under a special deal that allows you to upgrade it whenever a new version

is released.

  1. You purchase a used car.
  2. You purchase land, which you eventually hope to build a home on.

Instructions

(a) Identify the advantages and disadvantages of each of the two bases of measurement: cost and fair value.

(b) For each of the above situations, identify which basis of measurement would be the most appropriate to choose, and

explain why.

 

CHAPTER 3 Th e Accounting Information System

 

Questions

  1. What is an accounting information system?

Describe some of the factors that may impact the

design of a company’s information system.

(SO 1) 2. Why are some events recorded as accounting

transactions but others are not?

(SO 1) 3. Which of the following events should be recorded

in the accounting records? Explain your

answer in each case.

(a) Th e company wins an award as one of the top

50 companies in Canada to work for.

(b) Supplies are purchased on account.

(c) A shareholder dies.

(d) Th e company pays a cash dividend to its

shareholders.

(e) A local lawyer agrees to provide legal services

to the company for the next year.

(SO 1) 4. Can a business enter into a transaction that

affects only the left side of the accounting

equation? If so, give an example.

(SO 1) 5. What is the eff ect of each of the following transactions

on the expanded accounting equation?

(a) Paid cash for janitorial services.

(b) Purchased equipment on account.

(c) Issued common shares to investors in

exchange for cash.

(d) Paid income tax.

(e) Collected an account receivable.

(SO 2) 6. Natalie Boudreau, an introductory accounting

student, believes debit balances are favourable

and credit balances are unfavourable. Is Natalie

correct? Discuss.

(SO 2) 7. Given that both liabilities and shareholders’

equity are on the same side of the accounting

equation, why is it that all liability accounts are

increased by credits but all shareholders’ equity

accounts are not?

(SO 2) 8. For each of the following accounts, indicate

(a) whether the account would have a normal

debit or credit balance, and (b) the appropriate

statement classifi cation (income statement,

statement of changes in equity, statement of

fi nancial position) for each.

  1. Accounts Receivable
  2. Accounts Payable
  3. Equipment
  4. Dividends
  5. Supplies
  6. Service Revenue
  7. Unearned Revenue
  8. Income Tax Expense
  9. Prepaid Rent
  10. Bank Loan Payable

(SO 2) 9. For the following transactions, identify the

account to be debited and the account to be

credited:

(a) Supplies are purchased on account

(b) Payment of an amount owing to a supplier

(c) Cash is borrowed from the bank

(d) Employees are paid salaries in cash

(e) Cash is received from a customer in advance

(f) An expense is paid in advance

(g) Services are performed on account

(h) A customer’s account is collected

(i) A dividend is paid to shareholders

(j) Income tax is paid

(SO 2) 10. For each account listed below, indicate whether

it generally will have debit entries only, credit

entries only, or both debit and credit entries:

(a) Cash

(b) Accounts Receivable

(c) Dividends

(d) Accounts Payable

(e) Service Revenue

(f) Salaries Expense

(g) Unearned Revenue

(SO 3) 11. (a) What is a general journal? (b) How does the

journal facilitate the recording process?

(SO 3) 12. Explain why the format of the following items

in a journal entry are important: (a) including a

date, (b) recording debit entries fi rst,

(c) indenting credit entries, and (d) including a

brief explanation.

(SO 3) 13. Meghan is recording the purchase of a truck in

a journal entry and can’t decide what account

title to use for the truck. She is thinking about

using “Truck Purchased,” but she also likes the

account titles “Mack Truck” or “Big Rig,” which

better represent the type of truck the company

purchased. Give Meghan advice about choosing

an account title to use in a journal entry.

  1. An effi ciency expert who was reviewing the steps

in the accounting cycle suggested dropping the

general journal and recording and summarizing

transactions directly into the general ledger

instead. Comment on this suggestion.

  1. Does it matter how frequently transactions are

posted from the general journal to the general

ledger? Explain.

(SO 4) 16. (a) What is a general ledger? (b) In what order

are accounts usually arranged in a general

ledger?

(SO 4) 17. (a) What is a chart of accounts and why is it important?

(b) How does numbering the accounts

help?

(SO 4) 18. Arrange the following accounts in their normal

order in a chart of accounts: cash, common

shares, dividends, income tax expense, prepaid

insurance, service revenue, supplies, unearned

revenue.

(SO 5) 19. (a) What is a trial balance? (b) From what source

document(s) is it prepared?

(SO 5) 20. Does it matter in which order accounts are listed

in the trial balance?

(SO 5) 21. On a trial balance, why does the retained earnings

balance shown relate to the beginning of the

period rather than the end of the period?

(SO 5) 22. Two students are discussing the use of a trial balance.

Th ey wonder whether the following errors,

each considered separately, would prevent the

trial balance from balancing. What would you

tell the students?

(a) Th e bookkeeper debited Supplies for $750

and debited Accounts Payable for $750 for

the purchase of supplies on account.

(b) Cash collected on account was debited to

Cash for $1,000 and credited to Service

Revenue for $1,000.

(c) A journal entry recording the payment of

dividends was posted to the general ledger as

a debit to the Dividends account of $650 and

a credit to the Cash account of $560.

(SO 5) 23. Identify and describe the fi rst four steps in the

accounting cycle.

Brief Exercises

BE3–1 Presented below are a number of economic events. Prepare a tabular analysis of the eff ects of the above transactions

on the expanded accounting equation.

  1. Purchased supplies on account, $250.
  2. Provided a service on account, $500.
  3. Paid salaries expense, $300.
  4. Issued common shares in exchange for cash, $5,000.
  5. Paid a cash dividend to shareholders, $400.
  6. Received cash from a customer who had previously been billed for services provided, $500 (see item 2).
  7. Paid account owed to supplier, $250 (see item 1).
  8. Paid for insurance in advance, $100.
  9. Received cash in advance from a customer for services to be performed in the future, $300.
  10. Performed the service that the customer previously paid for (see item 9).

BE3–2 For each of the following accounts, indicate the (a) eff ect of a debit or credit on the account, (b) normal balance,

and (c) appropriate statement classifi cation (income statement, statement of changes in equity, and/or statement of fi nancial

position). Note that there may be more than one statement classifi cation in some cases.

  1. Accounts payable
  2. Advertising expense
  3. Service revenue
  4. Accounts receivable
  5. Unearned revenue
  6. Cash

Indicate debit and

credit eff ects and statement

classifi cation.

(SO 2)

  1. Dividends
  2. Common shares
  3. Prepaid insurance
  4. Equipment
  5. Retained earnings
  6. Income tax expense

BE3–3 Selected transactions for Ing Corporation for the month of June are presented below. For each transaction, prepare

a (a) basic analysis, (b) equation analysis, and (c) debit–credit analysis.

June 1 Issued common shares to shareholders in exchange for $2,500 cash.

2 Purchased supplies on account for $250.

12 Billed J. Kronsnoble $300 for welding work done.

22 Received cash from J. Kronsnoble for work billed on June 12.

25 Hired an employee to start work on July 2.

28 Received cash of $200 from K. Jones as a deposit for welding work to be done in July.

29 Paid for supplies purchased on June 2.

30 Paid $100 for income tax.

BE3–4 Riko Corporation has the following selected transactions:

  1. Issued common shares to shareholders in exchange for $5,000.
  2. Paid rent in advance for six months, $2,100.
  3. Paid administrative assistant $500 salary.
  4. Billed clients $1,200 for services provided.
  5. Received $900 from clients for services provided in item 4 above.
  6. Purchased $500 of supplies on account.
  7. Paid supplier amount owing, $500.
  8. Borrowed $1,000 cash from the bank.

For each transaction, indicate (a) the basic type of account debited and credited (asset, liability, shareholders’ equity),

(b) the specifi c account debited and credited, and (c) whether the specifi c account is increased or decreased to record this

transaction. Use the following format, in which the fi rst one has been done for you as an example:

Account Debited Account Credited

(a) (b) (c) (a) (b) (c)

Transaction

Basic

Type

Specifi c

Account Eff ect

Basic

Type

Specifi c

Account Eff ect

  1. Asset Cash Increase Shareholders’

equity

Common

Shares

Increase

BE3–5 Journalize the transactions given in BE3–1.

BE3–6 Journalize the transactions for Ing Corporation given in BE3–3.

BE3–7 Journalize the transactions for Riko Corporation given in BE3–4.

BE3–8 Fill in the missing amounts from the following T accounts.

BE3–9 Using T accounts, post the journal entries in BE3–6 to the general ledger.

BE3–10 Selected transactions are presented in journal entry form below. For each entry, (a) provide an explanation of

the transaction, and (b) using T accounts, post the journal entries to the general ledger.

GENERAL JOURNAL

Date Account Titles Debit Credit

May 5 Accounts Receivable 3,200

Service Revenue 3,200

12 Cash 1,900

Accounts Receivable 1,900

15 Supplies 200

Accounts Payable 200

20 Cash 2,000

Service Revenue 2,000

25 Salaries Expense 2,500

Cash 2,500

28 Accounts Payable 200

Cash 200

30 Income Tax Expense 750

Cash 750

BE3–11 From the ledger balances given below, listed in alphabetical order, prepare a trial balance for Carland Inc. at June 30,

  1. All accounts have a normal debit or credit balance.

Accounts payable $ 3,000 Income tax expense $ 400

Accounts receivable 4,000 Rent expense 1,000

Accumulated depreciation

—equipment

3,600 Retained earnings 12,650

Cash 4,400 Salaries expense 4,000

Common shares 10,000 Service revenue 7,600

Dividends 200 Trading investments 6,000

Equipment 17,000 Unearned revenue 150

BE3–12 Diff erent types of posting errors are identifi ed in the following table. For each error, indicate (a) whether the

trial balance will balance (yes or no), (b) the amount of the diff erence if the trial balance will not balance, and (c) the trial

balance column (debit or credit) that will have the larger total. Consider each error separately. Use the following form, in

which error 1 is given as an example:

(a) (b) (c)

Error

In

Balance Diff erence

Larger

Column Total

  1. A $1,200 debit to Supplies was posted as a $2,100 debit. No $900 Debit
  2. A $1,000 credit to Cash was posted twice as two credits

to Cash.

  1. A $5,000 debit to Dividends was posted to the Common

Shares account.

  1. A journal entry debiting Cash and crediting Service Revenue

for $2,500 was not posted.

  1. Th e collection of $500 cash on account was posted as a debit

of $500 to Cash and a credit of $500 to Accounts Payable.

  1. Th e payment of $1,000 on an account payable owed to the

insurance company was posted as a debit to the Insurance

Expense account. No credit was posted.

BE3–13 An inexperienced bookkeeper prepared the following trial balance. She fi nished with a huge sigh of relief because

she was able to balance the trial balance. (a) Is the trial balance correct? (b) If you answered “no” in (a), prepare a correct

trial balance, assuming all accounts have a normal debit or credit balance.

 

Exercises

E3–1 Selected transactions for Green Lawn Care Ltd. follow:

  1. Issued common shares to shareholders in exchange for $5,000 cash.
  2. Purchased $250 of supplies on account.
  3. Billed customers $2,500 for services performed.
  4. Paid a $100 dividend to shareholders.
  5. Received $1,800 cash from customers billed in transaction 3.
  6. Purchased equipment for $3,500, paying $500 cash and signing a bank loan in payment.
  7. Performed services for $1,200 cash.
  8. Paid full amount owing for supplies purchased in transaction 2.
  9. Paid $750 in salaries to employees.
  10. Paid $600 for insurance coverage in advance.

Instructions

Prepare a tabular analysis of the eff ects of the above transactions on the expanded accounting equation.

E3–2 Wong Computer Corporation entered into these transactions during the month of May:

  1. Purchased computers on account for $8,000 from Dell.
  2. Paid $1,600 for rent for the month of May.
  3. Provided computer services for $3,800 on account.
  4. Paid Ontario Hydro $300 cash for utilities used in May.
  5. Issued common shares to Li Wong in exchange for an additional $20,000 investment in the business.
  6. Paid Dell for computers purchased in transaction 1.
  7. Purchased a one-year accident insurance policy for $500 cash.
  8. Received $3,000 cash in partial payment of the account in transaction 3.
  9. Paid Li Wong a $500 dividend.
  10. Paid income tax of $250 for the month.

Instructions

(a) Prepare a tabular analysis of the eff ects of the above transactions on the expanded accounting equation.

(b) Calculate profi t for the month.

E3–3 You are presented with the following alphabetical list of items, selected from the fi nancial statements of Saputo Inc.:

Accounts payable and accrued liabilities Income taxes payable

Bank loan payable Interest expense

Cash Inventories

Dividends Prepaid expenses

Dividends payable Receivables

Furniture, machinery, and equipment Revenues

General and administrative expenses Trademarks

Goodwill

Income tax expense

Instructions

For each of the above accounts, identify the following:

(a) the type of account (assets, liabilities, share capital, dividends, revenues, expenses);

(b) the normal balance of the account; and

(c) on which fi nancial statement (income statement, statement of changes in equity, statement of fi nancial position)

Saputo would likely report the account.

E3–4 Selected transactions for the Decorators Mill Ltd., an interior decorator corporation in its fi rst month of business,

are as follows:

March 2 Issued common shares for $11,000 cash.

4 Purchased used car for $1,000 cash and $9,000 on account, for use in the business.

10 Billed customers $2,300 for services performed.

13 Paid $225 cash to advertise business opening.

25 Received $1,000 cash from customers billed on March 10.

27 Paid amount owing for used car purchased on March 4.

30 Received $700 cash from a customer for services to be performed in April.

31 Paid dividends of $500 to shareholders.

Instructions

For each of the above transactions, prepare a (a) basic analysis, (b) equation analysis, and (c) debit–credit analysis.

E3–5 Data for the Wong Computer Corporation were presented in E3–2.

Instructions

Journalize the transactions.

E3–6 Data for the Decorators Mill Ltd. were presented in E3–4.

Instructions

Journalize the transactions.

E3–7 Th e journal entries for the Decorators Mill were prepared in E3–6.

Instructions

Post the journal entries to T accounts.

E3–8 Selected transactions for the Basler Corporation during its fi rst month in business are presented below:

Sept. 1 Issued common shares for $20,000 cash.

2 Performed $9,000 of services on account for a customer.

4 Purchased equipment for $12,000, paying $5,000 in cash and borrowing the balance from the bank.

10 Purchased $500 of supplies on account.

25 Received $4,500 cash in advance for architectural services to be provided next month.

30 Paid account owing for supplies (see September 10 transaction).

30 Collected $5,000 on account owing from customer (see September 2 transaction).

Instructions

For each of the above transactions, do the following:

(a) Prepare a basic analysis.

(b) Prepare an equation analysis.

(c) Prepare a debit–credit analysis.

(d) Journalize the transaction.

(e) Using T accounts, post the journal entry to the general ledger.

E3–9 Selected transactions from the general journal of Kang, Inc. for its fi rst month of operations are presented here:

GENERAL JOURNAL

Date Account Titles Debit Credit

Aug. 1 Cash 3,000

Common Shares 3,000

7 Cash 1,800

Service Revenue 1,800

11 Equipment 4,000

Cash 1,500

Bank Loan Payable 2,500

14 Accounts Receivable 1,450

Service Revenue 1,450

16 Cash 900

Unearned Revenue 900

28 Cash 700

Accounts Receivable 700

30 Salary Expense 2,000

Cash 2,000

31 Dividends 500

Cash 500

Instructions

(a) Prepare an explanation for each of the journal entries listed above.

(b) Using T accounts, post the journal entries to the general ledger.

(c) Prepare a trial balance at August 31, 2015.

E3–10 Th e following is the general ledger for Holly Corp.:

Instructions

(a) Prepare an explanation for each ledger posting that was made above.

(b) Prepare a trial balance at October 31, 2015.

E3–11 Th e following is a list of accounts for Speedy Delivery Service, Inc. at July 31, 2015:

Accounts payable $ 9,500 Interest expense $ 3,600

Accounts receivable 14,000 Bank loan payable, due 2017 39,000

Accumulated depreciation

—equipment

21,400 Prepaid insurance 200

Cash 8,000 Rent expense 9,000

Common shares 38,000 Repairs and maintenance expense 5,700

Equipment 99,000 Retained earnings, Aug. 1, 2014 20,850

Depreciation expense 9,700 Salaries expense 25,000

Dividends 800 Salaries payable 800

Vehicles expense 4,750 Service revenue 75,000

Income tax expense 3,000 Trading investments 20,000

Insurance expense 1,800

Additional information:

During the year, the company issued common shares for $11,000.

Instructions

(a) Prepare a trial balance.

(b) Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the year.

(c) If you did not know the retained earnings amount in the trial balance, could you have prepared the fi nancial statements

in (b)?

E3–12 Th e bookkeeper for Castle’s Equipment Repair Corporation made these errors in journalizing and posting:

  1. A credit posting of $400 to Accounts Receivable was omitted.
  2. A debit posting of $750 for Prepaid Insurance was debited to Insurance Expense.
  3. A collection on account of $100 was journalized and posted as a $100 debit to Cash and a $100 credit to Service Revenue.
  4. A credit posting of $500 to Accounts Payable was made twice.
  5. A cash purchase of supplies for $250 was journalized and posted as a $250 debit to Supplies and a $25 credit to Cash.
  6. A debit of $465 to Advertising Expense was posted as $456.

Instructions

For each error, indicate:

(a) whether the trial balance will balance (yes or no),

(b) the amount of the diff erence if the trial balance will not balance, and

(c) the trial balance column (debit or credit) that will have the larger total.

Consider each error separately. Use the following format, in which the fi rst error is given as an example:

Problems: Set A

P3–1A On April 1, Adventures Travel Agency, Inc. began operations. Th e following transactions were completed during

the month:

  1. Issued common shares for $24,000 cash.
  2. Obtained a bank loan for $7,000.
  3. Paid $11,000 cash to buy equipment.
  4. Paid $1,200 cash for April offi ce rent.
  5. Paid $1,450 for supplies.
  6. Purchased $600 of advertising in the Daily Herald, on account.
  7. Earned $18,000 for services performed: cash of $2,000 was received from customers, and the balance of $16,000 was

billed to customers on account.

  1. Paid $400 dividends to shareholders.
  2. Paid the utility bill for the month, $2,000.
  3. Paid Daily Herald the amount due in transaction 6.
  4. Paid $40 of interest on the bank loan obtained in transaction 2.
  5. Paid employees’ salaries, $6,400.
  6. Received $12,000 cash from customers billed in transaction 7.
  7. Paid income tax, $1,500.

Instructions

(a) Prepare a tabular analysis of the eff ects of the above transactions on the expanded accounting equation.

(b) Calculate total assets, liabilities, and shareholders’ equity at the end of the month and total profi t for the month.

P3–2A On July 31, 2015, the general ledger of Hills Legal Services Inc. showed the following balances: Cash $4,000;

Accounts Receivable $1,500; Supplies $500; Equipment $5,000; Accounts Payable $4,100; Common Shares $3,500; and

Retained Earnings $3,400. During August, the following transactions occurred:

Aug. 3 Collected $1,200 of accounts receivable due from customers.

5 Received $1,300 cash for issuing common shares to new investors.

6 Paid $2,700 cash on accounts payable owing.

7 Earned fees of $6,500, of which $3,000 was collected in cash and the remainder was due on account.

12 Purchased additional equipment for $1,200, paying $400 in cash and the balance on account.

14 Paid salaries, $3,500, rent, $900, and advertising expenses, $275, for the month of August.

18 Collected the balance of the fees earned on August 7.

20 Paid dividends of $500 to shareholders.

24 Billed a client $1,000 for legal services provided.

26 Received $2,000 from Laurentian Bank; the money was borrowed on a bank loan payable that is

due in six months.

27 Signed an engagement letter to provide legal services to a client in September for $4,500. Th e

client will pay the amount owing aft er the work has been completed.

28 Received the utility bill for the month of August in the amount of $275; it is not due until

September 15.

31 Paid income tax for the month, $500.

Instructions

(a) Beginning with the July 31 balances, prepare a tabular analysis of the eff ects of the August transactions on the expanded

accounting equation.

(b) Prepare an income statement, a statement of changes in equity, and a statement of fi nancial position for August.

P3–3A You are presented with the following alphabetical list of selected items from the fi nancial statements of

Danier Leather Inc.:

Accounts payable and accrued liabilities Income tax payable

Accounts receivable Interest expense

Buildings Inventories

Cash Land

Common shares, beginning of year Prepaid expenses

Cost of sales Retained earnings, beginning of year

Furniture and equipment Sales

Income tax expense Selling, general, and administrative expenses

Instructions

(a) For each of the above accounts, identify (1) whether the account is increased by a debit or a credit and (2) the normal

balance of the account.

(b) For each of the above accounts, indicate (1) the appropriate classifi cation (current assets, non-current assets, current

liabilities, non-current liabilities, share capital, dividends, revenues, expenses), and (2) on which fi nancial statement

(income statement, statement of changes in equity, statement of fi nancial position) the company would likely report

the account.

P3–4A You are presented with the following transactions for Paddick Enterprises Ltd. for the month of February:

Feb. 2 Purchased supplies on account, $600.

3 Purchased equipment for $10,000 by signing a bank loan due in three months.

6 Earned service revenue of $50,000. Of this amount, $30,000 was received in cash. Th e balance was on

account.

13 Paid $500 in dividends to shareholders.

18 A customer paid $2,000 in advance for services to be performed next month.

20 Paid the amount owing for the supplies purchased on February 2.

23 Collected $20,000 of the amount owing from the February 6 transaction.

24 Paid offi ce expenses for the month, $22,000.

27 Recorded salaries due to employees for work performed during the month, $14,000.

28 Paid interest of $50 on the bank loan signed on February 3.

Instructions

(a) For each of the above transactions, prepare a (1) basic analysis, (2) equation analysis, and (3) debit–credit analysis.

(b) Prepare journal entries to record each of the above transactions.

P3–5A Th e Adventure Miniature Golf and Driving Range, Inc. opened on May 1. Th e following selected events and

transactions occurred during May:

May 1 Issued common shares for $120,000 cash.

4 Purchased Henry’s Golf Land for $270,000. Th e price consists of land $125,000; buildings $100,000;

and equipment $45,000. Paid cash of $100,000 and signed a mortgage payable for the balance.

4 Paid $1,500 for a one-year insurance policy; coverage begins next month.

5 Advertised the opening of the driving range and miniature golf course, paying advertising expenses

of $800.

6 Purchased golf clubs and other equipment for $9,000 on account from Titleist Corporation.

18 Received $8,800 from customers for golf fees earned.

20 Paid dividends of $1,000 to shareholders.

22 Received $1,200 from a school board that paid for students’ golf lessons that will be given in June.

29 Paid Titleist Corporation in full for equipment purchased on May 6.

30 Paid $800 of interest on the mortgage payable.

30 Paid salaries of $3,400.

Instructions

Journalize the May transactions.

P3–6A During the fi rst month of operations, the following events and transactions occurred for Virmani Architects Inc.:

Apr. 1 Invested cash of $10,000 and equipment of $6,000 in the company in exchange for common shares.

1 Hired a secretary-receptionist at a monthly salary of $1,900.

2 Paid offi ce rent for the month, $950.

3 Purchased architectural supplies on account from Halo Ltd., $1,900.

10 Completed blueprints on a carport and billed client $900.

13 Received $800 cash advance from a client for the design of a new home.

20 Received $1,500 for services performed for a client.

21 Received $500 from client for work completed and billed on April 10.

23 Received April’s telephone bill for $135; due May 15. (Hint: Use the Offi ce Expense account for

telephone services.)

30 Paid secretary-receptionist for the month, $1,900.

30 Paid 50% ($950) of the amount owed to Halo Ltd. on account (see April 3 transaction).

30 Paid $500 dividend.

Instructions

(a) Journalize the transactions.

(b) Using T accounts, post the April journal entries to the general ledger.

(c) Aft er the accountant fi nished journalizing and posting the above transactions, he complained that this process took too

much time. He thought it would be more effi cient to omit the journal entry step in the accounting cycle and record the

transactions directly in the general ledger. Explain to the accountant whether you think this is a good idea or not, and why.

P3–7A On February 28, 2015, the Star Th eatre, Inc.’s general ledger showed Cash $15,000; Land $85,000; Buildings

$77,000; Equipment $20,000; Accounts Payable $12,000; Mortgage Payable $118,000; Common Shares $40,000; and

Retained Earnings $27,000. During the month of March, the following events and transactions occurred:

Mar. 2 Received three movies to be shown during the fi rst three weeks of March. Th e fi lm rental was

$27,000. Of that amount, $10,000 was paid in cash and the remainder will be paid on March 12.

(Hint: Star Th eatre uses the account Rent Expense to record fi lm rentals).

2 Hired M. Brewer to operate concession stand. Brewer agrees to pay Star Th eatre 15% of gross

receipts, payable on the last day of each month, for the right to operate the concession stand. (Hint:

Star Th eatre uses the account Concession Revenue to record concessions earned.)

5 Ordered three additional movies, to be shown the last 10 days of March. Th e fi lm rental cost will be

$300 per night.

9 Received $16,300 from customers for admissions. (Hint: Star Th eatre uses the account Fees Earned

to record revenue from admissions.)

12 Paid balance due on the movies rented on March 2.

13 Paid the accounts payable owing at the end of February.

19 Paid advertising expenses, $950.

20 Received $16,600 from customers for admissions.

23 Received the movies ordered on March 5 and paid rental fee of $3,000 ($300 3 10 nights).

25 Received $18,400 from customers for admissions.

27 Paid salaries of $4,200.

30 Received statement from M. Brewer, showing gross concession receipts of $16,600, and the balance

due to Star Th eatre of $2,490 ($16,600 3 15%) for March. Brewer paid half of the balance due and

will remit the remainder on April 5.

30 Paid $1,250 of the balance due on the mortgage, as well as $750 of interest on the mortgage.

30 Paid $3,000 for the monthly income tax instalment.

Instructions

(a) Using T accounts, enter the beginning balances in the ledger as at February 28.

(b) Journalize the March transactions.

(c) Post the March journal entries to the ledger.

(d) Prepare a trial balance at March 31.

P3–8A Pamper Me Salon Inc.’s general ledger at April 30, 2015, included the following: Cash $5,000; Supplies $500;

Equipment $24,000; Accounts Payable $2,100; Bank Loan Payable $10,000; Unearned Revenue (from gift certifi cates) $1,000;

Common Shares $5,000; and Retained Earnings $11,400. Th e following events and transactions occurred during May:

May 1 Paid rent for the month of May, $1,000.

4 Paid $1,100 of the account payable at April 30.

7 Issued gift certifi cates for future services for $1,500 cash.

8 Received $1,200 cash from customers for services performed.

14 Paid $1,200 in salaries to employees.

15 Received $800 in cash from customers for services performed.

15 Customers receiving services worth $700 used gift certifi cates in payment.

21 Paid the remaining accounts payable from April 30.

22 Received $1,000 in cash from customers for services performed.

22 Purchased supplies of $700 on account. All of these were used during the month.

25 Received a bill for advertising for $500. Th is bill is due on June 13.

25 Received and paid a utilities bill for $400.

29 Received $1,700 in cash from customers for services performed.

29 Customers receiving services worth $600 used gift certifi cates in payment.

31 Interest of $50 was paid on the bank loan.

31 Paid $1,200 in salaries to employees.

31 Paid income tax instalment for the month, $150.

Instructions

(a) Using T accounts, enter the beginning balances in the general ledger as at April 30.

(b) Journalize the May transactions.

(c) Post the May journal entries to the general ledger.

(d) Prepare a trial balance as at May 31.

P3–9A You are presented with the following alphabetical list of accounts and balances (in thousands) for Taggar

Enterprises Inc. at June 30, 2015:

Accounts payable $ 1,500 Income tax payable $ 100

Accounts receivable 3,000 Interest expense 100

Accumulated depreciation—buildings 4,000 Land 7,400

Accumulated depreciation—equipment 1,000 Long-term investments 3,550

Buildings 15,000 Merchandise inventory 5,100

Cash 1,800 Mortgage payable, due 2021 15,000

Common shares 5,000 Offi ce expense 3,300

Cost of goods sold 13,700 Prepaid insurance 900

Equipment 3,000 Retained earnings, July 1, 2014 6,250

Income tax expense 1,000 Sales 25,000

Instructions

(a) Prepare a trial balance at June 30, sorting each account balance into the debit column or the credit column.

(b) If debits equal credits in Taggar’s trial balance, do you have reasonable assurance that no errors exist? Explain.

P3–10A Refer to the trial balance for Taggar Enterprises Inc. prepared in P3–9A. In addition to this information, note

that during the year, common shares in the amount of $2,000 were issued and $1,250 of the mortgage is currently due.

Instructions

Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the year.

P3–11A Th e following trial balance of Cantpost Ltd., at the end of its fi rst year of operations, June 30, 2015, does not balance:

Debit Credit

Cash $ 1,241

Accounts receivable $ 2,630

Supplies 860

Equipment 3,000

Accumulated depreciation

—equipment

600

Accounts payable 2,665

Unearned revenue 1,200

Common shares 1,000

Retained earnings, June 30, 2015 2,365

Dividends 800

Service revenue 8,440

Salaries expense 3,400

Offi ce expense 910

Depreciation expense 600

Income tax expense 365

$14,365 $15,711

Each of the listed accounts has a normal balance per the general ledger. However, each account may not have been

listed in the appropriate debit or credit column, or may not belong in the trial balance at all. In addition, an examination

of the general ledger and general journal reveals the following errors:

  1. Cash received from a customer on account was debited for $570, and Accounts Receivable was credited for the same

amount. Th e actual collection was for $750.

  1. Th e purchase of equipment on account for $360 was recorded as a debit to Supplies for $360 and a credit to Accounts

Payable for $360.

  1. Services were performed on account for a client for $890. Accounts Receivable was debited for $890 and Service

Revenue was credited for $89.

  1. A transposition (reversal of digits) error was made when copying the balance in the Salaries Expense account. Th e

correct balance should be $4,300.

  1. A payment for rent in the amount of $1,000 was neither recorded nor posted.

Instructions

Prepare the correct trial balance.

 

Problems: Set B

P3–1B On May 1, Marty’s Repair Shop, Inc. commenced operations. Th e following transactions were completed during

the month:

  1. Issued common shares for $28,000 cash.
  2. Paid $1,280 for May offi ce rent.
  3. Purchased equipment for $16,000, paying $4,000 cash and signing a bank loan payable for the balance.
  4. Purchased supplies on account, $700.
  5. Received $4,200 from customers for repair services provided.
  6. Paid for supplies purchased in transaction 4.
  7. Paid May telephone bill of $200.
  8. Provided repair services on account to customers, $3,600.
  9. Paid employee salaries, $2,000.
  10. Received $700 in advance for repair services to be provided next month.
  11. Collected $1,600 from customers for services billed in transaction 8.
  12. Paid $500 dividends to shareholders.
  13. Paid $80 of interest on the bank loan obtained in transaction 3.
  14. Paid income tax of $600.

Instructions

(a) Prepare a tabular analysis of the eff ects of the above transactions on the expanded accounting equation.

(b) Calculate total assets, liabilities, and shareholders’ equity at the end of the month and total profi t for the month.

P3–2B Th e general ledger of Corso Care Corp., a veterinary company, showed the following balances on August 31,

2015: Cash $4,500; Accounts Receivable $1,800; Supplies $350; Equipment $6,500; Accounts Payable $3,200; Common

Shares $2,500; and Retained Earnings $7,450. During September, the following transactions occurred:

Sept. 1 Paid the accounts payable owing at August 31.

1 Paid $1,200 rent for September.

3 Collected $1,450 of accounts receivable due from customers.

4 Hired a part-time offi ce assistant at $50 per day to start work the following week, on Monday,

September 7.

5 Received $2,300 cash for issuing common shares to new investors.

8 Purchased additional equipment for $2,050, paying $700 in cash and the balance on account.

14 Billed $500 for veterinary services provided.

15 Paid $300 for advertising expenses.

25 Received $2,500 from Canadian Western Bank; the money was borrowed on a loan payable due in

nine months.

25 Sent a statement reminding a customer that money was still owed from August.

28 Earned revenue of $4,500, of which $3,000 was received in cash. Th e balance is due in October.

29 Paid part-time offi ce assistant $750 for working 15 days in September.

30 Incurred utility expenses for the month on account, $175.

30 Paid dividends of $500 to shareholders.

30 Paid income tax for the month, $350.

Instructions

(a) Beginning with the August 31 balances, prepare a tabular analysis of the eff ects of the September transactions on the

expanded accounting equation.

(b) Prepare an income statement, a statement of changes in equity, and a statement of fi nancial position for September.

P3–3B You are presented with the following alphabetical list of selected items from the fi nancial statements of

Reitmans (Canada) Limited:

Administrative expenses Income tax payable

Buildings Inventories

Cost of goods sold Mortgage payable, due November 2017

Dividends Prepaid expenses

Finance income Retained earnings, beginning of year

Fixtures and equipment Sales

Goodwill Trade and other receivables

Income tax expense Trade payables

Instructions

(a) For each of the above accounts, identify (1) whether the account is increased by a debit or a credit and (2) the normal

balance of the account.

(b) For each of the above accounts, indicate (1) the appropriate classifi cation (current assets, non-current assets, current

liabilities, non-current liabilities, share capital, dividends, revenues, expenses), and (2) on which fi nancial statement

(income statement, statement of changes in equity, statement of fi nancial position) the company would likely report

the account.

P3–4B You are presented with the following transactions for the Dankail Corporation for the month of January:

Jan. 2 Issued $10,000 of common shares for cash.

5 Provided services on account, $2,500.

6 Obtained a bank loan for $30,000.

7 Paid $40,000 to purchase a hybrid car to be used solely in the business.

9 Received a $5,000 deposit from a customer for services to be provided in the future.

12 Billed customers $20,000 for services performed during the month.

19 Paid $500 to purchase supplies.

20 Provided $1,500 of services for the customer who paid in advance on January 9.

23 Collected $5,000 owing from customers from the January 12 transaction.

26 Received a bill for utilities of $125, due February 26.

29 Paid rent for the month, $1,500.

31 Paid $4,000 of salaries to employees.

31 Paid interest of $300 on the bank loan from the January 6 transaction.

31 Paid income tax for the month, $3,600.

Instructions

(a) For each of the above transactions, prepare a (1) basic analysis, (2) equation analysis, and (3) debit–credit analysis.

(b) Prepare journal entries to record the above transactions.

P3–5B Th e Mountain Biking Corp. opened on April 1. Th e following selected events and transactions occurred during April:

Apr. 1 Issued common shares for $100,000 cash.

3 Purchased an out-of-use ski hill costing $370,000, paying $60,000 cash and signing a bank loan

payable for the balance. Th e $370,000 purchase price consisted of land $204,000; buildings $121,000;

and equipment $45,000.

8 Purchased advertising space of $1,800 on account.

10 Paid salaries to employees, $2,800.

13 Hired a park manager at a salary of $4,000 per month, eff ective May 1.

14 Paid $5,500 for a one-year insurance policy.

17 Paid $600 of dividends to shareholders.

20 Received $10,600 in cash from customers for admission fees.

30 Paid $1,800 on account for the advertising purchased on April 8.

30 Paid $2,000 of interest on the bank loan.

30 Paid an income tax instalment of $800.

Instructions

Journalize the April transactions.

P3–6B During the fi rst month of operations, the following events and transactions occurred for Astromech Accounting

Services Inc.:

May 1 Issued common shares for $20,000 cash.

1 Paid offi ce rent of $950 for the month.

4 Hired a secretary-receptionist at a salary of $2,000 per month. She started work the same day.

4 Purchased $750 of supplies on account from Read Supply Corp.

11 Completed an income tax assignment and billed client $2,725 for services provided.

12 Received $3,500 in advance on a management consulting engagement.

15 Received $2,350 for services completed for Arnold Corp.

20 Received $1,725 from client for work completed and billed on May 11.

22 Paid one third of balance due to Read Supply Corp. (See May 4 transaction.)

25 Received a $275 telephone bill for May, to be paid next month. (Hint: Use the Offi ce Expense

account to record telephone services.)

29 Paid secretary-receptionist $2,000 salary for the month.

29 Paid monthly income tax instalment, $300.

29 Paid $250 dividend.

Instructions

(a) Journalize the transactions.

(b) Using T accounts, post the May journal entries to the general ledger.

(c) Aft er the accountant fi nished journalizing and posting the above transactions, she complained that this process took

too much time. She thought it would be more effi cient to omit the journal entry step in the accounting cycle and record

the transactions directly in the general ledger. Explain to the accountant whether you think this is a good idea or not,

and why.

P3–7B On March 31, 2015, the Lake Th eatre, Inc.’s general ledger showed Cash $6,000; Land $100,000; Buildings $80,000;

Equipment $25,000; Accounts Payable $5,000; Mortgage Payable $125,000; Common Shares $50,000; and Retained

Earnings $31,000. During the month of April, the following events and transactions occurred:

Apr. 2 Paid fi lm rental fee of $800 on fi rst movie. (Hint: Lake Th eatre uses the account Rent Expense to

record fi lm rentals.)

3 Paid advertising expenses, $620.

3 Hired Th oms Limited to operate concession stand. Th oms agrees to pay the Lake Th eatre 20%

of gross concession receipts, payable monthly, for the right to operate the concession stand. (Hint:

Lake Th eatre uses the account Concession Revenue to record concessions earned.)

6 Ordered two additional fi lms at $750 each.

11 Received $1,950 from customers for admissions. (Hint: Lake Th eatre uses the account Fees Earned

to record revenue from admissions.)

16 Paid $2,000 of the balance due on the mortgage. Also paid $850 in interest on the mortgage.

17 Paid $2,800 of the accounts payable.

20 Received one of the fi lms ordered on April 6 and was billed $750. Th e fi lm will be shown in April.

25 Received $7,300 from customers for admissions.

26 Paid salaries, $1,900.

27 Prepaid $700 rental fee on special fi lm to be run in May. (Hint: Use the account Prepaid Rent to

record rental fees paid in advance.)

30 Received statement from Th oms showing gross concession receipts of $5,600 and the balance due

to the Lake Th eatre of $1,120 ($5,600 3 20%) for April. Th oms paid half of the balance due and will

remit the remainder on May 5.

30 Paid $1,000 for the monthly income tax instalment.

Instructions

(a) Using T accounts, enter the beginning balances in the ledger as at March 31.

(b) Journalize the April transactions.

(c) Post the April journal entries to the ledger.

(d) Prepare a trial balance at April 30.

P3–8B KG Spring Skating School Inc. had the following account balances as at April 30, 2012: Cash $23,000; Equipment

$2,000; Accounts Payable $500; Unearned Revenue (for advance registration fees) $17,500; Common Shares $1,000; and

Retained Earnings $6,000. Th e following events and transactions occurred during May:

May 4 Paid for ice time for fi rst two weeks of the May school, $7,200. (Hint: Use the account Rent Expense

to record ice rentals.)

9 Paid accounts payable outstanding at April 30.

11 Booked ice with the city for the July session. It will cost $14,400.

11 Received and paid a bill for $500 for advertising of the May skating school.

15 Paid coaches and assistant coaches, $1,000.

18 Paid for ice time for second two weeks of the May school, $7,200.

21 Received a bill for Internet service for $100. Th is invoice is due on June 15. (Hint: Use the account

Offi ce Expense to record Internet costs.)

29 Last day of May session. All of the advance registration fees have now been earned.

29 Paid $200 cash for supplies used immediately.

29 Received advance registrations for the next four-week skating session in July, $2,200.

29 Purchased gift s for volunteers who helped out during May session, $300. (Hint: Use the account

Advertising Expense to record gift s.)

29 Paid coaches and assistant coaches, $1,000.

31 Paid income tax instalment for the month, $1,100.

Instructions

(a) Using T accounts, enter the beginning balances in the general ledger as at April 30.

(b) Journalize the May transactions.

(c) Post the May journal entries to the general ledger.

(d) Prepare a trial balance as at May 31.

P3–9B You are presented with the following alphabetical list of accounts and balances (in thousands) for Asian Importers

Limited as at January 31, 2015:

Accounts payable $ 46,300 Goodwill $ 7,600

Accounts receivable 30,200 Income tax expense 14,000

Accumulated depreciation—buildings 13,000 Interest expense 2,150

Accumulated depreciation—equipment 3,600 Land 42,500

Buildings 39,500 Merchandise inventory 74,250

Bank loan payable (due 2018) 10,050 Mortgage payable 19,750

Cash 6,000 Offi ce expense 67,750

Common shares 32,900 Other current liabilities 12,200

Cost of goods sold 244,200 Prepaid insurance 3,950

Dividends 1,850 Retained earnings, February 1, 2014 37,050

Equipment 10,900 Sales 370,000

Instructions

(a) Prepare a trial balance, sorting each account balance into the debit column or the credit column.

(b) If debits equal credits in Asian’s trial balance, do you have reasonable assurance that no errors exist? Explain.

P3–10B Refer to the trial balance for Asian Importers prepared in P3–9B. In addition to this information, note that

during the year, common shares in the amount of $12,900 were issued and $6,300 of the mortgage is currently due.

Instructions

Prepare an income statement, statement of changes in equity, and statement of fi nancial position for the ye

P3–11B Th e following trial balance of Messed Up Ltd., at the end of its fi rst year of operations, May 31, 2015, does not

balance:

Debit Credit

Cash $ 2,997

Accounts receivable 2,630

Equipment 9,200

Accumulated depreciation—equipment 4,200

Accounts payable 4,600

Common shares 4,250

Retained earnings, May 31, 2015 $ 2,147

Service revenue 14,529

Salaries expense 8,150

Advertising expense 1,132

Depreciation expense 2,100

Insurance expense 600

Income tax expense 400

$27,877 $29,058

Each of the listed accounts has a normal balance per the general ledger. However, each account may not have been

listed in the appropriate debit or credit column, or may not belong in the trial balance at all. An examination of the general

ledger and general journal reveals the following errors:

  1. Prepaid Insurance, Accounts Payable, and Income Tax Expense were each understated by $100.
  2. A transposition (reversal of digits) error was made in Service Revenue. Based on the posting made, the correct

balance was $14,259.

  1. A $750 dividend paid to shareholders was debited to Salaries Expense and credited to Cash.
  2. A $120 collection on account was recorded as a debit to Accounts Payable and a credit to Accounts Receivable.
  3. A $2,000 bank loan was signed in exchange for the purchase of equipment. Th e transaction was neither journalized

nor posted.

Instructions

Prepare the correct trial balance.

 

CHAPTER 4 Accrual Accounting Concepts

 

Questions

  1. Why are adjusting entries needed? Include in

your explanation a description of the recognition

criteria that relate to adjusting the accounts.

(SO 1) 2. Tony Galego, a lawyer, accepts a legal engagement

in March, does the work in April, bills

the client $8,000 in May, and is paid in June. If

Galego’s law fi rm prepares monthly fi nancial

statements, when should it recognize revenue

from this engagement? Why?

(SO 1) 3. In completing the engagement in question 2,

Tony Galego incurs expenses that are specifi cally

related to this engagement as follows: none

in March, $4,500 in April, and none in May and

June. How much expense should be deducted

from revenue in the month(s) when the revenue

is recognized? Why?

(SO 1) 4. How does the cash basis of accounting diff er

from the accrual basis of accounting? Which

basis gives more useful information for decisionmaking?

Why?

(SO 2) 5. Th e name “prepaid expense” implies that this

type of account is an expense account and

belongs on an income statement. However,

these accounts actually appear on the statement

of fi nancial position as assets. Explain (a) why

prepaid expense items are assets, and (b) why

they require adjustment at the end of each

period.

(SO 2) 6. Th e name “unearned revenue” implies that

this type of account is a revenue account and

belongs on an income statement. However, these

accounts actually appear on the statement of

fi nancial position as liabilities. Explain (a) why

unearned revenue items are liabilities, and

(b) why they require adjustment at the end of

each period.

  1. “Depreciation is a process of valuation that

results in the reporting of the fair value of the

asset.” Do you agree? Explain.

(SO 2) 8. Explain the diff erence between (a) depreciation

expense and accumulated depreciation, and

(b) cost and carrying amount.

(SO 2) 9. What is a contra asset account? Why do we use

a contra asset account to record accumulated

depreciation instead of directly reducing the

depreciable asset account?

  1. “An adjusting entry aff ects at least one statement

of fi nancial position and one income statement

account.” Do you agree? Why or why not?

  1. Adjusting entries for prepayments always include

the Cash account, and adjusting entries for accruals

never include the Cash account. Do you

agree? Why or why not?

  1. Th e original journal entry must fi rst be examined

before an adjusting entry for a prepayment can

be prepared. Why is this not also the case for an

adjusting entry for an accrual?

(SO 3) 13. A company makes an accrued revenue adjusting

entry for $780 and an accrued expense adjusting

entry for $510. How much was profi t overstated

or understated prior to these adjusting entries?

Explain.

(SO 3) 14. Reactor Corp. has incurred utility costs for the

month of December, but the utility company

does not send out its bills until the 15th of the

following month. Reactor does not plan on

recording the utility costs until it receives the

bill on January 15. Assuming Reactor prepares

adjusting entries monthly, when should it record

these costs—in December or in January? Identify

the date of the entry you believe should be used

and which accounts should be debited and

credited.

(SO 4) 15. Why is it appropriate to prepare fi nancial statements

directly from an adjusted trial balance but

not from an unadjusted trial balance?

  1. How do adjusting journal entries diff er from

transaction entries recorded on a daily basis?

How do closing journal entries diff er from

adjusting journal entries?

  1. Explain how an unadjusted trial balance,

adjusted trial balance, and post-closing trial

balance are similar, and how they diff er. How

oft en, and when, should each one be prepared?

  1. Why is the retained earnings balance on the

unadjusted trial balance the same amount that

appears on the adjusted trial balance? Why is the

retained earnings balance on an adjusted trial

balance diff erent from the amount that appears

on the post-closing trial balance?

(SO 5) 19. What are two reasons for recording closing

entries?

(SO 5) 20. Why is the account Dividends not closed with

the expense accounts?

(SO 5) 21. Identify whether the Income Summary account

would be debited or credited when making each

of the four closing entries, assuming the company

has (a) profi t for the year, and (b) a loss for

the year.

(SO 5) 22. Which steps in the accounting cycle may be done

daily, which steps are done on a periodic basis

(monthly or quarterly), and which steps are usually

done only at the company’s fi scal year end?

Brief Exercises

BE4–1 Transactions that aff ect cash do not necessarily aff ect profi t. Identify the impact, if any, of each of the following

transactions on cash and profi t. Th e fi rst transaction has been completed for you as an example.

Cash Profi t

(a) Purchased supplies for cash, $100 2$100 $0

(b) Made an adjusting entry to record use of $75 of the supplies in (a).

(c) Performed services on account, $1,000.

(d) Received $800 from customers in payment of their account in (c).

(e) Purchased equipment for cash, $5,000.

(f) Made an adjusting entry to record depreciation of equipment in (e),

$1,000.

(g) Obtained a $1,000 bank loan.

(h) Made an adjusting entry to accrue interest on the loan in (g), $50.

(i) Received $500 cash for services to be provided in the future.

(j) Made an adjusting entry relating to the amount received in (i) to

show that $200 of the services had now been provided.

(k) Made an adjusting entry to record utilities incurred but not yet

paid, $250.

BE4–2 Blindleia Care Corporation had the following selected transactions in September:

  1. Collected $200 cash from customers for services provided in August.
  2. Collected $500 cash from customers for services provided in September.
  3. Billed customers $600 for services provided in September.
  4. Provided $100 services to customers who paid in advance in August.
  5. Received $100 from customers in advance for services to be provided in October.

(a) Calculate revenue for the month of September using the accrual basis of accounting.

(b) Calculate revenue for the month of September using the cash basis of accounting.

BE4−3 Sain Advertising Ltd.’s opening trial balance on January 1 shows Supplies $1,500. On May 1, the company

purchased additional supplies for $4,800 on credit. On December 31, there are $2,300 of supplies on hand.

(a) Prepare the journal entry to record the purchase of supplies on May 1.

(b) Calculate the amount of supplies used during the year.

(c) Prepare the adjusting entry required at December 31.

(d) Using T accounts, enter the opening balances in the aff ected accounts, post the journal entries in (a) and (c), and

indicate the adjusted balance in each account.

BE4−4 On January 2, 2015, the Claymore Corporation purchased a delivery truck for $50,000 cash. Th e company uses

straight-line depreciation and estimates that the truck will have a fi ve-year useful life. Th e company has a December 31

year end and adjusts its accounts annually.

(a) Prepare the journal entry to record the purchase of the delivery truck on January 2.

(b) Prepare the adjusting entries required on December 31, 2015 and 2016.

(c) Indicate the statement of fi nancial position presentation of the delivery truck at December 31, 2015 and 2016.

BE4−5 On June 1, 2015, Bere Ltd. pays $6,000 to Marla Insurance Corp. for a one-year insurance policy. Both companies

have fi scal years ending December 31 and adjust their accounts annually.

(a) Record the June 1 transaction on the books of (1) Bere and (2) Marla.

(b) Calculate the amount of insurance that expired during 2015 and the unexpired cost at December 31.

(c) Prepare the adjusting entry required on December 31 by (1) Bere and (2) Marla.

(d) Post the above entries and indicate the adjusted balance in each account.

BE4−6 Th e total weekly payroll for Classic Auto Repairs Ltd. is $5,000 ($1,000 per day). Th e payroll is paid every

Monday for employee salaries earned during the previous fi ve-day workweek (Monday through Friday, inclusive). Salaries

were last paid on Monday, November 28. Th is year the company’s year end, November 30, falls on a Wednesday. Salaries

will be paid next on Monday, December 5.

Prepare the journal entries to record each of the following:

(a) Payment of the salaries on November 28

(b) Th e adjustment to accrue salaries at November 30

(c) Payment of the salaries on December 5

BE4–7 Zieborg Maintenance Corp. has a $375 monthly contract with Crispy Treat Inc. for general maintenance services.

Zieborg invoices Crispy on the fi rst of the month for services that it provided in the previous month. Crispy must then pay

for these services by the 10th of the following month. Zieborg has a November 30 year end and prepares adjusting entries

monthly.

(a) Prepare any adjusting entry required on November 30 by Zieborg.

(b) Given your entry in (a), will Zieborg also need to record a journal entry on December 1 when it invoices Crispy for

services provided in November? Why or why not?

(c) Zieborg receives $375 from Crispy on January 10 for services provided in November. Prepare Zieborg’s journal

entry.

BE4–8 On July 1, 2015, Nakhooda Limited purchased a truck for $40,000, paying $10,000 cash and signing a 6% sixmonth

bank loan payable for the remainder.

Prepare the journal entries to record each of the following:

(a) Th e purchase of the truck on July 1

(b) Th e accrual of interest at year end, December 31, assuming interest has not previously been accrued

(c) Repayment of the interest and the loan on January 1, 2016

BE4–9 Fill in the missing amounts in the following income tax schedule for the Ducharme Corporation. Assume that

2013 was the company’s fi rst year of operations.

2013 2014 2015

Income tax expense $2,600 $3,600 $ (c)

Income tax payable (a) 500 700

Income tax paid 2,200 (b) 4,200

BE4–10 Th e Oromocto Corporation reports the following adjusted account balances, shown in alphabetical order, at the

end of its fi scal year, February 28, 2015:

Accounts payable $13,000 Income tax payable $ 50

Accounts receivable 28,000 Insurance expense 3,500

Accumulated depreciation—equipment 5,400 Prepaid insurance 2,500

Cash 8,000 Rent expense 6,000

Common shares 20,000 Retained earnings 21,000

Depreciation expense 4,400 Salaries payable 3,000

Dividends 2,000 Salaries expense 16,400

Equipment 23,450 Supplies 1,000

Fees earned 39,500 Supplies expense 4,000

Income tax expense 300 Utilities expense 2,400

Prepare an adjusted trial balance at February 28.

BE4–11 Refer to the data in BE4–10 for Oromocto Corporation. During the year ended February 28, 2015, common

shares were issued for $5,000. Prepare (a) an income statement, (b) a statement of changes in equity, and (c) a statement

of fi nancial position.

BE4–12 Refer to the data in BE4–10 for Oromocto Corporation. Prepare the closing journal entries.

BE4–13 Th e income statement for Regina Cleaning Services Ltd. for the year ended November 30 shows Service

Revenue $126,000; Salaries Expense $90,000; Repairs and Maintenance Expense $15,000; and Income Tax Expense $4,200.

Th e statement of changes in equity shows an opening balance for Retained Earnings of $50,000 and Dividends $5,000.

(a) Calculate the profi t or loss for the year.

(b) Prepare the closing journal entries.

(c) Using T accounts, post the closing entries, and determine the ending balances.

BE4–14 Th e following selected accounts appear in the adjusted trial balance for Maple Leaf Foods Inc. Identify which

accounts would be included in Maple Leaf Foods’ post-closing trial balance.

(a) Accounts receivable

(b) Interest expense

(c) Prepaid expenses

(d) Dividends

(e) Depreciation expense

(f) Accounts payable and accruals

(g) Cost of goods sold

(h) Retained earnings

(i) Accumulated depreciation

(j) Income tax expense

Prepare adjusted trial

balance.

(SO 4)

Prepare fi nancial

statements.

(SO 4)

Prepare closing entries.

(SO 5)

Prepare and post

closing entries.

(SO 5)

Identify post-closing

trial balance accounts.

(SO 5)

Exercises

E4–1 Th e following independent situations require professional judgement to determine when to recognize revenue

from the transactions:

(a) WestJet sells you a non-refundable one-way airline ticket in September for your fl ight home at Christmas.

(b) You pay for a one-year subscription to Maclean’s Magazine in March.

(c) Th e Toronto Blue Jays sell season tickets to games in the Rogers Centre. Th e season begins in April and ends in October.

You purchase your tickets in February.

(d) The RBC Financial Group loans you money in August. The loan and the interest are repayable in full in

November.

(e) In August, you order a sweater from Sears using its on-line catalogue. Th e sweater arrives in September and you charge

it to your Sears credit card. You receive and pay the Sears bill in October.

Instructions

Identify when revenue should be recognized in each situation.

 

E4–2 In its fi rst year of operations, Athabasca Corp. earned $52,000 in service revenue. Of that amount, $8,000 was on

account and the remainder, $44,000, was collected in cash from customers.

Th e company incurred various expenses totalling $31,000, of which $27,500 was paid in cash. At year end, $3,500 was

still owing on account. In addition, Athabasca prepaid $2,000 for insurance coverage that covered the last half of the fi rst

year and the fi rst half of the second year. Athabasca expects to owe $3,000 of income tax when it fi les its corporate income

tax return aft er year end.

Instructions

(a) Calculate the fi rst year’s profi t under the accrual basis of accounting.

(b) Calculate the fi rst year’s profi t under the cash basis of accounting.

(c) Which basis of accounting (accrual or cash) gives the most useful information for decision makers? Explain.

E4–3 Action Quest Games Inc. adjusts its accounts annually. Th e following information is available for the year ended

December 31, 2015:

  1. Purchased a one-year insurance policy on June 1, for $1,800 cash.
  2. Paid $6,500 on August 31 for fi ve months’ rent in advance.
  3. On September 4, received $3,600 cash in advance from a corporation to sponsor a game each month for a total of nine

months for the most improved students at a local school.

  1. Signed a contract for cleaning services starting December 1, for $1,000 per month. Paid for the fi rst two months on

November 30. (Hint: Use the account Prepaid Cleaning to record prepayments.)

  1. On December 5, received $1,500 in advance from a gaming club. Determined that on December 31, $475 of these

games had not yet been played.

Instructions

(a) For each of the above transactions, prepare the journal entry to record the initial transaction.

(b) For each of the above transactions, prepare the adjusting journal entry that is required on December 31. (Hint: Use the

account Sponsorship Revenue for item 3 and Repairs and Maintenance Expense for item 4.)

(c) Post the journal entries in parts (a) and (b) to T accounts and determine the fi nal balance in each account balance.

(Note: Posting to the Cash account is not required.)

E4–4 Acadia Inc. owns the following long-lived assets:

Asset Date Purchased Cost Estimated Useful Life

Vehicles Jan. 1, 2012 $28,000 7 years

Equipment July 1, 2013 12,000 3 years

Furniture Jan. 1, 2015 10,000 5 years

Instructions

(a) Prepare depreciation adjusting entries for each asset for the year ended December 31, 2015, assuming the company

adjusts its accounts annually.

(b) For each asset, calculate its accumulated depreciation and carrying amount at December 31, 2015.

E4–5 Greenock Limited has the following information available for accruals for the year ended December 31, 2015. Th e

company adjusts its accounts annually.

  1. Th e December utility bill for $425 was unrecorded on December 31. Greenock paid the bill on January 11.
  2. Greenock is open seven days a week and employees are paid a total of $3,500 every Monday for a seven-day

(Monday–Sunday) workweek. December 31 is a Th ursday, so employees will have worked four days (Monday,

December 28—Th ursday, December 31) that they have not been paid for by year end. Employees will be paid next

on January 4.

  1. Greenock signed a $45,000, 5% bank loan on November 1, 2014, due in two years. Interest is payable on the fi rst day

of each following month.

  1. Greenock receives a fee from Pizza Shop next door for all pizzas sold to customers using Greenock’s facility. Th e

amount owing for December is $300, which Pizza Shop will pay on January 4. (Hint: Use the Fees Earned account.)

  1. Greenock rented some of its unused warehouse space to a client for $6,000 a month, payable the fi rst day of the

following month. It received the rent for the month of December on January 2.

Instructions

(a) For each situation, prepare the adjusting entry required at December 31. Round all calculations to the nearest dollar.

(b) For each situation, prepare the journal entry to record the subsequent cash transaction in 2016.

E4–6 Th e CCBC Corporation had the following post-closing trial balance at the beginning of its fi scal year,

July 1, 2015:

Debit Credit

Cash $ 4,400

Accounts receivable 6,550

Supplies 1,200

Equipment 15,000

Accumulated depreciation—equipment $ 4,500

Unearned revenue 2,500

Common shares 5,000

Retained earnings 15,150

Totals $27,150 $27,150

During the month of July, the following selected transactions took place:

July 2 Paid $1,500 for two months’ rent in advance for July and August.

7 Purchased $200 of supplies on account.

14 Collected half of outstanding accounts receivable.

15 Borrowed $1,000 from the bank at an interest rate of 5%.

21 Received $1,000 cash from a customer for services to be provided in August.

28 Provided $1,500 of services to a customer on account.

Additional information:

  1. At July 31, the company had provided $800 of services for a client that it had not billed or recorded.
  2. Supplies on hand at July 31 were $500.
  3. Th e equipment has a 10-year useful life.
  4. Interest is due on the bank loan on the fi rst day of each following month, beginning August 1.
  5. As at July 31, the company owed $2,500 to its employees for the month just ended.
  6. As at July 31, the company had earned $2,000 of revenue that had been paid in advance.

Instructions

(a) Record the July transactions.

(b) Prepare adjusting entries at July 31, assuming the company prepares adjusting entries monthly. Round all

calculations to the nearest dollar.

E4–7 On March 31, 2015, Easy Rental Agency Inc.’s trial balance included the following unadjusted account

balances. Th e company’s year end is December 31 and it adjusts its accounts quarterly.

Debit Credit

Prepaid insurance $14,400

Supplies 2,800

Equipment 21,600

Accumulated depreciation—equipment $ 5,400

Unearned revenue 9,600

Loan payable 20,000

Rent revenue 30,000

Salaries expense 14,000

An analysis of the accounts shows the following:

  1. Th e equipment, which was purchased on January 1, 2014, is estimated to have a useful life of four

years.

  1. One-third of the unearned rent revenue is still unearned at the end of the quarter.
  2. Th e loan payable has an interest rate of 6%. Interest is paid on the fi rst day of each following month and

was last paid March 1, 2015.

  1. Supplies on hand total $850 at March 31.
  2. Th e one-year insurance policy was purchased for $14,400 on January 1.
  3. Income tax is estimated to be $3,200 for the quarter.

Instructions

Prepare the quarterly adjusting entries required at March 31, 2015.

E4–8 A partial adjusted trial balance follows for Nolet Ltd. at January 31, 2015. Th e company’s fi scal year end

is December 31 and it makes adjustments monthly.

D ebit Credit

Supplies $ 700

Prepaid insurance 1,600

Equipment 7,200

Accumulated depreciation—equipment $3,660

Income tax payable 150

Unearned revenue 750

Service revenue 2,000

Depreciation expense 60

Insurance expense 400

Supplies expense 950

Income tax expense 100

Instructions

(a) If $1,600 was received in December and these services were performed as expected in January, what was

the balance in Unearned Revenue at January 1? Assume there were no other transactions that aff ected

Unearned Revenue during this period.

(b) If the amount in the Depreciation Expense account is the depreciation for one month, when was the equipment

purchased? Assume that there have been no purchases or sales of equipment since this original

purchase.

(c) If the amount in Insurance Expense is the amount of the January 31 adjusting entry, and the original insurance

premium was for one year, what was the total premium and when was the policy purchased?

(d) If the amount in Supplies Expense is the amount of the January 31 adjusting entry, and $750 of supplies

were purchased in January, what was the balance in Supplies on January 1?

(e) If $100 was paid in January, what was the balance in Income Tax Payable at January 1?

E4–9 Fraser Valley Services Ltd. reports the following adjusted account balances, shown in alphabetical

order, at the end of its fi scal year, August 31, 2015:

Accounts payable $ 2,800 Interest expense $ 1,500

Accounts receivable 18,225 Interest payable 1,500

Accumulated depreciation—equipment 5,905 Prepaid insurance 3,450

Bank loan payable, due September 1, 2018 25,000 Rent expense 15,000

Cash 11,430 Rent payable 1,250

Common shares 5,000 Retained earnings 5,400

Depreciation expense 2,275 Salaries expense 19,200

Dividends 600 Salaries payable 2,200

Equipment 25,600 Service revenue 54,275

Income tax expense 2,000 Supplies 3,400

Income tax payable 1,500 Supplies expense 1,750

Insurance expense 1,100 Unearned revenue 700

Instructions

Prepare an adjusted trial balance.

E4–10 Th e adjusted trial balance for Fraser Valley Services Ltd. was prepared in E4–9. During the year, the

company issued common shares for $1,000.

Instructions

Prepare (a) an income statement, (b) a statement of changes in equity, and (c) a statement of fi nancial position.

E4–11 Th e adjusted trial balance for Fraser Valley Services Ltd. was prepared in E4–9.

Instructions

(a) Prepare the closing entries at August 31.

(b) Prepare a post-closing trial balance.

 

Problems: Set A

P4–1A Your examination of the records of Southlake Corp. shows the company collected $187,800 in cash from customers

and paid $109,400 in cash for operating costs in its fi rst year of operations. If Southlake followed the accrual basis of

accounting, it would report the following year-end balances in selected accounts:

Accounts payable $ 3,000

Accounts receivable 8,400

Accumulated depreciation 24,600

Income tax payable 15,800

Prepaid insurance 3,000

Unearned revenue 2,800

Instructions

(a) Calculate Southlake’s profi t on a cash basis for the year.

(b) Calculate Southlake’s profi t on an accrual basis for the year. (Hint: Start with the profi t calculated on a cash basis in (a)

and then adjust for prepayments and accruals.)

(c) Which basis of accounting do you recommend Southlake use? Why?

P4–2A Ouellette Corporation began operations on January 2. Its year end is December 31, and it adjusts its accounts

annually. Selected transactions for the current year follow:

  1. On January 2, purchased supplies for $4,100 cash. A physical count at December 31 revealed that $700 of supplies

were still on hand.

  1. Purchased a vehicle for $45,000 on April 1, paying $5,000 cash and signing a $40,000 bank loan for the balance. Th e

vehicle is estimated to have a useful life of fi ve years.

  1. Purchased a $3,600, one-year insurance policy for cash on August 1. Th e policy came into eff ect on that date.
  2. Received a $1,600 advance cash payment from a client on November 9 for services to be provided in the future. As at

December 31, half of these services had been completed.

  1. On December 1, the company rented additional offi ce space for a six-month period starting on December 1 for $1,200

each month. It paid rent for the months of December and January in advance on this date.

Instructions

(a) For each of the above situations, prepare the journal entry for the original transaction.

(b) For each of the above situations, prepare any adjusting entry required at December 31.

P4–3A Zheng Corporation had the following selected transactions in the month of March. Th e company adjusts its

accounts monthly.

  1. Th e company has an 8%, $12,000 bank loan payable due in one year. Interest is payable on the fi rst day of each

following month.

  1. At the end of March, the company earned $250 interest on its investments. Th e bank deposited this amount in Zheng’s

cash account on April 1.

  1. Zheng has fi ve employees who each earn $200 a day. Salaries are normally paid on Fridays for work completed

Monday through Friday of the same week. Salaries were last paid on Friday, March 27. March 31 falls on a Tuesday

this year. Salaries will be paid next on Friday, April 3.

  1. At the end of March, the company owed the utility company $550 and the telephone company $200 for services received

during the month. Th ese bills were paid on April 10. (Hint: Use the Offi ce Expense account for the telephone services.)

  1. At the end of March, Zheng has earned service revenue of $3,000 that it has not yet billed. It bills its clients for this

amount on April 4. On April 30, it collects $2,000 of this amount due.

Instructions

(a) For each of the above situations, prepare the adjusting journal entry required at March 31.

(b) For each of the above situations, prepare the journal entry to record the subsequent cash transaction in April.

P4–4A Th e following independent events for New Age Th eatre Ltd. during the year ended November 30, 2015, require a

journal entry or an adjusting journal entry, or both. Th e company adjusts its accounts annually.

  1. On June 1, 2014, the theatre purchased vehicles for $80,000 cash. Th e vehicles’ estimated useful life is fi ve years.
  2. Th e theatre has eight plays each season. Th is year’s season starts in October 2015 and ends in May 2016 (one play per

month). Season tickets sell for $320. On October 1, 400 season tickets were sold for the 2015–2016 season. Th e theatre

credited Unearned Revenue for the full amount received on October 1 and uses a Ticket Revenue account to record

revenue earned from season tickets.

  1. Supplies on hand amounted to $1,000 at the beginning of the year. On February 17, additional supplies were purchased

for cash at a cost of $2,100. At the end of the year, a physical count showed that supplies on hand amounted to $500.

  1. On June 1, 2015, the theatre borrowed $100,000 from the Bank of Montreal at an interest rate of 6%. Th e principal is

to be repaid in one year. Th e interest is payable on the fi rst day of each following month.

  1. Th e New Age Th eatre rents a portion of its facilities for $400 a month to a local dance club that uses the space for

rehearsals. On November 2, the club’s treasurer accidentally sent a cheque for only $200 for the November rent. She

promised to send a cheque in December for the balance when she returned from vacation. On December 4, the theatre

received a $600 cheque for the balance owing from November plus all of December’s rent.

  1. Th e total weekly payroll is $7,000, paid every Monday for employee salaries earned during the prior seven-day week

(Sunday to Saturday). Salaries were last paid (and recorded) on Monday, November 30, and will be paid next on

Monday, December 7.

  1. Upon reviewing its income tax calculations on November 30, the theatre noted that an additional $1,250 of income

tax was owed. Th is additional amount was paid on December 29.

Instructions

(a) Prepare the journal entry to record the original transaction for items 1, 2, 3, 4, and 5.

(b) Prepare the year-end adjusting entry required for items 1 through 7 on November 30.

(c) Record the subsequent cash transactions in December for (1) the interest paid on December 1 (item 4), (2) the

cheque received on December 4 (item 5), (3) the payroll paid on December 7 (item 6), and (4) the income tax paid on

December 29 (item 7).

P4–5A A review of the ledger of Chance Corporation at July 31, 2015, produces the following unadjusted data for the

preparation of annual adjusting entries:

  1. Prepaid Insurance, July 31 unadjusted balance, $11,700: Th e company has separate insurance policies on its building and

its vehicles. Policy B4564 on the building was purchased on December 1, 2013, for $10,800. Th e policy has a term of two

years. Policy A2958 on the vehicles was purchased on February 1, 2015, for $4,500. Th is policy has a term of 18 months.

  1. Buildings, July 31 unadjusted balance, $444,000: Th e company owns two buildings. Th e fi rst was purchased on

September 1, 2001, for $252,000 and has an estimated 30-year useful life. Th e second was purchased on May 1, 2009,

for $192,000 and has an estimated 40-year useful life.

  1. Unearned Revenue, July 31 unadjusted balance, $51,000: Th e selling price of a magazine subscription is $50 for 12

monthly issues. A review of subscription contracts reveals the following:

Subscription Date Number of Subscriptions Sold

November 1, 2014 220

February 1, 2015 310

May 1, 2015 490

1,020

  1. Salaries Payable, July 31 unadjusted balance, $0: Th ere are nine salaried employees. Salaries are paid every Monday

for the previous six-day workweek (Monday to Saturday). Six employees receive a salary of $625 each per week, and

three employees earn $750 each per week. July 31 is a Friday.

Instructions

(a) Prepare a calculation to show why the unadjusted balance in the Prepaid Insurance account is $11,700 and why the

unadjusted balance in the Unearned Revenue account is $51,000.

(b) Prepare the adjusting journal entries required at July 31. (Hint: Use the account Subscription Revenue for item 3.)

P4–6A Near the end of its fi rst year of operations, December 31, 2015, Creative Designs Ltd. approached the local bank

for a $20,000 loan and was asked to submit fi nancial statements prepared on an accrual basis. Although the company kept

no formal accounting records, it did maintain a record of cash receipts and payments. Th e following information is available

for the year ended December 31:

Cash Receipts Cash Payments

Issue of common shares $ 20,000

Fees earned 157,600

Equipment $ 35,400

Supplies 6,800

Rent 20,000

Insurance 3,840

Income tax 6,000

Advertising 6,800

Salaries 59,800

Offi ce expense 1,800

Dividends 10,000

$177,600 $150,440

Additional information:

  1. Fees from design work earned but not yet collected amounted to $2,400.
  2. Th e equipment was purchased at the beginning of January and has an estimated six-year useful life.
  3. Supplies on hand on December 31 were $1,260.
  4. Rent payments included a $1,500 per month rental fee and a $2,000 deposit that is refundable at the end of the twoyear

lease. (Hint: Use the Prepaid Rent account for the refundable deposit.)

  1. Th e insurance was purchased on February 1 for a one-year period expiring January 31, 2016.
  2. Salaries earned for the last four days in December and to be paid in January 2016 amounted to $3,050.
  3. At year end, it was determined that an additional $7,000 is owed for income tax.

Instructions

(a) Calculate the cash balance at December 31.

(b) Prepare an accrual-based (1) income statement, (2) statement of changes in equity, and (3) statement of fi nancial

position.

P4–7A Th e following is River Tours Limited’s unadjusted trial balance at its year end, November 30, 2015. Th e company

adjusts its accounts annually.

Debit Credit

Cash $ 1,800

Accounts receivable 2,640

Supplies 965

Prepaid rent 2,400

Prepaid insurance 7,320

Equipment 13,440

Accumulated depreciation—equipment $ 3,360

Boats 140,400

Accumulated depreciation—boats 46,800

Accounts payable 1,925

Unearned revenue 14,000

Bank loan payable 54,000

Common shares 10,000

Retained earnings 27,225

Fees earned 110,575

Salaries expense 69,560

Repairs and maintenance expense 11,170

Rent expense 13,200

Interest expense 3,465

Advertising expense 825

Income tax expense 700

$267,885 $267,885

Additional information:

  1. Th e insurance policy has a one-year term beginning April 1, 2015. At that time, a premium of $7,320 was paid.
  2. Th e equipment has an estimated useful life of 8 years. Th e boats have an estimated useful life of 12 years.
  3. A physical count shows $300 of supplies on hand at November 30.
  4. Th e bank loan payable has a 7% interest rate. Interest is paid on the fi rst day of each following month.
  5. Deposits of $1,400 each were received for advance tour reservations from 10 school groups. At November 30, all of

these deposits have been earned.

  1. Employees are owed a total of $500 at November 30.
  2. A senior citizens’ organization that had not made an advance deposit took a river tour for $1,250. Th is group was not

billed until December for the services provided.

  1. Additional advertising costs of $260 have been incurred, but the bills have not been received by November 30.
  2. On November 1, the company paid $2,400 rent in advance for November and December.
  3. Income tax payable for the year is estimated to be an additional $300 beyond that recorded to date.

Instructions

(a) Prepare T accounts, and enter the unadjusted trial balance amounts.

(b) Prepare and post the adjusting journal entries required at November 30.

(c) Prepare an adjusted trial balance at November 30.

P4–8A On October 31, 2015, the Alou Equipment Repair Corp.’s post-closing trial balance was as follows. Th e company

adjusts its accounts monthly.

Debit Credit

Cash $15,580

Accounts receivable 15,820

Supplies 4,000

Equipment 18,000

Accumulated depreciation—equipment $ 3,600

Accounts payable 4,600

Salaries payable 1,000

Unearned revenue 1,000

Common shares 10,000

Retained earnings 33,200

$53,400 $53,400

During November, the following transactions were completed:

Nov. 9 Paid $2,200 to employees for salaries due, of which $1,000 is for October salaries payable and

$1,200 for November.

12 Issued common shares for $5,000.

13 Received $12,400 cash from customers in payment of accounts.

19 Received $11,400 cash for services performed in November.

20 Purchased supplies on account, $600.

21 Paid creditors $4,600 of accounts payable due.

23 Paid November rent, $600.

23 Paid salaries, $2,400.

27 Performed services on account, $3,800.

28 Paid a cash dividend, $500.

30 Received $1,100 from customers for services to be provided in the future.

Adjustment data for the month:

  1. Supplies on hand are $1,000.
  2. Accrued salaries payable are $1,000.
  3. Th e equipment has an estimated useful life of fi ve years.
  4. Unearned revenue of $800 was earned during the month.
  5. Income tax payable is estimated to be $1,100.

Instructions

(a) Prepare T accounts, and enter the opening balances at November 1.

(b) Prepare and post the November transaction entries.

(c) Prepare a trial balance at November 30.

(d) Prepare and post the adjusting journal entries for the month.

(e) Prepare an adjusted trial balance at November 30.

(f) Prepare (1) an income statement, (2) a statement of changes in equity, and (3) a statement of fi nancial position.

P4–9A Refer to the data for Alou Equipment Repair Corp. in P4−8A. Assume that Alou closes its books monthly.

Instructions

(a) Prepare the closing journal entries.

(b) Post the closing entries to the T accounts prepared in P4–8A.

(c) Prepare a post-closing trial balance at November 30.

P4–10A Accounts from the adjusted trial balance at September 30, 2015, are listed in alphabetical order below for Ozaki

Corp.:

Accounts payable $ 4,460 Income tax payable $ 200

Accounts receivable 8,435 Interest expense 105

Accumulated depreciation—equipment 750 Interest payable 105

Bank loan payable 7,800 Rent expense 1,500

Cash 3,250 Retained earnings 2,600

Common shares 7,000 Salaries expense 13,840

Depreciation expense 750 Salaries payable 840

Dividends 700 Supplies 1,265

Equipment 15,040 Supplies expense 485

Fees earned 22,485 Unearned revenue 550

Income tax expense 600 Utilities expense 820

Instructions

(a) Prepare an adjusted trial balance.

(b) Prepare the closing journal entries.

(c) Prepare a post-closing trial balance at September 30.

P4–11A Th e following is the unadjusted trial balance for Rainbow Lodge Ltd. at its year end, May 31, 2015. Th e company

adjusts its accounts monthly.

Debit Credit

Cash $ 6,400

Accounts receivable 11,800

Supplies 4,880

Prepaid insurance 4,550

Land 106,370

Buildings 168,000

Accumulated depreciation—buildings $ 16,800

Furniture 33,600

Accumulated depreciation—furniture 13,440

Accounts payable 8,140

Unearned revenue 17,500

Mortgage payable, due in 2019 126,000

Common shares 60,000

Retained earnings 41,580

Dividends 2,000

Rent revenue 200,320

Salaries expense 98,700

Utilities expense 23,870

Interest expense 9,240

Insurance expense 6,370

Advertising expense 1,000

Income tax expense 7,000

$483,780 $483,780

Additional information:

  1. An annual insurance policy was purchased for the fi rst time on October 1, 2014, for $10,920 cash.
  2. A count of supplies shows $1,340 of supplies on hand on May 31.
  3. Th e buildings have an estimated useful life of 20 years.
  4. Th e furniture has an estimated useful life of fi ve years.
  5. Customers must pay a $100 deposit if they want to book a room in advance during the peak period. An analysis of

these bookings indicates that 175 deposits were received and credited to Unearned Revenue. By May 31, 25 of the

deposits were earned.

  1. On May 25, a local business contracted with Rainbow Lodge to rent one of its housekeeping units for four months,

starting June 1, at a rate of $2,800 per month. An advance payment equal to one month’s rent was paid on May 25 and

credited to Rent Revenue.

  1. On May 31, Rainbow Lodge has earned $1,780 of rent revenue from customers who are currently staying at the inn.

Th e customers will only pay the amount owing when they check out in early June.

  1. Salaries of $1,590 are unpaid at May 31.
  2. Th e mortgage interest rate is 8%. Interest has been paid to May 1; the next payment is due June 1.
  3. Th e May utility bill of $2,240 has not yet been recorded or paid.
  4. Additional income tax is estimated to be $1,000.
  5. During the month of May, $4,000 of common shares were issued. (Note: Th is has already been recorded.)

Instructions

(a) Prepare T accounts, and enter the trial balance amounts.

(b) Prepare and post the adjusting journal entries for the month.

(c) Prepare an adjusted trial balance at May 31.

(d) Prepare (1) an income statement, (2) a statement of changes in equity, and (3) a statement of fi nancial position for

the year.

(e) A friend of yours is considering investing in the company and asks you to comment on the company’s operations and

fi nancial position. Is the company performing well or not? Does the fi nancial position look healthy or weak? Use specifi

c information from the fi nancial statements to support your answer.

P4–12A Refer to the data for Rainbow Lodge Ltd. in P4–11A.

Instructions

(a) Prepare the closing journal entries.

(b) Post the closing entries to the T accounts prepared in P4–11A.

(c) Prepare a post-closing trial balance at May 31.

Problems: Set B

P4–1B Your examination of the records of Northland Corp. shows the company collected $78,100 in cash from customers

and paid $53,900 in cash for operating costs in its fi rst year of operations. If Northland followed the accrual basis of accounting,

it would report the following year-end balances in selected accounts:

Accounts payable $ 905

Accounts receivable 1,450

Accumulated depreciation 8,625

Income tax payable 4,600

Prepaid insurance 810

Unearned revenue 700

Instructions

(a) Calculate Northland’s profi t on a cash basis for the year.

(b) Calculate Northland’s profi t on an accrual basis for the year. (Hint: Start with the profi t calculated on a cash basis in (a)

and then adjust for prepayments and accruals.)

(c) Which basis of accounting do you recommend Northland use? Why?

P4–2B Bourque Corporation began operations on January 2. Its year end is December 31, and it adjusts its accounts

annually. Selected transactions for the current year follow:

  1. On January 2, purchased supplies for $2,100 cash. A physical count at December 31 revealed that $550 of supplies

were still on hand.

  1. Purchased equipment for $20,000 cash on March 1. Th e equipment is estimated to have a useful life of fi ve years.
  2. Purchased a one-year, $5,040 insurance policy for cash on June 1. Th e policy came into eff ect on that date.
  3. On November 15, received a $1,275 advance cash payment from three clients for services to be provided in the future.

As at December 31, work had been completed for two of the clients ($425 each).

  1. On December 15, the company paid $2,500 rent in advance for the next month (January).

Instructions

(a) For each of the above situations, prepare the journal entry for the original transaction.

(b) For each of the above situations, prepare any adjusting journal entry required at December 31.

P4–3B Hangzhou Corporation had the following selected transactions in the month of November. Th e company adjusts

its accounts monthly.

  1. Hangzhou has a biweekly payroll of $6,000. Salaries are normally paid every second Monday for work completed for

the two preceding weeks. Employees work a fi ve-day week, Monday through Friday. Salaries were last paid Monday,

November 23, and will be paid next on Monday, December 7.

  1. Th e company has a 7%, $20,000 bank loan payable due September 1 of the next year. Interest is payable on the fi rst

day of each following month.

  1. At the end of November, Hangzhou has $1,000 of invoices for services provided to customers that have not yet been

sent. It mails these invoices on December 1, and collects the amounts due on December 21.

  1. At the end of November, the company earned $10 interest on the cash in its bank account. Th e bank deposited this

amount in the company’s cash account on December 1.

  1. At the end of November, it was estimated that the company owed $1,000 of income tax. Th is amount was paid on

December 18.

Instructions

(a) For each of the above situations, prepare the adjusting journal entry required at November 30.

(b) For each of the above situations, prepare the journal entry to record the subsequent cash transaction in December.

P4–4B Th e following independent events for Repertory Th eatre Ltd. during the year ended December 31, 2015, require

a journal entry or an adjusting journal entry, or both. Th e company adjusts its accounts annually.

  1. Supplies on hand amounted to $1,500 at the beginning of the year. On March 1, additional supplies were purchased

for $5,250 cash. At the end of the year, a physical count showed that supplies on hand amounted to $1,000.

  1. Th e theatre owns a truck that was purchased on January 2, 2015, for $120,000. Th e truck’s estimated useful life is four years.
  2. Th e theatre has nine plays each season, which starts in September 2015 and ends in May 2016 (one play per month).

Season tickets sell for $360. On August 21, 600 season tickets were sold for the upcoming 2015–2016 season. Th e

theatre credited Unearned Revenue for the full amount received on August 21 and uses a Ticket Revenue account to

record revenue earned from season tickets.

  1. On June 1, the theatre borrowed $30,000 from La Caisse Populaire Desjardins at an interest rate of 6%, to be repaid in

one year. Th e interest is payable on the fi rst day of each following month.

  1. Th e total weekly payroll is $9,000, paid every Monday for employee salaries earned during the prior six-day workweek

(Tuesday to Sunday). Th is year, December 31 falls on a Th ursday. Salaries were last paid (and recorded) on Monday,

December 28, and will be paid next on Monday, January 4.

  1. Repertory Th eatre rents a portion of its facilities for $600 a month to a local seniors’ choir that uses the space for

rehearsals. Th e choir’s treasurer was ill during December, and on January 6, the theatre received a cheque for both the

amount owing for the month of December and the rent for the month of January.

  1. Upon reviewing its books on December 31, the theatre noted that a telephone bill for the month of December

had not yet been received. A call to Aliant determined that the telephone bill was for $1,125. Th e bill was paid on

January 12. (Hint: Use the Offi ce Expense account for telephone services.)

Instructions

(a) Prepare the journal entry to record the original transaction for items 1, 2, 3, and 4.

(b) Prepare the year-end adjusting entry required for items 1 through 7 on December 31.

(c) Record the subsequent cash transaction in January for (1) the interest paid on January 1 (item 4), (2) payment of the

payroll on January 4 (item 5), (3) receipt of the rent on January 6 (item 6), and (4) payment of the telephone bill on

January 12 (item 7).

P4–5B A review of the ledger of Greenberg Corporation at October 31, 2015, produces the following unadjusted data for

the preparation of annual adjusting entries:

  1. Prepaid Advertising, October 31 unadjusted balance, $14,160: Th e company has two advertising contracts in two

trade magazines that publish monthly, with the fi rst advertisement running in the month following the month in

which the contract is signed. Contract A650 was signed February 1 to run in 12 magazine issues, starting March 1 for

$520 per month. Contract B974 was signed June 1 to run in 16 magazine issues starting July 1 for $495 per month.

  1. Unearned Revenue, October 31 unadjusted balance, $303,000: Th e company began subleasing offi ce space in its new

building on September 1. At October 31, the company had the following rental contracts that are paid in full for the

entire term of the lease.

Date

Term

(in months) Monthly Rent Number of Leases

Sept. 1 6 $4,500 5

Oct. 1 6 7,000 4

  1. Bank Loan Payable, October 31 unadjusted balance, $90,000: Th is represents a one-year, 8% bank loan signed on

April 1. Interest is payable at maturity.

  1. Vehicles, October 31 unadjusted balance, $39,000: Th e company owns a delivery truck, purchased for $39,000 on

April 1, 2014. Th e truck has a fi ve-year useful life.

Instructions

(a) Prepare a calculation to show why the unadjusted balance in the Prepaid Advertising account is $14,160 and why the

unadjusted balance in the Unearned Revenue account is $303,000.

(b) Prepare the adjusting journal entries required at October 31.

P4–6B Th e Radical Edge Ltd., a ski tuning and repair shop, opened November 1, 2014. Although the company did not

keep any formal accounting records, it did maintain a record of cash receipts and payments. Th e following information is

available at the end of the fi rst ski season, April 30, 2015:

Cash Receipts Cash Payments

Issue of common shares $20,000

Ski and snowboard repair services 66,500

Repair equipment $47,040

Rent 4,550

Insurance 2,760

Advertising 920

Utility bills 1,900

Salaries 7,200

Income tax 6,000

$86,500 $70,370

Additional information:

  1. At the end of April, customers owe Th e Radical Edge $1,440 for services they have received and not yet paid for.
  2. Th e repair equipment was purchased at the beginning of November and has an estimated useful life of eight years.
  3. On November 1, the company began renting space at a cost of $650 per month on a one-year lease. As required by the

lease contract, the company paid the last month’s (October 2015) rent in advance.

  1. Th e insurance policy was purchased November 1 and is eff ective for one year.
  2. At April 30, $4,240 is owed for unpaid salaries.
  3. At April 30, it was determined that an additional $800 is owed for income tax.

Instructions

(a) Calculate the cash balance at April 30.

(b) Prepare an accrual-based (1) income statement, (2) statement of changes in equity, and (3) statement of fi nancial position

for the six months ended April 30.

P4–7B Th e following is Ortega Limo Service Ltd.’s unadjusted trial balance at its year end, December 31, 2015. Th e company

adjusts its accounts annually.

Debit Credit

Cash $ 4,600

Accounts receivable 8,220

Supplies 2,500

Prepaid insurance 3,600

Prepaid rent 2,300

Vehicles 58,000

Accumulated depreciation—vehicles $ 14,500

Furniture 16,000

Accumulated depreciation—furniture 4,000

Unearned revenue 3,600

Bank loan payable, due September 1, 2019 27,475

Common shares 5,000

Retained earnings 7,600

Dividends 3,800

Service revenue 115,600

Salaries expense 57,000

Rent expense 12,650

Repairs and maintenance expense 4,690

Interest expense 2,415

Income tax expense 2,000

$177,775 $177,775

Additional information:

  1. Th e insurance policy has a one-year term beginning March 1, 2015. At that time, a premium of $3,600 was paid.
  2. A physical count of supplies at December 31 shows $570 of supplies on hand.
  3. Th e vehicles were purchased on January 2, 2014, and have an estimated useful life of four years.
  4. Th e furniture was purchased on July 2, 2012, and has an estimated useful life of 10 years.
  5. Service revenue earned but not billed or recorded at December 31 is $1,750.
  6. Interest on the 7% bank loan is paid on the fi rst day of each following quarter (January 1, April 1, July 1, and October 1).
  7. One of Ortega’s customers paid $3,600 in advance for a six-month contract at the rate of $600 per month. Th e contract

began on November 1 and Ortega credited Unearned Revenue at the time.

  1. Drivers’ salaries total $230 per day. At December 31, three days of salaries are unpaid.
  2. On December 1, Ortega paid $2,300 ($1,150 per month) for the December 2015 and January 2016 rent in advance.
  3. Income tax for the year is estimated to be $2,850. Th e company has paid $2,000 in income tax instalments to date.

Instructions

(a) Prepare T accounts and enter the trial balance amounts.

(b) Prepare and post the adjusting journal entries required at December 31.

(c) Prepare an adjusted trial balance at December 31.

P4–8B On August 31, 2015, the Rijo Equipment Repair Corp.’s post-closing trial balance was as follows. Th e company

prepares adjusting entries monthly.

Debit Credit

Cash $ 9,760

Accounts receivable 7,440

Supplies 1,600

Equipment 30,000

Accumulated depreciation—

equipment $ 3,000

Accounts payable 6,200

Salaries payable 1,400

Unearned revenue 800

Common shares 20,000

Retained earnings 17,400

$48,800 $48,800

During September, the following transactions were completed:

Sept. 4 Paid employees $2,200 for salaries due, of which $1,400 was for August salaries payable and $800

for September.

6 Received $5,400 cash from customers in payment of accounts.

11 Received $8,800 cash for services performed in September.

12 Sold common shares for $5,000.

17 Purchased supplies on account, $2,000.

21 Paid creditors $7,000 of accounts payable due.

24 Paid September and October rent, $2,000 ($1,000 per month).

25 Paid salaries, $2,200.

26 Performed services on account, $1,600.

27 Received $1,300 from customers for services to be provided in the future.

28 Paid a cash dividend, $500.

28 Paid income tax for the month, $600.

Adjustment data for the month:

  1. Supplies on hand total $800.
  2. Accrued salaries payable are $1,600.
  3. Accrued service revenue for $600.
  4. Th e equipment has a useful life of 10 years.
  5. Unearned revenue of $800 has been earned.

Instructions

(a) Prepare T accounts, and enter the opening balances at September 1.

(b) Prepare and post the September transaction entries.

(c) Prepare a trial balance at September 30.

(d) Prepare and post the adjusting journal entries for the month.

(e) Prepare an adjusted trial balance at September 30.

(f) Prepare (1) an income statement, (2) a statement of changes in equity, and (3) a statement of fi nancial position.

P4–9B Refer to the data for Rijo Equipment Repair Corp. in P4–8B. Assume that Rijo closes its books monthly.

Instructions

(a) Prepare the closing journal entries.

(b) Post the closing entries to the T accounts prepared in P4–8B.

(c) Prepare a post-closing trial balance at September 30.

P4–10B Accounts from the adjusted trial balance at December 31, 2015, are listed in alphabetical order below for Grant

Advertising Agency Limited:

Accounts payable $ 4,800 Insurance expense $ 1,600

Accounts receivable 19,750 Interest expense 700

Bank loan payable 10,000 Interest payable 700

Cash 11,000 Prepaid insurance 800

Common shares 20,000 Rent expense 7,200

Depreciation expense 13,200 Retained earnings 10,400

Dividends 2,000 Salaries expense 13,625

Equipment 66,000 Salaries payable 1,625

Accumulated depreciation—equipment 39,600 Trading investments 10,850

Fees earned 60,600 Supplies 1,265

Income tax expense 7,000 Supplies expense 5,935

Income tax payable 7,000 Unearned revenue 6,200

Instructions

(a) Prepare an adjusted trial balance.

(b) Prepare the closing journal entries.

(c) Prepare a post-closing trial balance at December 31.

P4–11B Th e following is the unadjusted trial balance for Rocky Mountain Resort Inc. at its year end, August 31, 2015.

Th e company adjusts its accounts annually.

Debit Credit

Cash $ 38,820

Supplies 6,990

Prepaid insurance 12,720

Land 70,000

Buildings 290,000

Accumulated depreciation—buildings $ 87,000

Furniture 57,200

Accumulated depreciation—furniture 22,880

Accounts payable 13,000

Unearned revenue 71,000

Mortgage payable, due 2019 120,000

Common shares 40,000

Retained earnings 72,000

Dividends 10,000

Rent revenue 497,000

Salaries expense 306,000

Utilities expense 75,200

Repairs and maintenance expense 28,250

Interest expense 7,700

Income tax expense 20,000

$922,880 $922,880

Additional information:

  1. Th e one-year insurance policy was purchased on May 31 for $12,720.
  2. A count of supplies on August 31 shows $1,380 of supplies on hand.
  3. Th e buildings have an estimated useful life of 50 years.
  4. Th e furniture has an estimated useful life of 10 years.
  5. Customers must pay a $200 deposit if they want to book a cottage during the peak period. An analysis of these bookings

indicates 355 deposits were received and credited to Unearned Revenue. Only 45 of these deposits have not been

earned by August 31.

  1. Salaries of $1,680 were unpaid at August 31.
  2. Th e August utility bill of $3,120 has not yet been recorded or paid.
  3. On August 25, a local business contracted with Rocky Mountain to rent one of the cottages for six months, starting

October 1, at a rate of $3,000 per month. An advance payment equal to two months’ (October and November) rent

was received on August 31 and credited to Rent Revenue.

  1. Th e mortgage interest rate is 7%. Interest has been paid to August 1; the next payment is due September 1.
  2. Income tax payable is estimated to be $2,000.
  3. During the month of May, $5,000 of common shares were issued. (Note: Th is has already been recorded.)

Instructions

(a) Prepare T accounts, and enter the trial balance amounts.

(b) Prepare and post the adjusting journal entries for the year.

(c) Prepare an adjusted trial balance at August 31.

(d) Prepare (1) an income statement, (2) a statement of changes in equity, and (3) a statement of fi nancial position.

(e) A friend of yours is considering investing in the company and asks you to comment on the results of operations and

fi nancial position. Is the company performing well or not? Does the fi nancial position look healthy or weak? Use

specifi c information from the fi nancial statements to support your answer.

P4–12B Refer to the data for Rocky Mountain Resort Inc. in P4–12B.

Instructions

(a) Prepare the closing journal entries.

(b) Post the closing entries to the T accounts prepared in P4–12B.

(c) Prepare a post-closing trial balance at August 31.

 

 

CHAPTER 5 Merchandising Operations

 

Questions

  1. (a) What is meant by the term operating cycle?

(b) Why is the normal operating cycle for a

merchandising company likely to be longer

than that of a service company?

(SO 1) 2. (a) Explain the income measurement process in

a merchandising company. (b) How does income

measurement diff er between a merchandising

company and a service company?

(SO 1) 3. Suppose you are starting a company that sells

used clothes. What factors would you consider

in determining whether to use a perpetual or

periodic inventory system?

(SO 1) 4. Song Yee wonders why a physical inventory

count is necessary in a perpetual inventory system.

Aft er all, the accounting records show how

much inventory is on hand. Explain why a physical

inventory count is required in a perpetual

inventory system.

(SO 2) 5. Why are purchases of merchandise for resale

not recorded in the same account as purchases

of other items, such as supplies or equipment?

Would it not be better to use one account to

record all these purchases?

(SO 2) 6. Butler’s Roofi ng Ltd. received an invoice for a

purchase of merchandise for $10,000, terms

1/10, n/30. (a) Calculate the cost of missing this

purchase discount to Butler’s Roofi ng. (b) Should

it take advantage of the cash discount off ered or

not? Explain.

(SO 2, 3) 7. Inventory was purchased on credit in April and

paid for in May. It was sold in June. In which

month should the company record the sale as

revenue and in which month should the company

record the cost of goods sold as expense?

(SO 2, 3) 8. (a) Distinguish between FOB shipping point

and FOB destination. (b) What freight term will

result in a debit to Merchandise Inventory by the

buyer? A debit to Freight Out by the seller?

(SO 2, 3) 9. Explain why purchase returns are credited directly

to the Merchandise Inventory account but

sales returns are not debited directly to the Sales

account.

(SO 2, 3) 10. (a) Distinguish between a quantity discount,

a purchase discount, and a sales discount.

(b) Explain how each kind of discount is

recorded.

(SO 3) 11. If merchandise is returned and restored to

inventory, the Cost of Goods Sold account is

credited. However, if merchandise is returned

but not restored to inventory (because it is not

resaleable), Cost of Goods Sold is not credited.

Why not?

(SO 3) 12. As the end of Agnew Inc.’s fi scal year approached,

it became clear that the company had excess inventory.

Belden Glass, the head of marketing and

sales, ordered his sales staff to “add 20% more

units to each order that you ship. Th e customers

can always ship the extra back next year if they

decide they don’t want it. We’ve got to do it to

meet this year’s sales goal.” Discuss the implications

of Belden’s order.

(SO 4) 13. Distinguish between a single-step and a multiplestep

income statement for a merchandising

company.

(SO 4) 14. Which type of income statement—single-step or

multiple-step—does Shoppers Drug Mart use?

You can fi nd its fi nancial statements in Appendix A

at the back of this textbook.

(SO 4) 15. (a) What is the diff erence between classifying

expenses in an income statement by nature or by

function? (b) Does this classifi cation apply only

to a single-step income statement, to a multiplestep

income statement, or both?

(SO 4) 16. Shoppers Drug Mart’s biggest competitor, aft er

Jean Coutu, is the Katz Group. Its Canadian

stores include Rexall Drug Stores, Guardian,

Medicine Shoppe, and Pharma Plus Drugmart,

among others. Katz is a private company, while

Shoppers and Jean Coutu are publicly traded

companies. How might Katz’s expenses reported

on its income statement diff er from those presented

by Shoppers and Jean Coutu?

(SO 4) 17. Why is interest expense reported as a nonoperating

expense and not as an operating

expense on a multiple-step income statement?

(SO 5) 18. Explain the diff erence, if any, between gross

profi t margin and profi t margin.

(SO 5) 19. What factors aff ect a company’s gross profi t

margin; that is, what can cause the gross profi t

margin to increase and what can cause it to

decrease?

(SO 5) 20. Identify two types of companies that you would

expect to have a high gross profi t margin and

two types of companies that you would expect to

have a low gross profi t margin.

(SO 6) *21. Identify the accounts that are added to or deducted

from purchases in a periodic inventory

system to determine the cost of goods purchased.

For each account, indicate (a) whether its balance

is added or deducted and (b) what its normal

balance is.

(SO 6) *22. How is the cost of goods sold calculated and

recorded in a periodic inventory system? In a

perpetual inventory system?

(SO 6) *23. What diff erences would be found on an income

statement prepared for a company using a

periodic inventory system, compared with a

company using a perpetual inventory system?

Brief Exercises

BE5–1 Th e operating cycles of three diff erent companies are shown below.

Company Operating Cycle (in days)

A 40

B 72

C 99

(a) Which company has the most effi cient operating cycle? (b) Identify which of the three companies is most likely a

service company, a merchandising company, and a manufacturing company.

BE5–2 Selected information from the income measurement process for a service company and a merchandising company

is shown below.

Company

Sales or Service

Revenue

Cost of

Goods Sold

Gross

Profi t

Operating

Expenses

Profi t before

Income Tax

Income Tax

Expense Profi t

A $100 $ 0 $ 0 $65 $ [1] $ 9 $[2]

B 100 [3] 60 [4] 35 [5] 26

(a) Determine the missing amounts [1] through [5]. (b) Identify which of the two companies—A or B—is a service company

and which is a merchandising company. Explain why you made the choices you did.

BE5–3 At the beginning of the year, Point Claire Shipping Ltd., a company that has a perpetual inventory system, had

$25,000 of merchandise inventory. During the year, inventory costing $100,000 was purchased. Of this, $12,000 was

returned to the supplier and a 5% discount was taken on the remainder. Freight costs incurred by the company for merchandise

purchases amounted to $2,400. Th e cost of goods sold during the year was $93,000. Determine the balance in the

Merchandise Inventory account at the end of the year.

BE5–4 On August 24, Pocras Corporation purchased merchandise on account from Wydell Inc. Th e selling price of

the goods is $900 and the cost of goods sold is $590. Both companies use perpetual inventory systems. Record the above

transactions on the books of both companies.

BE5–5 Prepare the journal entries to record the following purchase transactions in Xtra Inc.’s books. Xtra uses a

perpetual inventory system.

Jan. 2 Xtra purchased $15,000 of merchandise from Fundy Corp., terms 2/10, n/45,

FOB destination.

5 Th e appropriate company paid freight costs of $300.

6 Xtra returned $2,000 of the merchandise purchased on January 2, because it was not

needed.

11 Xtra paid the balance owed to Fundy.

BE5–6 Refer to BE5–5 and prepare the journal entries to record the following sales transactions in Fundy Corp.’s books.

Fundy uses a perpetual inventory system.

Jan. 2 Fundy sold $15,000 of merchandise to Xtra Inc., terms 2/10, n/45, FOB destination. Th e cost of

the merchandise sold was $11,250.

5 Th e appropriate company paid freight costs of $300.

6 Xtra returned $2,000 of the merchandise purchased from Fundy on January 2, because it was

not needed. Th e cost of the merchandise returned was $1,500, and it was restored to inventory.

11 Fundy received the balance due from Xtra.

BE5–7 Saguenay Limited reports the following information: sales $650,000; sales returns and allowances $25,000; sales

discounts $55,000; cost of goods sold $320,000; administrative expenses $100,000; selling expenses $25,000; other revenues

$20,000; other expenses $30,000; and income tax expense $25,000. Assuming Saguenay uses a multiple-step income statement,

calculate the following: (a) net sales, (b) gross profi t, (c) profi t from operations, (d) profi t before income tax, and (e) profi t.

BE5–8 Explain where each of the following items would appear on (a) a single-step income statement and (b) a multiple-step

income statement where expenses are classifi ed by nature: depreciation expense, cost of goods sold, freight out, income

tax expense, interest expense, interest revenue, rent revenue, salaries expense, sales, sales discounts, and sales returns and

allowances.

BE5–9 A company presented its income statement using the following format:

Sales revenue $x

Cost of goods sold x

Gross profi t x

Administrative expenses x

Selling expenses x

Profi t from operations x

Other revenues and expenses x

Profi t before income tax x

Income tax expense x

Profi t x

(a) Is this company using a single- or multiple-step form of income statement? (b) Is it classifying its expenses by nature

or by function? Explain.

BE5–10 In 2015, Modder Corporation reported net sales of $250,000, cost of goods sold of $137,500, operating expenses

of $50,000, and income tax expense of $20,000. In 2014, it reported net sales of $200,000, cost of goods sold of $114,000,

operating expenses of $40,000, other revenues of $10,000, and income tax expense of $15,000. (a) Calculate the gross profi t

margin and profi t margin for each year. (b) Comment on Modder’s changing profi tability.

BE5–11 In 2012, Canadian Tire Corporation reported sales revenue of $11,427.2 million, cost of goods sold of $7,929.3

million, and profi t of $499.2 million. In 2011, it reported sales revenue of $10,387.1 million, cost of goods sold of $7,326.4

million, and profi t of $467.0 million. (a) Calculate the gross profi t margin and profi t margin for each year. (b) Comment

on Canadian Tire’s changing profi tability.

BE5–12 From the information in BE5–5, prepare the journal entries to record the purchase transactions on Xtra Inc.’s

books, assuming a periodic inventory system is used instead of a perpetual inventory system.

*BE5–13 From the information in BE5–6, prepare the journal entries to record the sales transactions on Fundy Corp.’s

books, assuming a periodic inventory system is used instead of a perpetual inventory system.

*BE5–14 Bassing Corp. uses a periodic inventory system and reports the following information: sales $750,000; sales

returns and allowances $75,000; sales discounts $25,000; purchases $425,000; purchase returns and allowances $11,000;

purchase discounts $9,000; freight in $10,000; freight out $18,000; beginning inventory $60,000; and ending inventory

$100,000. Assuming Bassing uses a multiple-step income statement, calculate (a) net sales, (b) net purchases, (c) cost of

goods purchased, (d) cost of goods sold, and (e) gross profi t.

*BE5–15 Halifax Limited reported the following selected data for the year ended December 31, 2015: purchases $195,000;

purchase returns and allowances $6,600; purchase discounts $20,400; freight in $5,250; freight out $11,250; beginning inventory

$105,000; and ending inventory $120,000. (a) Prepare the cost of goods sold section for Halifax in a multiple-step income statement.

(b) Explain how the remainder of Halifax’s income statement would diff er, if at all, if it used a perpetual inventory system.

*BE5-16 At the end of the year, Tunnel Mountain Resorts Ltd., a company that has a periodic inventory system, had the

following account balances on its unadjusted trial balance: Merchandise Inventory $30,000, Purchases $262,000, Purchase

Discounts $4,000, Freight in $7,000. Th e inventory count at the end of the year determined that the inventory on hand

at that time cost $24,000. Record the adjusting journal entry that would be made at the end of the year to update the

Merchandise Inventory and Cost of Goods Sold accounts.

Exercises

E5–1 Listed below are selected companies, accompanied by a brief description of their business:

  1. Toys “R” Us, Inc. sells toys.
  2. Fasken Martineau Dumoulin LLP is a law fi rm.
  3. Atlantic Grocery Distributors Ltd. distributes food products to grocery stores.

Instructions

(a) Identify whether the primary type of business for each of the above companies is as a service company, merchandiser

(retailer) company, or merchandiser (wholesaler) company.

(b) Comment on how the operating cycles and income measurement processes of each of the above companies might

diff er, if at all.

E5–2 Listed below are selected examples of transactions related to the purchase and sale of merchandise inventory.

Assume a perpetual inventory system is in use.

  1. Purchase of $3,500 of inventory for cash.
  2. Purchase of $4,000 of inventory on account, terms 2/10, n/45.
  3. Payment of $400 cash for freight on purchase of inventory (FOB shipping point).
  4. Return of $750 of inventory to seller for credit on account.
  5. Payment of amount owed for purchase of $3,500 of inventory, terms 2/10, n/30, paid within discount period.
  6. Sale of inventory on account, terms n/30. Selling price $10,000; cost of sale $4,000.
  7. Payment of $600 cash for freight on sale of inventory (FOB destination).
  8. Return of unwanted inventory from buyer for credit on account. Selling price $1,000; cost of sale $400. Goods restored

to inventory for future resale.

  1. Return of damaged inventory from buyer for cash. Selling price $750; cost of sale $300. Goods not resaleable are discarded.
  2. Receipt of payment ($6,000) from customer on account, terms n/30.

Instructions

For each of the above transactions, indicate: (a) the basic type (asset, liability, revenue, or expense) of each account to be debited

and credited; (b) the specifi c name of the account(s) to debit and credit (for example, Merchandise Inventory); and (c) whether

each account is increased (1) or decreased (–) and by what amount. Th e fi rst one has been done for you as an example.

Account Debited Account Credited

(a) (b) (c) (a) (b) (c)

Basic Type of

Account

Specifi c

Account Amount

Basic Type of

Account

Specifi c

Account Amount

  1. Asset Merchandise

Inventory

1$3,500 Asset Cash –$3,500

E5–3 On September 1, the beginning of its fi scal year, Campus Offi ce Supply Ltd. had an inventory of 10 calculators at a

cost of $20 each. Th e company uses a perpetual inventory system. During September, the following transactions occurred:

Sept. 2 Purchased 75 calculators for $20 each from Digital Corp. on account, terms n/30.

10 Returned two calculators to Digital for $40 credit because they did not meet specifi cations.

11 Sold 26 calculators for $30 each to Campus Book Store, terms n/30.

14 Granted credit of $30 to Campus Book Store for the return of one calculator that was not

ordered. Th e calculator was restored to inventory.

21 Sold 30 calculators for $30 each to Student Card Shop, terms 1/10, n/30.

29 Paid Digital the amount owing.

30 Received payment in full from the Student Card Shop.

Instructions

(a) Record the September transactions.

(b) Create T accounts for the Merchandise Inventory and Cost of Goods Sold accounts. Post the opening balances and the

September transactions.

(c) Determine the ending balances in both dollars and quantities.

E5–4 Olaf Corp. uses a perpetual inventory system. Th e company had the following inventory transactions in April:

Apr. 3 Purchased merchandise from DeVito Ltd. for $28,000, terms 1/10, n/30, FOB shipping point.

6 Th e appropriate company paid freight costs of $700 on the merchandise purchased on

April 3.

7 Purchased supplies on account for $5,000.

8 Returned damaged merchandise to DeVito and was given a purchase allowance of $3,500.

Th e merchandise was repaired by DeVito and returned to inventory for future resale.

30 Paid the amount due to DeVito in full.

Instructions

(a) Record the above transactions in Olaf ’s books.

(b) Assume that Olaf paid the balance due to DeVito on April 12 instead of April 30. Prepare the journal entry to record

this payment on Olaf ’s books.

E5–5 Refer to the information in E5–4 for Olaf Corp. and the following additional information:

  1. Th e cost of the merchandise sold on April 3 was $19,000.
  2. Th e cost of the merchandise returned on April 8 was $2,300.
  3. DeVito uses a perpetual inventory system.

Instructions

(a) Record the transactions in the books of DeVito.

(b) Assume that DeVito received the balance due from Olaf on April 12 instead of April 30. Prepare the journal entry to

record this collection on DeVito’s books.

E5–6 Th e following merchandise transactions occurred in December. Both companies use a perpetual inventory system.

Dec. 3 Pictou Ltd. sold $18,000 of merchandise to Th ames Corp., terms 2/10, n/30, FOB shipping

point. Th e cost of the merchandise sold was $10,000.

7 Shipping costs of $450 were paid by the appropriate company.

8 Th ames returned unwanted merchandise to Pictou. Th e returned merchandise has a sales price

of $1,200, and a cost of $650. It was restored to inventory.

11 Pictou received the balance due from Th ames.

Instructions

(a) Record the above transactions in the books of Pictou.

(b) Record the above transactions in the books of Th ames.

(c) Calculate the gross profi t earned by Pictou on the above transactions.

E5–7 Th e following list of accounts is from the adjusted trial balance for Swirsky Corporation:

Accounts payable

Accounts receivable

Accumulated depreciation

Administrative expenses

Buildings

Cash

Common shares

Equipment

Income tax expense

Interest expense

Interest payable

Land

Merchandise inventory

Mortgage payable

Prepaid insurance

Property tax payable

Salaries payable

Sales

Sales discounts

Sales returns and allowances

Unearned revenue

Instructions

For each account, identify whether it should be reported on the statement of fi nancial position or income statement. Also

specify where the account should be classifi ed. For example, Accounts Payable would be classifi ed under current liabilities on

the statement of fi nancial position.

E5–8 Th e following selected accounts from the Blue Door Corporation’s general ledger are presented below for the year

ended December 31, 2015:

Advertising expense $ 55,000

Common shares 250,000

Cost of goods sold 1,085,000

Depreciation expense 125,000

Dividends 150,000

Freight out 25,000

Income tax expense 70,000

Insurance expense 15,000

Interest expense 70,000

Interest revenue 30,000

Merchandise inventory 67,000

Rent revenue 24,000

Retained earnings 535,000

Salaries expense 675,000

Sales 2,400,000

Sales discounts 8,500

Sales returns and allowances 41,000

Unearned revenue 8,000

Instructions

(a) Prepare a single-step income statement.

(b) Prepare a multiple-step income statement.

(c) Are the expenses classifi ed by nature or function in the list of accounts above? Explain.

E5–9 Income statement information is presented here for two companies:

Young Ltd. Rioux Ltée

Sales $99,000 $ [6]

Sales returns and allowances [1] 5,000

Net sales 89,000 100,000

Cost of goods sold 58,750 [7]

Gross profi t [2] 40,000

Operating expenses 19,500 [8]

Profi t from operations [3] 18,000

Other revenues 750 0

Other expenses 0 2,000

Profi t before income tax [4] [9]

Income tax expense 2,300 [10]

Profi t [5] 12,800

Instructions

(a) Calculate the missing amounts for items [1] to [10].

(b) Calculate the gross profi t margin and profi t margin for each company.

E5–10 Montmorency Ltée reported the following condensed income statement data (in thousands) for the year ended

August 31, 2015:

Administrative expenses $ 670

Cost of goods sold 4,030

Income tax expense 560

Net sales 7,090

Other expenses 270

Selling expenses 260

Instructions

(a) Prepare a multiple-step income statement.

(b) Are the expenses classifi ed by nature or function in the list of accounts above?

(c) Calculate the gross profi t margin and profi t margin.

E5–11 Best Buy Co., Inc. reported the following selected information for its three most recent fiscal years (in

U.S. $ millions):

2012 2011 2010

Net sales $50,705 $49,747 $49,694

Cost of goods sold 38,132 37,197 37,534

Profi t from operations 1,085 2,374 2,235

Profi t (loss) (1,231) 1,003 1,317

Instructions

(a) Calculate the gross profi t margin and profi t margin for Best Buy for each of the three years.

(b) Comment on whether the ratios have improved or deteriorated over the last three years.

(c) Recalculate the profi t margin for the three years using operating income instead of profi t. Does this result in a diff erent

trend than you saw in part (a)? If yes, what might be the reason for this change?

*E5–12 Data for Olaf Corp. and DeVito Ltd. are presented in E5–4 and E5–5.

Instructions

Repeat the requirements for E5–4 and E5–5, assuming a periodic inventory system is used instead of a perpetual inventory

system.

*E5–13 Duvall Ltd. and Pele Ltd. incurred the following merchandise transactions in June.

June 10 Duvall sold $5,000 of merchandise to Pele, terms 1/10, n/30, FOB shipping point. Th e merchandise

cost Duvall $3,000 when it was originally purchased.

11 Freight costs of $250 were paid by the appropriate company.

12 Duvall received damaged goods returned by Pele for credit. Th e goods were originally sold for

$500; the cost of the returned merchandise was $300. Th e merchandise was not returned to

inventory.

19 Duvall received full payment from Pele.

Instructions

(a) Prepare journal entries for each transaction in the books of Duvall Ltd., assuming (1) a perpetual inventory system is

used, and (2) a periodic inventory system is used.

(b) Prepare journal entries for each transaction for Pele Ltd., assuming (1) a perpetual inventory system is used, and (2) a

periodic inventory system is used.

*E5–14 Below are the cost of goods sold sections for the most recent two years for two companies using a periodic inventory

system:

Company 1 Company 2

Year 1 Year 2 Year 1 Year 2

Beginning inventory $ 200 $ [5] $1,000 $ [14]

Purchases 1,500 [6] [10] 8,550

Purchase returns and allowances 50 100 200 400

Purchase discounts 30 50 150 100

Net purchases [1] 1,800 7,210 [15]

Freight in 130 [7] [11] 550

Cost of goods purchased [2] [8] 7,800 [16]

Cost of goods available for sale [3] 2,300 [12] [17]

Ending inventory [4] 350 1,250 1,500

Cost of goods sold 1,480 [9] [13] [18]

Instructions

Fill in the numbered blanks to complete the cost of goods sold sections.

*E5–15 Th e following selected information is presented for Lively Limited for the year ended February 28, 2015. Lively

uses a periodic inventory system.

Accounts receivable $ 32,500

Administrative expenses 120,900

Common shares 85,000

Dividends 42,000

Freight in 8,450

Income tax expense 9,300

Interest expense 7,800

Merchandise inventory, Mar. 1, 2014 54,600

Merchandise inventory, Feb. 28, 2015 79,300

Purchases $ 273,000

Purchase discounts 39,000

Purchase returns and allowances 20,800

Sales 435,500

Sales discounts 27,300

Sales returns and allowances 15,600

Selling expenses 9,100

Unearned revenue

Instructions

(a) Prepare a multiple-step income statement.

(b) Prepare the year-end adjusting entry that would be made to update the Merchandise Inventory and Cost of Goods

Sold accounts.

Problems: Set A

P5–1A Th e Breeze Hair Salon Inc. began operations six months ago. Th e salon’s main business is hair styling and other

hair treatment services. Th e salon also purchases and sells all of the products it uses, plus hair accessories such as hair extensions

and jewellery. Th e sale of the products, while secondary to the salon’s main business, still constitutes a signifi cant

amount of revenue. Most sales are paid by the salon’s customers with cash, or paid for by debit and bank credit cards, which

are considered to be equivalent to cash.

Th e salon purchases its products from a local wholesaler, on credit terms of n/30 days. Normally, the salon purchases

a two-month supply of products at a time. Karen, the manager of the salon, is not comfortable with a high level of accounts

payable so the salon pays the wholesaler much earlier than 30 days if it has cash on hand.

When the salon’s accounting system was set up, a perpetual inventory system was established to track the products

sold. Staff have been complaining to Karen that it is time-consuming to scan each product sold. Both the staff

and customers are finding the additional time it takes to scan products to be frustrating, especially when the salon is

busy.

Karen had a physical inventory count performed aft er the salon’s fi rst six months of operations. When the quantities

of merchandise determined at the physical count were compared with the quantities per the perpetual system, there were

a number of discrepancies.

Karen has noticed that the salon oft en runs out of the more popular products. She also noticed that while some items

sell fast, others seem to collect dust. To get rid of these slow-moving products, the salon has to mark down the selling prices

of its products, which is aff ecting the company’s cash fl ow and gross profi t.

Instructions

(a) Explain to Karen what an operating cycle is and why the salon is having problems with its cash fl ow and gross profi t.

(b) Make a recommendation about what inventory system the salon should use and explain why.

(c) Explain to Karen the reasons for conducting an inventory count and advise her on the required frequency of

counts.

P5–2A Phantom Book Warehouse Ltd. distributes hardcover books to retail stores. At the end of May, Phantom’s inventory

consists of 175 books purchased at $18 each. Phantom uses a perpetual inventory system.

During the month of June, the following merchandise transactions occurred:

June 1 Purchased 140 books on account for $18 each from Reader’s World Publishers, terms n/45.

3 Sold 150 books on account to Th e Book Nook for $22 each, with a cost of $18, terms 2/10, n/45.

5 Received a $180 credit for 10 books returned to Reader’s World Publishers.

8 Sold 80 books on account to Read-A-Lot Bookstore for $25 each, with a cost of $18, terms 2/10,

n/45.

9 Issued a $300 credit memorandum to Read-A-Lot Bookstore for the return of 12 damaged books.

Th e books were determined to be no longer saleable and were destroyed.

11 Purchased 130 books on account for $15 each from Read More Publishers, terms n/45.

12 Received payment in full from Th e Book Nook.

17 Received payment in full from Read-A-Lot Bookstore.

22 Sold 125 books on account to Reader’s Bookstore for $25 each, with an average cost of $15, terms

2/10, n/45.

25 Granted Reader’s Bookstore a $375 credit for 15 returned books. Th ese books were restored to

inventory.

29 Paid Reader’s World Publishers in full.

Instructions

(a) Is the Phantom Book Warehouse a retailer or a wholesaler? Explain.

(b) Record the June transactions for Phantom. (Record transactions to the nearest cent.)

(c) Create a T account for the Merchandise Inventory account. Post the opening balance and June transactions, and

calculate the June 30 balance in the account.

(d) Determine the number of books Phantom has on hand on June 30. What is the average cost of these books on June 30?

(Hint: Divide the ending balance in the Merchandise Inventory account calculated in part (c) and divide it by the

number of books on hand at June 30. Round your answer to the nearest cent.)

P5–3A Presented here are selected transactions for Norlan Inc. during September of the current year. Norlan uses a

perpetual inventory system.

Sept. 2 Purchased equipment on account for $25,000, terms n/30, FOB destination.

3 Freight charges of $625 were paid by the appropriate party on the September 2 purchase of equipment.

4 Purchased merchandise on account from Hillary Corp. at a cost of $65,000, terms 1/15, n/30, FOB

shipping point.

5 Purchased supplies for $4,000 cash.

7 Freight charges of $1,600 were paid by the appropriate party on the September 4 purchase of

merchandise.

8 Returned damaged goods costing $5,000 that were originally purchased from Hillary on September 4.

Received a credit on account.

9 Sold merchandise costing $15,000 to Fischer Limited for $20,000 on account, terms 2/10, n/30,

FOB destination.

10 Freight charges of $375 were paid by the appropriate party on the September 9 sale of merchandise.

17 Received the balance due from Fischer.

18 Paid Hillary the balance due.

20 Purchased merchandise for $6,000 cash.

22 Sold inventory costing $20,000 to Kun-Tai Inc. for $27,000 on account, terms n/30, FOB shipping point.

23 Freight charges of $500 were paid by the appropriate party on the September 22 sale of

merchandise.

28 Kun-Tai returned merchandise sold for $10,000 that cost $7,500. Th e merchandise was restored to

inventory.

Instructions

(a) Record the September transactions on Norlan’s books.

(b) Assume that Norlan did not take advantage of the 1% purchase discount off ered by Hillary Corp. and paid Hillary on

Oct. 3 instead of September 18. Record the entry that Norlan would make on Oct. 3 and determine the cost of missing

this purchase discount to Norlan.

P5–4A At the beginning of the current golf season, on April 1, 2015 the general ledger of In the Pines Golf Shop showed

Cash $6,000; Merchandise Inventory $2,500; Common Shares $5,100; and Retained Earnings $3,400. In the Pines Golf

Shop uses a perpetual inventory system.

Th e following transactions occurred in April:

Apr. 3 Purchased golf bags, clubs, and balls on account from Balata Corp. for $4,600, terms 1/10, n/30,

FOB shipping point.

6 Freight of $120 was paid by the appropriate party on the April 3 purchase from Balata.

9 Received a $200 purchase allowance from Balata for returned merchandise.

10 Sold merchandise on account to members for $5,020, terms n/30. Th e cost of the merchandise sold

was $2,010.

12 Paid Balata in full.

14 Received payments on account from members, $2,125.

16 Purchased golf shoes, sweaters, and other accessories on account from Arrow Sportswear Limited

for $1,300, terms 2/10, n/30.

17 Received a $100 credit from Arrow Sportswear for returned merchandise.

20 Sold merchandise on account to members for $3,200, terms n/30. Th e cost of the merchandise sold

was $1,285.

24 Paid Arrow Sportswear in full.

27 Granted an $85 sales allowance to a member for soiled clothing. No merchandise was returned.

Instructions

(a) Prepare T accounts and enter the opening balances.

(b) Record and post the April transactions for In the Pines Golf Shop. Round all calculations to the nearest dollar.

(c) Prepare a trial balance as at April 30.

P5–5A Eagle Hardware Store Ltd. completed the following merchandising transactions in the month of May 2015. At

the beginning of May, Eagle’s ledger showed Cash $7,000; Accounts Receivable $1,500; Merchandise Inventory $3,500;

Common Shares $8,000; and Retained Earnings $4,000. Eagle Hardware uses a perpetual inventory system.

May 1 Purchased merchandise on account from Depot Wholesale Supply Ltd. for $5,800, terms 1/10, n/30,

FOB shipping point.

3 Freight charges of $145 were paid by the appropriate party on the merchandise purchased on

May 1.

4 Sold merchandise on account to Shep Ltd. for $3,500, terms 2/10, n/30, FOB destination. Th e cost

of the merchandise was $2,100.

7 Freight charges of $90 were paid by the appropriate party on the May 4 sale.

8 Received a $200 credit from Depot Wholesale Supply when merchandise was returned.

9 Paid Depot Wholesale Supply in full.

11 Purchased supplies for $400 cash.

14 Received payment in full from Shep Ltd. for merchandise sold on account on May 4.

15 Collected $1,000 of the accounts receivable outstanding at the beginning of the month. All accounts

were originally sold on terms of n/30, with no sales discounts.

18 Purchased merchandise from Harlow Distributors Inc. for $2,000, terms n/30, FOB destination.

21 Freight of $50 was paid by the appropriate party on the May 18 purchase of merchandise.

22 Sold merchandise to various customers for $6,500 cash. Th e cost of the merchandise was $3,900.

29 Paid a $100 cash refund to customers for returned merchandise. Th e cost of the returned merchandise

was $60. It was restored to inventory.

31 A physical inventory count was taken and determined that there was $5,100 of inventory on hand.

Prepare any adjustment required.

Instructions

(a) Prepare T accounts and enter the opening balances.

(b) Record and post the May transactions for Eagle Hardware Store.

(c) Prepare a partial multiple-step income statement for the month ended May 31, through to gross profi t.

(d) Prepare the current assets section of the statement of fi nancial position as at May 31.

P5–6A Th e adjusted trial balance of Club Canada Wholesale Inc. contained the following accounts at December 31, the

company’s year end:

CLUB CANADA WHOLESALE INC.

Adjusted Trial Balance

December 31, 2015

Debit Credit

Cash $ 8,875

Accounts receivable 17,600

Notes receivable 30,000

Merchandise inventory 92,400

Supplies 3,780

Land 72,000

Buildings 197,000

Accumulated depreciation—buildings $ 93,575

Equipment 83,500

Accumulated depreciation—equipment 33,400

Accounts payable 57,500

Unearned revenue 7,550

Income tax payable 3,500

Mortgage payable 86,000

Common shares 20,000

Retained earnings 139,675

Sales 922,360

Sales returns and allowances 17,745

Sales discounts 4,615

Cost of goods sold 692,100

Administrative expenses 116,115

Selling expenses 5,900

Interest expense 8,830

Interest revenue 2,400

Income tax expense 15,500

$1,365,960 $1,365,960

Instructions

(a) Prepare a single-step income statement.

(b) Prepare a multiple-step income statement.

(c) Compare the two statements and comment on the usefulness of each one.

(d) Are the expenses in the statements classifi ed by nature or by function? Explain.

P5–7A Th e unadjusted trial balance of Mesa Inc., at the company’s year end of December 31, follows:

MESA INC.

Trial Balance

December 31, 2015

Debit Credit

Cash $ 17,000

Accounts receivable 31,700

Merchandise inventory 28,750

Supplies 2,940

Prepaid insurance 3,000

Land 30,000

Buildings 150,000

Accumulated depreciation—buildings $ 24,000

Equipment 45,000

Accumulated depreciation—equipment 18,000

Accounts payable 33,735

Unearned revenue 4,000

Mortgage payable 147,100

Common shares 13,000

Retained earnings 31,425

Dividends 2,000

Sales 265,770

Sales returns and allowances 2,500

Sales discounts 3,275

Cost of goods sold 171,225

Salaries expense 30,950

Utilities expense 5,100

Interest expense 8,090

Income tax expense 5,500

$537,030 $537,030

Additional information and adjustment data:

  1. Th e 12-month insurance policy was purchased and was eff ective February 1, 2015.
  2. Th ere was $750 of supplies on hand on December 31.
  3. Depreciation expense for the year is $6,000 for the buildings and $4,500 for the equipment.
  4. Salaries of $750 are accrued and unpaid at December 31.
  5. Accrued interest expense at December 31 is $735.
  6. Unearned revenue of $975 is still unearned at December 31. On the sales revenue that was earned, the cost of goods

sold was $2,000.

  1. Of the mortgage payable, $9,800 is payable next year.
  2. Income tax of $500 is due and unpaid.
  3. A physical count of inventory indicates $23,800 on hand at December 31.
  4. Common shares of $3,000 were issued during the year.

Instructions

(a) Prepare T accounts and enter the trial balance amounts.

(b) Record and post the adjusting entries, assuming the company adjusts its accounts annually.

(c) Prepare an adjusted trial balance at December 31.

(d) Prepare a multiple-step income statement, statement of changes in equity, and statement of fi nancial position for the

year.

P5–8A Data for Club Canada Wholesale Inc. are presented in P5–6A.

Instructions

(a) Calculate the profi t margin and gross profi t margin.

(b) The vice-president of marketing and director of human resources have proposed that the company change its

compensation of the sales force to a commission basis rather than paying a fixed salary. Given the extra incentive,

they expect net sales to increase by 15%. They estimate that gross profit will increase by $27,000, operating

expenses by $13,500, and income tax expense by $2,700. Non-operating expense is not expected to change.

Calculate the expected new gross profit and profit amounts. (Hint: You do not need to prepare a formal income

statement.)

(c) Calculate the revised gross profi t margin and profi t margin, using the information you calculated in part (b). Comment

on the eff ect that this plan would have on profi tability and evaluate the merit of this proposal.

P5–9A Psang Inc. purchases its merchandise inventory on credit and uses a perpetual inventory system. Th e company

commenced operations on January 1, 2015, and during 2015 purchased merchandise costing $300,000. Of this amount,

80% was paid in 2015 with the balance paid in 2016. Th e company sold 90% of its inventory for $540,000 on credit. Of this

amount, 70% was collected in 2015 with the rest collected in 2016. Operating expenses of $120,000 were incurred in 2015

and all were paid by the end of the year. Th e income tax rate is 30% and all income taxes relating to 2015 were paid in 2016.

Th e following table indicates key amounts on the 2015 fi nancial statements:

2015

Income statement data

Sales [1]

Cost of goods sold [2]

Gross profi t [3]

Operating expenses [4]

Profi t before income tax [5]

Income tax expense [6]

Profi t [7]

Statement of fi nancial position data

Accounts receivable [8]

Merchandise inventory [9]

Accounts payable [10]

Income tax payable [11]

Instructions

(a) Calculate the balances for Sales and Accounts Receivable (items 1 and 8 above).

(b) Calculate the balances for Cost of Goods Sold, Merchandise Inventory, and Accounts Payable (items 2, 9, and 10

above).

(c) Calculate the gross profi t, the balance in Operating Expenses, and the profi t before income tax (items 3, 4, and 5

above).

(d) Calculate the balances for Income Tax Expense, profi t, and Income Tax Payable (items 6, 7, and 11 above).

(e) Calculate the gross profi t margin and profi t margin for the company. All companies in this industry sell their products

at approximately the same price and incur income tax at the same rate. If the company’s gross profi t margin and profi t

margin are higher than the industry average, what are the most likely explanations for this?

P5–10A Th e following selected information is available for Danier Leather Inc. for three fi scal years (in thousands):

2012 2011 2010

Current assets $ 60,965 $ 58,948 $ 54,836

Current liabilities 11,748 12,838 17,958

Revenue 148,219 157,621 164,217

Cost of goods sold 71,513 71,352 77,438

Profi t 4,003 7,568 7,219

Instructions

(a) Calculate the current ratio, gross profi t margin, and profi t margin for each year.

(b) Comment on whether the ratios have improved or deteriorated over the three years.

(c) Compare the 2012 ratios calculated in part (a) with the following industry averages: current ratio 2.0:1; gross profi t

margin 37.4%; and profi t margin 6.1%. Are Danier Leather’s ratios better or worse than those of its industry?

*P5–11A Data for Phantom Book Warehouse Ltd. are presented in P5–2A.

Instructions

(a) Record the June transactions on Phantom Book Warehouse’s books, assuming it uses a periodic inventory system

instead of a perpetual inventory system. (Record transactions to the nearest cent.)

(b) Identify the advantages and disadvantages of Phantom Book Warehouse using a periodic inventory system instead of

a perpetual inventory system.

*P5–12A Data for Norlan Inc. are presented in P5–3A.

Instructions

(a) Record the September transactions on Norlan’s books, assuming it uses a periodic inventory system instead of a perpetual

inventory system.

(b) Assume that Norlan did not take advantage of the 1% purchase discount off ered by Hillary Corp. and paid Hillary on

Oct. 3 instead of September 18. Record the entry that Norlan would make on Oct. 3 and determine the cost of missing

this purchase discount to Norlan.

*P5–13A Data for the In the Pines Golf Shop are presented in P5–4A.

Instructions

(a) Prepare T accounts and enter the opening balances.

(b) Record and post the April transactions for In the Pines Golf Shop, assuming it uses a periodic inventory system instead

of a perpetual inventory system. Th e inventory count on April 30 determined that merchandise costing $4,857 was on

hand. Round all calculations to the nearest dollar.

(c) Prepare an unadjusted trial balance as at April 30.

(d) Prepare the adjusting journal entry needed at the end of the period to update the Merchandise Inventory and Cost of

Goods Sold accounts.

*P5–14A You have been provided with the following selected accounts for Feisty Ltd. for the year ended April 30,

2015:

Inventory, May 1, 2014 $ 600,000

Purchases 5,900,000

Accounts receivable 780,000

Sales 9,300,000

Purchase discounts 40,000

Freight in 120,000

Land 900,000

Sales returns and allowances 250,000

Interest expense $ 30,000

Interest income 20,000

Accounts payable 600,000

Administrative expenses 810,000

Selling expenses 150,000

Cash 160,000

Common shares 200,000

Feisty conducted a physical inventory count on April 30, 2015. Inventory on hand at that date was determined to be

$700,000.

Instructions

(a) Prepare a partial multiple-step income statement for the year ended April 30, 2015, through to gross profi t.

(b) Prepare the period-end adjusting journal entry to update the Cost of Goods Sold and Merchandise Inventory

accounts.

(c) Calculate the gross profi t margin. If the industry average gross profi t margin is 30%, how does Feisty’s gross profi t

margin compare?

*P5–15A Andrea’s Athletic Wear Inc.’s unadjusted trial balance amounts (prior to recording the adjusting entry to update

Merchandise Inventory and Cost of Goods Sold accounts) appear in alphabetical order as follows on December 31,

2015, the end of its fi scal year:

Accounts payable $129,450

Accounts receivable 66,300

Accumulated depreciation—buildings 77,700

Accumulated depreciation—equipment 64,350

Administrative expenses 271,350

Buildings 285,000

Cash 25,500

Common shares 112,500

Dividends 12,000

Equipment 165,000

Freight in 8,400

Income tax expense 24,000

Interest expense 15,600

Land 112,500

Merchandise inventory, Jan. 1 $ 60,750

Mortgage payable 187,500

Prepaid insurance 3,600

Property tax payable 7,200

Purchases 602,400

Purchase discounts 33,750

Purchase returns and allowances 9,600

Retained earnings 102,900

Salaries payable 5,250

Sales 955,500

Sales discounts 22,500

Sales returns and allowances 12,000

Selling expenses 11,250

Unearned revenue 12,450

Additional information:

  1. Andrea’s Athletic Wear uses a periodic inventory system.
  2. A physical inventory count determined that merchandise inventory on December 31, 2015, was $108,900.
  3. Of the mortgage payable, $18,750 is due in the next year.
  4. Common shares of $37,500 were issued during the year.

Instructions

Prepare a multiple-step income statement and statement of changes in equity for 2015, and statement of fi nancial position

as at December 31.

 

Problems: Set B

P5–1B Th e Fashion Palace Inc. sells a variety of home decorating merchandise, including pictures, small furniture items,

dishes, candles, and area rugs. Th e company uses a periodic inventory system and counts inventory once a year. Most customers

use the option to purchase on account and many take more than a month to pay. Th e company does not have any

specifi c credit terms for its regular customers.

Th e general manager of Th e Fashion Palace, Rebecca Sherstabetoff , believes the company needs a bank loan because

the accounts payable have to be paid long before the accounts receivable are collected. Th e bank manager is willing to give

Th e Fashion Palace a loan but wants monthly fi nancial statements.

Rebecca has also noticed that, while some of the company’s merchandise sells very quickly, other items do not.

Sometimes she wonders just how long some of those older items have been in stock. She has observed that the company

seems to run out of some merchandise items on a regular basis. And she is wondering how she is going to fi nd someone

with the time to count the inventory every month so that monthly fi nancial statements can be prepared for the bank. She

has come to you for help.

Instructions

(a) Explain to Rebecca what an operating cycle is and why the company is having problems paying its bills.

(b) Make a recommendation about what inventory system the company should use and explain why.

(c) Explain to Rebecca the reasons for conducting an inventory count and advise her on the required frequency of

counts.

P5–2B Travel Warehouse Ltd. distributes suitcases to retail stores. At the end of June, Travel Warehouse’s inventory

consisted of 30 suitcases purchased at $45 each. Travel Warehouse uses a perpetual inventory system. During the month of

July, the following merchandising transactions occurred:

July 2 Purchased 55 suitcases on account for $45 each from Trunk Manufacturers Ltd., terms 2/10, n/30.

3 Received a $225 credit from Trunk Manufacturers aft er returning fi ve suitcases because they were

damaged.

6 Sold 50 suitcases on account to Satchel World Inc. for $80 each, with a cost of $45, terms 2/15, n/45.

7 Issued a $400 credit for fi ve suitcases returned by Satchel World because they were the wrong

model. Th e suitcases were returned to inventory.

9 Sold fi ve suitcases—this time the right model number—on account to Satchel World Inc. for $90

each, with a cost of $45, terms 2/15, n/45.

11 Paid Trunk Manufacturers the balance owing.

13 Sold 25 suitcases on account to Th e Going Concern, Limited for $80 each, with a cost of $45, terms

2/15, n/45.

16 Purchased 70 suitcases on account for $3,500 from Holiday Manufacturers, terms n/45.

17 Issued a $800 credit for ten suitcases returned by Th e Going Concern because they were damaged.

Th ese suitcases were not restored to inventory.

20 Received payment in full from Satchel World for all transactions.

27 Received payment in full from Th e Going Concern.

Instructions

(a) Is Travel Warehouse a retailer or a wholesaler? Explain.

(b) Record the July transactions for Travel Warehouse. (Record transactions to the nearest cent.)

(c) Create a T account for the Merchandise Inventory account. Post the opening balance and July transactions, and calculate

the July 31 balance in the account.

(d) Determine the number of suitcases Travel Warehouse has on hand on July 31. What is the average cost of these suitcases

on July 31? (Hint: Divide the ending balance in the Merchandise Inventory account calculated in part (c) and

divide it by the number of suitcases on hand at July 31. Round your answer to the nearest cent.)

P5–3B Presented here are selected transactions for Shaoshi Inc. during October of the current year. Shaoshi uses a perpetual

inventory system.

Oct. 1 Purchased merchandise on account from Micron Ltd. at a cost of $65,000, terms 1/15, n/30, FOB

shipping point.

1 Freight charges of $1,600 were paid by the appropriate party on the October 1 purchase of

merchandise.

5 Returned for credit $7,000 of damaged goods purchased from Micron on October 1.

8 Sold the remaining merchandise purchased from Micron to Guidant Corp. for $100,000 on

account, with a cost of $59,600, terms 2/10, n/30, FOB destination.

9 Freight charges of $2,300 were paid by the appropriate party on the October 8 sale of merchandise.

10 Guidant returned damaged merchandise that was purchased on October 8 for a $4,000 credit on

account. Th e merchandise originally cost $2,384 and was not restored to inventory.

12 Purchased supplies for $5,000 cash.

15 Purchased merchandise for $7,500 cash.

17 Received the balance owing from Guidant.

20 Purchased equipment on account for $45,000.

28 Sold merchandise for $30,000 on account to Deux Ltée, terms 2/10, n/30, FOB shipping point. Th e

merchandise had a cost of $18,000.

29 Freight charges of $750 were paid by the appropriate party on the October 28 sale of merchandise.

30 Paid Micron the balance owing.

31 Deux returned some of the merchandise that was purchased on October 28 for a $5,000 credit on

account. Th e merchandise originally cost $3,000 and was restored to inventory.

Instructions

(a) Record the October transactions on Shaoshi’s books.

(b) Assume that Shaoshi took advantage of the 1% purchase discount off ered by Micron Ltd. and paid Micron on October

14 rather than October 30. Record the entry that Shaoshi would make on October 14 and determine the cost of missing

this purchase discount to Shaoshi.

P5–4B At the beginning of the current tennis season, on April 1, the general ledger of Grand Slam Tennis Shop showed

Cash $8,000; Merchandise Inventory $5,400; Common Shares $6,000; and Retained Earnings $7,400. Grand Slam Tennis

Shop uses a perpetual inventory system.

Th e following transactions occurred in April:

Apr. 2 Purchased racquets and balls from Roberts Inc. for $4,900, terms 2/10, n/30, FOB shipping point.

3 Th e appropriate party paid $120 freight on the purchase from Roberts on April 2.

7 Received credit of $100 from Roberts for a damaged racquet that was returned.

11 Paid Roberts in full.

13 Purchased tennis shoes from Niki Sports Ltd. for $920 cash, FOB shipping point.

16 Th e appropriate party paid $15 freight on the purchase from Niki on April 13.

17 Purchased supplies for $1,300 cash from Discount Supplies Limited.

18 Received a $110 cash refund from Niki Sports for damaged merchandise that was returned.

20 Sold merchandise to members for $6,800 on account, terms n/30. Th e cost of the

merchandise was $4,080.

21 Some of the merchandise purchased on April 20, with a sales price of $1,000 and a cost of $600, was

returned by members. It was restored to inventory.

23 Sold merchandise to members for $5,600, terms n/30. Th e cost of the merchandise was $3,360.

25 Received cash payments on account from members, $8,000.

28 Granted a $150 sales allowance on account to a member for slightly torn tennis clothing. No

merchandise was returned.

30 Purchased equipment for use in the business from DomCo Ltd. for $3,600, terms n/45.

Instructions

(a) Prepare T accounts and enter the opening balances.

(b) Record and post the April transactions for Grand Slam Tennis. Round all calculations to the nearest dollar.

(c) Prepare a trial balance as at April 30, 2015.

P5–5B Nisson Distributing Ltd. completed the following merchandising transactions in the month of April. At the

beginning of April, Nisson’s general ledger showed Cash $4,000; Accounts Receivable $3,500; Merchandise Inventory

transactions $2,500; Common Shares $5,000; and Retained Earnings $5,000. Nisson uses a perpetual inventory

system.

Apr. 2 Purchased merchandise on account from Kai Supply Corp. for $8,900, terms 1/15, n/30, FOB shipping

point.

3 Th e appropriate party paid $225 freight on the April 2 purchase from Kai Supply.

5 Sold $11,600 of merchandise on account to Kananaskis Supply Ltd., terms 2/10, n/30, FOB

destination. Th e cost of the merchandise was $7,540.

9 The appropriate party paid $290 freight on the April 5 sale of merchandise to Kananaskis

Supply.

10 Issued a $1,600 credit for merchandise returned by Kananaskis Supply. Th e merchandise originally

cost $1,030 and was returned to inventory.

11 Purchased merchandise on account from Pigeon Distributors Limited for $4,200, terms 1/10, n/30,

FOB destination.

12 Th e appropriate party paid $100 freight on the April 11 purchase from Pigeon Distributors.

13 Received a $300 credit for merchandise returned to Pigeon Distributors.

14 Received the balance owing from Kananaskis Supply.

17 Paid Kai Supply in full.

20 Paid Pigeon Distributors in full.

23 Sold merchandise for $6,400 cash. Th e cost of the merchandise was $5,200.

24 Made a $400 cash refund for damaged merchandise returned from the April 23 purchase. Th e cost

of the merchandise returned was $260 and it was not restored to inventory.

27 Purchased merchandise from Tipsea Inc. for $6,100 cash.

30 Received a $500 refund for merchandise that was returned to Tipsea from the April 27 cash

purchase.

Instructions

(a) Prepare T accounts and enter the opening balances.

(b) Record and post the April transactions for Nisson.

(c) Prepare a partial multiple-step income statement for the month ended April 30, through to gross profi t.

(d) Prepare the current assets section of the statement of fi nancial position as at April 30.

P5–6B Th e adjusted trial balance of Brigus Wholesale Ltd. contained the following accounts at November 30, the

company’s fi scal year end:

BRIGUS WHOLESALE LTD.

Adjusted Trial Balance

November 30, 2015

Debit Credit

Cash $ 50,200

Accounts receivable 71,400

Notes receivable 50,000

Merchandise inventory 90,400

Supplies 3,000

Land 120,000

Buildings 204,000

Accumulated depreciation—buildings $ 34,000

Equipment 96,000

Accumulated depreciation—equipment 48,000

Accounts payable 97,000

Income tax payable 31,000

Unearned revenue 6,000

Mortgage payable 102,000

Common shares 60,000

Retained earnings 180,000

Sales 1,700,600

Sales returns and allowances 8,400

Sales discounts 7,500

Cost of goods sold 1,095,000

Administrative expenses 341,340

Selling expenses 86,200

Interest expense 7,400

Interest revenue 3,240

Income tax expense 31,000

$2,216,840 $2,261,840

Instructions

(a) Prepare a single-step income statement.

(b) Prepare a multiple-step income statement.

(c) Compare the two statements and comment on the usefulness of each one.

(d) Are the expenses in the statements classifi ed by nature or by function? Explain.

P5–7B Th e unadjusted trial balance of Fashion Centre Ltd. contained the following accounts at November 30, the

company’s fi scal year end:

FASHION CENTRE LTD.

Trial Balance

November 30, 2015

Debit Credit

Cash $ 22,000

Accounts receivable 30,600

Merchandise inventory 27,500

Supplies 1,650

Prepaid insurance 1,800

Long-term investments 37,000

Equipment 26,800

Accumulated depreciation—equipment $ 10,720

Accounts payable 34,400

Unearned revenue 3,000

Bank loan payable 35,000

Common shares 16,400

Retained earnings 30,000

Dividends 10,000

Sales 248,500

Sales returns and allowances 4,600

Sales discounts 4,520

Cost of goods sold 157,000

Salaries expense 32,600

Rent expense 13,850

Interest expense 4,000

Advertising expense 2,100

Income tax expense 2,000

$378,020 $378,020

Additional information and adjustment data:

  1. Th e 12-month insurance policy was purchased on August 1.
  2. Th ere is $950 of supplies on hand at November 30.
  3. Depreciation expense for the year is $5,360 on the equipment.
  4. Salaries of $1,210 are unpaid at November 30.
  5. Accrued interest expense at November 30 is $175.
  6. Of the unearned revenue, $2,400 has been earned by November 30. Th e cost of goods sold incurred in earning this

sales revenue is $1,560.

  1. Of the bank loan payable, $5,000 is to be paid in the next year; the remainder is long-term.
  2. Income tax of $1,100 is due and unpaid.
  3. A physical count of inventory indicates $25,000 on hand at November 30.
  4. Common shares of $5,000 were issued during the year.

Instructions

(a) Prepare T accounts and enter the trial balance amounts.

(b) Record and post the adjusting entries, assuming the company adjusts its accounts annually.

(c) Prepare an adjusted trial balance at November 30.

(d) Prepare a multiple-step income statement, statement of changes in equity, and statement of fi nancial position for the year.

P5–8B Data for Brigus Wholesale Ltd. are presented in P5–6B.

Instructions

(a) Calculate the profi t margin and gross profi t margin.

(b) Th e vice-president of marketing and director of human resources have proposed that the company change its

compensation of the sales force to a commission basis rather than paying a fi xed salary. Given the extra incentive, they

expect net sales to increase by 10%. Th ey estimate that gross profi t will increase by $60,000, operating expenses by

$32,000, and income tax expense by $4,000. Non-operating expense is not expected to change. Calculate the expected

new gross profi t and profi t amounts. (Hint: You do not need to prepare a formal income statement.)

(c) Calculate the revised gross profi t margin and profi t margin, using the information you calculated in part (b). Comment

on the eff ect that this plan would have on profi tability and evaluate the merit of this proposal.

P5–9B Tsang Inc. purchases its merchandise inventory on credit and uses a perpetual inventory system. Th e company

began operations on January 1, 2015, and during 2015 purchased merchandise costing $200,000. Of this amount, 75% was

paid in 2015 with the balance paid in 2016. Th e company sold 80% of its inventory for $400,000 on credit. Of this amount,

80% was collected in 2015 with the rest collected in 2016. Operating expenses of $140,000 were incurred in 2015 and all

were paid by the end of the year. Th e income tax rate is 30% and all income taxes relating to 2015 were paid in 2016. Th e

following table indicates key amounts on the 2015 fi nancial statements:

2015

Income statement data

Sales [1]

Cost of goods sold [2]

Gross profi t [3]

Operating expenses [4]

Profi t before income tax [5]

Income tax expense [6]

Profi t [7]

Statement of fi nancial position data

Accounts receivable [8]

Merchandise inventory [9]

Accounts payable [10]

Income tax payable [11]

Instructions

(a) Calculate the balances for Sales and Accounts Receivable (items 1 and 8 above).

(b) Calculate the balances for Cost of Goods Sold, Merchandise Inventory, and Accounts Payable (items 2, 9, and 10

above).

(c) Calculate the gross profi t, the balance in Operating Expenses, and the profi t before income tax (items 3, 4, and 5

above).

(d) Calculate the balances for Income Tax Expense, profi t, and Income Tax Payable (items 6, 7, and 11 above).

(e) Calculate the gross profi t margin and profi t margin for the company. All companies in this industry sell their products

at approximately the same price and incur income tax at the same rate. If the company’s gross profi t margin and profi t

margin are lower than the industry average, what are the most likely explanations for this?

P5–10B Th e following selected information is available for Volvo Group, headquartered in Sweden, for three fi scal years

(in SEK [Swedish krona] millions):

2012 2011 2010

Current assets 152,751 172,659 147,139

Current liabilities 131,105 143,679 124,059

Net sales 303,647 310,367 264,749

Cost of goods sold 235,085 236,685 201,797

Profi t 11,258 18,115 11,212

Instructions

(a) Calculate the current ratio, gross profi t margin, and profi t margin for each year.

(b) Comment on whether the ratios have improved or deteriorated over the three years.

(c) Compare the 2012 ratios calculated in part (a) with the following industry averages: current ratio 0.9:1; gross profi t

margin 13.5%; and profi t margin (3.8)%. Are Volvo’s ratios better or worse than those of its industry?

*P5–11B Data for Travel Warehouse Ltd. are presented in P5–2B.

Instructions

(a) Record the July transactions on Travel Warehouse’s books, assuming it uses a periodic inventory system instead of a

perpetual inventory system. (Record transactions to the nearest cent.)

(b) Identify the advantages and disadvantages of Travel Warehouse using a periodic inventory system instead of a perpetual

inventory system.

*P5–12B Data for Shaoshi Inc. are presented in P5–3B.

Instructions

(a) Record the October transactions on Shaoshi’s books, assuming it uses a periodic inventory system instead of a perpetual

inventory system.

(b) Assume that Shaoshi took advantage of the 1% purchase discount off ered by Micron Ltd. and paid Micron on October 14

rather than October 30. Record the entry that Shaoshi would make on October 14 and determine the cost of missing

this purchase discount to Shaoshi.

*P5–13B Data for Grand Slam Tennis Shop are presented in P5–4B.

Instructions

(a) Prepare T accounts and enter the opening balances.

(b) Record and post the April transactions for Grand Slam Tennis Shop, assuming it uses a periodic inventory system instead

of a perpetual inventory system. Th e inventory count on April 30 determined that merchandise costing $4,209 was on

hand. Round all calculations to the nearest dollar.

(c) Prepare an unadjusted trial balance as at April 30.

(d) Prepare the adjusting journal entry needed at the end of the period to update the Merchandise Inventory and Cost of

Goods Sold accounts.

*P5–14B You have been provided with the following selected accounts for Severn Limited for the year ended June 30, 2015:

Inventory, July 1, 2014 $ 520,000

Purchases 6,280,000

Accounts receivable 660,000

Sales 7,800,000

Purchase returns and allowances 240,000

Freight in 80,000

Administrative expenses 740,000

Land 1,400,000

Sales discounts 100,000

Interest expense 20,000

Interest revenue 40,000

Accounts payable 540,000

Selling expenses 120,000

Cash 500,000

Common shares 300,000

Severn conducted a physical inventory count on June 30, 2015. Inventory on hand at that date was determined to be

$600,000.

Instructions

(a) Prepare a partial multiple-step income statement for the year ended June 30, 2015, through to gross profi t.

(b) Prepare the period-end adjusting journal entry to update the Cost of Goods Sold and Merchandise Inventory accounts.

(c) Calculate the gross profi t margin. If the industry average gross profi t margin is 26%, how does Severn’s gross profi t

margin compare?

*P5–15B Th e Goody Shop Ltd.’s unadjusted trial balance amounts (prior to recording the adjusting journal entry to

update Merchandise Inventory and Cost of Goods Sold) appear in alphabetical order as follows on November 30, 2015,

the end of its fi scal year:

Administrative expenses $230,100

Accounts payable 32,310

Accounts receivable 13,770

Accumulated depreciation—buildings 61,200

Accumulated depreciation—equipment 19,880

Buildings 175,000

Cash 8,500

Common shares 26,000

Dividends 5,000

Equipment 57,000

Freight in 5,060

Income tax expense 10,000

Income tax payable 6,000

Interest expense 11,315

Land 85,000

Merchandise inventory, Dec. 1, 2014 $ 34,360

Mortgage payable 106,000

Prepaid insurance 4,500

Property tax payable 3,500

Purchases 684,700

Purchase discounts 16,000

Purchase returns and allowances 3,315

Retained earnings 82,800

Salaries payable 8,500

Sales 989,000

Sales discounts 15,000

Sales returns and allowances 10,000

Selling expenses 8,200

Unearned revenue 3,000

Additional information:

  1. Th e Goody Shop uses a periodic inventory system.
  2. A physical inventory count determined that merchandise inventory on November 30, 2015, was $37,350.
  3. Of the mortgage payable, $5,300 is due in the next year.
  4. Common shares of $25,000 were issued during the year.

Instructions

Prepare a multiple-step income statement, statement of changes in equity, and statement of fi nancial position for the year.

 

 

CHAPTER 6 Reporting and Analyzing Inventory

 

Questions

  1. Your friend Tom Wetzel has been hired to help take

the physical inventory in Kikujiro’s Hardware Store.

Explain to Tom how to do this job, giving him

specifi c instructions for determining the inventory

quantities that Kikujiro’s has legal title over.

(SO 1) 2. What is internal control? How does it apply to

taking a physical inventory count?

(SO 1) 3. Janine Ltd. ships merchandise to Fastrak

Corporation on December 30. Th e merchandise

reaches Fastrak on January 5. Indicate the terms

of sale (FOB shipping point or FOB destination)

that will result in the goods being included in

(a) Janine’s December 31 inventory and

(b) Fastrak’s December 31 inventory.

(SO 1) 4. Explain whether each of the following should

be included in the inventory of Kingsway Inc.:

(a) consigned goods held by a craft shop for sale

on Kingsway’s behalf, (b) goods taken home on

approval by a Kingsway customer, and (c) goods

sold but held for alteration by Kingsway.

(SO 2) 5. Distinguish between the three methods of determining

cost for inventories: specifi c identifi cation,

FIFO, and average cost. Give an example of a type

of inventory for which each method might be used.

(SO 2) 6. Which of the three inventory cost determination

methods assumes that goods available for

sale are identical? Which assumes that the fi rst

goods purchased are the fi rst to be sold? Which

matches the actual physical fl ow of merchandise?

(SO 2) 7. Explain why a new weighted average unit cost

must be calculated aft er each purchase when

using the average cost method in a perpetual

inventory system but not aft er each sale.

(SO 3) 8. What are the guidelines that a company should

consider when choosing among the three methods

of determining cost for inventories: specifi c

identifi cation, FIFO, and average cost?

(SO 3) 9. Which inventory cost method—FIFO or average

cost—provides the better measure of cost of

goods sold on the income statement? Th e better

measure of ending inventory on the statement of

fi nancial position? Explain.

(SO 3) 10. Compare the fi nancial eff ects (ignore income

tax) of using the FIFO and average inventory cost

methods during a period of declining prices on

(a) cash (pre-tax), (b) ending inventory, (c) cost of

goods sold, (d) profi t, and (e) retained earnings.

(SO 4) 11. If an error in counting ending inventory in one

year will have the reverse eff ect in the following

year, will this error need to be corrected when it

is discovered? Explain.

(SO 4) 12. Mila Ltd.’s ending inventory at December 31, 2014,

was understated by $5,000. Assuming that this

error is not detected, what eff ect will it have on

(a) 2014 profi t before income tax, (b) 2014 retained

earnings, (c) 2014 total shareholders’ equity,

(d) 2015 profi t before income tax, (e) 2015 retained

earnings, and (f) 2015 total shareholders’ equity?

(SO 4) 13. Shediac Inc. purchased inventory from Bathurst

Corp. four days prior to Shediac’s year end.

Bathurst shipped the goods to Shediac FOB

destination two days before year end but Shediac

did not receive the goods until the following

year. Th e inventory clerk recorded the purchase

of the inventory on credit prior to the yearend

inventory count by debiting inventory and

crediting accounts payable. Shediac performs

a physical inventory count each year-end and

makes any required adjustments. What overall

eff ect will this error have on the components of

the accounting equation—assets, liabilities, and

shareholders’ equity—at Shediac’s year end

(a) prior to any adjustment for the inventory

count results, and (b) aft er any adjustment?

(SO 5) 14. Explain the meaning of (a) cost and (b) net realizable

value, and explain (c) when the lower of

cost and net realizable value rule should be used

to value inventory.

(SO 5) 15. Why is the Cost of Goods Sold account debited

in the journal entry to record a decline in

inventory value under the lower of cost and net

realizable value rule even though no merchandise

has been sold?

(SO 5) 16. Would an increase in the days in inventory ratio

from one year to the next be viewed as an improvement

or a deterioration in how effi ciently

a company manages its inventory?

(SO 5) 17. What are the consequences for a company when

its inventory turnover ratio is (a) too high and

(b) too low?

(SO 2, 6) *18. Your classmate does not understand the difference

between the perpetual and periodic

inventory systems. “Th e same cost methods are

used in both systems,” he says, “and a physical

inventory count is required in both systems. So

what’s the diff erence?” Explain to your confused

classmate how the perpetual and periodic

inventory systems diff er.

(SO 6) *19. In a periodic inventory system, the ending

inventory is counted and costed. Th is number is

then used to calculate cost of goods sold. Emad

asks, “Why can’t you determine the cost of

goods sold fi rst instead of going through all of

these steps?” Explain this to Emad.

(SO 2, 6) *20. Explain why, when a company uses FIFO with

a periodic inventory system, the cost of goods

sold and ending inventory costs are the same

as they would be had FIFO been used with a

perpetual system.

(SO 2, 6) *21. Explain why, when a company uses average cost

method with a periodic inventory system, the

cost of goods sold and ending inventory costs

are diff erent from the amounts calculated when

using the average cost method with a perpetual

inventory system.

Brief Exercises

BE6–1 Helgeson Inc. identifi es the following items as possibly belonging in its physical inventory count. For each item,

indicate whether or not it should be included in the inventory.

(a) Goods shipped on consignment by Helgeson to another company

(b) Goods held on consignment by Helgeson from another company

(c) Goods in transit to a customer, shipped FOB shipping point

(d) Goods in transit to Helgeson from a supplier, shipped FOB destination

(e) Goods in transit to a customer, shipped FOB destination

(f) Goods in transit to Helgeson from a supplier shipped FOB shipping point

BE6–2 Th e Village Hat Shop Limited counted the entire inventory in its store on August 31 and arrived at a total inventory

cost of $66,000. Th e count included $6,000 of inventory held on consignment for a local designer; $500 of inventory

that was being held for customers who were deciding if they actually wanted to purchase the merchandise; and $1,000

of inventory that had been sold to customers but was being held for alterations. Th ere were two shipments of inventory

received on September 1. Th e fi rst shipment cost $5,000. It had been shipped on August 29, terms FOB destination. Th e

second shipment cost $3,750, plus freight charges of $250. It had been shipped on August 28, terms FOB shipping point.

Neither of these shipments was included in the August 31 count. Calculate the correct cost of the inventory on August 31.

BE6–3 On January 3, Piano Corp. purchased three portable electronic keyboards for $600 each. On January 20, it purchased

two more of the same model keyboards for $475 each. During the month, it sold two keyboards; one was purchased

on January 3 and the other was purchased on January 20. (a) Calculate the cost of goods sold and ending inventory for the

month using specifi c identifi cation. (b) Explain how management could manipulate profi t, if it wished to, using this method

BE6–4 Akshay Limited uses the FIFO cost method in a perpetual inventory system. Fill in the missing amounts for

items [1] to [18] in the following perpetual inventory schedule:

Purchases Cost of Goods Sold Balance

Date Units Cost Total Units Cost Total Units Cost Total

Apr. 1 15 $18 $270

6 30 [1] $450 [2] [3]

[4] [5] [6]

9 15 [7]

10 [8] [9] [10] [11] [12]

14 [13] 12 144 [14] [15]

[16] [17] [18]

BE6–5 Akshay Limited uses the average cost method in a perpetual inventory system. Fill in the missing amounts for

items [1] to [13] in the following perpetual inventory schedule. (Use unrounded numbers in your calculations but round

to the nearest cent for presentation purposes in your answer.)

Purchases Cost of Goods Sold Balance

Date Units Cost Total Units Cost Total Units Cost Total

Apr. 1 15 $18 $270

6 30 [1] $450 [2] [4] [3]

9 25 [5] [6] [7] [9] [8]

14 [10] 12 144 [11] [13] [12]

BE6–6 Battery Limited uses a perpetual inventory system. Th e inventory records show the following data for its fi rst

month of operations:

Date Explanation Units Unit Cost Total Cost Balance in Units

Aug. 2 Purchases 250 $7 $1,750 250

3 Purchases 500 10 5,000 750

10 Sales (300) 450

15 Purchases 900 12 10,800 1,350

25 Sales (325) 1,025

Calculate the cost of goods sold and ending inventory using (a) FIFO and (b) average cost. (For average, use unrounded

numbers in your calculations but round to the nearest cent for presentation purposes in your answer.)

BE6–7 Interactive.com just started business and is trying to decide which inventory cost method—FIFO or average

cost—to use. Assuming prices are falling, as they oft en do in the information technology sector, answer the following

questions for Interactive.com:

(a) Which method will result in having higher ending inventory? Will this method also result in an ending inventory value

that is closer to replacement cost? Explain.

(b) Which method will result in the higher cost of goods sold? Will this method also result in the most current cost of

goods sold matched against revenue? Explain.

(c) What guidelines are important for Interactive.com to consider as it tries to select the most appropriate inventory

cost method?

BE6–8 DuPlessis Corporation incorrectly recorded $25,000 of goods held on consignment for another company as a

purchase during the year ended December 31, 2015. Th e physical inventory count, which included the consigned goods,

agreed with the perpetual inventory accounting records at year end. What eff ect, if any, will this error have on total assets,

liabilities, and shareholders’ equity at December 31, 2015, assuming the error is not detected before year end?

BE6–9 In its year-end physical inventory count, Tire Track Corporation forgot to count tires it had stored outside its

warehouse in a trailer. As a result, ending inventory was understated by $7,000. Assuming that this error was not subsequently

discovered and corrected, what is the impact of this error on assets, liabilities, and shareholders’ equity at the end

of the current year? At the end of the next year?

BE6–10 Hawkeye Video Centre Ltd. accumulates the following cost and net realizable value data at December 31:

Inventory Categories Cost NRV

High defi nition camcorders $11,000 $10,200

Cameras 9,000 9,500

DVD players 14,000 12,800

(a) Calculate the lower of cost and net realizable value for Hawkeye’s inventory.

(b) Prepare the entry needed to adjust Hawkeye’s inventory value to the lower of cost or net realizable value at December 31.

BE6–11 Th e cost of Piper Music Inc.’s inventory at December 31, 2014, is $54,700. Its net realizable value on the same

date is $52,500. (a) Prepare the adjusting journal entry required, if any, to record the decline in value of the inventory, assuming

Piper Music uses a perpetual inventory system. (b) If Piper Music has the same inventory on hand at December 31,

2015, with a net realizable value of $55,000, what amount should it report its inventory at on that date?

BE6–12 Th e following information is available for Canadian Tire Corporation :

2012 2011 2010

Inventory $ 1,503 $ 1,449 $ 933

Net sales 11,427 10,387 9,213

Cost of goods sold 7,929 7,326 6,422

(a) Calculate the inventory turnover and days in inventory ratios for 2012 and 2011. (b) Did Canadian Tire’s inventory

management improve or deteriorate in 2012?

*BE6–13 In its fi rst month of operations, Queensland Inc. made three purchases of merchandise in the following sequence:

(1) 370 units @ $9 each, (2) 700 units @ $12 each, and (3) 800 units @ $11 each. A physical inventory count

determined that there were 600 units on hand at the end of the month. Assuming Queensland uses a periodic inventory

system, calculate the cost of the ending inventory and cost of goods sold using (a) FIFO and (b) average cost. (For average,

use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.)

*BE6–14 G-Mac Corporation reports the following inventory data for the month of January:

Date Explanation Units Unit Cost Total Cost

Jan 1 Beginning inventory 15 $4.50 $ 67.50

15 Purchases 18 5.00 90.00

27 Purchases 13 4.50 58.50

46 $216.00

A physical inventory count determined that there were 15 units on hand at the end of January.

(a) Calculate the cost of the ending inventory and cost of goods sold under FIFO, assuming G-Mac uses a periodic inventory

system. (Round your answers to the nearest cent.)

(b) Would your answers to part (a) diff er if G-Mac used a perpetual inventory system? Explain.

(c) Five of the 15 units on hand that were purchased on January 15, were damaged and had no resale value. Prepare the

entry to refl ect the damaged inventory under FIFO and a periodic inventory system.

*BE6–15 At the beginning of the year, Seller Ltd. had 700 units with a cost of $4 per unit in its beginning inventory. Th e

following inventory transactions occurred during the month of January:

Jan. 3 Sold 500 units on account for $6 each.

9 Purchased 1,000 units on account for $4 per unit.

15 Sold 800 units for cash at $8 each.

Prepare journal entries assuming that Seller Ltd. uses FIFO (a) under a perpetual inventory system and (b) under a periodic

inventory system.

Exercises

E6–1 Shippers Ltd. had the following inventory situations to consider at January 31, its year end:

  1. Goods held on consignment for Boxes Unlimited since December 22
  2. Goods shipped on consignment to Rinehart Holdings Ltd. on January 5
  3. Goods that are still in transit and were shipped to a customer FOB destination on January 29
  4. Freight costs due on goods in transit from item 3 above
  5. Goods that are still in transit and were shipped to a customer FOB shipping point on January 29
  6. Goods that are still in transit and were purchased FOB destination from a supplier on January 25
  7. Goods that are still in transit and were purchased FOB shipping point from a supplier on January 25

Instructions

Identify which of the above items should be included in inventory. If an item should not be included in inventory, state

where it should be recorded.

E6–2 Gatineau Bank is considering giving Novotna Corporation a short-term bank loan. Before doing so, it decides that

further discussions with Novotna’s accountant may be desirable. One area of particular concern is the inventory account,

which according to a recent physical inventory count has a balance of $285,000 at December 31. Th is count agreed with

the accounting records. Discussions with the accountant reveal the following:

  1. Novotna sold goods costing $35,000 to India-based Moghul Company, FOB destination, on December 28. Th e goods

are not expected to arrive in India until January 12. Th e goods were not included in the physical inventory count,

because they were not in the warehouse.

  1. Th e physical inventory count did not include goods costing $95,000 that were shipped to Novotna, FOB shipping

point, on December 27 and were still in transit at year end.

  1. Novotna received goods costing $28,000 on January 2. Th e goods were shipped FOB shipping point on December 26

by Cellar Corp. Th e goods were not included in the physical inventory count.

  1. Novotna sold goods costing $49,000 to United Kingdom–based Sterling of Britain Ltd., FOB shipping point, on December
  2. Th e goods were received by Sterling on January 8. Th ey were not included in Novotna’s physical inventory count.
  3. On December 31, Schiller Corporation had $30,500 of goods held on consignment for Novotna. Th e goods were not

included in the physical inventory count.

  1. Included in the physical inventory count were $15,000 of parts for outdated products that the company had not been

able to sell. It is unlikely that these obsolete parts will have any other use.

Instructions

(a) Determine the correct inventory amount on December 31.

(b) Explain why having an accurate inventory count is important to the bank in assessing whether to give Novotna a shortterm

bank loan or not.

E6–3 On February 28, Discount Electronics Ltd. has three home entertainment systems left in stock. Th e purchase dates,

serial numbers, and cost of each of the three systems are as follows:

Date Serial Number Cost

Jan. 2 #1012 $800

Feb. 1 #1045 740

28 #1056 680

All three systems are priced to sell at $1,300. By March 31, two systems had been sold and one system remained in inventory.

Instructions

(a) Explain how Discount Electronics would use specifi c identifi cation to determine the cost of goods sold and the cost

of the ending inventory.

(b) Explain how Discount Electronics could manipulate its profi t using specifi c identifi cation by “selectively choosing”

which home entertainment system to sell to the two customers in the month of March. What would Discount

Electronics’ cost of goods sold and gross profi t be if the company wished to minimize profi t? To maximize profi t?

Ignore income tax.

(c) What guidelines should Discount Electronics consider when deciding whether to use specifi c identifi cation or one of

the other cost methods to determine the cost of its inventory?

E6 – 4 Ohsweken Outdoor Stores Inc. uses a perpetual inventory system and has a beginning inventory, as at April 1, of

150 tents. Th is consists of 50 tents at a cost of $210 each and 100 tents at a cost of $225 each. During April, the company

had the following purchases and sales of tents:

Purchases Sales

Date Units Unit Cost Units Unit Price

Apr. 3 75 $400

10 200 $275

17 250 400

24 300 290

30 200 400

Instructions

(a) Determine the cost of goods sold and the cost of the ending inventory using FIFO.

(b) Calculate Ohsweken Outdoors’s gross profi t and gross profi t margin for the month of April.

(c) Is the gross profi t determined in part (b) higher or lower than it would be if Ohsweken Outdoors had used the average

cost method? Explain.

E6–5 Basis Furniture Ltd. uses a perpetual inventory system and has a beginning inventory, as at June 1, of 500 bookcases

at a cost of $125 each. During June, the company had the following purchases and sales of bookcases:

Purchases Sales

Date Units Unit Cost Units Unit Price

June 6 1,200 $127

10 1,000 $200

14 1,800 128

16 1,600 205

26 1,000 129

Instructions

(a) Determine the cost of goods sold and the cost of the ending inventory using the average cost method. (Use unrounded

numbers in your calculations but round to the nearest cent for presentation purposes in your answer.)

(b) Calculate Basis Furniture’s gross profi t and gross profi t margin for the month of June.

(c) Is the gross profi t determined in part (b) higher or lower than it would be if Basis Furniture had used FIFO?

Explain.

E6–6 Lakshmi Ltd. uses the perpetual inventory system and reports the following inventory transactions for the month

of June:

Date Explanation Units Unit Cost Total Cost

June 1 Beginning inventory 150 $5 $ 750

12 Purchases 230 6 1,380

15 Sale (250)

16 Purchases 450 7 3,150

23 Purchases 150 8 1,200

27 Sales (570)

Instructions

(a) Determine the cost of goods sold and the cost of the ending inventory using (1) FIFO and (2) average cost. Ignore

the eff ect of income tax. (For average, use unrounded numbers in your calculations but round to the nearest cent for

presentation purposes in your answer.)

(b) Which cost method results in the higher cost of goods sold? Why?

(c) Which cost method results in the higher profi t? Why?

(d) Which cost method results in the higher ending inventory? Why?

(e) Which cost method results in the higher cash fl ow? Why?

E6–7 Glenmount Inc. is trying to determine whether to use the FIFO or average cost method. Th e accounting records

show the following selected inventory information:

Purchases Cost of Goods Sold Balance

Date Units Cost Total Units Cost Total Units Cost Total

Oct. 2 9,000 $12 $108,000

15 15,000 14 210,000

29 22,000

Th e company accountant has prepared the following partial income statement to help management understand the

fi nancial statement impact of each cost determination method.

FIFO Average Cost

Sales $525,000 $525,000

Cost of goods sold

Gross profi t

Operating expenses 200,000 200,000

Profi t before income tax

Income tax expense (30%)

Profi t

Instructions

(a) Complete the perpetual inventory schedule shown above, assuming the use of the FIFO cost method.

(b) Complete the perpetual inventory schedule shown above, assuming the use of the average cost method. (Use unrounded

numbers in your calculations but round to the nearest cent for presentation purposes in your answer.)

(c) Fill in the missing information in the blanks shown in the income statements above.

(d) Explain whether the comparative profi ts of each cost method determined in part (c) will be expected to increase, decrease,

or not change if (1) costs fall, and (2) costs remain stable.

E6–8 Seles Hardware Limited reported the following amounts for its cost of goods sold and merchandise inventory:

2015 2014

Cost of goods sold $168,000 $154,000

Ending inventory 37,000 30,000

Seles made two errors: (1) ending inventory for 2015 was overstated by $2,000 and (2) ending inventory for 2014 was

understated by $4,000.

Instructions

(a) Calculate the correct ending inventory and cost of goods sold amounts for each year.

(b) Describe the impact of the error on (1) cost of goods sold, (2) profi t before income tax, (3) assets, (4) liabilities, and

(5) total shareholders’ equity for each of the two years.

(c) Explain why it is important that Seles Hardware correct these errors as soon as they are discovered.

E6–9 Aruba Inc. reported the following partial income statement data for the years ended December 31, 2015, and 2014:

2015 2014

Sales $265,000 $250,000

Cost of goods sold 205,000 194,000

Gross profi t 60,000 56,000

Merchandise inventory was reported in the current fi nancial position at $44,000, $52,000, and $49,000 at the end of 2013,

2014, and 2015, respectively. Th e ending inventory amounts for 2013 and 2015 are correct. However, the ending inventory

at December 31, 2014, is understated by $8,000.

Instructions

(a) Prepare correct income statements for 2014 and 2015 through to gross profi t.

(b) What is the cumulative eff ect of the inventory error on total gross profi t for these two years?

(c) Calculate the gross profi t margin for each of these two years, before and aft er the correction.

E6–10 Calabogie Camera Shop Ltd. reports the following cost and net realizable value information for its inventory at

December 31:

Units Unit Cost Unit NRV

Cameras:

Sony 4 $175 $160

Canon 8 150 152

Light Meters:

Gossen 12 135 139

Seconic 10 115 110

Instructions

(a) Determine the lower of cost and net realizable value of the ending inventory.

(b) Prepare the adjusting journal entry required, if any, to record the lower of cost and net realizable value of the inventory

assuming Calabogie Camera Shop uses a perpetual inventory system.

(c) A physical inventory count at December 31 found that two of the Canon cameras were badly damaged. It was determined

they had no resale value. Prepare the adjusting entry required, if any, to record the damaged cameras.

E6–11 Th e following information is available for Gildan Activewear Inc. , headquartered in Montreal, for three recent

fi scal years (in U.S. $ thousands):

2012 2011 2010

Inventory $ 553,068 $ 568,311 $ 332,542

Net sales 1,948,253 1,725,712 1,311,463

Cost of goods sold 1,552,128 1,288,106 947,206

Instructions

(a) Calculate the inventory turnover, days in inventory, and gross profi t margin for 2012 and 2011.

(b) Based on the ratios calculated in part (a), did Gildan’s liquidity and profi tability improve or deteriorate in 2012?

E6–12 Th e following comparative cost information is available for Kingswood Limited:

Average Inventory Cost of Goods Sold

FIFO $222,500 $750,000

Average cost 227,500 735,000

Kingswood’s current assets are $450,000, exclusive of inventory. Its current liabilities are $350,000.

Instructions

(a) Calculate Kingswood’s inventory turnover ratio assuming (1) FIFO and (2) average cost is used to determine the cost

of the ending inventory.

(b) Calculate Kingswood’s current ratio assuming (1) FIFO and (2) average cost is used to determine the cost of the ending

inventory.

(c) Does one cost method result in better measure of liquidity than the other for Kingswood? Explain.

*E6–13 Mawmey Inc. uses a periodic inventory system. Its records show the following for the month of May, with 15

units on hand at May 31:

Date Explanation Units Unit Cost Total Cost

May 1 Beginning inventory 30 $10 $300

12 Purchases 50 12 600

14 Purchases 20 15 300

Total

Instructions

Determine the cost of the ending inventory and cost of goods sold using (a) FIFO and (b) average cost. (For average, use

unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.)

*E6–14 Lakshmi Ltd. reports the following inventory transactions in a periodic inventory system for the month of June.

A physical inventory count determined that 225 units were on hand at the end of the month.

Date Explanation Units Unit Cost Total Cost

June 1 Beginning inventory 150 $5 $ 750

12 Purchases 230 6 1,380

16 Purchases 450 7 3,150

23 Purchases 150 8 1,200

Instructions

(a) Determine the cost of the ending inventory and cost of goods sold using (1) FIFO and (2) average cost. (For average,

use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.)

(b) For item 2 of part (a), explain why the average unit cost is not $6.50 [($5 1 $6 1 $7 1 $8) 4 4].

(c) By how much do the results for part (a) diff er from E6–6, where the same information was used in a perpetual inventory

system? Why?

*E6–15 Powder, Inc. sells an Xpert snowboard that is popular with snowboard enthusiasts. Th e following information

shows Powder’s purchases and sales of Xpert snowboards during November:

Date Transaction Units Unit Cost Unit Sales Price

Nov. 1 Beginning inventory 30 $295

5 Purchases 25 300

12 Sales (42) $460

19 Purchases 40 305

22 Sales (50) 470

25 Purchases 30 310

33

Instructions

(a) Determine the cost of goods sold and ending inventory using (1) FIFO and (2) average cost, assuming Powder uses a

perpetual inventory system. (For average, use unrounded numbers in your calculations but round to the nearest cent

for presentation purposes in your answer.)

(b) Determine the cost of goods sold and ending inventory using (1) FIFO and (2) average cost, assuming Powder uses a

periodic inventory system. (For average, use unrounded numbers in your calculations but round to the nearest cent

for presentation purposes in your answer.)

*E6–16 Refer to the data provided for Powder, Inc. in E6–15.

Instructions

(a) Prepare journal entries to record purchases and sales for Powder in a perpetual inventory system using (1) FIFO and

(2) average cost.

(b) Prepare journal entries to record purchases and sales for Powder in a periodic inventory system using (1) FIFO and

(2) average cost.

Problems: Set A

P6–1A Kananaskis Limited is trying to determine the amount of its ending inventory as at February 28, the company’s year

end. Th e accountant counted everything in the warehouse in early March, which resulted in an ending inventory amount of

$150,000. However, the accountant was not sure how to treat the following transactions, so he did not include them in the

count. He has asked for your help in determining whether or not the following transactions should be included in inventory:

  1. Feb. 1 Kananaskis shipped $1,800 of inventory on consignment to Banff Corporation. By February 28, Banff had

sold half of this inventory for Kananaskis.

  1. 15 Kananaskis received $800 of inventory on consignment from Craft Producers Ltd. By February 28,

Kananaskis had not sold any of this inventory.

  1. 19 Kananaskis was holding merchandise that had been sold to a customer on February 19 but needed alteration

before the customer would take possession. Th e merchandise cost $980 and alterations cost $120. Th e

customer plans to pick up the merchandise on March 2 aft er the alterations are complete.

  1. 23 Kananaskis shipped goods FOB shipping point to a customer. Th e merchandise cost $560. Th e appropriate

party paid the freight costs of $70. Th e receiving report indicates that the goods were received by the customer

on March 2.

  1. 24 Kananaskis purchased goods FOB shipping point from a supplier. Th e merchandise cost $750. Th e appropriate

party paid the freight costs of $80. Th e goods were shipped by the supplier on February 26 and

received by Kananaskis on March 3.

  1. 25 Kananaskis purchased goods FOB destination from a supplier. Th e merchandise cost $1,500. Th e appropriate

party paid the freight costs of $150. Th e goods were shipped by the supplier on February 27 and

received by Kananaskis on March 4.

  1. 27 Kananaskis shipped goods FOB destination costing $1,900 to a customer. Th e appropriate party paid the

freight costs of $200. Th e receiving report indicates that the customer received the goods on March 7.

  1. Mar. 5 Kananaskis had $1,260 of inventory isolated in the warehouse. Th e inventory is designated for a customer

who has requested that the goods not be shipped until March 5.

Instructions

(a) For each of the above situations, specify whether the item should be included in ending inventory, and if so, at what

amount. For each item that is not included in ending inventory, indicate who owns it and what account, if any, it should

have been recorded in.

(b) Calculate the revised ending inventory amount.

P6–2A Dean’s Sales Ltd., a small Ford dealership, has provided you with the following information with respect to its

vehicle inventory for the month of April. Th e company uses the specifi c identifi cation method.

Date Explanation Model Serial # Unit Cost/Price

Apr. 1 Beginning inventory Focus C81362 $22,000

Mustang G62313 27,000

Flex X3892 29,000

F-150 F1883 23,000

F-150 F1921 27,000

8 Sales Focus C81362 24,000

Mustang G62313 30,000

12 Purchases Mustang G71811 28,000

Mustang G71891 26,000

Flex X4212 28,000

Flex X4214 29,000

Escape E21202 27,000

18 Sales Mustang G71891 31,000

Flex X3892 32,000

F-150 F1921 30,500

Escape E21202 30,000

23 Purchases Focus C81528 25,000

Escape E28268 28,000

Instructions

(a) Determine the cost of goods sold and ending inventory for the month of April.

(b) Determine the gross profi t for the month of April.

(c) Discuss whether the specifi c identifi cation method is likely the most appropriate cost determination method for Dean’s

Sales.

P6–3A Sandoval Skateshop Ltd. reports the following inventory transactions for its skateboards for the month of April.

Th e company uses a perpetual inventory system.

Date Explanation Units Unit Cost Total Cost

Apr. 1 Beginning inventory 30 $50 $1,500

6 Purchases 15 45 675

9 Sales (35)

14 Purchases 20 40 800

20 Sales (25)

28 Purchases 20 35 700

Instructions

(a) Determine the cost of goods sold and cost of ending inventory using FIFO.

(b) Assume that Sandoval wants to change to the average cost method. What guidelines must it consider before making

this change?

(c) If the company does change to the average cost method and prices continue to fall, would you expect the cost of goods

sold and ending inventory amounts to be higher or lower than these amounts when using FIFO?

P6–4A Information for Sandoval Skateshop Ltd. is presented in P6–3A. Use the same inventory data and assume that the

company uses the perpetual inventory system.

Instructions

(a) Determine the cost of goods sold and cost of ending inventory using average cost. (Use unrounded numbers in your

calculations but round to the nearest cent for presentation purposes in your answer.)

(b) When the company counted its inventory at the end of April, it counted only 24 skateboards on hand. What journal

entry, if any, should the company make to record this shortage?

(c) If the company had not discovered this shortage, identify what accounts would be overstated or understated and by

what amount.

P6–5A Save-Mart Centre Inc. began operations on May 1 and uses a perpetual inventory system. During May, the company

had the following purchases and sales for one of its products:

Purchases Sales

Date Units Unit Cost Units Unit Price

May 1 12 $100

3 8 $250

8 10 110

13 8 275

15 6 115

20 6 300

27 4 325

Instructions

(a) Determine the cost of goods sold and cost of ending inventory using (1) FIFO and (2) average cost. Ignore the eff ect of

income tax. (For average, use unrounded numbers in your calculations but round to the nearest cent for presentation

purposes in your answer.)

(b) What guidelines should Save-Mart consider in choosing between the FIFO and average cost methods?

(c) Which cost method produces the higher gross profi t and profi t?

(d) Which cost method produces the higher ending inventory valuation?

(e) Which cost method produces the higher cash fl ow?

P6–6A You are provided with the following information for Amelia Inc., which purchases its inventory from a supplier

for cash and has only cash sales. Amelia uses the average cost method in a perpetual inventory system. Increased

competition has recently reduced the price of the product.

Date Explanation Units Unit Cost/Price

Apr. 1 Beginning inventory 50 $ 8

6 Purchases 110 9

8 Sales (140) 12

15 Purchases 120 7

20 Sales (110) 10

27 Purchases 20 6

Instructions

(a) Prepare all journal entries for the month of April for Amelia, the buyer. (Use unrounded numbers in your calculations

but round to the nearest cent for presentation purposes in your answer.)

(b) Determine the ending inventory amount for Amelia.

(c) On April 30, Amelia learns that the product has a net realizable value of $5 per unit. What amount should ending

inventory be valued at on the April statement of fi nancial position?

P6–7A In its physical inventory count at its February 28, 2014, year end, Th e Orange Sprocket Corporation included

inventory that was being held for another company to sell on consignment. Th e merchandise was sold in the next year and

inventory was correctly stated at February 28, 2015.

Instructions

Ignoring income tax, indicate the eff ect of this error (overstated, understated, or no eff ect) on each of the following at year end:

2015 2014

(a) Cash _________ _________

(b) Cost of goods sold _________ _________

(c) Profi t _________ _________

(d) Retained earnings _________ _________

(e) Ending inventory _________ _________

(f) Gross profi t margin ratio (40%) _________ _________

(g) Inventory turnover ratio (10 times) _________ _________

P6–8A Th e records of Kmeta Inc. show the following data for the years ended July 31:

2015 2014 2013

Income statement:

Sales $340,000 $320,000 $300,000

Cost of goods sold 233,000 220,000 209,000

Operating expenses 68,000 64,000 64,000

Statement of fi nancial position:

Merchandise inventory 40,000 40,000 24,000

Aft er the company’s July 31, 2015, year end, the accountant discovers two errors:

  1. Ending inventory on July 31, 2013, was actually $33,000, not $24,000. Kmeta owned goods held on consignment at

another company that were not included in the inventory account.

  1. Kmeta purchased $15,000 of goods from a supplier on July 30, 2014, with shipping terms FOB destination.

Although it did not receive the goods until August 4, 2014, the goods were included in the July 31, 2014, year-end

inventory. The purchase was then recorded properly on August 4, 2014.

Instructions

(a) For each of the three years, prepare both incorrect and corrected income statements through to profi t before income tax.

(b) What is the combined (total) impact of these errors on retained earnings (ignoring any income tax eff ects) for the three

years before correction? Aft er correction?

(c) Calculate both the incorrect and corrected inventory turnover ratios for 2015 and 2014.

P6–9A Tascon Corporation sells coff ee beans, which are sensitive to price fl uctuations. Th e following inventory information

is available for this product at December 31, 2014:

Coff ee Bean Units Unit Cost Net Realizable Value

Coff ea arabica 13,000 bags $5.60 $5.55

Coff ea robusta 5,000 bags 3.40 3.50

(a) Calculate Tascon’s inventory at the lower of cost and net realizable value.

(b) Prepare any journal entry required to record the LCNRV, assuming that Tascon uses a perpetual inventory

system.

(c) Assume that Tascon still holds this inventory a year later and that it has recovered from its decline in value; that is, the

coff ee’s net realizable value exceeds its cost. Should Tascon carry its inventory at December 31, 2015, at cost, net realizable

value, or some other value? Explain.

P6–10A You have been provided with the following information regarding Love Paper Ltd.’s inventory for June, July,

and August.

Paper Inventory (in tonnes) Cost/Tonne NRV/Tonne

June 30 6,000 $790 $850

July 31 6,700 850 815

August 31 5,500 815 790

Instructions

(a) Calculate the cost and net realizable value of Love Paper’s paper inventory at (1) June 30, (2) July 31, and

(3) August 31.

(b) Prepare any journal entry necessary to record the LCNRV of the paper inventory at (1) June 30, (2) July 31, and

(3) August 31. Assume that Love Paper uses a perpetual inventory system.

(c) Are there any diff erences in recording LCNRV for companies reporting using ASPE rather than IFRS?

P6–11A Th e following information is available for Th e Coca-Cola Company (in U.S. $ millions):

2012 2011 2010

Cost of goods sold $19,053 $18,216 $12,693

Inventories 3,264 3,092 2,650

Current assets 30,328 25,497 21,579

Current liabilities 27,821 24,282 18,508

In the notes to its fi nancial statements, Coca-Cola disclosed that it uses the FIFO and average cost methods to determine

the cost of its inventory.

Th e industry averages for the inventory turnover, days in inventory, and current ratios are as follows:

2012 2011

Inventory turnover 7.8 times 7.4 times

Days in inventory 47 days 49 days

Current ratio 1.2:1 1.1:1

Instructions

(a) Calculate Coca-Cola’s inventory turnover, days in inventory, and current ratios for 2012 and 2011. Comment on the

company’s liquidity over the two years, and in comparison with the industry.

(b) What might be the reason that Coca-Cola uses more than one cost method to determine the cost of its inventory?

P6–12A Th e following information is available for Tim Hortons Inc. and Starbucks Corporation , and their industry,

for a recent year:

Tim Hortons Starbucks Industry Average

Inventory turnover 16.1 times 5.3 times 24.4 times

Current ratio 1.3:1 1.9:1 1.2:1

Gross profi t margin 11.9% 56.3% 37.6%

Profi t margin 18.3% 10.4% 10.4%

Instructions

(a) Comment on the liquidity of the two companies in comparison with each other, and the industry.

(b) Comment on the profi tability of the two companies in comparison with each other, and the industry

*P6–13A Kane Ltd. had a beginning inventory on January 1 of 25 units of product SXL at a cost of $160 per unit. During

the year, purchases were as follows:

Units Unit Cost Total Cost

Mar. 15 70 $150 $10,500

July 20 50 145 7,250

Sept. 4 45 135 6,075

Dec. 2 10 125 1,250

Kane uses a periodic inventory system. At the end of the year, a physical inventory count determined that there were

20 units on hand.

Instructions

(a) Determine the cost of goods available for sale.

(b) Determine the cost of the ending inventory and the cost of the goods sold using (1) FIFO and (2) average cost.

(Use unrounded numbers in your calculation of the average unit cost but round to the nearest cent for presentation

purposes in your answer.)

*P6–14A Data for Kane Ltd. are presented in P6–13A. Assume that Kane sold product SXL for $200 per unit during

the year.

Instructions

(a) Prepare a partial income statement through to gross profi t for each of the two cost methods: (1) FIFO and (2) average

cost.

(b) Show how inventory would be reported in the current assets section of the statement of fi nancial position for (1) FIFO

and (2) average cost.

(c) Which cost method results in the lower inventory amount for the statement of fi nancial position? Th e lower gross

profi t amount for the income statement?

* P6– 15A You are provided with the following information about Lynk Inc.’s inventory for the month of August:

Date Description Units Unit Cost

Aug. 1 Beginning inventory 50 $90

4 Purchase 180 92

10 Sale (160)

18 Purchase 70 94

25 Sale (100)

28 Purchase 40 95

Instructions

(a) Calculate the cost of ending inventory and cost of goods sold using FIFO in (1) a periodic inventory system, and (2) a perpetual

inventory system.

(b) Compare your results for items 1 and 2 of part (a), commenting particularly on any diff erences or similarities between

the two inventory systems.

*P6–16A You are provided with the following information about Apple River Inc.’s inventory for the month of November:

Date Explanation Units Unit Cost

Nov. 1 Beginning inventory 100 $20

4 Purchase 500 21

11 Sale (450)

16 Purchase 750 22

20 Sale (800)

27 Purchase 600 23

Instructions

(a) Calculate the ending inventory and cost of goods sold using the average cost method in (1) a perpetual inventory system,

and (2) a periodic inventory system. (Use unrounded numbers in your calculations but round to the nearest cent

for presentation purposes in your answer.)

(b) Compare your results for items 1 and 2 of part (a), commenting specifi cally on any diff erences or similarities between

the two inventory systems.

 

Problems: Set B

P6–1B Banff Limited is trying to determine the value of its ending inventory as at February 28, the company’s year end.

Th e accountant counted everything that was in the warehouse in early March, which resulted in an ending inventory

amount of $112,000. However, the accountant was not sure how to treat the following transactions, so she did not include

them in the count, with the exception of item 8. She has asked for your help in determining whether or not the following

transactions should be included in inventory:

  1. Feb. 1 Banff received $1,800 of inventory on consignment from Kananaskis Limited. By February 28, Banff had

sold half of this inventory for Kananaskis.

  1. 5 Banff shipped $1,200 of inventory on consignment to a Jasper craft shop. By February 28, the craft shop

had sold half of this inventory for Banff .

  1. 20 Banff purchased goods FOB shipping point from a supplier. Th e merchandise cost $1,500. Th e appropriate

party paid the freight costs of $150. Th e goods were shipped by the supplier on February 22 and

received by Banff on March 1.

  1. 23 Banff shipped goods FOB shipping point to a customer. Th e merchandise cost $1,600. Th e appropriate

party paid the freight costs of $80. Th e receiving report indicates that the customer received the goods on

March 1.

  1. 24 Banff purchased goods FOB destination from a supplier. Th e merchandise cost $700. Th e appropriate

party paid the freight costs of $35. Th e goods were shipped by the supplier on February 26 and received

by Banff on March 2.

  1. 25 Banff shipped goods FOB destination to a customer. Th e merchandise cost $800. Th e appropriate party

paid the freight costs of $90. Th e receiving report indicates that the customer received the goods on

March 3.

  1. 27 A customer took goods home “on approval” from Banff. The merchandise cost Banff $1,300. The

customer is going to let Banff know whether it wants the merchandise before March 4.

  1. 28 Banff had damaged goods set aside in the warehouse because they were not saleable. Th ese goods were

included in the inventory count at their original cost of $800.

Instructions

(a) For each of the above situations, specify whether the item should be included in ending inventory, and if so, at what

amount. For each item that is not included in ending inventory, indicate who owns it and what account, if any, it should

have been recorded in.

(b) Calculate the revised ending inventory amount.

P6–2B Th e Piano Studio Ltd. has provided you with the following information with respect to its piano inventory for the

month of August. Th e company uses the specifi c identifi cation method.

Date Explanation Supplier Serial # Unit Cost/Price

Aug. 1 Beginning inventory Yamaha YH6318 $1,500

Suzuki SZ5716 1,100

Suzuki SZ5828 1,600

Kawai KG1268 1,500

Kawai KG1520 600

Steinway ST8411 2,600

Steinway ST0944 2,200

10 Sales Suzuki SZ5828 2,700

Kawai KG1520 1,000

15 Purchases Yamaha YH4418 1,300

Yamaha YH5632 1,600

18 Sales Yamaha YH4418 2,100

Steinway ST0944 3,700

22 Purchases Suzuki SZ6132 1,800

Suzuki SZ6148 1,600

26 Sales Suzuki SZ6132 2,900

Yamaha YH6318 2,500

Yamaha YH5632 2,600

Instructions

(a) Determine the cost of goods sold and ending inventory for the month of August.

(b) Determine the gross profi t for the month of August.

(c) Discuss whether the specifi c identifi cation method is likely the most appropriate cost determination method for the

Piano Studio.

P6–3B BigFishTackle Co. Ltd. reports the following inventory transactions for its fi shing rods for the month of April. Th e

company uses a perpetual inventory system.

Date Explanation Units Unit Cost Total Cost

Apr. 1 Beginning inventory 50 $230 $11,500

6 Purchases 35 240 8,400

9 Sales (55)

14 Purchases 40 245 9,800

20 Sales (50)

28 Purchases 30 250 7,500

Instructions

(a) Determine the cost of goods sold and cost of ending inventory using FIFO.

(b) Assume that BigFishTackle wants to change to the average cost method. What guidelines must it consider before making

this change?

(c) If the company does change to the average cost method and prices continue to rise, would you expect the cost of goods

sold and ending inventory amounts to be higher or lower than these amounts when using FIFO?

P6–4B Information for BigFishTackle Co. Ltd. is presented in P6–3B. Use the same inventory data and assume that the

company uses the perpetual inventory system.

Instructions

(a) Determine the cost of goods sold and cost of ending inventory using average cost. (Use unrounded numbers in your

calculations but round to the nearest cent for presentation purposes in your answer.)

(b) When the company counted its inventory at the end of April, it counted only 49 rods on hand. What journal entry, if

any, should the company make to record this shortage?

(c) If the company had not discovered this shortage, identify what accounts would be overstated or understated and by

what amount.

P6–5B Family Appliance Mart Ltd. began operations on May 1 and uses a perpetual inventory system. During May, the

company had the following purchases and sales for one of its products:

Purchases Sales

Date Units Unit Cost Units Unit Price

May 1 110 $19

6 140 22

11 200 $35

14 80 23

21 100 40

27 50 25

Instructions

(a) Determine the cost of goods sold and cost of ending inventory using (1) FIFO and (2) average cost. Ignore the eff ect of

income tax. (For average, use unrounded numbers in your calculations but round to the nearest cent for presentation

purposes in your answer.)

(b) What guidelines should Family Appliance Mart consider in choosing between the FIFO and average cost methods?

(c) Which cost method produces the higher gross profi t and profi t?

(d) Which cost method produces the higher ending inventory valuation?

(e) Which cost method produces the higher cash fl ow?

P6–6B You are provided with the following information for Geo Inc., which purchases its inventory from a supplier on

account. All sales are also on account. Geo uses the FIFO cost method in a perpetual inventory system. Increased competition

has recently decreased the price of the product.

Date Explanation Units Unit Cost Price

Oct. 1 Beginning inventory 60 $14

5 Purchases 100 13

8 Sales (130) 20

15 Purchases 35 12

20 Sales (50) 16

26 Purchases 15 11

Instructions

(a) Prepare all journal entries for the month of October for Geo, the buyer.

(b) Determine the ending inventory amount for Geo.

(c) On October 31, Geo learns that the product has a net realizable value of $10 per unit. What amount should ending

inventory be valued at on the October 31 statement of fi nancial position?

P6–7B In its physical inventory count at its March 31, 2014, year end, Backspring Corporation excluded inventory that

was being held on consignment for Backspring by another company. Th e merchandise was sold in the next year and the

inventory was correctly stated at March 31, 2015.

Instructions

Ignoring income tax, indicate the eff ect of this error (overstated, understated, or no eff ect) on each of the following at

year end:

2015 2014

(a) Cash ___________ ___________

(b) Cost of goods sold ___________ ___________

(c) Profi t ___________ ___________

(d) Retained earnings ___________ ___________

(e) Ending inventory ___________ ___________

(f) Gross profi t margin ratio (30%) ___________ ___________

(g) Inventory turnover ratio (8 times) ___________ ___________

P6–8B Th e records of Pelletier Inc. show the following data for the years ended July 31:

2015 2014 2013

Income statement:

Sales $320,000 $312,000 $300,000

Cost of goods sold 187,000 203,000 170,000

Operating expenses 52,000 52,000 50,000

Statement of fi nancial position:

Merchandise inventory 37,000 24,000 37,000

Aft er the company’s July 31, 2015, year end, the controller discovers two errors:

  1. Ending inventory at the end of 2013 was actually $27,000, not $37,000. Pelletier included goods held on consignment

for another company that were mistakenly included in the 2013 inventory account.

  1. Pelletier purchased $5,000 of goods from a supplier on July 30, 2014, with shipping terms FOB destination.

Although it did not receive the goods until August 4, 2014, Pelletier included the goods in the July 31, 2014,

year-end inventory. Th e purchase was then recorded properly on August 4, 2014.

Instructions

(a) For each of the three years, prepare both the incorrect and corrected income statements through to profi t before

income tax.

(b) What is the combined (total) impact of the errors on retained earnings (ignoring any income tax eff ects) for the three

years before correction? Aft er correction?

(c) Calculate both the incorrect and corrected inventory turnover ratios for each of 2015 and 2014.

P6–9B Flin Flon Limited sells three products whose prices are sensitive to price fl uctuations. Th e following inventory

information is available for these products at March 31, 2014:

Product Units Unit Cost Net Realizable Value

A 25 $ 7 $ 7

B 30 6 8

C 60 11 10

Instructions

(a) Calculate Flin Flon’s inventory at the lower of cost and net realizable value.

(b) Prepare any journal entry required to record the LCNRV, assuming that Flin Flon uses a perpetual inventory system.

(c) Assume that Flin Flon still holds product C a year later and that it has recovered its decline in value and that the net

realizable value of product C is now $11. Should Flin Flon carry its inventory of product C at March 31, 2015, at cost,

net realizable value, or some other value? Explain.

P6–10B You have been provided with the following information regarding R-Steel Inc.’s inventory for March, April,

and May.

Steel Inventory (in tonnes) Cost/Tonne NRV/Tonne

March 31 3,000 $725 $740

April 30 2,500 715 710

May 31 2,800 725 725

Instructions

(a) Calculate the cost and net realizable value of R-Steel’s inventory at (1) March 31, (2) April 30, and (3) May 31.

(b) Prepare any journal entry required to record the LCNRV of the steel inventory at (1) March 31, (2) April 30, and (3)

May 31. Assume that R-Steel uses a perpetual inventory system.

(c) Are there any diff erences in recording LCNRV for companies reporting using ASPE rather than IFRS?

P6–11B Th e following information is available for PepsiCo, Inc. (in U.S. $ millions):

2012 2011 2010

Cost of goods sold $31,291 $31,593 $26,575

Inventories 3,581 3,827 3,372

Current assets 18,720 17,441 17,569

Current liabilities 17,089 18,154 15,892

In the notes to its fi nancial statements, PepsiCo disclosed that it uses the FIFO and average cost methods to determine

the cost of the majority of its inventory.

Th e industry averages for the inventory turnover, days in inventory, and current ratios are as follows:

2012 2011

Inventory turnover 7.8 times 7.4 times

Days in inventory 47 days 49 days

Current ratio 1.2:1 1.1:1

Instructions

(a) Calculate PepsiCo’s inventory turnover, days in inventory, and current ratios for 2012 and 2011. Comment on the

company’s liquidity over the two years, and in comparison with the industry.

(b) What might be the reason that PepsiCo uses more than one cost method to determine the cost of its inventory?

P6– 12B Magna International Inc. is Canada’s top manufacturer of auto parts and systems. Its top competitor is Dana

Holdings Inc. Th e following information is available for these two competitors and their industry, for a recent year:

Magna Dana Industry Average

Inventory turnover 12.9 times 8.2 times 9.0 times

Current ratio 1.4:1 2.2:1 1.5:1

Gross profi t margin 11.6% 13.5% 17.2%

Profi t margin 3.6% 3.7% 4.6%

Instructions

(a) Comment on the liquidity of the two companies in comparison with each other, and the industry.

(b) Comment on the profi tability of the two companies in comparison with each other, and the industry.

(c) It would appear from the above ratios that the inventory turnover ratio may have an impact on the current ratio. Please

explain why.

*P6–13B Steward Inc. had a beginning inventory on January 1 of 400 units of product MLN at a cost of $18 per unit.

During the year, purchases were as follows:

Units Unit Cost Total Cost

Feb. 20 1,200 $19 $22,800

May 5 1,000 21 21,000

Aug. 12 1,200 20 24,000

Dec. 8 600 22 13,200

Steward uses a periodic inventory system. At the end of the year, a physical inventory count determined that there were

400 units on hand.

Instructions

(a) Determine the cost of goods available for sale.

(b) Determine the cost of the ending inventory and the cost of goods sold using (1) FIFO and (2) average cost. (Use unrounded

numbers in your calculation of the average unit cost but round to the nearest cent for presentation purposes

in your answer.)

*P6–14B Data for Steward Inc. are presented in P6–13B. Assume that Steward sold product MLN for $40 per unit during

the year.

Instructions

(a) Prepare a partial income statement through to gross profi t for each of the two cost methods: (1) FIFO and (2) average

cost.

(b) Show how inventory would be reported in the current assets section of the statement of fi nancial position for (1) FIFO

and (2) average cost.

(c) Which cost method results in the higher inventory amount for the statement of fi nancial position? Th e higher gross

profi t amount on the income statement?

* P6– 15B You are provided with the following information about Bear River Inc.’s inventory for the month of May:

Date Description Units Unit Cost

May 1 Beginning inventory 15,000 $2.30

6 Purchase 40,000 2.35

11 Sale (30,000)

14 Purchase 50,000 2.40

21 Sale (65,000)

27 Purchase 40,000 2.45

Instructions

(a) Calculate the ending inventory and cost of goods sold using FIFO in (1) a perpetual inventory system, and (2) a periodic

inventory system.

(b) Compare your results for items 1 and 2 of part (a), commenting specifi cally on any diff erences or similarities between

the two inventory systems.

* P6– 16B You are provided with the following information about Lahti Inc.’s inventory for the month of October.

Date Description Units Unit Cost

Oct. 1 Beginning inventory 50 $24

9 Purchase 125 26

15 Sale (150)

20 Purchase 70 27

29 Sale (55)

Instructions

(a) Calculate the cost of ending inventory and cost of goods sold using average cost in (1) a perpetual inventory system,

and (2) a periodic inventory system. (Use unrounded numbers in your calculations but round to the nearest cent for

presentation purposes in your answer.)

(b) Compare your results for items 1 and 2 of part (a), commenting specifi cally on any diff erences or similarities between

the two inventory systems.

 

=

 

CHAPTER 7 Internal Control and Cash

 

Questions

  1. Identify and describe the fi ve primary components

of a good internal control system.

(SO 1) 2. Identify the six control activities that apply to

most companies.

(SO 1) 3. How do documentation procedures contribute to

good internal control?

(SO 1) 4. Matt Tau is questioning the need for independent

checks of performance if the company

also segregates duties. What do you think about

this?

(SO 1) 5. When faced with labour shortages and high staff

turnover, most retail stores do not bother with

criminal record checks when hiring employees.

Explain what internal control activity is missing

from this practice and what kind of problems

this could result in.

(SO 1) 6. Kim is trying to design internal control activities

so that there is no possibility of errors or theft .

Explain to Kim why this may be impractical, and

even impossible.

(SO 2) 7. Explain how electronic funds transfers can result

in better internal control.

(SO 2) 8. In the corner grocery store, all the clerks make

change out of the same cash register drawer. Is

this a violation of an internal control activity?

Explain.

(SO 2) 9. Dent Department Stores Ltd. has just installed

new electronic cash registers with scanners in

its stores. How do these cash registers improve

control activities over cash receipts?

(SO 2) 10. “To have maximum control over cash payments,

all payments should be made by cheque.” Is this

true? Explain.

(SO 2) 11. At a dental offi ce, the receptionist schedules

appointments and can cancel them. She also collects

payment from patients (about 10% of them

pay cash) and maintains all of the accounting

records for the practice. Comment on whether

these arrangements can result in a limitation of

internal control and give rise to fraud.

  1. Who should be responsible for preparing a bank

reconciliation? Why?

  1. “Th e use of a bank contributes signifi cantly to

good internal control over cash.” Is this true?

Explain.

(SO 3) 14. Paul Pascal is confused about the lack of agreement

between the unadjusted cash balance per

books and the balance per bank. Explain the

possible causes for the lack of agreement to Paul,

and give an example of each cause.

(SO 3) 15. Kari Mora asks for your help concerning an NSF

cheque. Explain to Kari (a) what an NSF cheque is,

(b) how it is treated in a bank reconciliation, and

(c) whether it will require an adjusting entry and,

if an adjusting entry is required, what accounts

are typically debited and credited.

(SO 3) 16. Th e Diable Corporation wrote cheque #2375 for

$1,325 on March 16. At March 31, the cheque

had not cleared the company’s bank account and

was correctly listed as an outstanding cheque on

the March 31 bank reconciliation. If the cheque

has still not cleared the bank account on April

30, should it be included in the April bank reconciliation

or not? Explain.

(SO 3) 17. Sam Wing is an accounting clerk who has stolen

$1,700 in cash from the company he works for.

He prepares the bank reconciliation each month.

When he performs the reconciliation this month,

he knows that the adjusted cash balance will be

$1,700 higher than the adjusted bank balance because

of his theft . He therefore decides to falsify

the amount of outstanding cheques. Why would

he do this and would he overstate or understate

the amount?

(SO 4) 18. What account balances are included in cash and

cash equivalents?

(SO 4) 19. What is restricted cash? What are compensating

balances? How should these items be reported on

the statement of fi nancial position?

(SO 4) 20. At the end of its fi rst quarter in the 2015 fi scal

year, Brandon Corporation had an undrawn line

of credit facility that allowed the company to

borrow up to $16 million and pay it down whenever

it wants to. How should this line of credit be

reported on the statement of fi nancial position?

(SO 4) 21. Describe the six principles of cash management.

(SO 4) 22. Glenn Green owns Green’s Groceries Inc. He has

been reading about companies having too much

cash in the business press but doesn’t understand

how he can have too much cash. Explain the

concept of “too much cash” to Glenn and provide

him with some suggestions for the use of his cash.

Brief Exercises

BE7–1 Gina Milan is the new manager of Plenty Parking Ltd., a parking garage. She has heard about internal control but

is not clear about its importance for the company. Explain to Gina the six control activities, and give her an example of an

application of each control for Plenty Parking.

BE7–2 Match each of the following control activities with its appropriate description.

  1. Authorization of transactions and activities
  2. Segregation of duties
  3. Documentation
  4. Physical controls
  5. Independent checks of performance
  6. Human resource controls

(a) _____ All transactions should include original, detailed receipts.

(b) _____ Undeposited cash should be stored in the company safe.

(c) _____ Employees must take their full vacation allotment each year.

(d) _____ Surprise cash counts are performed by internal audit.

(e) _____ Responsibility for related activities should be assigned to specifi c employees.

(f) _____ Cheque signers are not allowed to record cash transactions.

BE7–3 Tene Ltd. has the following internal controls over cash receipts. Identify the control activity that is applicable to

each procedure.

  1. All over-the-counter receipts are recorded on cash registers.
  2. All cashiers are bonded.
  3. Daily cash counts are performed by the accounting supervisor.
  4. Th e duties of receiving cash, recording cash, and maintaining custody of cash are assigned to diff erent individuals.
  5. Only cashiers may operate cash registers.
  6. All cash is deposited intact in the bank account every day.

BE7–4 Rolling Hills Ltd. has the following internal controls over cash payments. Identify the control activity that is

applicable to each procedure.

  1. Company cheques are prenumbered.
  2. Th e bank statement is reconciled monthly by the assistant controller.
  3. Blank cheques are stored in a safe in the controller’s offi ce.
  4. Both the controller and the assistant controller are required to sign cheques or authorize electronic payments.
  5. Cheque signers are not allowed to record cash payments.
  6. All payments are made by cheque or electronic transfer.

BE7–5 For each of the items in the following list, identify where it is included on a bank reconciliation. Next to each item

write “bank 1” for an increase in the bank balance; “bank 2” for a decrease in the bank balance; “book 1” for an increase

in the book balance; “book 2” for a decrease in the book balance; or “NA” for not applicable, to indicate that the item is

not included in the bank reconciliation.

______ 1. Bank service charges

______ 2. An EFT collection on account

______ 3. Outstanding cheques from the current month (June)

______ 4. Outstanding cheques from a prior month (May) that are still outstanding

______ 5. Outstanding cheques from a prior month (May) that are no longer outstanding

______ 6. A bank error in recording a company cheque made out for $200 as $290

______ 7. A bank deposit for interest earned on an investment

______ 8. A company error in recording a $1,280 deposit as $1,680

______ 9. A bank service charge for an NSF cheque

_______ 10. A deposit in transit from the current month (June)

_______ 11. A company error in recording a cheque made out for $630 as $360

_______ 12. A bank error in recording a $2,575 deposit as $2,755

BE7–6 For the months of January and February, Monde Ltd. recorded cash deposits in its books of $5,000 and $5,600,

respectively. For the same two months, the bank reported deposits totalling $4,000 and $4,600, respectively. Assuming

that there were no deposits in transit at the beginning of January, what was the amount of deposits in transit at the end of

January and at the end of February?

BE7–7 In the month of November, its fi rst month of operations, Jayasinghe Inc. wrote cheques in the amount of $12,600.

In December, cheques in the amount of $9,500 were written. In November, $11,100 of these cheques were presented to

the bank for payment and $9,900 were presented in December. What is the amount of outstanding cheques at the end of

November and at the end of December?

BE7–8 Kashechewan Inc. mistakenly recorded a cheque as $68 that was written for $86. In addition, the company noticed

the bank had mistakenly deducted a cheque for $125 from its bank account that was written by another company.

(a) Explain how each of these errors should be treated on the bank reconciliation. (b) Identify any entries required on

Kashechewan’s books to correct these errors.

BE7–9 Th e following information relates to Southco Limited’s Cash account. Th e adjusted cash balance from June’s

bank reconciliation is $18,920. During the month of July, Southco recorded cash receipts of $21,700 and cash payments of

$24,300 in the general ledger Cash account. Calculate Southco’s unadjusted cash balance at July 31.

BE7–10 Using the data in BE7–9, determine or calculate the unadjusted cash balance for Southco Limited. An examination

of the company’s July bank statement shows a balance of $15,840 on July 31; outstanding cheques $2,300; deposits in

transit $4,300; EFT collections on account $1,960 that were not yet recorded on the books; NSF cheque $290; NSF fee $80;

and bank services charges $70. Prepare the bank reconciliation at July 31.

BE7–11 Using the data in BE7–10, prepare the adjusting entries required on July 31 for Southco.

BE7–12 Ouellette Ltée reports the following items: cash in bank $17,500; payroll bank account $6,000; cash register

fl oats $500; trading investments consisting of term deposits with maturity dates of less than 90 days $5,000; and cash

restricted for plant expansion $25,000. Ouellette also maintains a $5,000 compensating bank balance in a separate bank

account. Determine which accounts described above would be considered cash, cash equivalents, or other items to be

reported on the statement of fi nancial position.

BE7–13 Evergreen Inc. owns these assets at the statement of fi nancial position date:

Cash in bank (savings account) $12,000

Cash on hand 1,700

Income tax refund due from CRA 2,000

Cash in bank (chequing account) 24,000

Bank credit card slips 5,000

Debit card slips 2,400

Postdated cheques 1,000

(a) What amount should be reported as cash and cash equivalents in the statement of fi nancial position? (b) For any item

not included in (a), identify where it should be reported.

 

Exercises

E7–1 Th e following situations suggest either a strength or weakness in an internal control activity:

  1. At Tingley’s, Iryna and Inder work alternate lunch hours. Normally, Iryna works the cash register at the checkout

counter, but during her lunch hour Inder takes her place. Th ey both use the same cash drawer and jointly count cash

at the end of the day.

  1. Th e Do It Corporation accepts both cash and credit cards for its sales. Due to privacy legislation that requires credit

card information to be shredded within three months, it shreds all credit card slips aft er they are processed.

  1. Th e mail clerk at Genesis Legal Services prepares a daily list of all cash receipts. Th e cash receipts are forwarded to a

staff accountant, who deposits the cash in the company’s bank account. Th e list is sent to the accounts receivable clerk

for recording.

  1. Th e Candy Store can only aff ord a part-time bookkeeper. Th e bookkeeper’s responsibilities include making the bank

deposit, recording transactions, and reconciling the bank statement.

  1. Th e Decorator Shoppe counts inventory at the end of each month. Two staff members count the inventory together.

It is then priced and totalled by the accounting department and reconciled to the perpetual inventory records. Any

variances are investigated.

Instructions

(a) State whether each situation above is a control strength or weakness and explain why.

(b) For each weakness, suggest an improvement.

E7–2 Each of the following situations describes an instance of fraud:

  1. A bartender sells drinks to customers and, when they pay cash, he does not record the sale at the cash register and

keeps the cash.

  1. A bartender knows that there is a special on vodka tonight so he brings his own bottle of vodka to the bar. When a

customer orders vodka and pays cash, the bartender pours the vodka from his own bottle, does not record the sale at

the cash register, and keeps the cash.

  1. Th e receptionist at a spa enters all appointments into a computerized schedule. Aft er their appointment, the client

pays the receptionist for the service received. For about half of the customers who pay with cash, the receptionist

keeps the amount and deletes any record of the appointment from the schedule. Th e receptionist makes the bank

deposits and records all sales in the accounting system.

  1. Th e receptionist at a law fi rm has a key to a cabinet where company cheques are stored. She takes a cheque from the

cabinet, makes it payable to herself, and forges the signature of the fi rm’s managing partner on the cheque. She opens

the mail every day and when the bank statement is received, she performs the bank reconciliation. She covers the theft

by understating the amount of outstanding cheques on the bank reconciliation.

Instructions

(a) Is it possible to detect these types of fraud? Why or why not?

(b) Identify a control activity or activities that could help prevent each instance of fraud described above.

E7–3 Th e following control activities are used at Tolan Ltd. for over-the-counter cash receipts:

  1. Cashiers are experienced, so they are not bonded.
  2. All over-the-counter receipts are received by one of three clerks. Th e clerks share a cash register with a single cash drawer.
  3. To minimize the risk of robbery, cash in excess of $100 is stored in an unlocked strongbox in the stockroom until it

is deposited in the bank.

  1. At the end of each day, the total receipts are counted by the cashier on duty and reconciled to the cash register total.
  2. Th e company accountant makes the bank deposit and then records the day’s receipts.
  3. If a customer has the exact change and does not want a receipt, the sale is not entered in the cash register. Th e money

is kept in a loose change box.

Instructions

(a) For each of the above situations, explain the weakness and identify the control activity that is violated.

(b) For each weakness, suggest an improvement.

E7–4 Th e following control activities are used in Sheera’s Boutique Shoppe Ltd. for cash payments:

  1. Blank cheques are stored in an unmarked envelope on a shelf behind the cash register.
  2. Th e purchasing manager personally approves payments for purchases and signs the cheques issued to pay suppliers.
  3. When the store manager goes away for an extended period of time, she pre-signs cheques to be used in her absence.
  4. Th e company cheques are not prenumbered.
  5. Th e company accountant prepares the bank reconciliation and reports any discrepancies to the store manager.

Instructions

(a) For each of the above situations, explain the weakness and identify the control activity that is violated.

(b) For each weakness, suggest an improvement.

E7–5 Th e adjusted cash balance from Hudson Corporation’s August 31 bank reconciliation was $54,700. Hudson recorded

the following events in the general ledger Cash account during the month of September: (1) cheques totalling $127,492

were issued; (2) salaries of $49,900 deposited to employee accounts; (3) monthly EFT payment of $1,500 for insurance; and

(4) deposits totalling $128,658.

Instructions

(a) Calculate Hudson’s unadjusted cash balance in the general ledger Cash account on September 30, prior to the bank

reconciliation.

(b) Indicate the eff ect of items (1) through (4) in the bank reconciliation.

E7–6 Ten items that may or may not be involved in the bank reconciliation process for April are listed in the table shown below:

Bank Books Adjusting

Add Deduct Add Deduct Entry

Item (Credit) (Debit) (Debit) (Credit) Required

  1. Deposits in transit at the end of April ✓ No
  2. Deposits in transit at the beginning of April

that cleared the bank in April

  1. Outstanding cheques at the end of April
  2. Outstanding cheques at the beginning

of April that cleared the bank in April

  1. Cheque written for $250 recorded in

error as $520 on the books

  1. Deposit of $400 made in error by the

bank to the company’s account

  1. Bank service charges
  2. EFT, collection on account not previously

recorded by company

  1. NSF cheque received from customer
  2. Interest earned on bank account

Instructions

Complete the table shown above, identifying where each item should be included on a bank reconciliation prepared for

the month of April. Insert a check mark (✓) in the appropriate column indicating whether the item should be added to,

or deducted from, the bank or the books. If the item should not be included in the bank reconciliation, write “NA” for not

applicable. Finally, indicate whether the item will require an adjusting entry on the company books by writing “yes” or “no”

in the last column. Th e fi rst item has been done for you as an example.

E7–7 Th e cash records of Lejeune Inc. show the following situations:

Deposits in transit:

  1. Th e June 30 bank reconciliation indicated that deposits in transit total $2,000. During July, the general ledger account

Cash shows deposits of $14,750, but the bank statement indicates that $15,820 in deposits were received during the month.

  1. In August, deposits per bank statement totalled $22,500 and deposits per books were $22,900.

Outstanding cheques:

  1. Th e June 30 bank reconciliation reported outstanding cheques of $570. During July, the Lejeune books show that

$18,200 of cheques were issued. Th e bank statement showed that $17,200 of cheques cleared the bank in July.

  1. In August, cheques issued were $22,700 and cheques clearing the bank were $23,520.

Instructions

(a) What were the deposits in transit at July 31 and at August 31?

(b) What were the outstanding cheques at July 31 and at August 31?

E7–8 Th e following information is for Neopolitan Ltd. in July:

  1. Cash balance per bank, July 31, $8,833
  2. Cash balance per books, July 31, $7,190
  3. Bank service charge, $24
  4. Deposits in transit, $1,575
  5. Electronic receipts from customers in payment of their accounts, $883, not previously recorded by the company
  6. Outstanding cheques, $2,449
  7. Cheque #373 was correctly written and recorded by the company as $672. Th e bank deducted $762 from the company’s

account in error. Th e cheque was written for the purchase of offi ce supplies.

Instructions

(a) Prepare the bank reconciliation at July 31.

(b) Prepare any adjusting journal entries required from the reconciliation.

E7–9 A new accountant at La Maison Ltée is trying to identify which of the following amounts should be reported as cash

and cash equivalents in the April 30 year-end statement of fi nancial position:

  1. Currency and coin totalling $87 in a locked box used for incidental cash transactions
  2. A $10,000 government treasury bill, due the next month, May 31
  3. April-dated cheques worth $300 that La Maison has received from customers but not yet deposited
  4. An $85 cheque received from a customer in payment of its April account, but postdated to May 1
  5. A balance of $2,575 in the Royal Bank chequing account
  6. A balance of $4,000 in the Royal Bank savings account
  7. Prepaid postage of $75 in the postage meter
  8. A $50 IOU from the company receptionist
  9. Cash register fl oats of $250
  10. Over-the-counter receipts for April 30 consisting of $550 of currency and coin, $185 of cheques from customers,

$685 of debit card slips, and $755 of bank credit card slips. Th ese amounts were processed by the bank on May 1.

Instructions

(a) What amount should La Maison consider to be cash at April 30? What should it consider to be a cash equivalent?

(b) What combined amount would La Maison report as cash and cash equivalents on its year-end statement of fi nancial

position?

(c) In which fi nancial statement(s) and in what account(s) should the items not included in (a) be reported?

E7–10 Tory, Hachey, and Wedunn, three young lawyers who have joined together to open a law practice, are struggling to

manage their cash fl ow. Th ey have not yet built up enough clientele and revenues to support the cost of running their legal

practice. Initial costs, such as advertising and renovations to the premises, all result in outgoing cash fl ow at a time when

little is coming in! Tory, Hachey, and Wedunn have not had time to establish a billing system since most of their clients’ cases

have not yet reached the courts and the lawyers did not think it would be right to bill them until “results were achieved.”

Unfortunately, Tory, Hachey, and Wedunn’s suppliers do not feel the same way. Th eir suppliers expect them to pay their

accounts payable within a few weeks of receiving their bills. So far, there has not even been enough money to pay the three

lawyers, and they are not sure how long they can keep practising law without getting some money into their pockets!

Instructions

Provide suggestions for Tory, Hachey, and Wedunn to improve its cash management practices, in particular with respect

to accelerating the collection of its receivables and delaying the payment of its liabilities.

Problems: Set A

P7–1A Red River Th eatre has a cashier’s booth located near the theatre entrance. Th ere are two cashiers: one works from

1 p.m. to 5 p.m., the other from 5 p.m. to 9 p.m. Each cashier is bonded. Th e cashiers receive cash from customers and

operate a machine that ejects serially numbered tickets. Th e rolls of tickets are inserted and locked into the machine by the

theatre manager at the beginning of each cashier’s shift .

Aft er purchasing a ticket, which costs a diff erent amount depending on the day of the week and the customer’s age

group, the customer takes the ticket to an usher stationed at the entrance to the theatre lobby, a few metres from the

cashier’s booth. Th e usher tears the ticket in half, admits the customer, and returns the ticket stub to the customer. Th e usher

drops the other half of the ticket into a locked box.

At the end of each cashier’s shift , the theatre manager removes the ticket rolls from the machine and makes a cash

count. Th e cash count sheet is initialled by the cashier. At the end of the day, the manager deposits the total receipts in a

bank night deposit slot. In addition, the manager sends copies of the deposit slip and the initialled cash count sheets to the

head cashier for verifi cation and to the accounting department for comparison with sales records. Receipts from the fi rst

shift are stored in a safe located in the manager’s offi ce.

Instructions

(a) Identify the control activities and their application to cash receipts at the theatre.

(b) If the usher and cashier decided to collaborate to steal cash, what actions might they take?

P7–2A High Tech Inc. commenced operations recently. Two friends from university, John Deol and Rehana Gerdman,

jointly own the company’s shares. John and Rehana have developed a new soft ware application to track shipping. Th e two

friends spend most of their time on the development of new products and the marketing of the current product.

John and Rehana hired Fred Glass to be High Tech’s controller. Fred has been given overall responsibility for the books

and records of High Tech so that John and Rehana can spend their time on development and marketing.

Fred has one assistant, Asmaa. Both Fred and Asmaa have the authority to order goods for High Tech. Asmaa can

approve invoices for payment up to $5,000. Fred can approve any invoice for payment. Fred, John, and Rehana are all signing

offi cers on the company’s bank account. Only one of the three signing offi cers needs to sign a cheque under $20,000.

For cheques greater than $20,000, two signing offi cers must sign. Unsigned cheques are kept in the company safe. Th e safe

is kept locked and access to the safe is limited to the signing offi cers. Fred is responsible for preparing the monthly bank

reconciliations and making any necessary journal entries.

Instructions

(a) Identify the control weaknesses over the cash payments and the problems that could occur as a result of these

weaknesses.

(b) List the improvements in control activities that High-Tech should consider.

P7–3A Each of the following independent situations has one or more control activity weaknesses:

  1. Board Riders Ltd. is a small snowboarding club that off ers specialized coaching for snowboarders who want to improve

their skills. Group lessons are off ered every day. Members who want a lesson pay a $25 fee directly to the

instructor at the start of the lesson that day. Most members pay cash. At the end of the lesson, the instructor reports

the number of students and turns over the cash to the offi ce manager.

  1. Coloroso Agency Corp. off ers parenting advice to young single mothers. Most of the agency’s revenues are from government

grants. Th e general manager is responsible for all of the accounting work, including approving invoices for

payment, preparing and posting all entries into the accounting system, and preparing bank reconciliations.

  1. At Nexus Corporation, each salesperson is responsible for deciding on the correct credit policies for his or her customers.

For example, the salesperson decides if Nexus should sell to the customer on credit and how high the credit

limit should be. Salespeople receive a commission based on their sales.

  1. Algorithm Limited is a soft ware company that employs many computer programmers. Th e company uses accounting

soft ware that was created by one of the employees. In order to be more fl exible and share the workload, all of the

programmers have access to the accounting soft ware program in case changes are needed.

  1. Th e warehouse manager at Orange Wing Distributors Ltd. is well known for running an effi cient, cost-saving operation.

He has eliminated the requirement for staff to create receiving reports and purchase orders because it was taking

too long to prepare them.

Instructions

(a) Identify the control weakness(es) in each of the above situations and the problems that could occur as a result of these

weaknesses.

(b) Make recommendations for correcting each situation.

P7–4A Cedar Grove High School wants to raise money for a new sound system for its auditorium. Th e main fundraising

event is a dance at which the famous disc jockey Obnoxious Al will play rap music. Roger DeMaster, the music teacher, has

been given the responsibility for coordinating the fundraising eff orts. Th is is Roger’s fi rst experience with fundraising. He

decides to put the Student Representative Council (SRC) in charge of the event.

Roger had 500 unnumbered tickets printed for the dance. He left the tickets in a locked box on his desk and told the

SRC students to take as many tickets as they thought they could sell for $20 each. To ensure that no extra tickets would be

fl oating around, he told the students to get rid of any unsold tickets. When the students received payment for the tickets,

they were to bring the cash back to Roger, and he would put it in the locked box on his desk.

Some of the students were responsible for decorating the gymnasium for the dance. Roger gave each of them a key to

the locked box and told them that if they took money out to purchase materials, they should put a note in the box saying

how much they took and what it was used for. Aft er two weeks, the locked box appeared to be getting full, so Roger asked

Praveen Patel to count the money, prepare a deposit slip, and deposit the money in a bank account Roger had opened.

Th e day of the dance, Roger wrote a cheque from the account to pay Obnoxious Al. Al, however, said that he accepted

only cash and did not give receipts. Having no alternative, Roger took $500 out of the locked box and gave it to Al. At the

dance, Roger had Sara Wu working at the entrance to the gymnasium, collecting tickets from students and selling tickets

to those who had not prepurchased them. Roger estimated that 400 students attended the dance.

Th e following day, Roger closed out the bank account, which had $750 in it, and gave that amount plus the $1,800

in the locked box to Principal Orlowski. Principal Orlowski seemed surprised that, aft er generating roughly $8,000 (400

tickets @ $20) in sales, the dance netted only $2,550 in cash. Roger did not know how to respond.

Instructions

(a) Identify the control weaknesses over cash receipts and payments and the problems that could occur because of these

weaknesses.

(b) List the improvements in control activities that the school should consider.

P7–5A On July 31, Beaupre Ltd. had an unadjusted cash balance of $14,786. Th e bank statement from the Caisse Populaire

on that date showed a balance of $21,062. A comparison of the bank statement with the Cash account revealed the following:

  1. Th e bank statement included service charges of $100.
  2. Th e bank statement included electronic collections from customers on account totalling $4,110. Beaupre had not

recorded the EFT.

  1. A deposit of $1,800 made by another company was incorrectly added to Beaupre’s account by the Caisse Populaire.
  2. Salaries of $4,000 were paid electronically during the month. Th e company has already recorded these.
  3. Cheques outstanding on June 30 totalled $1,844. Of these, $1,378 worth cleared the bank in July. All cheques written

in July cleared the bank in July.

Instructions

(a) Prepare the bank reconciliation at July 31.

(b) Prepare any adjusting journal entries required from the reconciliation.

P7–6A Th e bank portion of last month’s bank reconciliation for Yap Ltd. at February 28 was as follows:

Prepare bank reconciliation

and adjusting

entries.

(SO 3)

Prepare bank reconciliation

and adjusting

entries.

(SO 3)

YAP LTD.

Bank Reconciliation

February 28

Cash balance per bank $14,368

Add: Deposits in transit 2,530

16,898

Less: Outstanding cheques

#3451 $2,260

#3470 1,535 3,795

Adjusted cash balance $13,103

YAP LTD.

Bank Statement

March 31

Amounts Amounts Added

Deducted from to Account

Date Description Account (Debits) (Credits) Balance

Feb. 28 Opening balance 14,368

Mar. 1 Cheque, No. 3451 2,260 12,108

1 Deposit 2,530 14,638

2 Cheque, No. 3470 1,535 13,103

4 Deposit 1,221 14,324

9 Cheque, No. 3471 1,427 12,897

10 Returned cheque—NSF, R. Aubut 550 12,347

10 NSF fee 40 12,307

15 EFT, loan payment 1,062 11,245

19 Cheque, No. 3472 1,641 9,604

26 Deposit 2,567 12,171

31 EFT, collection on account from M. Boudreault 230 12,401

31 Bank service charges 49 12,352

31 Debit and credit card fees 65 12,287

Th e adjusted cash balance per bank agreed with the cash balance per books aft er the bank reconciliation at February 28.

Th e March bank statement showed the following:

Yap’s cash receipts and payments for the month of March showed the following:

Cash Receipts

Date Amount

Mar. 4 $1,221

26 2,567

31 1,025

$4,813

Cash Payments

Date Number Amount

Mar. 7 3471 $1,427

15 3472 1,461

29 3473 487

$3,375

Additional information:

  1. Th e EFT loan payment should have been recorded by the company on March 15, but this entry was missed. Th e payment

included $62 of interest and a $1,000 payment on the loan principal.

  1. Th e bank made an error processing cheque #3472.
  2. Th e EFT collection was not previously recorded.
  3. Bank service charges ($49) and debit and credit card fees ($65) were not previously recorded.

Instructions

(a) Calculate the unadjusted cash balance per books at March 31, prior to reconciliation.

(b) What is the amount of the deposits in transit at March 31?

(c) What is the amount of the outstanding cheques at March 31?

(d) Prepare the bank reconciliation at March 31.

(e) Prepare any adjusting journal entries required from the reconciliation.

P7–7A Th e bank portion of last month’s bank reconciliation for Hamptons Limited at October 31 is shown here

Additional information:

  1. Th e EFT collection was not previously recorded. Th e collection of the note on November 28 was for $4,400, plus $608

interest. Interest was not previously accrued.

  1. EFT payments are recorded when they occur.
  2. Th e bank did not make any errors.
  3. Two errors were made by the company: one in recording a cheque and one in recording a cash receipt. Th e correction

of any errors in the recording of cheques should be made to Accounts Payable. Th e correction of any errors in the

recording of cash receipts should be made to Accounts Receivable.

Instructions

(a) Calculate the unadjusted cash balance per books as at November 30, prior to reconciliation.

(b) Prepare the bank reconciliation at November 30.

(c) Prepare any adjusting journal entries required from the reconciliation.

P7–8A A fi rst-year co-op student is trying to determine the amount of cash and cash equivalents that should be reported

on a company’s statement of fi nancial position. Th e following information was provided to the student at year end:

  1. Cash on hand in the cash registers totals $5,000.
  2. Th e balance in the commercial bank savings account is $100,000 and in the commercial bank chequing account,

$25,000. Th e company also has a U.S. bank account, which contains the equivalent of $45,000 Canadian at year end.

  1. A special bank account holds $150,000 in cash that is restricted for equipment replacement.
  2. Amounts due from employees (travel advances) total $12,000.
  3. Trading investments held by the company include $32,000 in a term deposit maturing in 120 days, a Government of

Canada bond for $75,000 that falls due in 30 days, and $40,000 in shares of Shoppers Drug Mart.

  1. Th e company has a supply of unused postage stamps totalling $150.
  2. Th e company has $1,750 of NSF cheques from customers that were returned by the bank. NSF fees charged by the

bank for processing these cheques totalled $80.

  1. Th e company keeps $5,000 as a compensating balance with respect to a long-term loan in a special account.

Instructions

(a) Determine which items listed above would be considered to be cash and which would be considered to be cash equivalents.

(b) What combined amount would the company report as cash and cash equivalents on the year-end statement of fi nancial

position?

(c) Identify where any items that were not reported as cash and cash equivalents in (a) should be reported.

P7–9A Rupert Inc. reports the following selected information (in thousands) in its April 30, 2015, fi nancial statements:

Calculate cash.

(SO 4)

Discuss reporting

of cash.

(SO 4)

Cash Receipts

Date Amount

Nov. 3 $ 2,424

7 1,980

12 5,150

20 5,908

27 3,300

30 2,676

$21,438

Cash Payments

Date Number Amount

Nov. 1 2475 $ 3,282

2 2476 4,760

2 2477 1,200

8 2478 3,500

15 2479 1,390

15 EFT, salaries 6,400

18 2480 1,224

20 2481 1,152

29 2482 1,660

30 EFT, salaries 6,400

$30,968

2015 2014

Cash and cash equivalents $41,817 $31,525

Restricted cash 5,350 3,100

Additional information: Restricted cash represents monies held for a potential lawsuit settlement.

Instructions

(a) Explain the diff erence between cash and cash equivalents. Why are they combined for reporting purposes?

(b) In which section of the statement of financial position would the restricted cash most likely be reported?

Explain.

(c) Explain why it is necessary to report restricted cash separately when cash equivalents, such as highly liquid trading

investments, are included in cash.

P7–10A Bev’s Design Services Ltd. commenced operations approximately nine months ago. Bev, the sole shareholder

and designer, organizes the hall and table decorations for a variety of functions. Bev has completed 15 contracts so far and,

with wedding season coming up, has 20 more signed contracts. However, the company has no cash in its bank account and

Bev has had to loan the business money from her personal funds.

For each signed contract, the company requires a $50 non-refundable deposit. Th e balance of the account receivable

is due three weeks following the function. For the weddings Bev has serviced, receipt of the amount due has occurred on

average fi ve weeks aft er the function. All the decorations must be purchased about two months before the function or once

the contract has been signed, whichever is earlier. Th e company pays for the decorations at the time of purchase. Recently,

the company has learned that it can apply for an account, which will permit it to pay 30 days aft er purchase.

Instructions

Identify ways the company can improve its cash management practices, in particular with respect to accelerating the

collection of its receivables and delaying the payment of its liabilities.

Problems: Set B

P7–1B Segal Offi ce Supply Limited recently changed its control activities over cash payments. Th e new activities include

the following features:

  1. All cheques are prenumbered and written by an electronic cheque-writing system.
  2. Before a cheque or electronic payment can be issued, each invoice must have the approval of Cindy van Bommel, the

purchasing agent, and Ray Mills, the receiving department supervisor.

  1. Cheques must be signed by either controller François Montpetit or assistant controller Mary Nishiyama. Before signing

a cheque, the signer is expected to compare the amount of the cheque with the amount on the invoice.

  1. Aft er signing a cheque, the signer stamps the invoice “Paid” and writes in the date, cheque number, and amount of the

cheque. Th e paid invoice is then sent to the accounting department for recording.

  1. Blank cheques are stored in a safe in the controller’s offi ce. Th e combination to the safe is known only to the controller

and assistant controller.

  1. Each month, the bank statement is reconciled by a staff accountant who does not record payments.

Instructions

Identify the control activities and their application to cash payments at Segal Offi ce Supply.

P7–2B You are asked to join the board of elders of a local church to help with the control activities for the off erings

collection made at weekly services. At a meeting of the board, you learn the following:

  1. Th e board of elders has delegated responsibility for the fi nancial management and audit of the fi nancial records to the

fi nance committee. Th is group prepares the annual budget and approves major payments but is not involved in collections

or record keeping. No audit has been done in recent years, because the same trusted employee has kept church

records and served as fi nancial secretary for 15 years. Th e church does not carry any fi delity insurance.

  1. Th e collection at the weekly service is taken by a team of ushers who volunteer to serve for one month. Th e ushers

take the collection plates to a basement offi ce at the back of the church. Th ey hand their plates to the head usher and

return to the church service. Aft er all plates have been turned in, the head usher counts the cash collected in them.

Th e head usher then places the cash in the church safe along with a note that includes the amount counted. Th e safe

is unlocked because no one can remember the combination, and aft er all, it is in a church.

  1. Th e morning aft er the service, the fi nancial secretary goes to the safe and recounts the collection. Th e secretary

withholds $200 to pay for cash purchases for the week, and deposits the remainder of the collection in the bank.

To facilitate the deposit, church members who contribute by cheque are asked to make their cheques payable to

“Cash.”

  1. Each month, the fi nancial secretary reconciles the bank statement and submits a copy of the reconciliation to the

board of elders. Th e reconciliations have rarely revealed any bank errors and have never shown any errors per

books.

Instructions

(a) Identify the control weaknesses in the handling of collections.

(b) List the improvements in control activities that should be recommended for (1) the head usher, (2) the ushers, (3) the

fi nancial secretary, and (4) the fi nance committee.

P7–3B Each of the following independent situations has one or more control activity weaknesses:

  1. Rowena’s Cleaning Service Inc. provides home cleaning services for a large number of clients who all pay cash.

Rowena collects the cash and keeps it in the glove compartment of her car until the end of the week when she has

time to count it and prepare a bank deposit.

  1. Hornet’s Convenience Store Limited sells a variety of items, including cigarettes, non-alcoholic beverages, and snack

foods. A long-term employee is responsible for ordering all merchandise, checking all deliveries, and approving invoices

for payment.

  1. At Ye Olde Ice Cream Shoppe Ltd., there are three sales clerks on duty during busy times. All three of them use the

same cash drawer.

  1. Most customers at Better Used Car dealership use the option to pay for their vehicles in 24 equal payments over two

years. Th ese customers send the company cheques or cash each month. Th e offi ce manager opens the mail each day,

makes a bank deposit with the cash and cheques received in the mail that day, and prepares and posts a journal entry

in the accounting records.

  1. Jimmy’s Truck Parts Ltd. employs sales staff who visit current and prospective customers. Th e sales staff keep product

samples in their vehicles so they can demonstrate the product to the customers. If a customer has a large order, the

order is e-mailed to the warehouse. Th e warehouse then ships the product to the customer on account. If a customer

wishes to purchase one or two sample items, the salesperson can sell these for cash or on account. To obtain more

inventory, the salespeople go to the warehouse and restock the vehicle themselves.

Instructions

(a) Identify the control weakness(es) in each of the above situations and the problems that could occur as a result of these

weaknesses.

(b) Make recommendations for correcting each situation.

P7–4B Th e president of a registered charity, the Helping Elderly Low-Income People Foundation (HELP), approaches

you for help on a special project to set up the charity’s accounting system. HELP is a relatively new organization that is regulated

by both the federal and provincial governments. Th e organization is required to maintain current fi nancial records

for the public to scrutinize. In other words, the records must be available to anyone who is interested in reviewing them. It

is now the end of the charity’s fi rst fi scal year, and HELP has come to you with a shoebox of receipts and bank statements.

You notice that the bank statements are still in their envelopes—they have not been opened.

Th e charity’s revenue is mostly from donations. A van driver takes volunteers around the city and they go door to door

asking for donations. Th e volunteers give a donation receipt for amounts over $20. Since volunteering takes a lot of time,

the charity has many short-term volunteers and anyone is welcome to be one.

Two car companies generously donated vans to the organization. Th e van drivers are paid $50 a day, which they take

from the donations. Drivers keep a summary of the total donations collected by the volunteers, and at the end of the day

the drivers take the money to a bank and deposit it. Drivers also pay for their gas out of the donated funds.

HELP also held a fundraising dance last month. Th e president said he was disappointed with the project, though,

because it did not bring in much money. To keep costs down, the president made the dance tickets by photocopying tickets

and cutting them up. He gave them out to volunteers to sell for $25 each. He estimates that he printed 500 tickets, but can

only account for about $5,000 (200 tickets @ $25) of revenues turned in by his volunteers.

Instructions

(a) Identify the control weaknesses over cash receipts and payments.

(b) List the improvements in control activities that HELP should consider.

P7–5B On May 31, O’Hearne Limited had an unadjusted cash balance per books of $13,126. Th e bank statement from

Community Bank on that date showed a balance of $15,230. A comparison of the bank statement with the company’s Cash

account revealed the following:

  1. Th e bank statement included a bank service charge of $80.
  2. Th e bank statement included electronic collections totalling $4,188. Th ese were not previously recorded.
  3. Outstanding cheques at April 30 totalled $2,900. Of these, $2,240 worth cleared the bank in May. Th ere were $1,892

of cheques written in May that were still outstanding on May 31.

  1. Included with the cancelled cheques was a cheque issued by O’Bearne Inc. for $1,200 that was incorrectly charged to

O’Hearne by the bank.

  1. On May 31, the bank statement showed a returned (NSF) cheque for $1,350 issued by a customer in payment of its

account. In addition, the bank charged an $80 processing fee for this transaction.

  1. Th e May 31 deposit of $1,926 was not included in the deposits on the May bank statement. Th e deposit had been

placed in the bank’s night deposit vault on May 31.

Instructions

(a) Prepare the bank reconciliation at May 31.

(b) Prepare any adjusting journal entries required from the reconciliation.

P7–6B Th e bank portion of last month’s bank reconciliation showed the following for River Adventures Ltd.:

P7–7B Th e bank portion of last month’s bank reconciliation f Prepare bank recon- or Racine Limited at November 30 is shown here:

Additional information:

  1. Th e EFT collection was not previously recorded.
  2. EFT payments are recorded when they occur.
  3. Th e bank did not make any errors.
  4. One error was made by the company. Th e correction of any errors in recording cheques should be made to Accounts

Payable. Th e correction of any errors in recording cash receipts should be made to Accounts Receivable.

Instructions

(a) Calculate the unadjusted cash balance per books as at November 30, prior to reconciliation.

(b) Prepare the bank reconciliation at December 31.

(c) Prepare any adjusting journal entries required from the reconciliation.

P7–8B A new accounting student has been asked to determine the balance that should be reported as cash and cash

equivalents as at December 31 for one of the fi rm’s clients. Th e following information is available:

  1. Cash on hand in the cash registers on December 31 totals $1,600. Of this amount, $500 is kept on hand as a cash

fl oat.

  1. At December 31, the company has debit card slips in the cash register totalling $500.
  2. At December 31, the company has MasterCard credit card slips in the cash register totalling $975.
  3. Th e balance in the bank chequing account at December 31 is $7,460.
  4. Trading investments include $5,000 in a Government of Ontario bond that falls due in 80 days.
  5. Th e company sold $250 of merchandise to a customer late in the day on December 31. Th e customer had forgotten

her wallet and promised to pay the amount on January 2.

  1. Th e company has a U.S. dollar bank account. At December 31, its U.S. funds were the equivalent of $2,241

Canadian.

  1. In order to hook up utilities, the company is required to deposit $1,000 in trust with Hydro One. Th is amount must

remain on deposit until a satisfactory credit history has been established. Th e company expects to have this deposit

back within the year.

Instructions

(a) Determine which items listed above would be considered to be cash and which would be considered to be cash equivalents.

(b) What combined amount would the company report as cash and cash equivalents on the year-end statement of

fi nancial position?

(c) Identify where any items that were not reported as cash and cash equivalents in (a) should be reported.

P7–9B Boardwalk Real Estate Investment Trust reports the following selected information (in thousands) in its

December 31, 2012, fi nancial statements:

Calculate cash.

(SO 4)

Discuss reporting of

cash.

2012 2011 (SO 4)

Cash $138,656 $255,894

Segregated tenants’ security deposits 12,090 11,561

Additional information:

  1. Cash consists of bank balances and interest-earning bank accounts.
  2. Segregated tenants’ security deposits are held on behalf of tenants and are returned at the end of a lease if the apartment

rented to the tenant is undamaged. Th ey are considered restricted cash as they are held in trust bank accounts.

Instructions

(a) Why do you think that the security deposits are not reported along with the cash as cash equivalents?

(b) In which section of the statement of fi nancial position would the segregated tenants’ security deposits most likely be

reported? Explain.

P7–10B Jackie Ledbetter started a business, Jackie’s Designs Inc., aft er fi nishing her interior design courses eight months

ago. Jackie has been fortunate in that the company has already completed six contracts, has four more signed contracts,

and has booked three meetings with prospective customers. Th e prospective customers are referrals from the six contracts

she has already completed.

Jackie is having diffi culty understanding why her business has no cash in the bank since it has been so successful. You

asked her to explain the terms of the contracts and her system for purchases.

A contract is signed once the customer and Jackie agree on the work to be done. Th ere is no deposit on signing the

contract. Th e contract price is a fl at fee for Jackie’s work and cost plus a percentage for all items purchased by the company.

Th e fee for Jackie’s work is due once the contract is completed.

Th e amount for items purchased by the company is due three weeks aft er the items are delivered to the customer, in

case the customer wants to return them. To date, an average contract takes four months to complete. Th e company does

not have a formalized system for purchases. If a customer agrees that they would like to purchase certain items, Jackie will

purchase the items when she fi nds them. Generally, she uses cash to pay for the items at the time of purchase. Th e items are

then delivered to the customer within a week.

Instructions

Identify ways the company can improve its cash management practices, in particular with respect to accelerating the collection

of its receivables and delaying the payment of its liabilities.

 

 

CHAPTER 8 Reporting and Analyzing Receivables

 

Questions

(SO 1) 1. (a) What are the three major types of receivables?

(b) Give examples of each type of receivable.

(SO 1) 2. Distinguish between trade receivables and nontrade

receivables.

(SO 1) 3. (a) When should a receivable be recorded for a

service company? For a merchandising company?

(b) Explain how your answer relates to the

revenue recognition criteria.

(SO 1) 4. Canadian Tire accepts its own company (nonbank)

credit card, bank credit cards, and debit

cards. (a) What are the advantages of accepting

each type of card? (b) Explain how the accounting

diff ers for each type of card.

(SO 1) 5. (a) What are the advantages of using an accounts

receivable subsidiary ledger? (b) Describe the

relationship between the general ledger control

account and the subsidiary ledger.

(SO 2) 6. (a) What is an aging schedule? (b) How is an

aging schedule used to determine total estimated

uncollectible accounts?

(SO 2) 7. (a) What is the purpose of the account

Allowance for Doubtful Accounts? (b) Although

the normal balance of this account is a credit

balance, it can sometimes have a debit balance.

Explain how and when this can happen.

(SO 2) 8. Why is the bad debts expense that is reported

in the income statement usually not the same

amount as the allowance for doubtful accounts

amount reported in the statement of fi nancial

position?

(SO 2) 9. Mohamed cannot understand why the net realizable

value does not change when an uncollectible

account is written off under the allowance

method. Clarify this for Mohamed.

(SO 2) 10. When an account receivable that was previously

written off is later collected, two separate journal

entries are usually made rather than one compound

journal entry. Explain why.

  1. (a) How are accounts receivable and notes receivable

alike? (b) How do they diff er?

  1. (a) Under what circumstances is interest normally

recorded for (1) an account receivable and (2) a

note receivable? (b) When interest is recorded,

is Accounts Receivable or Interest Receivable

debited for (1) an account receivable and (2) a

note receivable? Explain.

(SO 3) 13. Danielle does not understand why a note receivable

is not immediately recorded at its maturity

amount (principal plus interest), rather than its

principal amount. Aft er all, you know you are

going to collect both the principal and the interest

and you know how much each will be. Clarify

this for Danielle.

(SO 3) 14. Cobden Inc. borrowed money from Scotiabank,

signing a promissory note. Which company is the

maker of the note? Th e payee? Which company

would record a note receivable? A note payable?

(SO 3) 15. What is the diff erence between honouring a note

receivable at maturity and dishonouring a note at

maturity?

(SO 3) 16. Athabasca Ltd. has several dozen notes receivable.

It expects approximately 10% of these notes

to be uncollectible. How should these estimated

notes be accounted for?

(SO 4) 17. Indicate how accounts receivable and allowance

for doubtful accounts should be presented on the

statement of fi nancial position.

(SO 4) 18. Saucier Ltd. has accounts receivable, notes

receivable due in three months, notes receivable

due in two years, an allowance for doubtful

accounts, an allowance for doubtful short-term

notes, sales tax recoverable, and income tax receivable.

How should the receivables be reported

on the statement of fi nancial position?

(SO 4) 19. (a) Identify three income statement accounts that

are related to receivables. (b) Indicate where each account

would be reported on the income statement.

(SO 5) 20. What are the four steps in good receivables

management?

(SO 5) 21. Canam Group’s receivables turnover was 3.1 times

in 2012 and 3.3 times in 2011. Based on this information,

has Canam’s receivables management

improved or worsened?

(SO 5) 22. Th e president of Ho Inc. proudly announces that

her company has improved its liquidity since its

current ratio has increased substantially. (a) Does

an increase in the current ratio always indicate

improved liquidity? (b) What other ratio or

ratios might you review to determine whether or

not the increase in the current ratio indicates an

improvement in fi nancial health?

(SO 5) 23. Why should a company not want to have a

receivables turnover that is signifi cantly higher

than that of its competitors? Why would it not

want a receivables turnover that is signifi cantly

lower than that of its competitors?

Brief Exercises

BE8–1 Presented below are several receivables transactions. For each transaction, indicate whether the receivables

should be reported as accounts receivable, notes receivable, or other receivables on a statement of fi nancial position.

(a) Advanced $10,000 to an employee.

(b) Estimated $5,000 of income tax to be refunded.

(c) Received a promissory note of $5,000 for services performed.

(d) Sold merchandise on account to a customer for $6,000.

(e) Sold merchandise for $1,200 to a customer who used a company credit card in payment.

(f) Sales tax (HST) of $2,500 is recoverable at the end of the quarter.

(g) Extended a customer’s account for six months by accepting a note in exchange for the amount owed on the account.

BE8–2 Record the following transactions on the books of Essex Corp., which uses a perpetual inventory system.

(a) On July 1, Essex Corp. sold merchandise on account to Cambridge Inc. for $42,000, terms 2/10, n/30. Th e cost of the

merchandise sold was $30,000.

(b) On July 8, Cambridge returned merchandise worth $7,200 to Essex. Its original cost was $4,320. Th e merchandise was

restored to inventory.

(c) On July 9, Cambridge paid for the merchandise.

(d) Assume now that Cambridge did not pay on July 9, as indicated in transaction (c). At the end of August, Essex added

one month’s interest to Cambridge’s account for the overdue receivable. Essex charges 24% per year on overdue accounts.

Round calculations to the nearest dollar.

BE8–3 An Ultramar gas station accepted a Visa card in payment of a $100 gas bill. Th e bank charges a $2 fee. (a) What

entries should the Ultramar gas station make to record the sale and the bank charges related to this sale? (b) How would

these entries be diff erent if payment had been made with an Ultramar credit card instead of a Visa card?

BE8–4 Information related to Bryant Limited is presented below for its fi rst month of operations.

Credit Sales

Jan. 7 Chiu Corp. $1,800

15 Elbaz Inc. 6,000

23 Lewis Corp. 3,700

Cash Collections

Jan. 17 Chiu Corp. $ 700

24 Elbaz Inc. 2,000

29 Lewis Corp. 3,700

Post the above transactions individually to the accounts receivable subsidiary ledger for each customer, and in summary

form at the end of the month to the accounts receivable control account in the general ledger.

BE8–5 At December 31, Canton Imports Ltd. estimates that 4% of total accounts receivable will become uncollectible.

Accounts receivable are $600,000 at the end of the year. Allowance for Doubtful Accounts has a credit balance of $3,600

prior to recording any year-end adjusting entries. (a) Prepare the adjusting journal entry to record bad debts expense at

December 31. (b) Assuming that Allowance for Doubtful Accounts had a debit balance of $4,000 instead of a credit balance

of $3,600, how would the journal entry recorded in part (a) above change?

BE8–6 Refer to BE8–5 and assume that Canton Imports decides to refi ne its estimate of uncollectible accounts by preparing

an aging schedule. (a) Complete the following aging schedule, and (b) prepare the adjusting journal entry at December 31 to

record bad debts expense, assuming that the allowance account has a credit balance of $3,600.

Number of Days

Outstanding

Accounts

Receivable

Estimated Percentage

Uncollectible

Total Estimated

Uncollectible Accounts

0–30 days $368,000 1%

31–60 days 120,000 4%

61–90 days 72,000 10%

Over 90 days 40,000 20%

Total $600,000

BE8–7 At the end of 2014, Searcy Corp. has accounts receivable of $600,000 and an allowance for doubtful accounts of

$36,000. On January 24, 2015, Searcy learns that its $8,000 receivable from Hutley Inc. is not collectible. Management authorizes

a write off . (a) Prepare the journal entry to record the write off . (b) What is the net realizable value of the accounts

receivable (1) before the write off and (2) aft er the write off ?

BE8–8 Assume the same information as in BE8–7, but that on March 4, 2015, Searcy Corp. receives payment in full of

$8,000 from Hutley Inc. aft er the write off . Prepare the required journal entry(ies) to record this transaction.

BE8–9 Data on three promissory notes receivable due to Aptara Inc. at December 31, 2014, follow:

Note Issue Date Term in Months Principal Interest Rate

#1 Apr. 1, 2014 15 $1,800,000 6%

#2 July 2, 2014 9 168,000 5%

#3 Nov. 1, 2014 12 420,000 4%

Aptara’s year end is December 31 and it adjusts its books annually. For each of the above notes, calculate the amount

of (a) interest revenue to be recorded in 2014, (b) interest revenue to be recorded in 2015, if any, and (c) total interest

revenue. Round calculations to the nearest dollar.

BE8–10 On January 2, Kuril Ltd. sold merchandise on account to R. James for $48,000, terms n/30. Th e company

uses a perpetual inventory system and the merchandise originally cost $32,000. On February 1, R. James gave Kuril

a fi ve-month, 7% note in settlement of this account. On April 30, Kuril’s year-end, annual adjusting entries were

made. On July 1, R. James paid the note and accrued interest. Prepare the journal entries for Kuril to record the above

transactions.

BE8–11 Stratus Ltd. sells merchandise on April 1, 2014, to Red River Enterprises in return for a 12-month, 9%, $10,000

note, with interest due at maturity. Th e company uses a perpetual inventory system and the cost of the inventory sold was

$6,000. Stratus has a December 31 year end and adjusts its accounts annually. Prepare the journal entries that Stratus will

record with regard to this note from April 1, 2014, until the note matures on March 31, 2015.

BE8–12 Using the information provided in BE8–11 above, prepare the journal entries that Red River Enterprises will

record regarding the issue of the note and the purchase of the merchandise inventory. Red River uses a perpetual inventory

system, has a September 30 year end, and adjusts its accounts annually.

BE8–13 Xavier Limited accepts a three-month, 6%, $40,000 note receivable in settlement of an account receivable on

April 1, 2015. Interest is due at maturity.

(a) Prepare the journal entries required by Xavier Limited to record the issue of the note on April 1, and the settlement of

the note on July 1, assuming the note is honoured and that no interest has previously been accrued.

(b) Repeat part (a) assuming that the note is dishonoured, but eventual collection is expected.

(c) Repeat part (a) assuming that the note is dishonoured and eventual collection is not expected.

BE8–14 Nias Corporation reported the following selected items at February 28, 2015:

Accounts payable $938,000 Notes receivable—due November 1, 2015 $300,000

Accounts receivable 470,000 Notes receivable—due April 1, 2018 400,000

Allowance for doubtful accounts 30,000 Prepaid rent 8,000

Bad debts expense 24,000 Sales tax recoverable 38,000

Cash 150,000 Trading investments 330,000

Merchandise inventory 380,000 Unearned revenue 5,000

Prepare the current assets section of Nias’s statement of fi nancial position.

BE8–15 Maple Leaf Foods Inc. reported the following selected information (in thousands) for the three years ended

December 31, 2012, 2011, and 2010:

2012 2011 2010

Trade receivables (gross) $ 55,954 $ 81,477 $ 65,084

Allowance for doubtful accounts 204 5,789 6,764

Net sales 4,864,779 4,893,624 4,968,119

(a) Calculate Maple Leaf ’s receivables turnover and average collection period for 2012 and 2011. (b) Indicate whether each

of the receivables turnover and average collection period is better or worse in 2012.

Exercises

E8–1 On January 6, Compton Limited sold merchandise on account to Singh Inc. for $24,000, terms 2/10, n/30. Th e

merchandise originally cost Compton $16,000. On January 15, Singh paid the amount due. Both Compton and Singh use

a perpetual inventory system.

Instructions

(a) Prepare the entries on Compton’s books to record the sale and related collection.

(b) Prepare the entries on Singh’s books to record the purchase and related payment.

E8–2 Selected transactions follow for Discovery Sports Ltd. during the company’s fi rst month of business.

Feb. 2 Sold $1,140 of merchandise to Andrew Noren on account, terms n/30.

4 Andrew Noren returned for credit $140 of the merchandise purchased on February 2.

5 Sold $760 of merchandise to Dong Corporation on account, terms 2/10, n/30.

8 Sold $842 of merchandise to Michael Collins for cash.

10 Sold $920 of merchandise to Rafi k Kurji, who paid with a Discovery Sports (company) credit card.

14 Dong Corporation paid its account in full.

17 Andrew Noren purchased an additional $696 of merchandise on account, terms n/30.

22 Sold $1,738 of merchandise to Batstone Corporation, terms 2/10, n/30.

28 Andrew Noren paid $1,000 on account.

Instructions

(a) Prepare the journal entries to record each of the above transactions. Ignore any cost of goods sold entries in this question.

Round calculations to the nearest dollar.

(b) Set up T accounts for the Accounts Receivable general ledger (control) account and for the Accounts Receivable subsidiary

ledger accounts. Post the journal entries to these accounts.

(c) Prepare a list of customers and the balances of their accounts from the subsidiary ledger. Prove that the total of the

subsidiary ledger balances is equal to the control account balance.

E8–3 Chinook Limited’s general ledger reports a balance in Accounts Receivable of $360,000 at the end of December.

Instructions

(a) Assuming that Allowance for Doubtful Accounts has a credit balance of $4,400 and that uncollectible accounts are

determined to be $36,000 by aging the accounts, record the adjusting entry at December 31.

(b) Assuming the same information as in part (a) except that uncollectible accounts are expected to be 9% of total accounts

receivable, record the adjusting entry at December 31.

(c) Assuming the same information as in part (a) except that the Allowance for Doubtful Accounts has a debit balance of

$2,400, record the adjusting entry at December 31.

E8–4 Gemini Ltd. has accounts receivable of $370,000 and an unadjusted credit balance in its allowance for doubtful

accounts of $8,800 at March 31. Th e company’s accounts receivable and percentage estimates of its uncollectible accounts

are as follows:

Number of Days

Outstanding Accounts Receivable

Estimated Percentage

Uncollectible

0–30 $260,000 2%

31–60 50,400 10%

61–90 34,000 30%

Over 90 25,600 50%

Total $370,000

Instructions

(a) Prepare an aging schedule to determine the total estimated uncollectibles at March 31.

(b) Prepare the adjusting entry at March 31 to record bad debts expense.

(c) What is the net realizable value of the receivables at March 31?

E8–5 On December 31, 2014, when its accounts receivable were $300,000 and its account Allowance for Doubtful

Accounts had an unadjusted debit balance of $2,000, Ceja Corp. estimated that $16,800 of its accounts receivable would become

uncollectible, and it recorded the bad debts adjusting entry. On May 11, 2015, Ceja determined that Robert Worthy’s

account was uncollectible and wrote off $1,900. On November 12, 2015, Worthy paid the amount previously written off .

Instructions

(a) Prepare the required journal entries to record each of the above transactions.

(b) What is the net realizable value of the receivables on (1) December 31, 2014, (2) May 11, 2015, and (3) November 12, 2015,

assuming that the total amount of accounts receivable of $300,000 is unchanged on each of these three dates except for any

changes recorded in (a).

E8–6 At the beginning of March, Paragon Limited, which records adjusting entries at the end of each month, had

accounts receivable of $30,000 and an allowance for doubtful accounts of $5,000. During March, the company had credit

sales of $40,000 and collected $35,000 from customers. It also wrote off a certain amount of uncollectible receivables during

the month and recorded a certain amount of bad debts expense at the end of the month. No accounts that were written

off during the month were subsequently recovered. At the end of March, aft er all journal entries had been recorded and

posted, the balance in Accounts Receivable was $32,000 while Allowance for Doubtful Accounts had a balance of $4,500.

Instructions

(a) Prepare T accounts for Accounts Receivable and Allowance for Doubtful Accounts. Post the above transactions and

determine the missing amounts for the write off of uncollectible receivables and bad debts expense.

(b) Prepare the journal entry that would have been made by the company to write off uncollectible receivables during March.

(c) Prepare the journal entry that would be made by the company to record bad debts expense for the month of March.

E8–7 Passara Supply Corp. has the following selected transactions for notes receivable.

Nov. 1 Loaned $48,000 cash to A. Bouchard on a one-year, 8% note.

Dec. 1 Sold goods to Wright, Inc., receiving a two-month, 6%, $8,400 note. Th e goods cost $5,000.

15 Received a six-month, 7%, $16,000 note in exchange for an account from Aquilina Corporation.

Feb. 1 Collected the amount owing on the Wright note.

28

28

Accrued interest on all notes receivable at year end. Interest is calculated to the nearest half month

and is due at maturity.

Analyzed each note and estimated that uncollectible notes at year end totalled $16,000.

Instructions

Record the above transactions for Passara Supply Corp. Round calculations to the nearest dollar.

E8–8 Refer to E8–7 for information about the note between Passara Supply Corp. and Wright, Inc. Round calculations

to the nearest dollar.

Instructions

Record the transactions related to the note on Wright’s books on December 1, December 31 (Wright’s year end), and February 1.

E8–9 Th e following selected transactions for notes receivable are for Acre Limited.

May 1 Received a six-month, 5%, $12,000 note on account from Blackstone Limited. Interest is due at maturity.

June 30 Accrued interest on the Blackstone note on this date, which is Acre’s year end.

July 31 Lent $10,000 cash to an employee, Noreen Wong, issuing a three-month, 7% note. Interest is due at

the end of each month.

Aug. 31 Received the interest due from Ms. Wong.

Sept. 30 Received the interest due from Ms. Wong.

Oct. 31 Received payment in full for the employee note from Ms. Wong.

Nov. 1 Wrote off the Blackstone note as Blackstone defaulted. Future payment is not expec

Instructions

Record the above transactions for Acre Limited. Round calculations to the nearest dollar.

E8–10 Deere & Company had the following balances in its short-term receivable accounts at October 31, 2012

(in U.S. millions): Allowance for Doubtful Trade and Notes Receivables $66.0; Allowance for Doubtful Financing

Receivables $177.0; Financing Receivables $22,159.1; Other Receivables $1,790.9; and Trade Accounts and Notes

Receivable $3,799.1.

Instructions

Show the presentation of Deere & Company’s receivables in the current assets section of its statement of fi nancial position

at October 31.

E8–11 Apollo Corporation reported the following selected accounts and amounts at November 30, 2015:

Accounts payable $ 22,600

Accounts receivable 18,200

Advances to employees 2,900

Allowance for doubtful accounts 1,300

Allowance for doubtful notes (current) 5,000

Bad debts expense 2,000

Cash 7,500

Interest expense 2,400

Interest revenue 6,000

Merchandise inventory 26,400

Notes receivable (current) 25,000

Notes receivable (non-current) 75,000

Prepaid insurance 1,500

Sales 370,000

Sales discounts 12,000

Sales tax recoverable 3,150

Instructions

(a) Identify which of the above accounts are statement of fi nancial position (SFP) accounts and which are income statement

(IS) accounts.

(b) Indicate where each of the income statement accounts would be reported (for example, operating revenue, operating

expenses, non-operating expenses, or non-operating revenue).

(c) Prepare the current assets section of Apollo’s statement of fi nancial position.

E8–12 Th e following information (in millions) was taken from the December 31 fi nancial statements of Canadian

National Railway Company (CN):

2012 2011 2010

Accounts receivable, gross $ 841 $ 836 $ 796

Allowance for doubtful accounts 10 16 21

Accounts receivable, net 831 820 775

Revenues 9,920 9,028 8,297

Total current assets 1,869 1,848 1,590

Total current liabilities 2,203 1,715 1,906

Instructions

(a) For 2012 and 2011, calculate CN’s current ratio, receivables turnover, and average collection period.

(b) Comment on any improvement or deterioration in CN’s management of its accounts receivable.

E8–13 Th e following ratios are for Lin Inc.

2015 2014

Current ratio 1.5:1 1.3:1

Receivables turnover 10 times 12 times

Inventory turnover 9 times 11 times

Instructions

(a) Is Lin’s short-term liquidity improving or deteriorating in 2015? Explain.

(b) Identify any steps Lin might have taken, or wish to take, to improve the management of its accounts receivable and inventor

 

Problems: Set A

P8–1A At January 1, 2015, Underwood Imports Inc. reported the following on its statement of fi nancial position:

Accounts receivable $1,990,000

Allowance for doubtful accounts 124,000

During 2015, the company had the following summary transactions for receivables:

  1. Sales on account, $5,200,000
  2. Sales returns and allowances, $80,000
  3. Collections of accounts receivable, $5,400,000
  4. Interest added to overdue accounts, $400,000
  5. Write off s of accounts receivable deemed uncollectible, $150,000
  6. Collection of accounts previously written off as uncollectible, $60,000
  7. Aft er considering all of the above transactions, total estimated uncollectible accounts, $100,000

Instructions

(a) Prepare journal entries to record each of the above summary transactions.

(b) (1) Prepare T accounts for Accounts Receivable and Allowance for Doubtful Accounts, (2) enter the opening

balances, (3) post the above summary entries, and (4) determine the ending balances.

(c) Determine the net realizable value of the accounts receivable as at January 1 and December 31.

(d) Show the statement of fi nancial position presentation of the receivables as at December 31.

(e) Show the income statement presentation of the revenue and expense accounts for the year ended December 31.

P8–2A At the beginning of the current period, Azim Enterprises Ltd. had balances in Accounts Receivable of $1,600,000

and in Allowance for Doubtful Accounts of $88,000 (credit). During the period, Azim had credit sales of $3,800,000 and

collections of $4,084,000. It wrote off $116,000 of accounts receivable. However, an $8,000 account written off as uncollectible

was recovered before the end of the current period. Uncollectible accounts are estimated to total $72,000 at the

end of the period.

Instructions

(a) Prepare the entries to record sales and collections during the period.

(b) Prepare the entry to record the write off of the $116,000 accounts deemed uncollectible during the period.

(c) Prepare the entry(ies) to record the collection of the $8,000 account written off as part of the uncollectible accounts in part (b).

(d) Prepare the entry to record bad debts expense for the period.

(e) (1) Prepare T accounts for Accounts Receivable and Allowance for Doubtful Accounts, (2) enter the opening balances,

(3) post the journal entries prepared in parts (a) through (d), and (4) determine the ending balances.

(f) Show the statement of fi nancial position presentation of the receivables at the end of the period.

P8–3A Wilton Corporation reported the following selected information in its general ledger at December 31:

Accounts Receivable Sales

Beg. bal. 18,000 78,000

55,000

(a) (b)

End. bal. (c)

Allowance for Doubtful Accounts Bad Debts Expense

Beg. bal. 1,800 (f)

1,000

Unadj. bal. 800

(d)

End. bal. (e)

All sales were on account. Some accounts receivable were collected. One account was written off ; there were no subsequent

recoveries. At the end of the year, uncollectible accounts were estimated to total $2,000.

Instructions

Using your knowledge of receivables transactions, determine the missing amounts. (Hint: You may not be able to solve the

above items in alphabetical order. In addition, you may fi nd it helpful to reconstruct the journal entries.)

P8–4A Th e following selected information is from Richibucto Limited’s partial aging schedule at year end:

Number of Days

Outstanding Accounts Receivable

Estimated Percentage

Uncollectible

0–30 days $240,000 1%

31–60 days 120,000 5%

61–90 days 100,000 10%

Over 90 days 60,000 25%

Total $520,000

Th e unadjusted balance in Allowance for Doubtful Accounts is a credit of $20,000.

Instructions

(a) Complete the aging schedule and calculate the total estimated uncollectible accounts from the above information.

(b) (1) Prepare the adjusting journal entry to record the bad debts using the information determined in part (a). (2) Would

your journal entry be diff erent if the unadjusted balance in Allowance for Doubtful Accounts were a debit of $20,000?

(c) In the following year, $4,000 of the outstanding receivables is determined to be specifi cally uncollectible. Prepare the

journal entry to write off the uncollectible amount.

(d) Richibucto subsequently collects $1,700 of the $4,000 that was determined to be uncollectible in part (c). Prepare the

journal entry(ies) to record the collection.

(e) Comment on how your answers in parts (a) to (d) would change if the company used a percentage of total accounts

receivable of 6%, rather than aging the accounts.

(f) What are the advantages to the company of aging the accounts receivable rather than applying a percentage to total

accounts receivable?

P8–5A An aging analysis of Yamoto Limited’s accounts receivable at December 31, 2015 and 2014, showed the following:

Number of Days

Outstanding Accounts Receivable

Estimated Percentage

Uncollectible

2015 2014

0–30 days $300,000 $320,000 3%

31–60 days 64,000 114,000 6%

61–90 days 86,000 76,000 12%

Over 90 days 130,000 50,000 24%

Total $580,000 $560,000

Additional information:

  1. At December 31, 2014, the unadjusted balance in Allowance for Doubtful Accounts was a credit of $9,000.
  2. In 2015, $42,000 of accounts were written off as uncollectible and $3,000 of accounts previously written off were recovered.

Instructions

(a) Prepare an aging schedule to calculate the estimated uncollectible accounts at December 31, 2014 and 2015. Note that

the estimated percentages uncollectible are the same for both years. Comment on the results.

(b) Record the adjusting entry relating to bad debts on December 31, 2014.

(c) Record the write off of uncollectible accounts in 2015.

(d) Record the collection of accounts previously written off in 2015.

(e) Prepare the adjusting entry relating to bad debts on December 31, 2015.

(f) Calculate the net realizable value of Yamoto’s accounts receivable at December 31, 2014 and 2015.

P8–6A Th e following selected transactions occurred for Bleumortier Corporation. Th e company uses a perpetual inventory

system, has a May 31 year end, and adjusts its accounts annually.

Feb. 1 Sold merchandise for $6,000 to Morgan Ltd., which used a Bleumortier company credit card to pay

for it. Th e cost of goods sold was $4,000.

3 Sold $13,400 of merchandise costing $8,800 to Gauthier Company and accepted Gauthier’s twomonth,

6% note in payment. Interest is due at maturity.

26 Sold $8,000 of merchandise to Mathias Corp., terms n/30. Th e cost of the merchandise sold was

$5,400.

Mar. 6 Sold $4,000 of merchandise that cost $3,000 to Superior Limited. Superior paid using a bank credit

card. Th e bank deducted $120 of service charges (credit card fees) from Bleumortier’s bank account

with respect to this sale.

31 Accepted a two-month, 7%, $8,000 note from Mathias for the balance due. Interest is due at maturity.

(See February 26 transaction.)

Apr. 3 Collected the Gauthier note in full. (See February 3 transaction.)

May 31 Th e Mathias note of March 31 was dishonoured. It is expected that Mathias will eventually pay the

amount owed.

May 31 Recorded accrued interest for four months on outstanding credit card amount due from Morgan.

Interest on unpaid credit card balances is charged at 24% per annum (2% per month).

(See February 1 transaction.)

Instructions

Record the above transactions. Round calculations to the nearest dollar.

P8–7A On November 1, 2015, Sokos Inc. accepted a three-month, 6%, $40,000 note from Malmo Inc. in settlement of its

account. Interest is due on the fi rst day of each month, starting December 1. Both companies’ year ends are December 31.

Instructions

(a) Prepare all journal entries for Sokos over the term of the note. Assume that the note is collected in full on the maturity date.

(b) Prepare all journal entries for Malmo over the term of the note. Assume that the note is paid in full on the maturity date.

(c) Assume that instead of honouring the note at maturity, Malmo dishonours it. Prepare the necessary journal entry on

Sokos’s books at the maturity date, February 1, 2016, assuming that eventual collection of the note is (1) expected, and

(2) not expected. Interest was last paid by Malmo on January 1.

P8–8A Tardif Corporation adjusts its books monthly. On September 30, 2015, notes receivable include the following:

Issue Date Maker Principal Interest Term

Mar. 31, 2015 RES Inc. $17,000 6% 7 months

May 31, 2015 Ihara Ltd. 17,500 4% 18 months

Aug. 31, 2015 Dragon Limited 6,000 7% 2 months

Sept. 30, 2015 MGH Corp. 20,500 5% 16 months

Interest is due at maturity for the RES and Dragon notes. Interest is due on the fi rst day of the month for the Ihara and

MGH notes. At September 30, the balance in the Allowance for Doubtful Notes account is nil. In October, the following

selected transactions were completed.

Oct. 1 Received the interest due from Ihara and MGH.

31 Received notice that Dragon was unable to pay its note as scheduled. It expects to be able to pay in

the future.

31 Th e RES note matured and was received in full.

31 Accrued interest on the Ihara and MGH notes.

31 Analyzed the remaining notes for collectibility. Estimated that $17,500 of notes may not be collectible

in the future because of signifi cant labour issues currently being experienced by Ihara.

Instructions

(a) Calculate the balance in the Interest Receivable and Notes Receivable accounts at September 30, 2015.

(b) Record the October transactions. Round calculations to the nearest dollar.

(c) (1) Prepare T accounts for the Interest Receivable, Notes Receivable, and Allowance for Doubtful Notes accounts,

(2) enter the opening balances, (3) post the entries recorded in part (b), and (4) determine the ending balances.

(d) Show the statement of fi nancial position presentation of the receivables accounts at October 31.

P8–9A Canadiana Corporation reports the following selected accounts (in thousands) at December 31, 2015:

Accounts payable $1,978 Interest revenue $ 112

Accounts receivable, gross 1,630 Land 1,077

Accumulated depreciation—buildings 960 Merchandise inventory 1,902

Accumulated depreciation—equipment 488 Notes receivable (current) 2,481

Allowance for doubtful accounts 32 Notes receivable (non-current) 101

Bad debts expense 138 Sales 12,637

Buildings 2,734 Sales discounts 341

Cash 592 Supplies 85

Cost of goods sold 9,741 Trading investments 196

Equipment 737

Income tax receivable 99

Instructions

Prepare the assets section of Canadiana’s statement of fi nancial position.

P8–10A Presented here is selected information for Nike, Inc. (in U.S. $ millions) and Adidas AG (in euro millions):

Nike Adidas

Net sales $24,128 €13,344

Allowance for doubtful accounts, beginning of year 74 127

Allowance for doubtful accounts, end of year 50 151

Accounts receivable (gross), beginning of year 3,212 1,794

Accounts receivable (gross), end of year 3,330 1,858

Instructions

(a) Calculate the receivables turnover and average collection period for both companies. Th e industry average for the

receivables turnover was 7.5 times and the average collection period was 49 days.

(b) Comment on the diff erence in the two companies’ collection experiences, and that of their industry counterparts.

P8–11A Th e following selected ratios are available for Pampered Pets Inc. for the most recent three years:

2015 2014 2013

Current ratio 2.6:1 2.4:1 2.1:1

Receivables turnover 8.2 times 7.4 times 6.7 times

Inventory turnover 9.9 times 8.7 times 7.5 times

Instructions

(a) Calculate the average collection period and days in inventory for each year.

(b) Is Pampered Pets’ liquidity improving or worsening? Explain.

(c) Do changes in turnover ratios aff ect profi tability? Explain.

(d) Do changes in turnover ratios aff ect cash fl ow? Explain.

(e) Identify any steps that the company may wish to take in order to improve its management of receivables and

inventory.

Problems: Set B

P8–1B At January 1, 2015, Bordeaux Inc. reported the following information on its statement of fi nancial position:

Accounts receivable $480,000

Allowance for doubtful accounts 35,000

During 2015, the company had the following summary transactions for receivables:

  1. Sales on account, $1,600,000
  2. Sales returns and allowances, $250,000
  3. Collections of accounts receivable, $1,500,000
  4. Interest added to overdue accounts, $125,000
  5. Write off s of accounts receivable deemed uncollectible, $45,000
  6. Collection of accounts previously written off as uncollectible, $10,500
  7. Aft er considering all of the above transactions, total estimated uncollectible accounts, $25,000

Instructions

(a) Prepare the journal entries to record each of the above summary transactions.

(b) (1) Prepare T accounts for Accounts Receivable and Allowance for Doubtful Accounts, (2) enter the opening balances,

(3) post the above summary entries, and (4) determine the ending balances.

(c) Determine the net realizable value of the accounts receivable as at January 1 and December 31.

(d) Show the statement of fi nancial position presentation of the receivables as at December 31.

(e) Show the income statement presentation of the revenue and expense accounts for the year ended December 31.

P8–2B At the beginning of the current period, Huang Ltd. had balances in Accounts Receivable of $200,000 and in

Allowance for Doubtful Accounts of $14,000 (credit). During the period, Huang had credit sales of $800,000 and collections

of $723,000. It wrote off $21,000 of accounts receivable. However, a $3,500 account written off as uncollectible

was recovered before the end of the current period. Uncollectible accounts are estimated to total $16,000 at the end of

the period.

Instructions

(a) Prepare the entries to record the sales and collections during the period.

(b) Prepare the entry to record the write off of uncollectible accounts during the period.

(c) Prepare the entry(ies) to record the collection of the $3,500 account written off as uncollectible in part (b).

(d) Prepare the entry to record bad debts expense for the period.

(e) (1) Prepare T accounts for Accounts Receivable and Allowance for Doubtful Accounts, (2) enter the opening balances,

(3) post the journal entries prepared in parts (a) through (d), and (4) determine the ending balances.

(f) Show the statement of fi nancial position presentation of the receivables at the end of the period.

P8–3B Yasukuni Corporation reported the following selected information in its general ledger at June 30:

Accounts Receivable

Accounts Receivable Sales

Beg. bal. (a) (e)

(b)

225,000 230,000

End. bal. 22,500

Allowance for Doubtful Accounts Bad Debts Expense

Beg. bal. 1,000 (f)

250

Unadj. bal. 750

(c)

End. bal. (d)

All sales were on account. Some accounts receivable were collected. One account was written off ; there were no subsequent

recoveries. At the end of the year, uncollectible accounts were estimated to total $1,150.

Instructions

Using your knowledge of receivables transactions, determine the missing amounts. (Hint: You may not be able to solve the

above items in alphabetical order. In addition, you may fi nd it helpful to reconstruct the journal entries.)

P8–4B Th e following selected information is from Imagine Corporation’s partial aging schedule:

Number of Days

Outstanding

Accounts

Receivable

Estimated

Percentage

Uncollectible

0–30 days $110,000 1%

31–60 days 50,000 5%

61–90 days 20,000 10%

Over 90 days 12,500 20%

Total $192,500

Th e unadjusted balance in Allowance for Doubtful Accounts is a debit of $5,000.

Instructions

(a) Complete the aging schedule and calculate the total estimated uncollectible accounts from the above information.

(b) (1) Prepare the adjusting journal entry to record the bad debts using the information determined in part (a). (2) Would

your journal entry be diff erent if the unadjusted balance in Allowance for Doubtful Accounts were a credit of $5,000?

(c) In the following year, $3,000 of the outstanding receivables is determined to be uncollectible. Prepare the journal entry

to write off the uncollectible amount.

(d) Imagine Corporation subsequently collects $1,500 of the $3,000 that was determined to be uncollectible in part (c).

Prepare the journal entry(ies) to record the collection.

(e) Comment on how your answers in parts (a) to (d) would change if Imagine used a percentage of total accounts receivable

of 4%, rather than aging the accounts.

(f) What are the advantages to the company of aging the accounts receivable rather than applying a percentage to total

accounts receivable?

P8–5B An aging analysis of Reiko Limited’s accounts receivable at December 31, 2015 and 2014 showed the following:

Number of Days Accounts Receivable Estimated Percentage

Outstanding 2015 2014 Uncollectible

0–30 days $240,000 $220,000 3%

31–60 days 104,000 86,000 6%

61–90 days 62,000 52,000 12%

Over 90 days 34,000 22,000 20%

Total $440,000 $380,000

Additional information:

  1. At December 31, 2014, the unadjusted balance in Allowance for Doubtful Accounts was a credit of $3,000.
  2. In 2015, $28,000 of accounts were written off as uncollectible and $3,000 of accounts previously written off were

recovered.

Instructions

(a) Prepare an aging schedule to calculate the estimated uncollectible accounts at December 31, 2014 and 2015. Note that

the estimated percentages uncollectible are the same for both years. Comment on the results.

(b) Record the adjusting entry relating to bad debts on December 31, 2014.

(c) Record the write off of uncollectible accounts in 2015.

(d) Record the collection of accounts previously written off in 2015.

(e) Prepare the adjusting entry relating to bad debts on December 31, 2015.

(f) Calculate the net realizable value of Reiko accounts receivable at December 31, 2014 and 2015.

P8–6B Th e following selected transactions occurred for Vu Ltd. Th e company uses a perpetual inventory system, has a

September 30 year end, and adjusts its accounts annually.

Jan. 2 Loaned Emily Collis, an employee, $6,000 on a four-month, 8% note. Interest is due at maturity.

5 Sold $8,000 of merchandise to Asiz Limited, terms n/15. Th e merchandise cost $4,800.

20 Accepted Asiz Limited’s two-month, 9%, $8,000 note for its balance due. Interest is due each month

on the 20th. (See January 5 transaction.)

Feb. 20 Collected interest on the Asiz note. (See January 20 transaction.)

Mar. 20 Collected the Asiz note in full. (See January 20 and February 20 transactions.)

May 2 Collected the Collis note in full. (See January 2 transaction.)

25 Accepted Th undercloud Inc.’s three-month, 8%, $3,000 note in settlement of a past-due balance on

account. Interest is due at maturity.

Aug. 1 Vu has introduced its own credit card. Pierpont Ltd. used the card to buy merchandise for $6,000

that cost Vu $4,000.

25 Th e Th undercloud note was dishonoured. Eventual collection is not expected. (See May 25

transaction.)

Sept. 30 Recorded accrued interest for two months on outstanding credit card amount due from Pierpont.

Interest on unpaid balances is charged at 24% per annum (2% per month). (See August 1

transaction.)

Instructions

Record the above transactions. Round calculations to the nearest dollar.

P8–7B On August 1, 2015, Cappuccitti Limited accepted a two-month, 4%, $30,000 note from Dil-Dil Inc. in settlement

of its account. Interest is due on the fi rst day of each month, starting September 1. Both companies’ year ends are

August 31.

Instructions

(a) Prepare all journal entries for Cappuccitti over the term of the note. Assume that the note is collected in full on the

maturity date.

(b) Prepare all journal entries for Dil-Dil over the term of the note. Assume that the note is paid in full on the

maturity date.

(c) Assume that instead of honouring the note at maturity, Dil-Dil dishonours it. Prepare the necessary journal entry on

Cappuccitti’s books at the maturity date, October 1, 2015, assuming that eventual collection of the note is (1) expected,

and (2) not expected. Interest was last paid by Dil-Dil on September 1.

P8–8B Kitimat Corporation adjusts its books monthly. On November 30, 2015, notes receivable include the following:

Issue Date Maker Principal Interest Term

Mar. 31, 2015 Kootenay Inc. $17,000 6% 9 months

May 31, 2015 Cassiar Ltd. 15,000 4% 18 months

Aug. 31, 2015 Namu Limited 6,000 7% 4 months

Sept. 30, 2015 Siska Corp. 20,000 5% 16 months

Interest is due at maturity for the Kootenay and Namu notes. Interest is due on the fi rst day of each month for the Cassiar and

Siska notes. At November 30, the balance in the Allowance for Doubtful Notes account is nil. In December, the following

selected transactions were completed.

Dec. 1 Received the interest due from Cassiar and Siska.

31 Received notice that Namu was unable to pay its note as scheduled. It does not expect to be able to

pay in the future.

31 Th e Kootenay note matured and was received in full.

31 Accrued interest on the Cassiar and Siska notes.

31 Analyzed the remaining notes for collectibility. Estimated that $20,000 of notes may not be

collectible in the future because of signifi cant economic issues currently being experienced by

Siska.

Instructions

(a) Calculate the balance in the Interest Receivable and Notes Receivable accounts at November 30, 2015.

(b) Record the December transactions. Round calculations to the nearest dollar.

(c) (1) Prepare T accounts for the Interest Receivable, Notes Receivable, and Allowance for Doubtful Notes accounts,

(2) enter the opening balances, (3) post the entries recorded in part (b), and (4) determine the ending balances.

(d) Show the statement of fi nancial position presentation of the receivables accounts at December 31.

P8–9B Outaouais Inc. reports the following selected accounts (in thousands) at January 31, 2015:

Accounts payable $ 2,857 Income tax receivable $ 20

Accounts receivable, gross 2,468 Interest revenue 35

Accumulated depreciation—buildings 250 Land 200

Accumulated depreciation—equipment 375 Merchandise inventory 3,000

Allowance for doubtful accounts 268 Notes receivable (current) 50

Bank indebtedness 100 Notes receivable (non-current) 300

Bad debts expense 135 Notes payable (current) 1,000

Buildings 1,000 Sales 29,000

Cost of goods sold 19,000 Sales returns and allowances 800

Equipment 750 Supplies 50

Goodwill 100

Instructions

Prepare the assets section of Outaouais’s statement of fi nancial position.

P8–10B Presented here is selected information (in millions) from the most recent fi nancial statements of Rogers

Communications Inc. and Shaw Communications Inc.:

Rogers Shaw

Net sales $12,486 $4,998

Allowance for doubtful accounts, beginning of year 119 29

Allowance for doubtful accounts, end of year 129 28

Accounts receivable (gross), beginning of year 1,693 472

Accounts receivable (gross), end of year 1,665 461

Instructions

(a) Calculate the receivables turnover and average collection period for both companies. Th e industry average for the

receivables turnover was 7.5 times and the average collection period was 49 days.

(b) Comment on the diff erence in the companies’ collection experiences, and that of their industry counterparts.

P8–11B Th e following selected ratios are available for Tianjin Inc. for the most recent three years:

2015 2014 2013

Current ratio 1.5:1 1.5:1 1.5:1

Receivables turnover 8 times 7 times 6 times

Inventory turnover 6 times 7 times 8 times

Instructions

(a) Calculate the average collection period and days in inventory for each year.

(b) Is Tianjin’s liquidity improving or worsening? Explain.

(c) Do changes in turnover ratios aff ect profi tability? Explain.

(d) Do changes in turnover ratios aff ect cash fl ow? Explain.

(e) Identify any steps that the company may wish to consider in order to improve its management of receivables and inventory.

 

CHAPTER 9 Reporting and Analyzing Long-Lived Assets

 

Questions

(SO 1) 1. (a) Susan Leung is uncertain about how to determine

the cost of property, plant, and equipment.

Explain this for her. (b) Susan is also wondering

what an asset retirement cost is and how that

aff ects the cost of property, plant, and equipment.

(SO 1) 2. Fern Inc. purchases equipment and incurs a

number of expenditures before it is ready to use

the equipment. Give two examples of operating

expenditures and two examples of capital

expenditures and explain how these expenditures

on new equipment would be recorded and why.

(SO 1) 3. What are land improvements? Should the cost of

clearing and grading land be recorded as a land

improvement or not? Why or why not?

(SO 1) 4. Explain the diff erence between an operating lease

and a fi nance lease. What accounts are recorded

on the fi nancial statements for each type of lease?

(SO 2) 5. Contrast the eff ects of the three depreciation methods

on (1) depreciation expense, (2) profi t,

(3) accumulated depreciation, and (4) carrying

amount in each of the following: (a) the early years of

an asset’s life, and (b) over the total life of the asset.

(SO 2) 6. Why is the depreciable amount (the asset’s cost

less residual value) used in the straight-line and

units-of-production methods but not in the

diminishing-balance method?

(SO 2) 7. Why must the calculation of depreciation be adjusted

for any fraction of a year since the purchase

when the straight-line and diminishing-balance

methods are used, but no adjustment is needed

when the units-of-production method is used?

(SO 2) 8. (a) What factors should a company consider

when choosing among the straight-line,

diminishing-balance, or units-of-production

depreciation methods? (b) When choosing

between the cost model or revaluation model?

(SO 2) 9. (a) How is an impairment loss calculated?

Recorded? (b) How can impairment losses create

problems for users in comparing the fi nancial

results of a company over multiple years?

(SO 3) 10. If equipment is sold in the middle of a fi scal

year, why does depreciation have to be updated

for the partial period? Doesn’t the journal entry

to record the sale subsequently remove the

accumulated depreciation from the books anyway?

(SO 3) 11. How is a gain or loss on the sale of property,

plant, or equipment calculated? Is the calculation

the same for the retirement of property, plant, or

equipment?

(SO 3) 12. Rashid Corporation owns a machine that is fully

depreciated but is still being used. How should

Rashid account for this asset and report it in the

fi nancial statements?

(SO 2, 4) 13. What are the similarities and diff erences between

accounting for tangible and intangible assets?

(SO 4) 14. Why are intangible assets with a fi nite life

amortized, but intangible assets with an

indefi nite life are not?

(SO 4) 15. Hefl in Corporation has been amortizing its

fi nite-life intangible assets over their legal lives.

Th e company’s accountant argues that this is

appropriate because an intangible asset’s legal

life is known with certainty, but the useful life of

an intangible asset is subjective. (a) Why is this

not correct? (b) What impact might using the

legal life instead of the useful life have on the

company’s fi nancial statements?

(SO 4) 16. Two years ago, Pesowski Corp. purchased a

patent for $5 million that allows the company to

produce and sell a special video game controller.

During the year, the company determined that

Sucha Ltd. was producing and selling a similar

game controller. Pesowski spent $100,000 on

legal fees to successfully enforce its rights under

the patent. How should Pesowski account for the

legal fees and why?

(SO 4) 17. Bob Leno, a business student, is working on a

case for one of his classes. Th e company in the

case needs to raise cash to market a new product

it has developed. His roommate Saul Cain, an

engineering student, takes one look at the company’s

statement of fi nancial position and says,

“Th is company has an awful lot of goodwill. Why

don’t you recommend that they sell some of it to

raise cash?” How should Bob respond to Saul?

(SO 5) 18. Explain how long-lived assets and transactions

relating to them should be reported on the

(a) statement of fi nancial position, (b) income

statement, and (c) statement of cash fl ows.

(SO 5) 19. What information about long-lived assets

should be disclosed in the notes to the fi nancial

statements for a company reporting under IFRS?

Under ASPE?

(SO 5) 20. Why are gains and losses on disposal of property,

plant, and equipment presented in the operating

section of the income statement rather than the

non-operating section?

(SO 6) 21. Give an example of an industry that would be

characterized by (a) a high asset turnover and

low profi t margin, and (b) a low asset turnover

and high profi t margin.

(SO 6) 22. How can the profi t margin and asset turnover ratios

be used to help explain the return on assets?

(SO 6) 23. In 2012, Tim Hortons Inc. reported net sales of

$2,226 million, profi t of $403 million, and average

total assets of $2,244 million. In 2011, its net

sales were $2,012 million, profi t was $383 million,

and average total assets were $2,343 million.

Did the company’s return on assets and asset

turnover ratios improve or deteriorate in 2012.

Brief Exercises

BE9–1 Th ese expenditures were incurred by Shumway Ltd. in purchasing land: cash price $50,000; legal fees $2,500;

removal of old building $5,000; cost of clearing and grading $3,500; installation of fence $3,000. What is the cost of the land?

BE9–2 Basler Ltd. incurs these expenditures in purchasing a truck: invoice price $42,000; installation of a trailer hitch

$1,000; one-year accident insurance policy $900; motor vehicle licence $150; painting and lettering $750. What is the cost

of the truck?

BE9–3 Indicate whether each of the following items is an operating expenditure (O) or a capital expenditure (C). If the

expenditure is neither, write NA for “not applicable” in the space provided.

(a) Repaired building roof, $1,500

(b) _____ Replaced building roof, $27,500

(c) _____ Purchased building, $480,000

(d) _____ Purchased insurance on equipment

in transit, $350

(e) _____ Purchased truck, $55,000

(f) _____ Purchased oil and gas for truck, $155

(g) _____ Replaced tires on truck, $500

(h) _____ Anticipated retirement costs for plant, $500,000

(i) _____ Added new wing to building, $250,000

(j) _____ Painted interior of building, $1,500

BE9–4 Buckingham Ltd. purchases a delivery truck on January 1, 2015, at a cost of $86,000. Th e truck is expected to have

a residual value of $6,000 at the end of its four-year useful life. Buckingham has a December 31 year end. Calculate the

depreciation using the straight-line method (a) for each year of the truck’s life, and (b) in total over the truck’s life.

BE9–5 Depreciation information for Buckingham Ltd. is given in BE9–4. Assuming the delivery truck was purchased

on May 1 instead of January 1 and that the company records depreciation to the nearest month, calculate the depreciation

expense using the straight-line method for 2015 and 2016.

BE9–6 Depreciation information for Buckingham Ltd. is given in BE9–4. Using the diminishing-balance method and

assuming the depreciation rate is equal to one time the straight-line rate, calculate the depreciation (a) for each year of the

truck’s life, and (b) in total over the truck’s life.

BE9–7 Depreciation information for Buckingham Ltd. is given in BE9–4. Assuming the delivery truck was purchased on

May 1 instead of January 1, calculate the depreciation expense using the diminishing-balance method for 2015 and 2016.

Assume the depreciation rate is equal to one time the straight-line rate.

BE9–8 Speedy Taxi Service uses the units-of-production method to calculate depreciation on its taxicabs. Each cab is

expected to be driven 325,000 km. Taxi 10 was purchased on March 1, 2014, for $33,000 and is expected to have a residual

value of $500. Taxi 10 was driven 125,000 km in 2014 and 105,000 km in 2015. Speedy Taxi Service has a December 31 year

end. Calculate the depreciation expense on Taxi 10 for 2014 and 2015.

BE9–9 Tibble Corporation uses straight-line depreciation, prepares adjusting entries annually, and has a December 31

year end. It purchased equipment on January 1, 2014, for $200,000. Th e equipment had an estimated useful life of fi ve

years and a residual value of $20,000. On December 31, 2015, the company tests for impairment and determines that the

equipment’s recoverable amount is $100,000. (a) Assuming annual depreciation has already been recorded at December 31,

calculate the equipment’s carrying amount at December 31, 2015. (b) Calculate the amount of the impairment loss, if any.

BE9–10 Goo-Yeong Limited sells equipment on September 30, 2015, for $42,000 cash. Th e equipment originally cost

$144,000 when purchased on January 1, 2013. It has an estimated residual value of $4,000 and a useful life of fi ve years.

Depreciation was last recorded on December 31, 2014, the company’s year end. Prepare the journal entries to (a) update

depreciation using the straight-line method to September 30, 2015, and (b) record the sale of the equipment.

BE9–11 Ruiz Ltd. retires equipment that cost $42,000. No proceeds were received. Prepare journal entries to record the

transaction if accumulated depreciation is (a) $42,000, and (b) $40,000.

BE9–12 Surkis Corporation purchased a patent for $180,000 cash on April 2, 2015. Its legal life is 20 years and

its estimated useful life is 5 years. Th e company’s year end is December 31 and it prepares adjusting entries annually.

(a) Prepare the journal entry to record the (1) purchase of the patent on April 2, 2015, and (2) amortization for the fi rst year

ended December 31, 2015. (b) Show how the patent would be reported on the statement of fi nancial position at December 31.

BE9–13 A company manufacturing hockey bags registered trademarks for $1,000 cash for its revolutionary RackDri

hockey bags on June 1, 2015. On December 1, 2015, it paid $10,000 cash for legal costs to successfully defend its trademarks

in court. (a) Prepare the journal entry to record the (1) registration of the trademarks on June 1, and (2) the legal

costs on December 1. (b) Should the cost of the trademarks be amortized? Explain.

BE9–14 Indicate whether each of the following items should be recorded as property, plant, and equipment (PP&E) or

an intangible asset (I) on the statement of fi nancial position. If the asset does not fi t either of these categories, write NA for

“not applicable” in the space provided.

(a) Accumulated amortization

(b) Asset retirement cost for a building

(c) Assets under fi nance lease

(d) Building

(e) Franchise

(f) Merchandise inventory

(g) Common shares

(h) Impairment loss

(i) Land

(j) Land improvements

(k) Leasehold improvements

(l) Licence right

(m) Operating lease

(n) Patent

(o) Research costs

(p) Trademark

BE9–15 Canadian Tire Corporation, Limited reported the following selected information about long-lived assets at

December 29, 2012 (in millions):

Accumulated depreciation—buildings $1,102.9

Accumulated depreciation—fi xtures and equipment 591.4

Accumulated amortization—fi nite-life intangible assets 604.6

Accumulated depreciation—other property and equipment 424.2

Buildings 2,683.7

Fixtures and equipment 880.4

Goodwill 376.9

Indefi nite-life intangible assets 385.0

Finite-life intangible assets 932.6

Land 744.2

Other property and equipment 1,153.7

Prepare the long-lived assets section of the statement of fi nancial position for Canadian Tire.

BE9–16 Coca-Cola and Pepsi reported the following selected ratios:

Coke Pepsi

Return on assets 10.9% 8.4%

Asset turnover 0.6 times 0.9 times

(a) Identify which company has the better (1) return on assets ratio and (2) asset turnover ratio. (b) Based on these two

ratios, which company would you expect to have the better profi t margin?

BE9–17 Gildan Activewear Inc. reported the following selected fi nancial information (all in U.S. $ millions): net sales of

$1,948 in 2012, $1,726 in 2011, and $1,311 in 2010. Th e company also reported a profi t of $148 in 2012, $234 in 2011, and

$198 in 2010. Assets at the end of 2012 were $1,896; at the end of 2011, $1,858; and at the end of 2010, $1,335. (a) Calculate

Gildan’s (1) asset turnover, (2) profi t margin, and (3) return on assets for 2012 and 2011. (b) Comment on whether the

return on assets changed primarily due to a changing asset turnover or a changing profi t margin.

 

Exercises

E9–1 Th e following expenditures relating to property, plant, and equipment were made by Bachinski Ltd.:

  1. Paid $600,000 for a plant site.
  2. Paid $8,000 of legal fees on the purchase of the plant site.
  3. Paid $33,000 to demolish an old building on the plant site; residual materials were sold for $5,000.
  4. Paid $35,000 for paving the parking lot on the plant site.
  5. Paid $37,600 in architect fees for the design of the new plant.
  6. Promised to pay $50,000 in restoration costs when the company is fi nished using the plant site.
  7. Paid $90,000 for a new delivery truck.
  8. Paid $5,000 to have the company name and advertising slogan painted on the new truck.
  9. Paid a $1,250 motor vehicle licence fee on the new truck.
  10. Paid $3,800 for a one-year accident insurance policy on the new truck.

Instructions

(a) Explain what types of expenditures should be included in determining the cost of property, plant, and equipment.

(b) List the numbers of the above transactions, and beside each number write the account title that the expenditure should

be debited to.

E9–2 Hohnberger Enterprises purchased equipment on March 15, 2015, for $75,000. Th e company also paid the following

amounts: $500 for freight charges; $200 for insurance while the equipment was in transit; $1,800 for a one-year

insurance policy; $2,100 to train employees to use the new equipment; and $2,800 for testing and installation. Th e equipment

was ready for use on April 1, but the company did not start using it until May 1.

Hohnberger has estimated the equipment will have a 10-year useful life with no residual value. It expects to consume

the equipment’s future economic benefi ts evenly over the useful life. Th e company has a December 31 year end.

Instructions

(a) Calculate the cost of the equipment.

(b) When should the company begin depreciating the equipment: March 15, April 1, or May 1? Why?

(c) Which depreciation method should the company use? Why?

(d) Using the method chosen in part (c), calculate the depreciation on the equipment for 2015.

E9–3 Cirrus Ltd. purchased a new machine on April 4, 2012, at a cost of $172,000. Th e company estimated that the

machine would have a residual value of $16,000. Th e machine is expected to be used for 10,000 working hours during its

four-year life. Actual machine usage was 1,500 hours in 2012; 2,200 hours in 2013; 2,300 hours in 2014; 2,100 hours in

2015; and 1,900 hours in 2016. Cirrus has a December 31 year end.

Instructions

(a) Calculate depreciation for the machine under each of the following methods: (1) straight-line, (2) diminishing-balance

using double the straight-line rate, and (3) units-of-production.

(b) Which method results in the highest depreciation expense over the life of the asset? Highest profi t? Highest cash

fl ow?

E9–4 At the beginning of 2015, Lindy Weink, the controller of Lafrenière Inc., reviewed the expected useful life and

residual value of two of the company’s machines and proposed changes as follows:

Useful Life (in years) Residual Value

Machine Date Acquired Cost Original Proposed Original Proposed

#1 Jan. 1, 2005 $800,000 20 25 $40,000 $62,000

#2 Jan. 1, 2013 120,000 5 4 5,000 3,600

Instructions

(a) Calculate the annual depreciation for each asset using the straight-line method and the original useful life and residual

value.

(b) Calculate the accumulated depreciation and carrying amount of each asset on December 31, 2014.

(c) If the company accepts Lindy’s proposed changes in useful life and residual value, will depreciation expense for each

asset in 2015 be higher or lower than depreciation expense in 2014? Explain.

E9–5 Shown below are the T accounts relating to equipment that was purchased for cash by a company on the fi rst day

of the current year. Th e equipment was depreciated on a straight-line basis with an estimated useful life of 10 years and

a residual value of $100. Part of the equipment was sold on the last day of the current year for cash proceeds while the

remaining equipment that was not sold became impaired.

Instructions

Reconstruct the journal entries to record the following and derive the missing amounts:

(a) Purchase of equipment on January 1. What was the cash paid?

(b) Depreciation recorded on December 31. What was the depreciation expense?

(c) Sale of part of the equipment on December 31. What was the gain on disposal?

(d) Impairment loss on the remaining equipment on December 31. What was the impairment loss?

E9–6 Rahim Corporation purchased a boardroom table for $5,000. Th e company planned to keep it for four years, aft er

which it was expected to be sold for $500.

Instructions

(a) Calculate the depreciation expense for each of the fi rst three years under (1) the straight-line method, and (2) the

double-diminishing-balance method.

(b) Assuming Rahim sold the table for $1,225 at the end of the third year, calculate the gain or loss on disposal under each

depreciation method.

(c) Determine the impact on profi t (total depreciation of the table plus any loss on disposal or less any gain on disposal)

of each method over the entire three-year period.

E9–7 Presented here are selected transactions for Spector Limited for 2015. Spector uses straight-line depreciation and

records adjusting entries annually.

Jan. 1 Sold a delivery truck for $18,000 cash. Th e truck cost $62,000 when it was purchased on January 1,

2012, and was depreciated based on a four-year useful life with a $6,000 residual value.

Sept. 1 Sold computers that were purchased on January 1, 2013. Th ey cost $10,980 and had a useful life of

three years with no residual value. Th e computers were sold for $500 cash.

Dec. 30 Retired equipment that was purchased on January 1, 2006. Th e equipment cost $150,000 and had a

useful life of 10 years with no residual value. No proceeds were received.

Instructions

Record the above transactions.

E9–8 A co-op student, Toni Johnston, encountered the following situations at Chin Corporation, a publicly traded company:

  1. Toni learned that Chin is depreciating its buildings and equipment, but not its land. She could not understand why

land was omitted, so she prepared journal entries to depreciate all the company’s property, plant, and equipment,

including land, for the current year.

  1. Toni determined that Chin’s amortization policy on its intangible assets was wrong. Th e company was amortizing its

patents but not its goodwill. She fi xed that for the current year by adding goodwill to her adjusting entry for amortization.

She told a fellow student that she felt she had improved the consistency of the company’s accounting policies by

making these changes.

  1. Chin has a building still in use that has a zero carrying amount but a substantial fair value. Toni felt that this practice

did not benefi t the company’s users and so she wrote the building up to its fair value. Aft er all, she reasoned, you can

write down assets if fair values are lower. Writing them up if fair value is higher is yet another example of the improved

consistency that her employment has brought to the company’s accounting practices.

Instructions

Explain whether or not the accounting treatment in each of the above situations is appropriate. If not, explain what the

appropriate accounting treatment should be.

E9–9 Amarista Corporation has the following selected transactions during the year ended December 31, 2015:

Jan. 1 Purchased a copyright for $120,000 cash. Th e copyright has a useful life of six years and a

remaining legal life of 30 years.

Mar. 1 Acquired a franchise with a contract period of nine years for $540,000; the expiration

date is March 1, 2024. Paid cash of $40,000 and borrowed the remainder from the bank.

Sept. 1 Purchased a trademark for $75,000 cash. As the purchase was being fi nalized, spent $35,000 cash in

legal fees to successfully defend the trademark in court.

Instructions

(a) Prepare the entries to record the above transactions.

(b) Prepare the entries to record any amortization at December 31.

E9–10 Collins Ltd. has these transactions related to intangible assets and goodwill in 2015, its fi rst year of operations:

Jan. 2 Purchased a patent with an estimated useful life of five years and a legal life of 20 years for

$40,000.

Apr. 1 Acquired another company and recorded goodwill of $300,000 as part of the purchase.

July 1 Acquired a franchise for $250,000. Th e franchise agreement is renewable and not expected to

expire.

Sept. 1 Incurred research costs of $150,000.

30 Incurred development costs of $50,000. A marketable product has been identifi ed and production

will commence in the near future.

Dec. 31 Recorded annual amortization.

31 Tested the intangible assets for impairment. Recoverable amounts exceeded carrying amounts in all

cases. Also tested goodwill and determined that it had a recoverable amount of $270,000.

Instructions

(a) Prepare the entries to record the above transactions. Assume all costs incurred during January through September

were incurred for cash.

(b) Show the presentation of the intangible assets and goodwill on the statement of fi nancial position at December 31.

E9–11 Reitmans (Canada) Limited reported the following selected information as at February 2, 2013 (in thousands):

Accumulated depreciation—buildings $ 22,467

Accumulated depreciation—fi xtures and equipment 85,936

Accumulated depreciation—leasehold improvements 101,961

Accumulated amortization—soft ware 10,191

Amortization expense 5,080

Buildings 53,149

Depreciation expense 53,047

Fixtures and equipment 166,756

Goodwill 42,426

Land 5,860

Impairment loss 2,128

Leasehold improvements 189,730

Operating leases 494,752

Reversal of impairment loss 600

Soft ware (intangible assets) 28,916

Trademarks 499

Instructions

(a) Identify in which fi nancial statement (statement of fi nancial position, income statement, or neither) and which section

of the statement each of the above items should be reported.

(b) Prepare the long-lived assets section of the statement of fi nancial position.

E9–12 Th e following selected ratios have been chosen for two companies in diff erent industries:

Return on Assets Asset Turnover Profi t Margin

Company A 6.6% 3.5 times 1.9%

Company B 5.7% 0.8 times 7.2%

One company is Costco Wholesale Corporation in the retail industry; the other is Suncor Energy Inc. in the oil and gas industry.

Instructions

Identify whether Company A or Company B is likely Costco, operating in the retail industry. Explain.

E9–13 Ajax Limited reported the following information (in millions) at December 31, 2015: net sales $14,000; profi t

$550; total assets at December 31, 2015, $7,200; and total assets at December 31, 2014, $6,800.

Instructions

(a) Calculate the following ratios for the year: (1) return on assets, (2) asset turnover, and (3) profi t margin.

(b) By showing the appropriate calculation (using unrounded numbers), prove mathematically how the profi t margin and

asset turnover work together to explain the return on assets.

(c) On average, the ratio values for Ajax’s competitors are return on assets 4.5%, asset turnover 1.5 times, and profi t margin

3.0%. Compare these with those of Ajax and determine if Ajax is performing better than the industry.

 

Problems: Set A

P9–1A Th e transactions that follow are expenditures related to property, plant, and equipment:

  1. Operator controls on equipment were replaced for $7,000, because the original control devices were not adequate.
  2. A total of $4,600 was spent for decorative landscaping (planting fl owers and shrubs, etc.).
  3. A new air conditioning system for the offi ce was purchased for $16,000.
  4. Windows broken in a labour dispute were replaced for $2,400.
  5. A fee of $1,500 was paid for adjusting and testing new machinery before its use.
  6. Machinery damaged by a forklift was repaired for $5,000.
  7. Th e transmission in a delivery truck was repaired for $2,500.
  8. Expenditures totalling $3,000 were incurred to repaint the exterior of the building.
  9. Paid $20,000 to convert the company’s delivery vehicles from gasoline to propane.
  10. Paid $10,000 to convert the company’s light bulbs to energy effi cient bulbs.

Instructions

For each of the transactions listed above, indicate the title of the account that you think should be debited in recording the

transaction. Briefl y explain your reasoning.

P9–2A For the year ended December 31, 2015, Westlake Ltd. had the following transactions related to the purchase of

property. Assume all transactions are for cash unless otherwise stated.

Feb. 7 Purchased real estate for $550,000, paying $150,000 cash and signing a mortgage payable for the

balance. Th e site had an old building on it and the fair values of the land and building were $500,000

and $50,000, respectively. Th e old building will be demolished and a new apartment building will be

constructed on the site.

9 Paid legal fees of $11,000 on the real estate purchase of February 7.

15 Paid $30,000 to demolish the old building and make the land ready for the construction of the

apartment building.

17 Received $8,000 from the sale of material from the demolished building.

28 Paid $2,000 to grade the land in preparation for the construction of the apartment building.

Mar. 2 Paid architect fees of $36,000 to design the apartment building.

July 2 Th e full cost for construction of the apartment building was $1.3 million. Paid $340,000 cash and

signed a bank loan payable for the balance.

3 Purchased a one-year insurance policy on the fi nished building for $5,000.

Aug. 29 Paid $24,000 for the paving of sidewalks and a parking lot for the building.

Instructions

(a) Record the above transactions.

(b) Determine the cost of the land, land improvements, and building that will appear on Westlake’s December 31 statement

of fi nancial position.

(c) When would depreciation begin on the items recorded above?

P9–3A Mazlin Limited purchased a machine on account on April 2, 2015, at an invoice price of $360,000. On April 4,

it paid $2,000 for delivery of the machine. A one-year, $4,000 insurance policy on the machine was purchased on April 5.

On April 18, Mazlin paid $8,000 for installation and testing of the machine. Th e machine was ready for use on April 30.

Mazlin estimates the machine’s useful life will be fi ve years with a residual value of $80,000. Mazlin has a December

31 year end.

Instructions

(a) Determine the cost of the machine.

(b) Calculate the annual depreciation and total depreciation over the asset’s life using (1) the straight-line method and (2)

the double-diminishing-balance method. Which method causes profi t to be lower in the early years of the asset’s life?

(c) Assume instead that, when Mazlin purchased the machine, there was no residual value and the company had a legal

obligation to ensure that the machine would be recycled at the end of its useful life. Th e cost of the recycling will be signifi

cant. Would this have an impact on the answers to parts (a) and (b) above? Explain (calculations are not required).

P9–4A Valmont Limited purchased equipment on March 27, 2015, at a cost of $122,000. Management is contemplating

the merits of using the diminishing-balance or units-of-production method of depreciation instead of the straight-line

method, which it currently uses for other equipment. Th e new equipment has an estimated residual value of $2,000 and an

estimated useful life of either four years or 40,000 units. Demand for the products produced by the equipment is sporadic

so the equipment will be used more in some years than in others. Assume the equipment produces the following number

of units each year: 7,400 units in 2015; 10,200 units in 2016; 9,900 units in 2017; 10,000 units in 2018; and 2,500 units in

  1. Valmont has a December 31 year end.

Instructions

(a) Prepare separate depreciation schedules for the life of the equipment using (1) the straight-line method, (2) the

double-diminishing-balance method, and (3) the units-of-production method.

(b) Compare the total depreciation expense and accumulated depreciation under each of the three methods over the life

of the equipment.

(c) How does each method of depreciation aff ect the company’s cash fl ows?

(d) Which method do you recommend? Why?

P9–5A On January 1, 2013, Penaji Corporation acquired equipment costing $65,000. It was estimated at that time that

the equipment would have a useful life of eight years and a residual value of $3,000. Th e straight-line method of depreciation

is used by the company for its equipment, and its year end is December 31.

At the beginning of 2015 (the beginning of the third year of the equipment’s life), the company’s engineers reconsidered

their expectations. Th ey estimated that the equipment’s useful life would more likely be six years in total, instead of

the previously estimated eight years.

Instructions

(a) Calculate the equipment’s accumulated depreciation and carrying amount at the beginning of 2015 immediately before

the change in useful life.

(b) Would you expect Penaji’s depreciation expense to increase or decrease in 2015 aft er the change in useful life?

Why?

(c) Should the company treat the change in useful life retroactively or only for current and future periods? Explain.

(d) If Penaji had not revised the equipment’s remaining useful life at the beginning of 2015, what would its total depreciation

expense have been over the equipment’s life? What would have been the accumulated depreciation and carrying

amount at the end of the equipment’s useful life?

(e) Would you expect the company’s total depreciation expense to change aft er the useful life has been revised? Would

there be changes to the accumulated depreciation and carrying amount at the end of the equipment’s useful life?

P9–6A Altona Limited purchased delivery equipment on March 1, 2013, for $130,000 cash. At that time, the equipment

was estimated to have a useful life of fi ve years and a residual value of $10,000. Th e equipment was disposed of on

September 30, 2015. Altona uses the diminishing-balance method at one time the straight-line depreciation rate, has an

August 31 year end, and makes adjusting entries annually.

Instructions

(a) Record the acquisition of equipment on March 1, 2013.

(b) Record depreciation at August 31, 2013, 2014, and 2015.

(c) Record the disposal of the equipment on September 30, 2015, under each of the following independent assumptions:

  1. It was sold for $60,000.
  2. It was sold for $80,000.
  3. It was retired for no proceeds.

P9–7A Yukon Productions Corp. purchased equipment on March 1, 2015, for $70,000. Th e company estimated the equipment

would have a useful life of three years and produce 12,000 units, with a residual value of $10,000. During 2015, the equipment

produced 4,900 units. On November 30, 2016, the machine was sold for $18,000 and had produced 5,600 units that year.

Instructions

(a) Record all the necessary journal entries for the years ended December 31, 2015 and 2016, using the following

depreciation methods: (1) straight-line, (2) single-diminishing-balance, and (3) units-of-production.

(b) Complete the following schedule for each method of depreciation and compare the total expense over the two-year

period.

Straight-Line Diminishing-Balance Units-of-Production

Depreciation expense

2015

2016

Total depreciation expense for two years

1 Loss (or 2 gain) on disposal

5 Net expense for two years

P9–8A At January 1, 2015, Youngstown Limited reported the following property, plant, and equipment accounts:

Accumulated depreciation—buildings $ 62,200,000

Accumulated depreciation—equipment 54,000,000

Buildings 97,400,000

Equipment 150,000,000

Th e company uses straight-line depreciation for buildings and equipment, its year end is December 31, and it makes

adjusting entries annually. Th e buildings are estimated to have a 40-year useful life and no residual value; the equipment

is estimated to have a 10-year useful life and no residual value.

During 2015, the following selected transactions occurred:

Apr. 1 Purchased land for $4.4 million. Paid $1.1 million cash and issued a three-year, 6% mortgage

payable for the balance. Interest on the mortgage is payable annually each April 1.

May 1 Sold equipment for $300,000 cash. Th e equipment cost $2.8 million when originally purchased on

January 1, 2007.

June 1 Sold land for $3.6 million. Received $900,000 cash and accepted a three-year, 5% note for the

balance. Th e land cost $1.4 million when purchased on June 1, 2009. Interest on the note is due

annually each June 1.

July 1 Purchased equipment for $2.2 million cash.

Dec. 31 Retired equipment that cost $1 million when purchased on December 31, 2005. No proceeds were

received.

31 Tested land for impairment and found that its recoverable value was $20 million.

Instructions

(a) Record the above transactions.

(b) Record any adjusting entries required at December 31.

(c) Prepare the property, plant, and equipment section of the company’s statement of fi nancial position at December 31.

P9–9A Th e following is a list of items that might or might not be classifi ed as intangible assets and goodwill:

  1. Goodwill recorded in the purchase of a business
  2. Equipment acquired using a fi nance lease
  3. Cost of purchasing a franchise
  4. Cost of purchasing a patent
  5. Legal costs incurred to successfully defend a patent (see item 4)
  6. Goodwill generated internally
  7. Aircraft acquired using an operating lease
  8. Cost of purchasing a trademark
  9. Legal costs incurred to unsuccessfully defend a trademark (see item 8)
  10. Research costs incurred to identify a cure for cancer

Instructions

(a) Identify which of the above items would be reported as intangible assets and goodwill on the statement of fi nancial position.

(b) For those items in part (a) reported as intangible assets and goodwill, identify the specifi c account title that would be

used to record the asset.

(c) For those items in part (a) reported as intangible assets and goodwill, identify which assets would likely be amortized.

(d) For any of the above items that are not intangible assets or goodwill, identify the specifi c account title, fi nancial statement,

and classifi cation under which it would be reported. If it would not be reported on any fi nancial statement,

state so.

P9–10A Th e intangible assets and goodwill reported by Ghani Corporation at December 31, 2014, follow:

Copyrights $36,000

Less: Accumulated amortization 18,000 $ 18,000

Trademarks 54,000

Goodwill 125,000

Total $197,000

A copyright (#1) was acquired on January 1, 2013, and has a useful life of four years. Th e trademarks were acquired on

January 1, 2011, and are expected to have an indefi nite life. Th e company has a December 31 year end and prepares

adjusting journal entries annually.

Th e following cash transactions may have aff ected intangible assets and goodwill during 2015:

Jan. 5 Paid $7,000 in legal costs to successfully defend the trademarks against infringement by another

company.

July 1 Developed a new product, incurring $210,000 in research and $50,000 in development costs with

probable future benefi ts. Th e product is expected to have a useful life of 20 years.

Sept. 1 Paid $60,000 to a popular hockey player to appear in commercials advertising the company’s

products. Th e commercials will air in early September.

Oct. 1 Acquired another copyright (#2) for $180,000. Th e new copyright has a useful life of four years.

Dec. 31 Determined the recoverable amount of the goodwill to be $90,000. Th ere was no indication that

the copyrights or trademarks were impaired.

Instructions

(a) Prepare journal entries to record the transactions.

(b) Prepare any adjusting journal entries required at December 31.

(c) Show the presentation of the intangible assets and goodwill on the statement of fi nancial position at December 31,

2015.

P9–11A Th e Second Cup Limited and Starbucks Corporation reported the following information in 2012:

Second Cup

(in CAD millions)

Starbucks

(in USD millions)

Total assets, 2012 $ 88.7 $ 8,219.2

Total assets, 2011 105.6 7,360.4

Revenue, 2012 26.3 13,299.5

Profi t (loss), 2012 (9.4) 1,383.8

Industry averages were as follows: profi t margin, 7.7%; asset turnover, 1.1 times; and return on assets, 8.4%.

Instructions

(a) For each company, calculate the (1) profi t margin, (2) asset turnover, and (3) return on assets ratios for 2012.

(b) Second Cup reported an impairment loss for goodwill and trademarks of $15.3 million on its 2012 income statement.

Had this impairment loss not occurred, it would have reported a profi t of $5.9 million and total assets, 2012, of $104

million. Recalculate the profi t margin, asset turnover and return on assets ratios for Second Cup, assuming there was

no impairment loss. Starbucks did not report any impairment losses in 2012.

(c) Which ratios—those calculated for Second Cup in part (a) or in part (b)—should be used for comparison with

Starbucks? Using your chosen ratios, comment on how eff ectively each company is using its assets to generate sales

and produce profi t.

P9–12A Delicious Limited competes in the fast food industry with Scrumptious Limited. Delicious embarked on a major

expansion in 2015, borrowing a large amount of money and acquiring a small competitor. Th e acquisition doubled the

number of restaurants that Delicious has. Scrumptious, on the other hand, took a more conservative approach and did not

buy any new assets, focusing instead on a strategy of making existing operations more effi cient.

Data for the two companies are provided below in thousands of dollars:

2015 2014 2013

Delicious

Total assets $2,000 $1,100 $1,000

Net sales 3,100 1,500 1,600

Profi t 350 150 140

Scrumptious

Total assets 800 900 1,000

Net sales 1,900 1,700 2,000

Profi t 180 200 210

Instructions

(a) Calculate the (1) profi t margin, (2) asset turnover, and (3) return on asset ratios for each company in 2014 and 2015.

(b) Provide an explanation for the year-over-year changes in the ratios calculated in part (a).

Problems: Set B

P9–1B Th e following expenditures are for a forklift :

  1. Rebuilding of the diesel engine, $10,000
  2. New tires, $2,000
  3. New safety cab, $5,000
  4. Replacement of the windshield, $800
  5. Training a new operator, $1,600
  6. New paint job, $2,000
  7. One-year accident insurance policy, $1,110
  8. Payment to an operator to reorganize where items were stored in the warehouse to increase effi ciency, $2,400.
  9. Added air conditioning for the operator’s comfort, $2,000.
  10. Completed annual maintenance inspection, $500.

Instructions

For each of the transactions listed above, indicate the title of the account that you think should be debited in recording the

transaction. Briefl y explain your reasoning.

P9–2B For the year ended December 31, 2015, Kadmen Ltd. incurred the following transactions related to the purchase

of a property. Assume all transactions are for cash unless otherwise stated.

Jan. 22 Purchased real estate for a future plant site for $440,000, paying $110,000 cash and signing a

mortgage payable for the balance. Th ere was an old building on the site and the fair values of the

land and building were $340,000 and $100,000, respectively. Th e old building will be demolished

and a new plant will be constructed on the site.

24 Paid legal fees of $9,000 on the real estate purchase of January 22.

31 Paid $50,000 to demolish the old building to make room for the new plant.

Feb. 13 Graded and fi lled the land at a cost of $16,000 in preparation for the construction.

28 Received $15,000 from the sale of material from the demolished building.

Mar. 14 Paid $68,000 in architect fees for the building plans.

Apr. 22 Paid excavation costs for the new building of $34,000.

June 15 Received a bill from the building contractor for half of the cost of the new building, $600,000. Paid

$150,000 cash and signed a bank loan payable for the balance.

Sept. 29 Received a bill for the remaining $600,000 owed to the building contractor for the completion of the

construction of the new building. Paid $200,000 cash and signed a bank loan payable for the balance.

Oct. 1 Paved the parking lots, driveways, and sidewalks for $84,000.

Instructions

(a) Record the above transactions.

(b) Determine the cost of the land, land improvements, and building that will appear on Kadmen’s December 31 statement

of fi nancial position.

(c) When would depreciation begin on the items recorded above?

P9–3B Mouskori Limited purchased a machine on September 3, 2015, at a cash price of $187,800. On September 4, it

paid $1,200 for delivery of the machine. A one-year, $1,950 insurance policy on the machine was purchased on September 6.

On September 20, Mouskori paid $7,000 for installation and testing of the machine. Th e machine was ready for use on

September 30.

Mouskori estimates the machine’s useful life will be four years, or 40,000 units, with no residual value. Assume the

equipment produces the following number of units each year: 2,500 units in 2015; 10,300 units in 2016; 9,900 units in 2017;

8,800 units in 2018; and 8,500 units in 2019. Mouskori has a December 31 year end.

Instructions

(a) Determine the cost of the machine.

(b) Calculate the annual depreciation and the total depreciation over the asset’s life using (1) straight-line depreciation,

(2) double-diminishing-balance depreciation, and (3) units-of-production depreciation. Which method causes profi t

to be lower in the early years of the asset’s life?

(c) Assume instead that, when Mouskori Corporation purchased the machine, there was no residual value and the company

had a legal obligation to ensure that the machine would be recycled at the end of its useful life. Th e cost of this

recycling will be signifi cant. Would this have an impact on the answers to parts (a) and (b) above? Explain (calculations

are not required).

P9–4B Fast Arrow Ltd. purchased a new bus on October 3, 2015, at a total cost of $330,000. Management is contemplating

the merits of using the diminishing-balance or units-of-production methods of depreciation instead of

the straight-line method, which it currently uses for its other buses. The new bus has an estimated residual value of

$30,000, and an estimated useful life of either four years or 600,000 km. Use of the bus will be sporadic so it could

be much higher in some years than in other years. Assume the new bus is driven as follows: 15,000 km in 2015;

200,000 km in 2016; 125,000 km in 2017; 190,000 km in 2018; and 70,000 km in 2019. Fast Arrow has an October 31

year end.

Instructions

(a) Prepare separate depreciation schedules for the life of the bus using (1) the straight-line method, (2) the doublediminishing-

balance method, and (3) the units-of-production method.

(b) Compare the total depreciation expense and accumulated depreciation under each of the three methods over the life

of the bus.

(c) How does each method of depreciation aff ect the company’s cash fl ows?

(d) Which method do you recommend? Why?

P9–5B On January 1, 2013, Bérubé Ltée acquired equipment costing $60,000. It was estimated at that time that the

equipment would have a useful life of fi ve years and a residual value of $4,500. Th e straight-line method of depreciation is

used by Bérubé for its equipment, and its year end is December 31.

At the beginning of 2015 (the beginning of the third year of the equipment’s life), the company’s engineers reconsidered

their expectations. Th ey estimated that the equipment’s useful life would more likely be seven years in total, instead

of the previously estimated fi ve years.

Instructions

(a) Calculate the equipment’s accumulated depreciation and carrying amount at the beginning of 2015, immediately before

the change in useful life.

(b) Would you expect the company’s depreciation expense to increase or decrease in 2015 aft er the change in useful life?

Why?

(c) Should Bérubé treat the change in the useful life retroactively or only for current and future periods? Explain.

(d) If the company had not revised the equipment’s remaining useful life at the beginning of 2015, what would its total

depreciation expense have been over the equipment’s life? What would have been the accumulated depreciation and

carrying amount at the end of the equipment’s useful life?

(e) Would you expect Bérubé’s total depreciation expense to change aft er the useful life has been revised? Would there be

changes to the accumulated depreciation and carrying amount at the end of the equipment’s useful life?

P9–6B Balmoral Limited purchased equipment on January 1, 2013, for $170,000 on account. At that time, the equipment

was estimated to have a useful life of fi ve years and a $2,000 residual value. Th e equipment was disposed of on June 1, 2015,

when the company relocated to new premises. Balmoral uses the diminishing-balance method at one time the straight-line

depreciation rate, has a September 30 year end, and make adjusting entries annually.

Instructions

(a) Record the acquisition of the equipment on January 1, 2013.

(b) Record the depreciation at September 30, 2013 and 2014.

(c) Record the disposal of the equipment on June 2, 2015, under each of the following independent assumptions:

  1. It was sold for $105,000.
  2. It was sold for $80,000.
  3. It was retired for no proceeds.

P9–7B PEI Productions Ltd. purchased equipment on February 1, 2015, for $50,000. Th e company estimated the equipment

would have a useful life of three years and would produce 10,000 units, with a residual value of $10,000. During 2015,

the equipment produced 4,000 units. On October 31, 2016, the machine was sold for $12,000; it had produced 5,000 units

that year.

Instructions

(a) Record all the necessary entries for the years ended December 31, 2015 and 2016, for the following depreciation

methods: (1) straight-line, (2) single-diminishing-balance, and (3) units-of-production.

(b) Complete the following schedule for each method of depreciation and compare the total expense over the two-year period.

Straight-Line

Diminishing-

Balance

Units-of-

Production

Depreciation expense

2015

2016

Total depreciation expense for two years

1 Loss (or 2 gain) on disposal

5 Net expense for two years

P9–8B At January 1, 2015, Hammersmith Limited reported the following property, plant, and equipment accounts:

Accumulated depreciation—buildings $24,200,000

Accumulated depreciation—equipment 30,000,000

Buildings 57,000,000

Equipment 96,000,000

Land 8,000,000

Th e company uses straight-line depreciation for buildings and equipment, its year end is December 31, and it makes

adjusting entries annually. Th e buildings are estimated to have a 40-year life and no residual value; the equipment is estimated

to have a 10-year useful life and no residual value.

During 2015, the following selected transactions occurred:

Apr. 1 Purchased land for $3.8 million. Paid $950,000 cash and issued a 10-year, 6% mortgage

payable for the balance. Interest is payable at maturity.

May 1 Sold equipment for $700,000 cash. Th e equipment cost $1.5 million when it was originally

purchased on January 1, 2011.

June 1 Sold land for $2.4 million. Received $760,000 cash and accepted a 6% note for the balance.

Th e note is due at maturity. Th e land cost $600,000 when purchased on June 1, 2005.

July 1 Purchased equipment for $2 million on account, terms n/60.

Sept. 2 Paid amount owing on account for purchase of equipment on July 1.

Dec. 31 Retired equipment that cost $940,000 when purchased on December 31, 2005.

No proceeds were received.

31 Tested land for impairment and found that its recoverable value was $11 million.

Instructions

(a) Record the above transactions.

(b) Record any adjusting entries required at December 31.

(c) Prepare the property, plant, and equipment section of the company’s statement of fi nancial position at December 31.

P9–9B Th e following is a list of items that might or might not be classifi ed as intangible assets and goodwill:

  1. Goodwill recorded in the purchase of a business
  2. Equipment acquired using a fi nance lease
  3. Cost of purchasing a fi ve-year soft ware licensing agreement
  4. Cost of purchasing a patent
  5. Legal costs incurred to unsuccessfully defend a patent (see item 4)
  6. Goodwill generated internally
  7. Vehicles acquired using an operating lease
  8. Cost of registering a trade name
  9. Legal costs incurred to successfully defend a trade name (see item 8)
  10. Research costs incurred to identify a cure for AIDS

Instructions

(a) Identify which of the above items would be reported as intangible assets and goodwill on the statement of fi nancial position.

(b) For those items in part (a) reported as intangible assets and goodwill, identify the specifi c account title that would be

used to record the asset.

(c) For those items in part (a) reported as intangible assets and goodwill, identify which assets would likely be amortized.

(d) For any of the above items that are not intangible assets or goodwill, identify the specifi c account title, fi nancial statement,

and classifi cation under which it would be reported. If it would not be reported on any fi nancial statement, state so.

P9–10B Th e intangible assets and goodwill reported by Ip Corp. at December 31, 2014, follow:

Patents $70,000

Less: Accumulated amortization 14,000 $ 56,000

Copyrights $48,000

Less: Accumulated amortization 28,800 19,200

Goodwill 210,000

Total $285,200

Th e patents were acquired in January 2013 and have a useful life of 10 years. A copyright (#1) was acquired in January 2010

and also has a useful life of 10 years. Th e company has a December 31 year end and prepares adjusting journal entries annually.

Th e following cash transactions may have aff ected intangible assets and goodwill during 2015:

Jan. 2 Paid $22,500 in legal costs to successfully defend the patents against infringement

by another company. Determined that the revised annual amortization for

the patents will be $9,812.

July 1 Developed a new product, incurring $220,000 in research costs and $60,000

in development costs with probable future benefi ts. Th e useful life of the new

product is equal to 20 years.

Sept. 1 Paid $11,000 to an Olympic rower to appear in commercials advertising the

company’s products. Th e commercials will air in September.

Oct. 1 Acquired a second copyright for $16,000. Copyright #2 has a useful life of fi ve

years.

Dec. 31 Determined the recoverable amount of the goodwill to be $175,000. Th ere was

no indication that the patents or copyrights were impaired.

Instructions

(a) Prepare the journal entries to record the above transactions.

(b) Prepare any adjusting journal entries required at December 31.

(c) Show the presentation of the intangible assets and goodwill on the statement of fi nancial position at December 31, 2015.

P9–11B Le Château Inc. and Reitmans (Canada) Limited are two competitors in the retail clothing industry. Th ey

reported the following information in 2012 (in millions of dollars):

Le Château Reitmans

Total assets, 2012 $233.8 $ 633.9

Total assets, 2011 246.1 659.4

Net sales, 2012 302.7 1,019.4

Profi t (loss), 2012 (2.4) 47.5

Industry averages are as follows: profi t margin, 6.0%; asset turnover, 2.0 times; and return on assets, 12.0%.

Instructions

(a) For each company, calculate the profi t margin, asset turnover, and return on assets ratios for 2012.

(b) Based on your calculations in part (a), comment on how eff ectively each company is using its assets to generate sales

and produce profi t.

(c) What additional information about long-lived assets would assist you in your comparison of the two companies in

part (b)?

P9–12B Two brewing companies that compete against each other are Northern Ale Ltd. (NAL) and Brew Right Inc.

(BRI). Th e industry is experiencing a slump and each company has undertaken a diff erent strategy to adapt to this situation.

NAL has adopted an expansion strategy by borrowing funds to purchase another company. Th is has boosted 2015

sales by 67% and 2015 profi t by 47%, which the company CEO has mentioned in several press releases. BRI has decided to

streamline operations and cut costs by looking at more effi cient ways to operate the business.

Data for the two companies are listed below in thousands of dollars:

2015 2014 2013

Northern Ale

Total assets $2,500 $1,100 $1,000

Net sales 2,500 1,500 1,600

Profi t 220 150 160

Brew Right

Total assets 1,100 1,050 1,000

Net sales 1,800 1,500 1,400

Profi t 250 150 140

Instructions

(a) Calculate the profi t margin, asset turnover, and return on asset ratios for each company in 2014 and 2015.

(b) Provide an explanation for the year-over-year changes in the ratios calculated in part (a).

(c) Comment on which company has been more successful in executing its strategy.

 

==

 

CHAPTER 10 Reporting and Analyzing Liabilities

 

Questions

(SO 1) 1. Identify the similarities and diff erences between

accounts payable and short-term notes payable.

(SO 1) 2. What is the diff erence between an operating line

of credit and a short-term bank loan payable?

(SO 1) 3. Your roommate says, “Sales tax is a part of the

cost of doing business and should be reported

in the cost of goods sold section of the income

statement.” Do you agree? Explain.

(SO 1) 4. Explain how recording property tax can result

in an expense (property tax expense), a liability

(property tax payable), and an asset (prepaid

property tax).

(SO 1) 5. What is the diff erence between (a) gross and net

pay, and (b) employee payroll deductions and

employee benefi ts?

(SO 1) 6. What criterion must be met before a contingent

liability can be recorded as a provision? How

does this criterion diff er depending on whether

the company is a public company using IFRS or a

private company using ASPE?

(SO 1) 7. Review Note 22 to the Shoppers Drug Mart

fi nancial statements in Appendix A where it

reports provisions. Why would the company

discuss a claim that is not reasonably determinable?

Is such an item considered to be a provision

or a contingent liability?

(SO 1, 2) 8. Explain how to determine the current and noncurrent

portions of debt for presentation in the

liabilities section of the statement of fi nancial

position.

(SO 2) 9. Identify the similarities and diff erences between

short-term notes payable and long-term instalment

notes payable.

(SO 2) 10. Distinguish between instalment notes payable

with fi xed principal payments plus interest

and those with blended principal and interest

payments.

(SO 2) 11. When students borrow money for their postsecondary

education under the Canada Student

Loans Program, they sign an instalment note

payable. It must be repaid, starting six months

aft er graduation, in equal monthly amounts

including principal and interest. Is this a fi xed or

blended payment pattern?

(SO 2) 12. When students borrow money for their postsecondary

education under the Canada Student

Loans Program, they can choose a fi xed interest

rate of prime 1 5% or a fl oating interest rate of

prime 1 2.5%. (a) Explain the diff erence between

these two types of interest rates. (b) Which

interest rate—fi xed or variable—do you think

you would prefer? Explain.

(SO 2) 13. Doug Bareak, a friend of yours, has recently

purchased a home for $200,000. He paid $20,000

down and fi nanced the remainder with a 20-year,

5% mortgage that is payable in blended payments

of principal and interest of $1,290 per month. At

the end of the fi rst month, Doug received a statement

from the bank indicating that only $540

of the principal was paid during the month. At

this rate, he calculated that it would take over 28

years to pay off the mortgage. Explain why Doug

is incorrect.

(SO 3) 14. In general, what are the requirements for the

fi nancial statement presentation of (a) current

liabilities and (b) non-current liabilities?

(SO 3) 15. Distinguish between liquidity and solvency.

Provide an example of two ratios that can be

used to measure each.

(SO 3) 16. Explain how an operating line of credit can help

a company’s liquidity.

(SO 3) 17. Explain why the debt to total assets ratio should

never be interpreted without referring to the

times interest earned ratio.

(SO 3) 18. Explain why it is important to know if a company

has signifi cant operating lease commitments.

(SO 4) *19. Identify the similarities and diff erences between

bonds payable and (a) instalment notes payable,

and (b) common shares.

(SO 4) *20. Ki-Hoon Inc. sold bonds with a face value of

$100,000 for $104,000. Was the market interest

rate equal to, less than, or greater than the bonds’

coupon interest rate? Explain.

(SO 4) *21. Is there a diff erence between the interest expense

recorded in the income statement and the

interest paid during the year when a bond is sold

(a) at a discount and (b) at a premium? Explain

why.

 

Brief Exercises

BE10–1 Abbotsford Bikes Ltd. reports cash sales of $6,000 on October 1. (a) Record the sales assuming they occurred

in Ontario and are subject to 13% HST (charged on selling price only). (b) Record the sales assuming they occurred in

Quebec and are subject to 5% GST and 9.975% QST (charged on selling price before GST).

BE10–2 Pierce Corp. has a December 31 year end. It received its property tax assessment of $36,000 for the calendar

year on April 30. Th e property tax bill is payable on July 15. Prepare the journal entries to record the property tax on (a)

April 30, (b) July 15, and (c) December 31, assuming the company adjusts its accounts annually.

BE10–3 Zerbe Consulting Inc.’s gross salaries for the biweekly period ended August 22 were $15,000. Deductions

included $743 for CPP, $267 for EI, and $6,258 for income tax. Th e employer’s payroll costs were $743 for CPP and $374

for EI. Prepare journal entries to record (a) the payment of salaries on August 22; (b) the employer payroll costs on

August 22, assuming they will not be remitted to the government until September; and (c) the payment to the government

on September 1 of all amounts owed.

BE10–4 Romez Limited borrowed $60,000 from the bank on July 1 for three months; 5% interest is payable the fi rst of

each month, starting August 1. Romez’s year end is August 31. Prepare journal entries to record (a) the receipt of the bank

loan on July 1; (b) (1) the payment of interest on August 1, (2) the accrual of interest on August 31, (3) the payment of

interest on September 1, and (4) the payment of interest on October 1; and (c) payment of the bank loan at maturity on

October 1.

BE10–5 For each of the following independent situations, indicate whether it should be recorded as a provision or disclosed

as a contingent liability for a publicly traded company reporting under IFRS. Indicate if your answer would change

if the company were a private company reporting under ASPE.

(a) A pending lawsuit for which a negative outcome has been estimated and determined to be “likely”

(b) A pending lawsuit, about which the outcome cannot be determined

(c) A nuisance lawsuit, which the company is not anticipated to lose

(d) A loan guarantee for a subsidiary company that has a credit rating of AA

BE10–6 Assume that you qualify for a $25,000 loan from the Canada Student Loans Program to help fi nance your education.

You are considering whether to repay this loan on graduation with a fi xed interest rate of prime 1 5% or a fl oating

interest rate of prime 1 2.5%. Assuming you start repaying your loan immediately upon graduation, information related

to your loan options follows:

Fixed Interest Rate Floating Interest Rate

Amount of loan $25,000 $25,000

Prime interest rate assumed 2.75% 2.75%

Number of months to repay loan 120 months 120 months

Monthly instalment payment $300 $268

Total interest payable over life of loan $11,003 $7,188

(a) Identify the advantages and disadvantages of each interest rate option. (b) Explain which option you think is best for

you and why.

BE10–7 Assad Inc. issued a fi ve-year, 7% instalment note payable, with fi xed principal payments plus interest, due annually.

Th e following instalment payment schedule is partially completed:

Interest Period Cash Payment Interest Expense

Reduction of

Principal Principal Balance

Issue date $50,000

1 $13,500 $ [1] [2] 40,000

2 12,800 2,800 [3] [4]

3 [5] 2,100 [6] [7]

4 11,400 1,400 [8] 10,000

5 10,700 700 [9] [10]

(a) Fill in the missing amounts for items [1] through [10]. Round all amounts to the nearest dollar. (b) What are the current

and non-current portions of the note at the end of period 3?

BE10–8 Hyatt Inc. issued a fi ve-year, 7% instalment loan payable, with blended principal and interest payments due annually.

Th e following instalment payment schedule is partially completed:

*Adjusted for rounding diff erences.

(a) Fill in the missing amounts for items [1] to [10]. Round all amounts to the nearest dollar. (b) What are the current and

non-current portions of the loan at the end of period 3?

BE10–9 Eyre Inc. signs a 10-year, 7%, $300,000 mortgage payable on November 30, 2014, to obtain fi nancing for a

new building. Th e terms provide for payments at the end of each month. Prepare the entries to record the mortgage on

November 30, 2014, and the fi rst two payments on December 31, 2014, and January 31, 2015, assuming the payment is

(a) a fi xed principal payment of $2,500, plus interest, and (b) a blended principal and interest payment of $3,483. Round

all amounts to the nearest dollar.

BE10–10 Identify which of the following transactions would be classified as a current liability and which would be

classified as a non-current liability. For those that are neither, identify where they should be classified or disclosed.

(a) A bank loan payable due in two years, with principal due at maturity and interest due the fi rst of each month

(b) Cash received in advance by Air Canada for airline tickets

(c) HST collected on sales

(d) Unused amount of operating line of credit

(e) Provision relating to a lawsuit settlement expected to be paid next month

(f) Obligations due under operating leases

(g) Bonds payable, due in 10 years

(h) Payroll deductions withheld from the employees’ weekly pay

(i) Prepaid property tax

(j) A $75,000 mortgage payable, of which $5,000 is due in the next year

BE10–11 Th e Molson Coors Brewing Company’s fi nancial statements recently reported the following selected data (in

U.S. $ millions):

Total current assets $ 1,748.0

Total current liabilities 2,598.7

Total assets 16,212.2

Total liabilities 8,220.6

Income tax expense 154.5

Interest expense 185.0

Profi t 443.0

Calculate Molson Coors’s (a) current ratio, (b) debt to total assets ratio, and (c) times interest earned ratio.

BE10–12 Th e following solvency ratios are available for Fromage Corporation:

2015 2014

Debt to total assets 40% 52%

Times interest earned 7 times 11 times

(a) Identify whether the change in each ratio is an improvement or deterioration. (b) Did the company’s overall solvency

improve or deteriorate in 2015?

*BE10–13 On January 1, 2015, Carvel Corp. issued fi ve-year bonds with a face value of $500,000 and a coupon interest

rate of 6%, with interest payable semi-annually. How much would Carvel receive from the sale of these bonds if the

market interest rate was (a) 5%, (b) 6%, and (c) 7%?

*BE10–14 Using the information from BE10–13, prepare a partial bond amortization table for the fi rst two interest payments

assuming that interest is paid on July 1 and January 1 and that the bonds sold when the market interest rate was

  • 5%, (b) 6%, and (c) 7%.

 

*BE10–15 Using the information from BE10–14, assume that the company has a December 31 year end and records adjusting

entries annually. Record the journal entries relating to the bonds on January 1, July 1, and December 31, assuming

that when the bonds were sold, the market interest rate was (a) 5%, (b) 6%, and (c) 7%.

Exercises

E10–1 A list of transactions follows.

  1. Purchased inventory (perpetual system) on account.
  2. Extended payment terms of the account payable in item 1 by issuing a nine-month, 5% note payable.
  3. Recorded accrued interest on the note payable from item 2.
  4. Recorded repayment of the note and accrued interest from items 2 and 3.
  5. Recorded cash received from sale of services, plus HST.
  6. Recorded salaries expense, employee payroll deductions, and paid employees.
  7. Recorded employer’s share of employee benefi ts.
  8. Recorded property tax expense and property tax payable when bill was received.
  9. Recorded a receipt of cash for services that will be performed in the future.
  10. Recorded the performance of services for item 9.

Instructions

Set up a table using the format that follows. Indicate the eff ect of each of the above transactions on the fi nancial statement categories

in the table: use “1” for increase, “2” for decrease, and “NE” for no eff ect. Th e fi rst one has been done for you as an example.

Assets Liabilities Shareholders’ Equity Revenues Expenses Profi t

  1. 1 1 NE NE NE NE

E10–2 Chen Wholesalers Ltd. incurred the following transactions related to current liabilities.

  1. Chen’s cash register showed the following totals at the end of the day on March 17: pre-tax sales $50,000; GST $2,500;

and PST $3,500.

  1. Chen received its property tax bill for the calendar year for $52,800 on May 1, payable July 1.
  2. Chen’s gross payroll for the week of August 15 was $81,000. Th e company deducted $4,010 for CPP, $1,442 for EI,

$6,400 for pension, and $16,020 for income tax from the employees’ pay. Chen’s payroll costs for the week were $4,010

for CPP and $2,019 for EI.

  1. On October 1, Chen borrowed $100,000 from First Bank for a six-month period; 4% interest on the bank loan is payable

the fi rst of each month.

Instructions

(a) Record the above transactions.

(b) Assuming that Chen’s year end is December 31 and that it makes adjusting entries annually, prepare any adjusting

entries required for the property tax in transaction 2 and the interest in transaction 4.

E10–3 Dougald Construction Ltd. borrowed $250,000 from TD Bank on October 1, 2014, for a nine-month period;

5% interest is payable at maturity. Both companies have a December 31 year end and make adjusting entries annually.

Instructions

(a) For Dougald Construction, record (1) the receipt of the bank loan on October 1, 2014; (2) the accrual of interest on

December 31, 2014; and (3) the payment of the loan on July 1, 2015.

(b) For the TD Bank, record (1) the issue of the bank loan on October 1, 2014; (2) the accrual of interest on December 31,

2014; and (3) the collection of the loan on July 1, 2015. (Hint: Th e TD Bank uses a Notes Receivable account to record

its loans. You might fi nd it helpful to review accounting for notes receivable in Chapter 8.)

E10–4 Walmart Stores, Inc. is sued about once every two hours every day of the year. Th ese allegations range from falls

on icy parking lots to injuries sustained in shoppers’ stampedes to a murder with a rifl e purchased at one of its stores. Th e

company recently disclosed the following in the notes to its fi nancial statements:

Th e Company is involved in a number of legal proceedings. Th e Company has made accruals with respect to

these matters, where appropriate. For some matters, the amount of liability is not probable or the amount cannot

be reasonably estimated and therefore accruals have not been made. However, where a liability is reasonably

possible and material, such matters have been disclosed.

Instructions

(a) Th e above states that “the company has made accruals . . . where appropriate.” Explain when it would be appropriate

for Walmart to accrue a liability as a provision rather than disclose it as a contingent liability.

(b) How might the accrual or disclosure of these legal proceedings change if Walmart were a private company reporting

under ASPE?

E10–5 Ste. Anne Corp. issued a 10-year, 5%, $150,000 mortgage payable to fi nance the construction of a building at

December 31, 2014. Th e terms provide for semi-annual instalment payments on June 30 and December 31.

Instructions

(a) Record the issue of the mortgage payable on December 31, 2014.

(b) Record the fi rst two instalment payments on June 30, 2015, and December 31, 2015, assuming the payment is (1) a

fi xed principal payment of $7,500, and (2) a blended principal and interest payment of $9,622. Round all amounts to

the nearest dollar.

(c) Explain why interest expense is the same regardless of whether the payment is blended or based on fi xed principal

payments for the six months ending June 30 but diff erent for the six months ended December 31.

E10–6 On July 1, 2014, Granville Ltd. borrowed $9,000 by signing a two-year, 6% note payable. Th e note is payable in two

annual blended principal and interest instalments of $4,909 on June 30. Adjusting journal entries are recorded annually at

year end on December 31.

Instructions

(a) Prepare an instalment payment schedule for the term of the note. Round all amounts to the nearest dollar.

(b) Record (1) the issue of the note on July 1, 2014; (2) the accrual of interest on December 31, 2014; and (3) the fi rst payment

on June 30, 2015.

(c) What amounts would be reported as current and non-current in the liabilities section of Granville’s statement of fi nancial

position on December 31, 2015?

E10–7 Th e following instalment payment schedule is for a long-term bank loan payable:

Interest Period Cash Payment Interest Expense

Reduction of

Principal Principal Balance

Issue date $100,000.00

1 $23,097.48 $5,000.00 $18,097.48 81,902.52

2 23,097.48 4,095.13 19,002.35 62,900.17

3 23,097.48 3,145.01 19,952.47 42,947.70

4 23,097.48 2,147.38 20,950.10 21,997.60

5 23,097.48 1,099.88 21,997.60 0.00

Instructions

(a) Is the above schedule a fi xed principal or blended principal and interest payment schedule?

(b) Assuming payments are made annually, what is the interest rate on the bank loan?

(c) Prepare the journal entry to record the fi rst instalment payment.

(d) What are the current and non-current portions of the bank loan at the end of period 2?

E10–8 Shaw Communications Inc. reported the following liabilities (in thousands) in its August 31, 2012, fi nancial

statements:

Accounts payable and accrued

liabilities $ 811

Current portion of long-term debt 451

Deferred income taxes 1,085

Income taxes payable 156

Long-term debt 4,812

Pension liability 401

Provisions 27

Unearned revenue 157

Instructions

(a) Identify which of the above liabilities are likely current and which are likely non-current. Say if an item fi ts in either

category. Explain the reasoning for your selections.

(b) Prepare the liabilities section of Shaw Communications Inc.’s statement of fi nancial position.

E10–9 Th e following selected information (in thousands) was taken from Fruition Collections Ltd.’s December 31 statement

of fi nancial position:

2015 2014

Current assets

Cash $2,574 $1,021

Accounts receivable 2,147 1,575

Inventories 1,201 1,010

Other current assets 322 192

Total current assets $6,244 $3,798

Total current liabilities $4,503 $2,619

Instructions

(a) Calculate the current ratio for each of the two years. (1) Based only on this information, would you say that the company’s

liquidity is strong or weak? (2) What additional information should you request to complete your assessment of liquidity?

(b) Suppose that Fruition Collections used $1 million of its cash to pay off $1 million of its accounts payable. Would this

transaction change the current ratio?

(c) At December 31, 2015, Fruition Collections had an unused operating line of credit of $4 million. Does this information

aff ect the assessment of the company’s short-term liquidity that you made in part (a) above?

E10–10 Buhler Industries Inc.’s fi nancial statements contain the following selected data (in thousands):

2012 2011

Total assets $250,755 $241,733

Total liabilities 89,830 97,171

Profi t 16,363 11,917

Income tax expense 3,278 3,623

Interest expense 3,507 3,004

Instructions

(a) Calculate the debt to total assets and times interest earned ratios for 2012 and 2011. Did Buhler’s solvency improve or

deteriorate in 2012?

(b) Th e notes to Buhler’s fi nancial statements show that the company has an operating line of credit (credit facility) with

the Bank of Montreal for $60 million that can be drawn on at any time and repaid at any time. Over $13 million of this

credit facility has been drawn on. What does this mean and how is this shown in the fi nancial statements?

*E10–11 Th e following information about two independent bond issues was reported in the fi nancial press.

  1. BC Provincial 2.70% bonds, maturing December 18, 2022, were issued at a price of 99.9 to yield a market interest rate of 2.71%.
  2. Bank of Montreal 5.10% bonds, maturing April 21, 2021, were issued at a price of 108.97 to yield a market interest

rate of 2.08%.

Instructions

(a) Were the BC Provincial bonds issued at a premium or a discount?

(b) Were the Bank of Montreal bonds issued at a premium or a discount?

(c) Explain why the market interest rate on the Bank of Montreal bonds is lower than the market interest rate on the BC

Provincial bonds.

(d) Record the issue of $100,000 of each of these two bonds.

*E10–12 On October 1, 2015, Spooner Corporation issued $800,000 of 10-year, 5% bonds at 100. Interest is payable semiannually

on October 1 and April 1. Spooner’s year end is December 31 and the company records adjusting entries annually.

Instructions

(a) Prepare journal entries to record the following:

  1. Th e issue of the bonds on October 1, 2015
  2. Th e accrual of interest on December 31, 2015
  3. Th e payment of interest on April 1, 2016

(b) Identify what amounts, if any, would be reported as a current liability and non-current liability with respect to the

bond and bond interest accounts on December 31, 2015.

*E10–13 A partial bond amortization schedule follows for Hwee Corporation:

Semi-Annual

Interest Period

Interest

Payment

Interest

Expense

Discount/Premium

Amortization

Unamortized

Discount/Premium

Bond Carrying

Amount

Issue date

(Oct. 31)

$74,387 $925,613

1 (Apr. 30) $25,000 [1] $2,768 [2] 928,381

2 (Oct. 31) 25,000 $27,851 [3] 68,768 [4]

3 (Apr. 30) [5] 27,937 [6] [7] 934,169

Instructions

(a) Fill in the missing amounts for items [1] to [7].

(b) What is the face value of the bonds?

(c) Were the bonds issued at a discount or at a premium?

(d) What is the coupon interest rate on the bonds? Th e market interest rate?

(e) Explain why interest expense is greater than interest paid.

(f) Explain why interest expense will increase each period.

(g) What will be the bonds’ carrying amount on their maturity date?

*E10–14 Tarawa Limited issued $1 million of 10-year, 5% bonds on January 1, 2015, at a price to yield a market interest

rate of 6%. Interest is payable semi-annually on July 1 and January 1. Tarawa has a December 31 year end.

Instructions

(a) Calculate the bonds’ present value (issue price) on January 1.

(b) Record the issue of the bonds on January 1.

(c) Record the payment of interest on July 1.

(d) Record the accrual of interest on December 31.

Problems: Set A

P10–1A On February 28, 2015, Molega Ltd.’s general ledger contained the following liability accounts:

Accounts payable $42,500

CPP payable 2,680

EI payable 1,123

Sales tax payable 5,800

Income tax payable 5,515

Unearned revenue 15,000

Th e following selected transactions occurred during the month:

Mar. 2 Issued a three-month, 6% note payable in exchange for an account payable in the amount of

$10,000. Interest is due at maturity.

5 Sold merchandise for cash totalling $40,000, plus 13% HST. Th e cost of goods sold was $24,000.

Molega uses a perpetual inventory system.

9 Received the property tax bill of $18,000 for the calendar year. It is payable on May 1.

12 Provided services for customers who had made advance payments of $11,300 including HST,

which is not payable until the related sale occurs.

13 Paid $5,800 HST to the Receiver General for sales tax collected in February.

16 Paid $9,318 to the Receiver General for amounts owing from the February payroll for employee

payroll deductions of $7,323 (CPP $1,340, EI $468, and income tax $5,515) and for employee

benefi ts of $1,995 (CPP $1,340 and EI $655).

27 Paid $30,000 to trade creditors on account.

31 Paid employees for the month. Gross salaries totalled $16,000 and payroll deductions included CPP of

$792, EI of $285, and income tax of $5,870. Employee benefi ts included CPP of $792 and EI of $399.

Instructions

(a) Record the above transactions.

(b) Record any required adjusting entries at March 31.

(c) Prepare the current liabilities section of the statement of fi nancial position at March 31.

P10–2A Cling-on Ltd. sells rock-climbing products and also operates an indoor climbing facility for climbing enthusiasts.

On September 1, 2015, the company had a balance of $12,000 in its Bank Loan Payable account, representing a loan

from the local credit union on July 1. Th e loan and 6% interest are both payable at maturity, on September 30. Note that the

company records adjusting entries annually at its year end, December 31.

During the next four months, Cling-on incurred the following:

Sept. 1 Purchased inventory on account for $15,000 from Black Diamond, terms n/30. Th e company

uses a perpetual inventory system.

30 Repaid the $12,000 bank loan payable to the credit union (see opening balance), as well as any

interest owed.

Oct. 1 Issued a six-month, 7%, $15,000 note payable to Black Diamond in exchange for the account

payable (see Sept. 1 transaction). Interest is payable on the fi rst of each month.

2 Borrowed $25,000 from Montpelier Bank for 12 months at 8% to fi nance the building of a

new climbing area for advanced climbers (use the asset account Buildings). Interest is payable

monthly on the fi rst of each month.

Nov. 1 Paid interest on the Black Diamond note and Montpelier Bank loan.

Dec. 1 Paid interest on the Black Diamond note and Montpelier Bank loan.

2 Purchased a vehicle for $28,000 from Auto Dealer Ltd. to transport clients to nearby climbing

sites. Paid $8,000 as a down payment and borrowed the remainder from the Montpelier Bank

for 12 months at 7%. Interest is payable quarterly, at the end of each quarter.

31 Recorded accrued interest for the Black Diamond note and Montpelier Bank loans.

Instructions

(a) Record the above transactions.

(b) Open T accounts for the Interest Expense, Interest Payable, Bank Loans Payable, and Notes Payable accounts and enter

any opening balances. Post the above entries.

(c) Assuming there is no other interest expense than that recorded in the transactions above, show the income statement

presentation of interest expense for the year ended December 31.

(d) Show the statement of fi nancial position presentation of the bank loans, notes, and interest payable at December 31.

P10–3A On September 30, 2014, Coldwater Corporation purchased equipment for $1.1 million. Th e equipment was

purchased with a $100,000 down payment and a three-year, 8%, $1-million bank loan for the balance. Th e terms provide

for payment of the bank loan with quarterly fi xed principal payments of $83,333, plus interest, starting on December 31.

Coldwater has a November 30 year end and records adjusting entries annually.

Instructions

(a) Record the purchase of equipment on September 30, 2014.

(b) Record the accrual of interest expense on November 30, 2014. Round to the nearest dollar.

(c) Record the fi rst two instalment payments, on December 31, 2014, and March 31, 2015. Round all amounts to the

nearest dollar.

(d) Repeat part (b) and (c) assuming that the terms provide for quarterly blended principal and interest payments of

$94,560, rather than fi xed principal payments of $83,333, plus interest.

P10–4A Starlight Graphics Ltd. signed a 10-year, 6.5%, $700,000 mortgage on June 30, 2014, to help fi nance a new

research laboratory. Th e mortgage terms provide for semi-annual blended principal and interest payments of $48,145.

Payments are due on December 31 and June 30. Th e company’s year end is June 30.

Instructions

(a) Prepare an instalment payment schedule for the fi rst two years. Round all amounts to the nearest dollar.

(b) Record the receipt of the mortgage loan on June 30, 2014.

(c) Record the fi rst two instalment payments, on December 31, 2014, and June 30, 2015.

(d) Show the statement of fi nancial position presentation of the mortgage payable at June 30, 2015.

P10–5A Peter Furlong has just approached a venture capitalist for fi nancing for his sailing school. Th e lender is willing

to loan the Furlong Sailing School $100,000 at a high-risk interest rate of 12%. Th e loan is payable over three years in fi xed

principal payments each quarter of $8,333, plus interest. Peter signs a note payable and receives the loan on April 30, 2015.

He makes the fi rst payment on July 31. Th e company’s year end is October 31.

Instructions

(a) Prepare an instalment payment schedule for the three years. Round all amounts to the nearest dollar.

(b) Record the receipt of the loan on April 30.

(c) Record the fi rst two instalment payments, on July 31 and October 31.

(d) Show the statement of fi nancial position presentation of the note payable at October 31, 2015.

(e) Explain how the quarterly and total cash payments would change if the note had been payable in blended principal and

interest payments of $10,046, rather than fi xed principal payments plus interest.

P10–6A Th e following transactions occurred in Wendell Corporation, which has a December 31 year end.

  1. Property taxes of $40,000 were assessed on March 1 for the calendar year. Th ey are payable by May 1.
  2. Wendell signed a fi ve-year, 7%, $200,000 instalment note payable on July 1. Th e note requires fi xed principal payments

of $40,000, plus interest annually on each June 30 for the next fi ve years.

  1. Wendell purchased merchandise for $120,000 on December 23 on account, terms n/30, FOB shipping point. Th e

merchandise was shipped on December 28 and received by Wendell on January 2.

  1. Wendell received $10,000 from customers on December 21 for services to be performed in January.
  2. On December 31, Wendell sold merchandise for $8,000, plus 13% HST. Th e cost of goods sold was $5,000. Th e company

uses a perpetual inventory system.

  1. Weekly salaries of $6,000 are paid every Friday for a fi ve-day workweek (Monday to Friday). Th is year, December

31 is a Wednesday. Payroll deductions for the three days include CPP of $297, EI of $107, and income tax of $1,300.

Employee benefi ts include CPP of $297 and EI of $150. Payroll deductions will be paid on January 15.

  1. Wendell is the defendant in a negligence lawsuit. Wendell’s legal counsel estimates that Wendell may suff er a $75,000

loss if it loses the suit. In legal counsel’s opinion, it is not possible at this time to determine whether or not the case

will be lost.

  1. Aft er the preparation of its corporate income tax return at year end, Wendell determined that total income tax

payable for the year was $50,000 but $45,000 of this amount was paid during the year when the company paid tax

instalments.

  1. Wendell reported non-current debt of $250,000 at December 31, of which $30,000 was due within the next year.
  2. Wendell has a $100,000 operating line of credit available, on which no funds have yet been drawn.

Instructions

(a) Identify which of the above transactions gave rise to amounts that should be reported in the current liabilities section

or the non-current liabilities section of Wendell’s statement of fi nancial position on December 31. Identify the account

title(s) and amount(s) for each reported liability.

(b) Indicate any information that should be disclosed in the notes to Wendell’s fi nancial statements.

P10–7A You have been presented with the following selected information taken from the fi nancial statements of Magna

International Inc. (in U.S. $ millions):

2012 2011 2010

Statement of fi nancial position

Accounts receivable $ 4,774 $ 4,398 $ 3,543

Inventory 2,512 2,045 1,822

Total current assets 9,135 8,146 7,485

Total assets 17,109 14,679 13,674

Current liabilities 6,684 5,724 4,968

Total liabilities 7,651 6,477 5,648

Income statement

Net sales $30,837 $28,748 $23,465

Cost of goods sold 27,010 25,434 20,483

Interest expense 16 0 0

Income tax expense 324 202 194

Profi t 1,433 1,018 1,003

Instructions

(a) Calculate each of the following ratios for 2012 and 2011. Industry ratios are shown in parentheses.

  1. Current ratio (2012, 1.5:1; 2011, 1.5:1)
  2. Receivables turnover (2012, 6.7 times; 2011, 6.2 times)
  3. Inventory turnover (2012, 9.0 times; 2011, 11.4 times)
  4. Debt to total assets (2012, 34.6%; 2011, 37.1%)
  5. Times interest earned (2012, 7.6 times; 2011, 8.0 times)

(b) Based on your results in part (a), comment on Magna’s liquidity and solvency.

(c) Magna had a U.S. $2.25-billion operating line of credit, all of which was unused at December 31, 2012. Most of the

bank debt held by the company was in Brazilian and Chinese currencies, which fell in value relative to the Canadian

dollar in 2012. Discuss the implications of this information for your analysis.

(d) Magna had operating lease commitments totalling U.S. $1,634 million in 2012 and U.S. $1,608 million in 2011. Discuss

the implications of this information for your analysis.

P10–8A Th e following selected liquidity and solvency ratios are available for two companies operating in the petroleum

industry:

Petro-Zoom Sun-Oil Industry Average

Current ratio 1.3:1 1.2:1 1.4:1

Receivables turnover 12 times 13 times 13 times

Inventory turnover 16 times 10 times 19 times

Debt to total assets 41% 39% 34%

Times interest earned 21 times 24 times 26 times

Instructions

Assume that you are the credit manager of the local bank. Answer the following questions, using relevant ratios to justify

your answer.

(a) Both Petro-Zoom and Sun-Oil have applied for a short-term loan from your bank. Which of the two companies is

more liquid and should get more consideration for a short-term loan? Explain.

(b) Both Petro-Zoom and Sun-Oil have applied for a long-term loan from your bank. Are you concerned about the solvency

of either company? Explain why or why not.

*P10–9A When market interest rates were 6%, three companies issued bonds on January 1, 2015. Each company has

a December 31 year end and each company issued bonds with a face value of $100,000 that pay interest annually on

December 31. Able Limited sold its bonds at 100 and off ered a coupon interest rate of 6%, while Beta Corp. sold its bonds

at 94 and off ered a coupon interest rate of 4%. Charles Inc. sold its bonds at 105 and off ered a 7% coupon interest rate.

Instructions

(a) Record the issue of the bonds by each company on January 1, 2015.

(b) Prepare the entry that each company would record for the payment of interest on December 31, 2015.

(c) Explain why some of the companies are not recording an interest expense on the bonds that is equal to the interest

that was actually paid.

(d) Determine the balance in each company’s Bonds Payable account on December 31, 2015.

*P10–10A On July 1, 2014, Global Satellites Corporation issued $1.5 million of 10-year, 7% bonds to yield a market

interest rate of 6%. Th e bonds pay semi-annual interest on July 1 and January 1. Global has a December 31 year end.

Instructions

(a) Calculate the bonds’ present value (issue price) on July 1.

(b) Prepare an amortization table through January 1, 2016 (three interest periods) for this bond issue. Round all amounts

to the nearest dollar.

(c) Record the issue of the bonds on July 1.

(d) Prepare the adjusting entry on December 31, 2015, to accrue the interest on the bonds.

(e) Show the statement of fi nancial position presentation of the liabilities at December 31, 2015.

(f) Record the payment of interest on January 1, 2016.

 

Problems: Set B

P10–1B On January 1, 2015, Burlington Inc.’s general ledger contained these opening balances for its liability accounts: Record and present

current liabilities.

Accounts payable $52,000 (SO 1, 3)

CPP payable 3,810

EI payable 1,598

Sales tax payable $18,000

Income tax payable 7,700

Unearned revenue 16,000

Th e following selected transactions occurred during the month.

Jan. 5 Sold merchandise for cash totalling $20,000, plus 5% GST and 7% PST. Th e cost of goods sold was

$14,000. Burlington uses a perpetual inventory system.

13 Paid $18,000 ($7,500 GST to the Receiver General and $10,500 PST to the provincial Minister of

Finance) for sales taxes collected in December.

14 Paid $13,108 to the Receiver General for amounts owing from the December payroll for the employee

payroll deductions of $10,271 (CPP $1,905, EI $666, and income tax $7,700) and employee

benefi ts of $2,837 (CPP $1,905 and EI $932).

15 Borrowed $18,000 from HSBC Bank for three months; 6% interest is payable monthly on the 15th

of each month.

19 Provided services for customers who had made advance payments of $11,200. Th is amount includes

applicable GST and PST, which is not payable until the related revenue is earned.

22 Paid $32,000 to trade creditors on account.

28 Received assessment of property taxes of $4,200 for the calendar year. Th ey are payable on March 1.

29 Paid employees for the month. Gross salaries totalled $40,000 and payroll deductions included CPP of

$1,980, EI of $712, and income tax of $9,474. Employee benefi ts included CPP of $1,980 and EI of $997.

Instructions

(a) Record the above transactions.

(b) Record any required adjusting entries at January 31.

(c) Prepare the current liabilities section of the statement of fi nancial position at January 31.

P10–2B Sparky’s Mountain Bikes Ltd. markets mountain-bike tours to clients vacationing in various locations in the

mountains of British Columbia. On March 1, 2015, the company had a balance of $30,000 in Notes Payable for a sixmonth,

7% note issued to Easy Finance Corp. on October 1, with interest payable at maturity. Note that the company

records adjusting entries annually at its year end, June 30.

In preparation for the upcoming summer biking season, Sparky’s engaged in the following transactions:

Mar. 2 Purchased Cannondale bikes for use as rentals by borrowing $16,000 from the Western Bank for a

three-month period; 8% interest is payable at maturity.

31 Paid the $30,000 note payable to Easy Finance Corp. (see opening balance), as well as any interest

owed.

Apr. 1 Issued a nine-month, 6%, $50,000 note to Mountain Real Estate for the purchase of mountain

property on which to build bike trails. Interest is payable at the fi rst of each month.

May 1 Paid interest on the Mountain Real Estate note (see April 1 transaction).

2 Borrowed $36,000 from Western Bank for a four-month period. Th e funds will be used for working

capital for the beginning of the season. 7% interest is payable at maturity.

June 1 Paid interest on the Mountain Real Estate note (see April 1 transaction).

2 Paid principal and interest to the Western Bank (see March 2 transaction).

29 Purchased trailers for $10,000 to transport the bikes from one location to another. Paid $1,000 as

a down payment and borrowed the remainder from the Western Bank for a 12-month period; 6%

interest is payable quarterly, at the end of each quarter starting September 30.

30 Recorded accrued interest for the Mountain Real Estate note and Western Bank loan.

Instructions

(a) Record the above transactions.

(b) Open T accounts for the Interest Expense, Interest Payable, Bank Loans Payable, and Notes Payable accounts and enter

any opening balances. Post the above entries.

(c) Assuming there is no other interest expense than that recorded in the transactions above, show the income statement

presentation of the interest expense for the year ended June 30.

(d) Show the statement of fi nancial position presentation of the notes, bank loans, and interest payable at June 30.

P10–3B On July 31, 2015, Myron Corporation purchased equipment for $750,000. Th e equipment was purchased with a

$50,000 down payment and by borrowing a four-year, 6%, $700,000 bank loan payable for the balance. Th e terms provide

for the bank loan to be repaid with monthly blended principal and interest instalment payments of $16,440 starting on

August 31. Myron has a September 30 year end.

Instructions

(a) Record the purchase of equipment and the receipt of the bank loan on July 31.

(b) Record the fi rst two instalment payments, on August 31 and September 30. Round all amounts to the nearest dollar.

(c) Repeat part (b) assuming that the terms provide for monthly fi xed principal payments of $14,583, plus interest, rather

than blended payments of $16,440.

P10–4B Beaumont Building Supplies Limited signed a 10-year, 8%, $1-million mortgage on December 31, 2014, to help

fi nance a plant expansion. Th e terms of the mortgage provide for semi-annual fi xed principal payments of $50,000, plus

interest. Payments are due on June 30 and December 31.

Instructions

(a) Prepare an instalment payment schedule for the fi rst two years. Round all amounts to the nearest dollar.

(b) Record the issue of the mortgage payable on December 31, 2014.

(c) Record the fi rst two instalment payments, on June 30, 2015, and December 31, 2015.

(d) Show the statement of fi nancial position presentation of the mortgage payable at December 31, 2015.

P10–5B A local ski hill has just approached a venture capitalist for fi nancing for its new business venture, the development

of another local ski hill. On April 1, 2013, the venture capitalist loaned the company $100,000 at an interest rate of

13%. Th e loan is payable over four years in annual blended principal and interest instalments of $33,619, due each March

  1. Th e fi rst payment is due March 31, 2014. Th e ski hill’s year end is March 31.

Instructions

(a) Prepare an instalment payment schedule for the loan period. Round all amounts to the nearest dollar.

(b) Record the receipt of the loan on April 1, 2013.

(c) Record the fi rst two instalment payments, on March 31, 2014, and March 31, 2015.

(d) Show the statement of fi nancial position presentation of the loan payable as at March 31, 2015.

(e) Explain how the annual and total interest expense would change if the loan had been payable in fi xed principal payments

of $25,000, plus interest, rather than in blended principal and interest payments.

P10–6B Th e following transactions are for Iqaluit Ltd., which has an April 30 year end.

  1. Received property taxes assessment of $12,000 on March 1 for the calendar year. Th ey are payable by May 1.
  2. Purchased equipment for $35,000 on April 1 by making a $5,000 down payment and borrowing the remainder from

the bank for a six-month period; 6% interest is payable on the fi rst of each month.

  1. Purchased merchandise for $7,000 on April 27 on account, terms 2/10, n/30.
  2. Sold merchandise on April 28 for $15,000, plus 5% GST. (Th ere is no PST in Nunavut, where Iqaluit Ltd. is based.) Th e

cost of the goods sold was $10,500. Th e company uses a perpetual inventory system.

  1. Received $25,000 from customers on April 29 for services to be performed in May.
  2. Weekly salaries of $10,000 are paid every Friday for a fi ve-day workweek (Monday to Friday). Th is year, April 30 is a

Th ursday. Payroll deductions for the four days include CPP of $495, EI of $178, and income tax of $3,710. Employee

benefi ts include CPP of $495 and EI of $249. Payroll deductions will be paid on May 15.

  1. Iqaluit was named in a lawsuit alleging negligence for an oil spill that leaked into the neighbouring company’s water

system. Iqaluit’s legal counsel estimates that the company will likely lose the suit but the amount of the loss cannot be

determined yet.

  1. Iqaluit paid income tax instalments of $80,000 throughout the year. Aft er the preparation of its year-end corporate

income tax return, it was determined that the total income tax payable for the year was $55,000.

  1. Iqaluit reported non-current liabilities of $150,000 at April 30, of which $15,000 was due within the next year.
  2. Iqaluit has a $50,000 operating line of credit available, on which no funds have yet been drawn.

Instructions

(a) Identify which of the above transactions give rise to amounts that should be reported in the current liabilities section

or the non-current liabilities section of Iqaluit’s statement of fi nancial position on April 30. Identify the account title(s)

and amount(s) for each reported liability.

(b) Indicate any information that should be disclosed in the notes to Iqaluit’s fi nancial statements.

P10–7B Th e following selected information was taken from Barrick Gold Corporation’s fi nancial statements (in U.S.

$ millions):

2012 2011 2010

Statement of fi nancial position

Accounts receivable $ 449 $ 426 $ 370

Inventory 2,695 2,498 1,798

Total current assets 5,863 6,545 7,071

Total assets 47,282 48,884 34,637

Current liabilities 4,415 2,911 2,491

Total liabilities 22,774 23,330 13,420

Income statement

Net sales $14,547 $14,236 $11,001

Cost of goods sold 7,654 6,240 5,162

Interest expense 177 199 180

Income tax expense (recovery) (236) 2,287 1,561

Profi t (loss) (677) 4,537 3,630

Instructions

(a) Calculate each of the following ratios for 2012 and 2011. Industry ratios are shown in parentheses.

  1. Current ratio (2012, 2.3:1; 2011, 2.4:1)
  2. Receivables turnover (2012, 19.0 times; 2011, 19.1 times)
  3. Inventory turnover (2012, 3.7 times; 2011, 4.0 times)
  4. Debt to total assets (2012, 20.6%; 2011, 20.6%)
  5. Times interest earned (2012, 17.3 times; 2011, 18.9 times)

(b) Based on your results in part (a), comment on Barrick Gold’s liquidity and solvency.

(c) Barrick Gold has three pages of disclosure in the notes to its statements about pending litigation. Discuss the implications

of this information for your analysis.

P10–8B Th e following selected liquidity and solvency ratios are available for two companies operating in the fast food industry:

Grab ‘N Gab Chick ‘N Lick Industry Average

Current ratio 0.8:1 0.7:1 0.9:1

Receivables turnover 46 times 38 times 34 times

Inventory turnover 39 times 45 times 31 times

Debt to total assets 49% 40% 39%

Times interest earned 10 times 5 times 7 times

Instructions

Assume that you are the credit manager of the local bank. Answer the following questions, using relevant ratios to justify

your answer.

(a) Both Grab ‘N Gab and Chick ‘N Lick have applied for a short-term loan from your bank. Which of the two companies

is more liquid and should get more consideration for a short-term loan? Explain.

(b) Both Grab ‘N Gab and Chick ‘N Lick have applied for a long-term loan from your bank. Are you concerned about the

solvency of either company? Explain why or why not.

*P10–9B When market interest rates were 5%, three companies issued bonds on January 1, 2015. Each company has

a December 31 year end and each company issued bonds with a face value of $200,000 that pay interest annually on

December 31. Delta Limited sold its bonds at 100 and off ered a coupon interest rate of 5%, while Founders Corp. sold its

bonds at 94 and off ered a coupon interest rate of 3%. Grand Inc. sold its bonds at 108 and off ered a 7% coupon interest rate.

Instructions

(a) Record the issue of the bonds by each company on January 1, 2015.

(b) Prepare the entry that each company would record for the payment of interest on December 31, 2015.

(c) Explain why some of the companies are not recording an interest expense on the bonds that is equal to the interest

that was actually paid.

(d) Determine the balance in each company’s Bonds Payable account on December 31, 2015.

*P10–10B On July 1, 2014, Ponasis Corporation issued $1 million of 10-year, 6% bonds at a price to yield a market interest

rate of 7%. Th e bonds pay semi-annual interest on July 1 and January 1. Ponasis has a December 31 year end.

Instructions

(a) Calculate the bonds’ present value (issue price) on July 1.

(b) Prepare an amortization table through January 1, 2016 (three interest periods) for this bond issue. Round all amounts

to the nearest dollar.

(c) Record the issue of the bonds on July 1.

(d) Prepare the adjusting entry on December 31, 2015, to accrue the interest on the bonds.

(e) Show the statement of fi nancial position presentation of the liabilities at December 31, 2015.

(f) Record the payment of interest on January 1, 2016.

 

========================================================================

 

CHAPTER 11 Reporting and Analyzing Shareholders’ Equity

 

Questions

(SO 1) 1. Pat Kabza, a student, asks for your help in

understanding the diff erent corporation characteristics.

(a) Explain the following characteristics

to Pat and identify whether they are an advantage

or a disadvantage for a large, publicly traded

corporation: (1) separate legal existence,

(2) limited liability of shareholders, (3) transferable

ownership rights, (4) ability to acquire capital,

(5) continuous life, (6) separation of management

and ownership, (7) government regulations, and

(8) income tax. (b) Would your answers to part

(a) change if you were commenting about the

advantages and disadvantages for a small, private

corporation rather than a large, publicly traded

corporation? Explain.

(SO 1) 2. Letson Corporation is authorized to issue

100,000 common shares. During its fi rst two

years of operation, Letson issued 60,000 shares.

(a) Aft er this transaction, how many more shares

is Letson able to issue? (b) Are both authorized

and issued shares recorded in the general journal?

(SO 1) 3. Richard Boudreault purchased 100 lululemon

athletica common shares for $18 a share from

the company’s initial public off ering. A few years

later, Richard purchased 200 more lululemon

shares for $71 each on the Toronto Stock

Exchange. Explain the impact of each of

these transactions on lululemon’s assets,

liabilities, and shareholders’ equity.

(SO 1) 4. Th e market capitalization of Plazacorp Retail

Properties Limited was $278 million at the end

of 2011 and $317 million at the end of 2012.

Explain what “market capitalization” means and

describe the eff ect of this increase in market capitalization

between 2011 and 2012 on Plazacorp’s

assets, liabilities, and shareholders’ equity.

(SO 1) 5. What is legal capital? How is the value of the

legal capital determined? Why is legal capital

reported separately from retained earnings in the

shareholders’ equity section of the statement of

fi nancial position?

(SO 2) 6. Compare the rights of preferred shareholders

with those of common shareholders. Include in

your answer the areas in which preferred shares

are given priority over common shares.

(SO 2) 7. When common and preferred shares are issued

for a consideration other than cash (for example,

goods or services), at what value should the

shares be recorded for a publicly traded company

using IFRS? Would your answer change if it were

a private company using ASPE?

(SO 2) 8. (a) What is a normal course issuer bid? (b) Why

might a company wish to reacquire some of its

own shares?

(SO 2) 9. Th e Royal Bank of Canada has a noncumulative

class of preferred shares with an annual dividend

rate of $1.125. Assad David owns 1,000 of these

shares. If the Royal Bank declares and pays a

quarterly dividend on these shares, how much

dividend can Assad expect to receive for the

quarter?

(SO 2) 10. What is the diff erence between cumulative and

noncumulative preferred shares? Can dividends

in arrears arise for both types of preferred shares?

Explain.

(SO 3) 11. What conditions must be met before a cash

dividend can be paid?

(SO 3) 12. Contrast the eff ects of the (a) declaration date,

(b) record date, and (c) payment date for a

cash dividend on a company’s (1) assets,

(2) liabilities, (3) share capital, (4) retained

earnings, (5) total shareholders’ equity, and

(6) number of shares.

(SO 3) 13. Contrast the eff ects of a (a) cash dividend,

(b) stock dividend, and (c) stock split on a

company’s (1) assets, (2) liabilities, (3) share

capital, (4) retained earnings, (5) total

shareholders’ equity, and (6) number of shares.

(SO 3) 14. Bella Corporation has 10,000 common shares

issued when it announces a 3-for-1 split. Before

the split, the shares were trading for $120 per

share. (a) Aft er the split, how many shares will be

issued? (b) Aft er the split, what will be the likely

share price?

(SO 3) 15. Why are cash and stock dividends recorded in

the general journal but stock splits are not?

(SO 4) 16. Indicate how each of the following should be

reported in (a) the statement of changes in equity

and (b) the shareholders’ equity section of the

statement of fi nancial position: (1) preferred

shares, (2) common shares, (3) stock dividends

distributable, (4) additional contributed capital,

(5) retained earnings, and (6) accumulated other

comprehensive income.

(SO 4) 17. For what reason might a company restrict its

retained earnings? How is a restriction reported

in the fi nancial statements?

(SO 4) 18. Distinguish between other comprehensive

income and accumulated other comprehensive

income. Include in your answer how and where

each is reported in the fi nancial statements.

(SO 4) 19. (a) What is the diff erence between a statement

of changes in equity and statement of retained

earnings? (b) How do each of these relate to the

shareholders’ equity section of the statement of

fi nancial position?

(SO 4) 20. Distinguish between the content of the

(a) shareholders’ equity sections and (b) fi nancial

statements of a publicly traded company using

IFRS and a private company using ASPE.

(SO 5) 21. Indicate whether each of the following is

generally considered favourable or unfavourable

by a potential investor:

(a) A decrease in the payout ratio

(b) An increase in the dividend yield

(c) A decrease in the return on common

shareholders’ equity

(d) An increase in earnings per share

(SO 5) 22. Coca-Cola recently reported dividends per share

of U.S. $1.00 and a dividend yield of 1.5%.

Pepsi reported dividends per share of U.S. $2.15

and a dividend yield of 3.0% for the same period.

Can you fi gure out which company had the

higher share price?

(SO 5) 23. In the calculation of earnings per share, why is

the weighted average number of common shares

used instead of the number of common shares at

the end of the year?

(SO 5) 24. Why do the earnings per share and return on

common shareholders’ equity ratios use profi t

available to common shareholders in their

numerator rather than profi t?

(SO 5) 25. Company A has a payout ratio of 30% and a

dividend yield of 2%. Company B has a payout

ratio of 50% and a dividend yield of 3%.

Which company’s shares would be of more

interest to an investor wanting a steady

dividend income?

Brief Exercises

BE11–1 In November 2012, the Hudson’s Bay Company issued an IPO on the Toronto Stock Exchange. Shares purchased

under the IPO were sold at $17 per share. If a shareholder purchased Hudson’s Bay’s shares in January 2013, they

would have paid $16.81 per share. Explain the impact on Hudson’s Bay’s fi nancial position of the shares sold (a) under the

IPO in November 2012 for $17 and (b) on the Toronto Stock Exchange in January 2013 for $16.81.

BE11–2 On May 1, Armada Corporation incorporated and authorized 100,000 preferred shares and an unlimited

number of common shares. On May 2, Armada issued 1,000 common shares for $15 per share. On June 15, it issued

an additional 500 common shares for $17 per share. On November 1, Armada issued 100 preferred shares for $30 per

share. On December 15, it issued an additional 100 preferred shares for $35 per share. (a) Record the share transactions.

(b) Indicate how many shares are authorized and how many are issued at the end of the year for the (1) preferred shares

and (2) common shares.

BE11–3 On March 8, Daschen Inc., a publicly traded company, issued 5,000 preferred shares for cash of $30 per share.

On April 20, when the shares were trading at $35, the company issued an additional 3,000 preferred shares in exchange for

land with a fair value of $110,000. (a) Prepare the journal entries for each transaction. (b) Would your answer change if you

were unable to determine the land’s fair value on April 20?

BE11–4 Canaan Limited had 20,000 $2 cumulative preferred shares issued. It was unable to pay any dividend to the preferred

shareholders in the current year. (a) What are the dividends in arrears? (b) How would the dividends in arrears be

reported in the fi nancial statements? (c) Would your answer to part (a) change if the preferred shares were noncumulative

rather than cumulative?

BE11–5 Th e Seabee Corporation has 30,000 $2 noncumulative preferred shares. It declares a quarterly cash dividend on

November 15 to shareholders of record on December 10. Th e dividend is paid on December 31. Prepare the entries on the

appropriate dates to record the cash dividend.

BE11–6 Satina Corporation has 100,000 common shares. It declares a 5% stock dividend on December 1 to shareholders

of record on December 20. Th e shares are issued on January 10. Th e share price is $15 on December 1, $14.50 on December

20, and $14.75 on January 10. Prepare the entries on the appropriate dates to record the stock dividend.

BE11–7 In January 2013, Lorillard, Inc. completed a 3-for-1 stock split. Immediately before the split, Lorillard had

129 million common shares trading at U.S. $117 per share. (a) How many shares did it have aft er the stock split?

(b) What was the most likely price of the shares aft er the stock split? (c) How would Lorillard record or report this stock

split?

BE11–8 Indicate whether each of the following transactions would increase (1), decrease (–), or have no eff ect (NE) on

total assets, total liabilities, total shareholders’ equity, and the number of shares:

Assets Liabilities

Shareholders’

Equity

Number

of Shares

(a) Declared cash dividend.

(b) Paid cash dividend declared in (a).

(c) Declared stock dividend.

(d) Distributed stock dividend declared in (c).

(e) Split stock 2-for-1.

BE11–9 Luxat Corporation reported the following statement of changes in equity accounts for the year ended December

31, 2015.

LUXAT CORPORATION

Statement of Changes in Equity

Year Ended December 31, 2015

Additional

Contributed

Capital

Retained

Earnings

Accumulated

Other

Comprehensive

Income Total

Common

Shares

Bal., Jan. 1 $1,500,000 $500,000 $3,000,000 $100,000 $5,100,000

Issued common shares [1] [2]

Declared and issued stock dividend 110,000 [3] [4]

Declared cash dividends (135,000) (135,000)

Comprehensive income

Profi t 750,000 [5]

Other comprehensive income [6] 25,000

Bal., Dec. 31 $2,050,000 $ [7] $3,505,000 $125,000 $ [8]

Determine the missing amounts for items [1] to [8].

BE11–10 Refer to the data given in BE11–9 for Luxat Corporation. Luxat had an unlimited number of common shares

authorized and 550,000 shares issued at December 31. Prepare the shareholders’ equity section of its statement of fi nancial

position at December 31, 2015.

BE11–11 For the year ended December 31, 2015, Stirling Farms Limited, a private company, reported a profi t of $150,000.

Th e company declared cash dividends of $90,000 and paid $80,000 of these dividends during the year. (a) Prepare a statement

of retained earnings for the year, assuming the balance in Retained Earnings on January 1, 2015, was $490,000. (b) How

would this statement change if Stirling Farms were a publicly traded company?

BE11–12 Paul Schwartz, president of Schwartz Corporation, believes that it is good practice to maintain a constant

payout of dividends relative to profi t. Last year, profi t was $600,000, and the company paid $60,000 in dividends. Th is year,

due to some unusual circumstances, the company had a profi t of $2 million. Paul expects next year’s profi t to be about

$700,000. (a) What was Schwartz Corporation’s payout ratio last year? (b) If it is to maintain the same payout ratio, what

amount of dividends would it pay this year? (c) Is this a good idea? In other words, what are the pros and cons of maintaining

a constant payout ratio?

BE11–13 Canadian National Railway and Canadian Pacifi c Railway have a dividend of $1.50 per common share

and $1.40 per common share, respectively. Th e market price of their shares is $93.72 per share and $108.55 per share,

respectively. (a) Calculate the dividend yield for each company. (b) Which company would investors prefer if they wish to

purchase shares for the purpose of dividend income?

BE11–14 Messier Inc. had 34,000 common shares on January 1, 2015. On August 31 and November 30, 9,000 and 6,000

common shares were issued, respectively. Calculate (a) the number of common shares issued at December 31, 2015, and

(b) the weighted average number of common shares for 2015.

BE11–15 Refer to the data for Messier Inc. given in BE11–14. Messier reported a profi t of $370,000. Messier also had

10,000 $2 cumulative preferred shares, on which the dividend for the current year was declared and paid. Calculate the

earnings per share.

BE11–16 Castera Inc. reported a profi t of $500,000 and a weighted average number of common shares of 200,000 for the

year. It also had 25,000 $2 preferred shares. Calculate earnings per share assuming (a) the preferred shares are cumulative

and the dividend was not paid, (b) the preferred shares are noncumulative and the dividend was paid, and (c) the preferred

shares are noncumulative and the dividend was not paid.

BE11–17 Salliq Ltd. reported the following selected information for the year ended January 31, 2015: profi t, $14,000;

beginning shareholders’ equity, $104,000; and ending shareholders’ equity, $122,000. Salliq has no preferred shares.

(a) Calculate the return on common shareholders’ equity. (b) Explain how your calculation in part (a) would change if

Salliq had preferred shares and had paid the preferred shareholders a dividend.

 

Exercises

E11–1 Th e following is a recent stock market listing for Bombardier Inc. Class B (common) shares:

365-day

stock sym div high low close chg

vol

(000) yld

p/e

high low ratio

4.93 2.97 Bombardier BBD.B 0.10 4.10 4.02 4.02 20.08 12,260 2.53 9.14

Instructions

(a) What is the highest price Bombardier’s shares traded for during the year? Th e lowest?

(b) What is the annual per share dividend paid on these shares?

(c) If you had purchased 1,000 common shares at Bombardier’s closing price of the day in the above listing, what would

be the total cost of your share purchase?

(d) What was the closing price of Bombardier’s common shares on the previous day?

(e) How many Bombardier common shares were sold on the trading day of the listing?

E11–2 Santiago Corp., a publicly traded company, had 2,500 preferred shares issued with a balance of $55,000 and

140,000 common shares issued with a balance of $700,000 at the beginning of the year. Th e following share transactions

occurred during the year:

June 12 Issued 50,000 common shares for $6 per share.

July 11 Issued 1,000 preferred shares for $25 per share.

Oct. 1 Issued 10,000 common shares in exchange for land. Th e common shares were trading for $7 per

share on that date. Th e fair value of the land was estimated to be $75,000.

Nov. 15 Issued 25,000 preferred shares for $28 per share.

Instructions

(a) Record the above transactions.

(b) Calculate the number of shares and balance in the account for each of the preferred and common shares at the end of

the year.

E11–3 Moosonee Ltd. was incorporated as a private company on January 2, 2015, and is authorized to issue an unlimited

number of common shares and $1 preferred shares. Th e company had the following share transactions in its fi rst month

of operations:

Jan. 6 Issued 200,000 common shares for $1.50 per share.

12 Issued 50,000 common shares for $1.75 per share.

18 Issued 10,000 preferred shares for $25 per share.

31 Issued 10,000 common shares in exchange for $15,000 of legal services.

Instructions

(a) Record the above transactions.

(b) What is the number of preferred and common shares at the end of January?

(c) If Moosonee were a publicly traded company, how might the journal entry to record the noncash transaction on

January 31 change?

E11–4 Marsh Corporation issued 400,000 $1 cumulative preferred shares. In its fi rst year of operations, it paid $300,000

of dividends to its preferred shareholders. In its second year, the company paid dividends of $400,000 to its preferred

shareholders.

Instructions

(a) What is the total annual preferred dividend supposed to be for the preferred shareholders?

(b) Calculate any dividends in arrears in years 1 and 2.

(c) Explain how dividends in arrears should be reported in the fi nancial statements.

(d) If the preferred shares were noncumulative rather than cumulative, how much dividend would the company have been

obligated to pay its preferred shareholders in each year?

E11–5 On January 1, 2015, Tarow Corporation had 80,000 common shares, recorded at $600,000, and retained earnings

of $1,000,000. During the year, the following transactions occurred:

Apr. 1 Issued 5,000 common shares at $20 per share.

June 15 Declared a cash dividend of $0.25 per share to common shareholders of record on June 30, payable on

July 10.

Aug. 21 Declared a 5% stock dividend to common shareholders of record on September 5, distributable on

September 20. Th e shares were trading for $22 a share on August 21, $24 on September 5, and $26 on

September 20.

Nov. 1 Issued 3,000 common shares at $25 per share.

Dec. 20 Declared a cash dividend of $0.30 per share to common shareholders of record on December 31,

payable on January 10.

Instructions

(a) Record the above transactions for 2015. (Note: Closing entries are not required.)

(b) Open T accounts and post to the shareholders’ equity accounts journalized in (a).

(c) What is the number of common shares at the end of the year?

E11–6 Laine Inc. is considering one of three following courses of action: (1) paying a $0.50 cash dividend, (2) distributing

a 5% stock dividend, or (3) eff ecting a 2-for-1 stock split. Th e current share price is $14 per share.

Instructions

Help Laine make its decision by completing the following chart (treat each possibility independently):

Before Action

Aft er Cash

Dividend

Aft er Stock

Dividend

Aft er

Stock Split

Total assets $1,250,000

Total liabilities $ 250,000

Shareholders’ equity

Common shares 600,000

Retained earnings 400,000

Total shareholders’ equity 1,000,000

Total liabilities and shareholders’ equity $1,250,000

Number of common shares 100,000

E11–7 Milford Corporation had the following transactions and events:

  1. Issued preferred shares for cash.
  2. Declared a cash dividend on the preferred shares.
  3. Paid the cash dividend declared in (2).
  4. Issued common shares for cash.
  5. Issued common shares for a noncash exchange of assets.
  6. Completed a 2-for-1 stock split of the common shares.
  7. Declared a stock dividend on the common shares.
  8. Distributed the stock dividend declared in (7).
  9. Restricted retained earnings.
  10. Reported other comprehensive income from an unrealized gain on investments.

Instructions

Indicate whether each of the above transactions would increase (1), decrease (2), or have no eff ect (NE) on assets,

liabilities, and key categories within shareholders’ equity, as shown in the following table. Th e fi rst one has been done for

you as an example.

E11–8 Th e general ledger of Val d’Or Corporation contains the following selected accounts and information:

  1. Cash
  2. Common shares
  3. Other comprehensive income—Revaluation gain from revaluing property, plant, and equipment to fair value
  4. Long-term investments
  5. Preferred shares
  6. Retained earnings
  7. Gain on disposal
  8. Cash dividends
  9. Stock split
  10. Stock dividends distributable

Instructions

Indicate whether each of the above accounts should be reported in the statement of changes in equity. If yes, indicate

whether the account should be reported in the share capital, retained earnings, or accumulated other comprehensive

income section of the statement. If not, indicate in which fi nancial statement (statement of fi nancial position or income

statement) and in which section the account should be reported or write NE (no eff ect), if the statement is not aff ected. Th e

fi rst account has been done for you as an example.

Statement of Changes in Equity

Account

Share

Capital

Retained

Earnings

Accumulated

Other

Comprehensive

Income

Other

Financial

Statement Classifi cation

  1. Cash NE NE NE Statement

of fi nancial

position

Current assets

E11–9 Th e following accounts appear in the ledger of Ozabal Inc. aft er the books are closed at December 31, 2015:

Accumulated other comprehensive loss $ 50,000

Common shares (unlimited number of shares authorized, 250,000 shares issued) 500,000

Stock dividends distributable 50,000

Additional contributed capital 25,000

Preferred shares ($1.25 noncumulative, 100,000 shares authorized, 10,000 shares issued) 250,000

Retained earnings (of which $100,000 is restricted for a plant expansion) 900,000

Instructions

Prepare the shareholders’ equity section of Ozabal’s statement of fi nancial position, including any required note

disclosure.

E11–10 Th e Blue Canoe Limited reported the following changes to its shareholders’ equity accounts for the year ended

December 31, 2015.

Classify accounts.

(SO 4)

Prepare shareholders’

equity section.

(SO 4)

Prepare statement of

changes in equity and

shareholders’ equity

section.

(SO 4)

Retained earnings:

Balance, Jan. 1 $1,500,000

Profi t 400,000

Cash dividends (70,000)

Balance, Dec. 31 $1,830,000

Common shares:

Balance, Jan. 1 $ 800,000

Shares issued 180,000

Balance, Dec. 31 $ 980,000

Accumulated other comprehensive income:

Balance, Jan. 1 $ 90,000

Other comprehensive income (25,000)

Balance, Dec. 31 $ 65,000

Additional contributed capital:

Balance, Jan. 1 $540,000

Balance, Dec. 31 $540,000

Instructions

(a) Prepare a statement of changes in equity for the year.

(b) Prepare the shareholders’ equity section of the balance sheet at December 31.

E11–11 Sobeys Inc. is a private company. It reported beginning retained earnings at May 7, 2011, of $1,362.8 million.

During the year ended May 5, 2012, it reported a profi t of $322.5 million and declared and paid dividends on its common

shares of $70.5 million. It also reported other deductions to retained earnings of $47.5 million.

Instructions

(a) Prepare a statement of retained earnings for the year ended May 5, 2012.

(b) If Sobeys were a publicly traded company, would it still have to prepare a statement of retained earnings? Explain.

E11–12 Th e following selected information is available for two competitors, Nike, Inc. and Adidas AG:

(in millions, except for per share information)

Nike

(in U.S. $)

Adidas

(in euros)

Market price per share $53.68 €67.33

Total cash dividends 619 282

Dividends per share 1.565 1.35

Profi t 2,223 791

Instructions

(a) Calculate the (1) payout and (2) dividend yield ratios for each company.

(b) Which company would investors favour for dividend income purposes? Explain.

E11–13 Chinook Corporation started the year ended November 30, 2015, with 60,000 common shares and no preferred

shares issued. Th e following changes in share capital occurred during the year:

Feb. 28 Issued 15,000 common shares for $225,000.

Sept. 1 Issued 20,000 $1 cumulative preferred shares for $500,000.

Nov. 1 Issued 6,000 common shares in exchange for land. Th e shares were trading for $20 on this date and

the fair value of the land was $115,000.

30 Reported profi t of $351,250.

30 Declared the quarterly cash dividend to the preferred shareholders of record on December 16,

payable on December 31.

Instructions

(a) Calculate the profi t available for the common shareholders.

(b) Calculate the weighted average number of common shares for the year.

(c) Calculate the earnings per share for the year.

E11–14 Selected fi nancial information (in millions, except per share information) is available for CIBC at October 31:

2012 2011 2010

Total cash dividends paid to common shareholders $ 1,470 $ 1,391 $ 1,350

Cash dividends per common share $ 3.64 $ 3.51 $ 3.48

Profi t available to common shareholders $ 3,173 $ 2,690 $ 2,114

Common shareholders’ equity $15,332 $13,335 $11,643

Market price per common share $ 78.56 $ 73.96 $ 78.23

Weighted average number of common shares 404 396 388

Instructions

(a) Calculate the (1) payout, (2) dividend yield, (3) earnings per share, and (4) return on common shareholders’ equity

ratios for the common shareholders for 2012 and 2011.

(b) Using the information in part (a), comment on CIBC’s dividend record and earnings performance over the two-year

period.

E11–15 Selected ratios are shown below for two competing toolmakers, Stanley Black & Decker, Inc. and Snap-On

Incorporated.

Stanley Black &

Decker Snap-On

Payout ratio 2.4% 1.7%

Dividend yield 2.6% 1.9%

Earnings per share (in U.S. dollars) $3.42 $5.03

Return on common shareholders’ equity 8.3% 17.9%

Instructions

Which of the two companies’ shares would you prefer to purchase if you were looking for an income-oriented investment

to supplement your income? Explain which ratios you used to support your answer.

 

Problems: Set A

P11–1A Th e following shareholders’ equity accounts are reported by Talty Inc. on January 1, 2015:

Preferred shares ($6 cumulative, 6,000 issued) $ 600,000

Common shares (500,000 issued) 4,000,000

Retained earnings 1,958,000

Accumulated other comprehensive income 25,000

Th e following selected transactions, given in chronological order, occurred during the year:

  1. Issued 10,000 common shares for $14 per share.
  2. Issued 5,000 common shares in exchange for equipment. Th e fair value of the shares was $14 per share. Th e fair value

of the equipment could not be reliably determined.

  1. Issued 1,000 preferred shares for $100 per share.
  2. Th e annual preferred share cash dividend was declared and paid during the year.
  3. Determined that the company had an other comprehensive loss of $5,000 from the revaluation of land.

Instructions

For each of the above transactions, indicate its impact on the items in the table that follows. Indicate if the item will increase

(1) or decrease (2), and by how much, or if there will be no eff ect (NE). Th e fi rst transaction has been done for you as an

example.

Shareholders’ Equity

Assets Liabilities

Preferred

Shares

Common

Shares

Retained

Earnings

Accumulated

Other

Comprehensive

Income

  1. 1$140,000 NE NE 1$140,000 NE NE

P11–2A Remmers Corporation, a publicly traded company, was organized on January 1, 2015. It is authorized to issue

an unlimited number of $3 noncumulative preferred shares and an unlimited number of common shares. Th e following

share transactions were completed during the company’s fi rst year of operations:

Jan. 10 Issued 500,000 common shares for $2 per share.

Mar. 1 Issued 10,000 preferred shares for $50 per share.

May 1 Issued 50,000 common shares for $3 per share.

July 24 Issued 16,800 common shares for $60,000 cash and used equipment. Th e equipment originally

cost $15,000. It now has a carrying amount of $7,500 and a fair value of $8,000. Th e common

shares were trading for $4 per share on this date.

Sept. 1 Issued 5,000 common shares for $5 per share.

Nov. 1 Issued 2,000 preferred shares for $50 per share.

Dec. 15 Declared a $36,000 cash dividend to the preferred shareholders, to shareholders of record on

December 31, payable on January 10.

31 Reported profi t of $650,000 for the year.

Instructions

(a) Record the above transactions for 2015, including any required entries to close dividends and profi t to Retained

Earnings.

(b) Open T accounts and post to the shareholders’ equity accounts.

(c) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31.

P11–3A Largent Corporation, a publicly traded company, is authorized to issue 200,000 $4 cumulative preferred shares

and an unlimited number of common shares. On January 1, 2015, the general ledger contained the following shareholders’

equity accounts:

Preferred shares (8,000 shares issued) $ 440,000

Common shares (70,000 shares issued) 1,050,000

Additional contributed capital 25,000

Retained earnings 800,000

Accumulated other comprehensive income 10,000

Th e following equity transactions occurred in 2015:

Feb. 6 Issued 10,000 preferred shares for $600,000.

Apr. 6 Issued 20,000 common shares for $560,000.

May 29 Declared a semi-annual cash dividend to the preferred shareholders of record at June 12, payable

July 1.

Aug. 22 Issued 5,000 common shares in exchange for a building. At the time of the exchange, the building

was valued at $165,000 and the common shares at $150,000.

Dec. 15 Th e board decided there were insuffi cient funds to declare the semi-annual dividend to the

preferred shareholders.

31 Profi t for the year was $582,000.

Instructions

(a) Record the above transactions, including any entries required to close dividends and profi t to Retained Earnings.

(b) Open T accounts and post to the shareholders’ equity accounts.

(c) Prepare the statement of changes in equity for the year.

(d) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31, including any required

note disclosure.

P11–4A On January 1, 2015, Conway Ltd., a private company, had the following shareholders’ equity accounts:

Preferred shares, $5 noncumulative, unlimited number authorized, none issued

Common shares, unlimited number authorized, 1.5 million issued $1,500,000

Retained earnings 1,900,000

Th e following selected transactions occurred during 2015:

Jan. 2 Issued 100,000 preferred shares at $100 per share.

Feb. 8 Issued 50,000 common shares in exchange for land. On this date, the value of the land was

$105,000. Th e common shares have not recently traded but the last time they traded, they sold for

$2.50 per share.

Mar. 5 Declared the quarterly cash dividend to preferred shareholders of record on March 20, payable

April 1.

Apr. 18 Issued 200,000 common shares at $3 per share.

June 5 Declared the quarterly cash dividend to preferred shareholders of record on June 20, payable

July 1.

Sept. 5 Declared the quarterly cash dividend to preferred shareholders of record on September 20, payable

October 1.

Dec. 5 Declared the quarterly cash dividend to preferred shareholders of record on December 20, payable

January 1.

14 Declared a cash dividend of $0.50 per share to the common shareholders of record on

December 29, payable January 10.

31 Profi t for the year was $1 million.

Instructions

(a) Record the above transactions for 2015, including any entries required to close dividends and profi t to Retained

Earnings.

(b) Open T accounts and post to the shareholders’ equity accounts.

(c) Prepare a statement of retained earnings for the year.

(d) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31.

(e) Conway is a private company following ASPE. If it followed IFRS instead, how might your answers in parts (a) through

(d) change?

P11–5A Th e general ledger of Robichaud Corporation, a publicly traded company, contained the following shareholders’

equity accounts in 2015:

January 1 December 31

Preferred shares (10,000 and 20,000 shares issued, respectively) $ 500,000 $1,000,000

Common shares (320,000 and 370,000 shares issued, respectively) 2,700,000 3,700,000

Stock dividends distributable 0 407,000

Retained earnings 2,980,000 3,345,000

A review of the accounting records for the year ended December 31, 2015, reveals the following information:

  1. On January 1, 10,000 $5 noncumulative preferred shares were issued for $50 each. An unlimited number are

authorized.

  1. On October 1, 50,000 common shares were sold for cash at $20 per share. An unlimited number are authorized.
  2. Th e annual preferred shareholders’ cash dividend was declared and paid during the year.
  3. On December 31, a 5% stock dividend was declared on common shares when the share price was $22. Th e stock

dividend is distributable on January 20.

  1. Profi t for the year was $872,000.
  2. On December 31, the board of directors authorized a $500,000 restriction on retained earnings for a plant

expansion.

Instructions

(a) Reproduce the Preferred Shares, Common Shares, Stock Dividends, Stock Dividends Distributable, and Retained

Earnings general ledger accounts for the year. (Hint: Although not required, you may fi nd it helpful to prepare

journal entries.)

(b) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31, including any required

note disclosure.

P11–6A Th e condensed statement of fi nancial position of Laporte Corporation reports the following amounts:

LAPORTE CORPORATION

Statement of Financial Position (partial)

June 30, 2015

Total assets $16,000,000

Total liabilities $ 6,000,000

Shareholders’ equity

Common shares, unlimited number authorized, 400,000 issued $2,000,000

Retained earnings 8,000,000 10,000,000

Total liabilities and shareholders’ equity $16,000,000

Th e common shares are currently trading for $30 per share. Laporte wants to assess the impact of three possible alternatives:

  1. Payment of a $1.50 per share cash dividend
  2. Distribution of a 5% stock dividend
  3. A 3-for-2 stock split

Instructions

(a) Determine the impact of each alternative on (1) assets, (2) liabilities, (3) common shares, (4) retained earnings,

(5) total shareholders’ equity, and (6) the number of shares.

(b) Identify the advantages and disadvantages of each alternative for the company.

P11–7A On January 1, 2015, Wirth Corporation, a publicly traded company, had these shareholders’ equity accounts:

Common shares (unlimited number of shares authorized,

110,000 shares issued) $1,100,000

Retained earnings 540,000

Accumulated other comprehensive income 60,000

During the year, the following transactions occurred:

Jan. 15 Declared a $1 per share cash dividend to shareholders of record on January 31, payable

February 15.

Apr. 15 Declared a 10% stock dividend to shareholders of record on April 30, distributable May 15. On

April 15, April 30, and May 15, the share prices were $15, $13.50, and $14, respectively.

Oct. 1 Eff ected a 2-for-1 stock split. On October 1, the share price was $20.

Dec. 31 Determined that profi t for the year was $350,000.

Instructions

(a) Record the above transactions, including any required entries to close dividends and profi t to Retained Earnings.

(b) Open T accounts as required and post to the shareholders’ equity accounts.

(c) Prepare a statement of changes in equity for the year.

(d) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31.

P11–8A Gualtieri Inc.’s shareholders’ equity accounts were as follows at the beginning of the current fi scal year,

August 1, 2015:

$5 noncumulative preferred shares (25,000 shares issued) $2,500,000

Common shares (350,000 shares issued) 3,750,000

Retained earnings 2,250,000

Total shareholders’ equity $8,500,000

During the year, the following selected transactions occurred:

Dec. 1 Issued 60,000 common shares for $25 per share.

Feb. 1 Issued 10,000 common shares for $26 per share.

June 20 Declared the annual preferred cash dividend to shareholders of record on July 10, payable

on July 31.

July 31 Profi t for the year ended July 31, 2015, was $1,280,000.

Instructions

(a) Calculate the weighted average number of common shares for the year.

(b) Calculate the earnings per share.

(c) Why is it important to use a weighted average number of shares in the calculation of earnings per share? Why not just

use the number of shares issued at year end?

(d) Would your answer to part (b) change if the preferred share dividend had not been declared on June 20? Explain.

P11–9A Th e following summary of the payout, dividend yield, and earnings per share (in U.S. $) ratios is available for

fi ve years ended December 31 for Barrick Gold Corporation:

Payout Ratio Dividend Yield Earnings per Share

2008 44% 1.1% $0.96

2009 n/a 1.1 (4.73)

2010 14 1.0 3.50

2011 11 1.0 4.49

2012 n/a 2.2 (0.66)

Instructions

(a) What are some possible reasons that Barrick Gold’s dividend payout ratio declined from 44% in 2008 to 14% in 2010,

while its dividend yield ratio changed very little—from 1.1% in 2008 to 1.0% in 2010? Note that there is no payout ratio

available in 2009 or 2012 because of the loss incurred in those years.

(b) Why do you think Barrick Gold’s dividend yield increased from 1% in 2011 to 2.2% in 2012, despite the fact that the

company reported a loss in 2012?

(c) If you were one of Barrick Gold’s creditors, what would you think about the company continuing to pay dividends

(such as in 2009 and 2012) regardless of whether it reports a profi t or a loss? Explain.

P11–10A Th e following selected information (in millions, except for per share information) is available for the National

Bank of Canada for the year ended October 31:

2012 2011

Weighted average number of common shares 161.4 162.4

Profi t available to common shareholders $1,518 $1,137

Common cash dividends per share 3.08 2.74

Total common cash dividends 485 437

Average common shareholders’ equity 6,089 5,535

Market price per common share 77.18 69.61

Industry averages were as follows:

Payout ratio 30.0% 40.0%

Dividend yield 4.3 3.8

Earnings per share n/a n/a

Return on common shareholders’ equity 24.4 17.7

Instructions

(a) Calculate the following ratios for the common shareholders for each fi scal year:

  1. Payout ratio
  2. Dividend yield
  3. Earnings per share
  4. Return on common shareholders’ equity

(b) Comment on the above ratios for 2012 in comparison with the prior year, and in comparison with the industry.

P11–11A Selected ratios for two companies operating in the petroleum industry follow, along with the industry

averages:

Ratio Petro-Boost World Oil Industry Average

Profi t margin 10.0% 8.4% 10.9%

Return on common shareholders’ equity 15.1% 29.6% 11.3%

Return on assets 11.0% 12.6% 6.2%

Asset turnover 1.1 times 1.5 times 0.5 times

Earnings per share $4.06 $4.38 n/a

Price-earnings ratio 14.2 times 17.1 times 13.0 times

Payout ratio 12.3% 9.9% 0.2%

Dividend yield 1.9% 0.7% 1.2%

Instructions

(a) Compare the profi tability of Petro-Boost with that of World Oil, and with the industry average. Which company is

more profi table? Explain.

(b) You would like to invest in the shares of one of the two companies. Your goal is to have regular income from your

investment that will help pay your tuition fees for the next few years. Which of the companies is a better choice for

you? Explain.

(c) Assume that instead of looking for regular income, you are looking for growth in the share value so that you can resell

the shares at a gain in the future. Now which of the two companies is better for you? Explain.

Problems: Set B

P11–1B Th e following shareholders’ equity accounts are reported by Branch Inc. on January 1, 2015:

Preferred shares ($4 noncumulative, 35,000 issued) $ 350,000

Common shares (150,000 issued) 2,400,000

Retained earnings 1,276,000

Accumulated other comprehensive income 15,000

Th e following selected transactions, given in chronological order, occurred during the year:

  1. Issued 10,000 common shares for $30 per share.
  2. Issued 500 preferred shares for $100 per share.
  3. Issued 1,000 common shares in exchange for land. Th e fair value of the shares was $30 per share. Th e fair value of the

land was $29,000.

  1. Declared and paid the preferred shareholders a $2 per share cash dividend.
  2. Determined that the company had other comprehensive income of $5,000 from the revaluation of land.

Instructions

For each of the above transactions, indicate its impact on the items in the table below. Indicate if the item will increase

(1) or decrease (–), and by how much, or if there will be no eff ect (NE). Th e fi rst transaction has been done for you as an

example.

Shareholders’ Equity

Assets Liabilities

Preferred

Shares

Common

Shares

Retained

Earnings

Accumulated

Other

Comprehensive

Income

  1. 1$300,000 NE NE 1$300,000 NE NE

P11–2B Wetland Corporation, a publicly traded company, was organized on June 1, 2014. It is authorized to issue an

unlimited number of $4 cumulative preferred shares and an unlimited number of common shares. Th e following share

transactions were completed during the company’s fi rst year of operations:

June 5 Issued 80,000 common shares for $4 per share.

Aug. 21 Issued 5,000 preferred shares for $100 per share.

Sept. 15 Issued 22,000 common shares in exchange for land. Th e asking price of the land was $100,000

and the fair value was $95,000. Th e common shares were trading for $4.25 per share on

this date.

Nov. 20 Issued 78,000 common shares for $4.50 per share.

Mar. 9 Issued 10,000 common shares for $5 per share.

Apr. 16 Issued 2,000 preferred shares for $100 per share.

May 15 Declared the annual preferred cash dividend to the preferred shareholders, to shareholders of

record on May 30, payable on June 10.

31 Reported profi t of $250,000 for the year.

Instructions

(a) Record the above transactions for the year ended May 31, 2015, including any required entries to close dividends and

profi t to Retained Earnings.

(b) Open T accounts and post to the shareholders’ equity accounts.

(c) Prepare the shareholders’ equity section of the statement of fi nancial position at May 31.

P11–3B Ujjal Corporation, a publicly traded company, is authorized to issue an unlimited number of $5 noncumulative

preferred shares and an unlimited number of common shares. On February 1, 2015, the general ledger contained the

following shareholders’ equity accounts:

Preferred shares (44,000 shares issued) $ 440,000

Common shares (70,000 shares issued) 1,050,000

Additional contributed capital 75,000

Retained earnings 1,000,000

Accumulated other comprehensive income 65,000

Th e following equity transactions occurred during the year ended January 31, 2016:

Feb. 28 Issued 1,500 preferred shares for $150,000.

Apr. 12 Issued 100,000 common shares for $3.5 million.

May 25 Issued 2,500 common shares in exchange for land. At the time of the exchange, the land was

valued at $85,000 and the common shares at $87,500.

Dec. 29 Declared a $2.50 per share cash dividend to the preferred shareholders of record at January 15,

payable February 1.

Jan. 31 A loss of $5,000 was incurred for the year.

Instructions

(a) Record the above transactions for the year ended January 31, 2016, including any entries required to close dividends

and loss to Retained Earnings.

(b) Open T accounts and post to the shareholders’ equity accounts.

(c) Prepare the statement of changes in equity for the year.

(d) Prepare the shareholders’ equity section of the statement of fi nancial position at January 31, 2016.

P11–4B On January 1, 2015, Schipper Ltd., a private company, had the following shareholders’ equity accounts:

Preferred shares, $2 noncumulative, unlimited number authorized, none issued

Common shares, unlimited number authorized, 100,000 issued $150,000

  1. Retained earnings 580,000

 

Th e following selected transactions occurred during 2015:

Jan. 2 Issued 10,000 preferred shares for $50 per share.

Mar. 10 Declared the quarterly cash dividend to preferred shareholders of record on March 22, payable

April 1.

June 10 Declared the quarterly cash dividend to preferred shareholders of record on June 22, payable

July 1.

Aug. 12 Issued 10,000 common shares for $7.30 per share.

Sept. 1 Declared the quarterly cash dividend to preferred shareholders of record on September 22, payable

October 1.

Oct. 15 Issued 2,000 common shares in exchange for equipment. Th e common shares had not traded

recently but were valued at $7.60 per share on the last date they had traded. Th e value of the

equipment was $15,000 on October 15.

Dec. 1 Th e fourth quarter cash dividend to preferred shareholders was not declared or paid.

31 A loss of $50,000 was reported for the year.

Instructions

(a) Record the above transactions for 2015, including any required entries to close dividends and loss to Retained

Earnings.

(b) Open T accounts and post to the shareholders’ equity accounts.

(c) Prepare a statement of retained earnings for the year.

(d) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31.

(e) Schipper is a private company following ASPE. If it followed IFRS instead, how might your answers in parts (a)

through (d) change?

P11–5B Th e general ledger of Maggio Corporation, a publicly traded company, contained the following shareholders’

equity accounts in 2015:

January 1 December 31

Preferred shares (15,000 and 15,000 shares issued, respectively) $ 750,000 $ 750,000

Common shares (255,000 and 291,500 shares issued, respectively) 3,210,000 3,857,000

Retained earnings 980,000 1,373,000

A review of the accounting records for the year ended December 31, 2015, reveals the following information:

  1. On March 1, 20,000 common shares were sold for $17.50 per share. An unlimited number are authorized.
  2. On August 18, a 6% stock dividend was declared for 16,500 common shares when the share price was $18. Th e stock

dividend was distributed on September 25.

  1. Th e preferred shares are $4 cumulative. An unlimited number of preferred shares are authorized. Th e quarterly

preferred shareholders’ cash dividend was declared and paid in each quarter.

  1. Profi t for the year was $750,000.
  2. On December 31, the directors authorized a $200,000 restriction on retained earnings in accordance with a debt covenant.

Instructions

(a) Reproduce the Preferred Shares, Common Shares, Stock Dividends, Stock Dividends Distributable, and Retained Earnings

general ledger accounts for the year. (Hint: Although not required, you may fi nd it helpful to prepare journal entries.)

(b) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31, including any required

note disclosure.

P11–6B Th e condensed statement of fi nancial position of Erickson Corporation reports the following amounts:

ERICKSON CORPORATION

Statement of Financial Position (partial)

January 31, 2015

Total assets $9,000,000

Total liabilities $2,500,000

Shareholders’ equity

Common shares, unlimited number authorized, 500,000 issued $3,000,000

Retained earnings 3,500,000 6,500,000

Total liabilities and shareholders’ equity $9,000,000

Th e common shares are currently trading for $15 per share. Erickson wants to assess the impact of three possible alternatives

on the corporation and its shareholders:

  1. Payment of a $1 per share cash dividend
  2. Distribution of a 5% stock dividend
  3. A 2-for-1 stock split

Instructions

(a) Determine the impact of each alternative on (1) assets, (2) liabilities, (3) common shares, (4) retained earnings,

(5) total shareholders’ equity, and (6) the number of shares.

(b) Identify the advantages and disadvantages of each alternative for the company.

P11–7B On January 1, 2015, Stengel Corporation, a publicly traded company, had these shareholders’ equity accounts:

Common shares (unlimited number of shares authorized, 75,000 issued) $1,700,000

Retained earnings 900,000

Accumulated other comprehensive loss 125,000

During the year, the following transactions occurred:

Feb. 1 Declared a $1 per share cash dividend to shareholders of record on February 15, payable March 1.

Apr. 1 Eff ected a 3-for-1 stock split. On April 1, the share price was $36.

July 1 Declared a 5% stock dividend to shareholders of record on July 15, distributable July 31. On July 1,

July 15, and July 31, the share prices were $14, $13.50, and $13.75, respectively.

Dec. 31 Determined that profi t for the year was $400,000.

Instructions

(a) Record the above transactions, including any entries required to close dividends and profi t to Retained Earnings.

(b) Open T accounts as required and post to the shareholders’ equity accounts.

(c) Prepare a statement of changes in equity for the year.

(d) Prepare the shareholders’ equity section of the statement of fi nancial position at December 31.

P11–8B Blue Bay Logistics Ltd.’s shareholders’ equity accounts were as follows at the beginning of the current fi scal year,

April 1, 2014:

$5 cumulative preferred shares (20,000 shares issued) $1,950,000

Common shares (500,000 shares issued) 3,750,000

Retained earnings 1,500,000

Total shareholders’ equity $7,200,000

During the year, the following selected transactions occurred:

June 1 Issued 2,000 common shares for $12 per share.

July 1 Issued 50,000 common shares for $13 per share.

Feb. 28 Declared the annual preferred cash dividend to shareholders of record on March 12, payable on

April 1.

Mar. 31 Profi t for the year ended March 31, 2015, was $1,016,750.

Instructions

(a) Calculate the weighted average number of common shares for the year.

(b) Calculate the earnings per share.

(c) Why is it important to use profi t available to common shareholders in the calculation of earnings per share? Why not

just use profi t?

(d) Would your answer to part (b) change if the preferred share dividend had not been declared on February 28? Explain.

P11–9B Th e following summary of the payout, dividend yield, and earnings per share ratios is available for fi ve years

ended December 31 for TransAlta Corporation:

Payout Ratio Dividend Yield Earnings per Share

2008 91.5% 4.4% $1.18

2009 129.8% 4.9 0.90

2010 125.1% 5.5 1.16

2011 66.9% 5.5 1.31

2012 n/a 7.7 (2.61)

Instructions

(a) What are some possible reasons that TransAlta’s dividend payout ratio increased from 91.5% in 2008 to 129.8% in 2009

at a time when the earnings per share fell from $1.18 per share to $0.90 per share?

(b) Why do you think that TransAlta continued to pay dividends in 2012 in a year when it reported a loss per share? Note

there is no payout ratio available in 2012 because of the loss incurred that year.

(c) Why do you think that TransAlta’s dividend yield increased from 5.5% in 2011 to 7.7% in 2012 at a time when the

earnings per share fell from a profi t of $1.31 per share to a loss of $2.61 per share?

(d) If you were an investor looking for dividend income, would you be happy with TransAlta’s dividend policy? Explain.

P11–10B Th e following selected information (in millions, except for per share information) is available for Scotiabank

for the year ended October 31:

2012 2011

Weighted average number of common shares 1,133 1,072

Profi t available to common shareholders $6,023 $4,965

Common cash dividends per share 2.19 2.05

Total common cash dividends 2,493 2,200

Average common shareholders’ equity 30,804 24,042

Market price per common share 54.25 52.53

Industry averages were as follows:

Payout ratio 30.0% 40.0%

Dividend yield 4.3 3.8

Earnings per share n/a n/a

Return on common shareholders’ equity 24.4 17.7

Instructions

(a) Calculate the following ratios for the common shareholders for each fi scal year:

  1. Payout ratio
  2. Dividend yield
  3. Earnings per share
  4. Return on common shareholders’ equity

(b) Comment on the above ratios for 2012 in comparison with the prior year and in comparison with the industry.

P11–11B Selected ratios for two retailers follow, along with the industry averages:

Bargain Hunters Discount Paradise Industry Average

Profi t margin 6.8% 3.5% 3.7%

Return on common shareholders’ equity 24.9% 22.4% 20.8%

Return on assets 10.2% 8.8% 9.2%

Asset turnover 1.5 times 2.5 times 2.5 times

Earnings per share $3.30 $2.49 n/a

Price-earnings ratio 12.3 times 17.0 times 16.3 times

Payout ratio 9.4% 25.0% 19.3%

Dividend yield 0.8% 2.5% 1.2%

Instructions

(a) Compare the profi tability of Bargain Hunters with that of Discount Paradise, and with the industry average. Which

company is more profi table? Explain.

(b) You would like to invest in the shares of one of the two companies. Your goal is to have regular income from your

investment that will help pay your tuition fees for the next few years. Which of the two companies is a better choice

for you? Explain.

(c) Assume that instead of looking for regular income, you are looking for growth in the share value so that you can resell

the shares at a gain in the future. Now which of the two companies is better for you? Explain.

 

 

CHAPTER 12 Reporting and Analyzing Investments

 

Questions

(SO 1) 1. What are the reasons why corporations invest in

debt and equity securities?

(SO 1) 2. Explain the diff erences between non-strategic

and strategic investments.

(SO 1, 4) 3. Cumby Corporation is a golf equipment retailer

that owns 1,000 common shares of Suncor

Energy Inc. It intends to sell these shares if it

needs cash. (a) Is the investment in Suncor considered

a non-strategic investment or a strategic

investment? Explain your reasoning. (b) Would

the investment be classifi ed as a current asset

or a non-current asset on Cumby’s statement of

fi nancial position?

(SO 2, 4) 4. At what amount—cost, amortized cost, or fair

value—are each of the following most likely to be

reported at on a statement of fi nancial position:

(a) common shares in a publicly traded company

that will probably be sold within a year, (b) bond

investments that will be held until maturity, and

(c) shares in a private company that do not have

a determinable fair value?

(SO 2) 5. What is the diff erence between realized gains/

losses and unrealized gains/losses?

(SO 2) 6. Communications Inc. reported trading investments

at their fair value of $255 million on its

year-end statement of fi nancial position. Th ese

securities were purchased earlier in the year at a

cost of $245 million. (a) How should the

diff erence between these two amounts be

recorded and reported? (b) Would your answer

diff er if the fair value of these securities could not

be determined?

(SO 2) 7. Timmerman Ltd. purchased $1 million of 10-

year bonds at face value (100) in 2015. Th e bonds

were trading at 105 (recall that a bond price in

this case means that the bond trades at 105% of

its maturity value) on December 31, 2015. (a)

At what amount would the bonds be reported in

the December 31, 2015, statement of fi nancial

position if management accounted for the bonds

using the fair value through profi t or loss model?

(b) How would any related interest revenue be

reported?

(SO 2) 8. Music Makers Ltd. reported trading investments

with an original cost of $115,000 and a fair

value of $130,000 at December 31, 2014. It also

reported an unrealized gain of $15,000 relating to

the investment. During 2015, the investment was

sold for $125,000. Describe how the sale of the

investment would be recorded and reported in

the 2015 fi nancial statements.

(SO 3) 9. What constitutes “signifi cant infl uence”? Is it

safe to conclude that there is signifi cant infl uence

when a company owns 20% of the common

shares of another company?

(SO 3) 10. Identify what is included in the carrying amount

of a strategic equity investment using the (a) cost

model and (b) equity method.

(SO 3) 11. Explain how, and why, the investment revenue

diff ers when a strategic long-term equity investment

is accounted for using the (a) cost model

and (b) equity method.

(SO 4) 12. Indicate how (a) trading investments, (b) investment

in associates, and (c) debt investments held

to maturity are classifi ed on the statement of

fi nancial position.

(SO 4) 13. Identify the proper statement presentation of

the following accounts: (a) Unrealized Gain on

Trading Investments, (b) Realized Loss on Trading

Investments, (c) Revenue from Investment in

Associates, and (d) Dividends received from an

investment accounted for using the equity method.

(SO 4) 14. Distinguish between other comprehensive

income and accumulated other comprehensive

income. Indicate how each is reported in the

fi nancial statements. Explain how closing entries

for other comprehensive income diff er from closing

entries for profi t.

(SO 4) 15. Explain how the income statement, statement

of comprehensive income, statement of changes

in equity, and statement of fi nancial position are

interrelated.

  1. George Weston Ltd. owns 63% of the common

shares of Loblaw Companies Ltd. (a) What

method should George Weston Ltd. use to account

for this investment? (b) Which company

is the parent? Th e subsidiary? (c) What kind of

fi nancial statements should George Weston Ltd.

prepare to properly present this investment?

(SO 5) *17. Compare the accounting for a debt investment

in bonds with the accounting for a bond

liability.

*18. Explain why premiums and discounts on bond

investments must be amortized when using the

amortized cost model and why no amortization

occurs when using the fair value through profi t

or loss model.

(SO 5) *19. When bonds mature, a journal entry is recorded

on the books of both the investor and the

investee (issuer). However, when bonds are sold

by the investor prior to maturity on the open

market, the sale of the bond investment results

in a journal entry on the books of the investor,

but not on the books of the investee (issuer).

Explain why.

Brief Exercises

BE12–1 Identify whether each of the following is most likely (a) a debt or equity investment, and (b) a non-strategic or

strategic investment. (c) Identify the most likely reason (such as earning gains, interest, dividends, obtaining infl uence or

control) for making the investment.

(a) (b) (c)

Debt or

Equity

Investment?

Non-strategic

or Strategic

Investment?

Reason for

Making the

Investment?

  1. 120-day treasury bill
  2. A few common shares of a small oil company

purchased with a temporary surplus of cash

  1. 30% of the common shares of a company

purchased in order to obtain a position on the

board of directors

  1. Bonds purchased with a temporary cash surplus
  2. 100% of the common shares of a company

purchased to amalgamate its operations with

those of the investor

  1. Five-year bonds intended to be held for the

entire term of the bonds

BE12–2 On January 1, 2015, Columbia Ltd. purchased $200,000 of 10%, 10-year bonds at face value (100) with the intention

of selling the bonds early next year. Interest is received semi-annually on July 1 and January 1. At December 31, 2015,

which is the company’s fi scal year end, the bonds were trading in the market at 97 (this means 97% of maturity value).

Using the fair value through profi t or loss model, prepare the journal entries to record (a) the purchase of the bonds on

January 1, (b) the receipt of the interest on July 1, and (c) any adjusting entries required at December 31.

BE12–3 Using the data presented in BE12–2, assume that the bonds were sold for $194,000 on January 2, 2016. Record

the sale of the bonds.

BE12–4 On August 1, 2015, McLellan Ltd. purchased 1,000 Datawave common shares for $45,000 cash with the intention

of trading the shares and using the fair value through profi t or loss model. On December 31, 2015, McLellan’s year end,

the shares’ fair value was $49,000. Prepare the journal entry to record (a) the purchase of this investment on August 1, and

(b) any adjusting journal entry required at December 31.

BE12–5 Using the data presented in BE12–4, assume that the shares were sold for $47,000 on February 1, 2016. Record

the sale.

BE12–6 On January 1, Rook Corporation, a publicly traded company, purchased 25% of Hook Ltd. common shares

for $400,000. At December 31, Hook paid a $32,000 dividend (Rook received its share that day) and reported profit of

$800,000. The shares’ fair value at December 31 was $420,000. Record each of these transactions, assuming Rook has

significant influence over Hook and is using the equity method to account for this investment. How much revenue

would be reported by Rook because of its share of Hook?

BE12–7 Using the data presented in BE12–6, assume that Rook Corporation reports under ASPE and has chosen to

account for its investment in Hook Ltd. using the cost model because the shares do not trade in an active market. Record

each of the transactions and any necessary adjusting journal entries under this assumption. How much revenue would be

reported by Rook in this situation? Explain why this diff ers from your answer in BE12–6.

BE12–8 Chan Inc., a publicly traded company, purchased 20% of Dong Ltd.’s common shares for $225,000 on January 1.

During the year, Dong reported profi t of $350,000 and paid a dividend of $40,000. Th e investment’s fair value at

December 31 was $275,000. (a) Assuming there is signifi cant infl uence, indicate the balance in the investment account

at year end and where it would be reported in the statement of financial position if Chan uses the equity method.

(b) Assuming Chan does not have signifi cant infl uence, determine the balance in the investment account at year end

and where it would be reported in the statement of fi nancial position if the fair value through profi t or loss model is

used. (c) Assuming Chan reports under ASPE and chooses the cost model because fair value cannot be determined

on December 31, determine the balance in the investment account at year end and where it would be reported in the

statement of fi nancial position.

BE12–9 Indicate on which fi nancial statement (the statement of fi nancial position, income statement, or statement of

changes in equity) each of the following accounts would be reported. Also give the appropriate fi nancial statement classifi

cation (such as current assets, non-current assets, shareholders’ equity, and other revenues and expenses). Assume all

trading investments are accounted for using the fair value through profi t or loss model.

Financial

Statement Classifi cation

A bond investment that will mature next year

Dividend revenue from a trading investment

Investment in associate

Investment of a few hundred common shares in a large publicly traded

company that is held for trading purposes

A bond investment that management intends to hold for 10 years

Realized gain on a trading investment

Unrealized gain on a trading investment

Dividends received from a strategic investment accounted for using

the equity method

Interest earned on a trading investment

BE12–10 Rosewater Corporation, a publicly traded company, reported a realized gain in the year ended April 30, 2015,

on the sale of a long-term bond investment that was held to earn interest revenue. For the same year, the company also

had an unrealized loss of $28,000 on its equity trading investments and $17,000 of revenue relating to its share of the

profi t of an associate. Th e accountant was not sure if these items should have been included in profi t or in other comprehensive

income. Identify whether each of the above items should be included in profi t or OCI. Would your answer change

if Rosewater made an election under IFRS to use fair value through OCI for the trading investments?

BE12–11 Sabre Corporation, which reports under IFRS, has the following investments at December 31, 2015:

  1. Trading investments: common shares of National Bank, cost $25,000, fair value $29,000.
  2. Investment in an associate (40% ownership): common shares of Sword Corp., cost $110,000, fair value cannot be

determined as the shares do not trade publicly. Investment was purchased on January 1, 2015. For the year ended

December 31, 2015, Sword Corp. reported profi t of $25,000 and paid out dividends of $8,000.

  1. Equity investment: common shares of Epee Inc. (18% ownership) purchased on July 1, 2015, cost $210,000, fair value

at December 31, 2015, $275,000. Management intends to purchase more shares of Epee in two years. Epee earned

$21,000 for the year ended December 31, 2015, and paid out dividends of $1,000, which were received at the end of

each quarter in 2015.

  1. Bond investment that is to be held to maturity: bonds of Ghoti Ltd., purchased at a cost equal to its maturity value of

$160,000, fair value $172,000.

Prepare a partial statement of fi nancial position for Sabre Corporation at December 31, 2015.

BE12–12 Brookfield Asset Management Inc., a publicly traded company, reported in its financial statements for

the year ended December 31, 2012, the following information: purchases of investments in associates, $1,232 million;

share of profit of associates, $1,243 million; dividends received from associates, $375 million; investment in associates

at year end, $11,689 million. Explain how each of these amounts should be reported in Brookfield’s financial

statements.

*BE12–13 On June 30, $150,000 of fi ve-year, 10% Orbite bonds are issued at $138,960 to yield a market interest rate of

12%. Interest is payable semi-annually each June 30 and December 31. (a) Record the purchase of these bonds on June 30

and the receipt of the fi rst interest payment on December 31 on the books of the investor assuming the bonds are to be

held to maturity. (b) Record the issue of the bonds on June 30 and the fi rst interest payment on December 31 on the books

of the investee (issuer).

Exercises

E12–1 Gleason Telecommunications Ltd. has several investments in debt and equity securities of other companies:

  1. 15% of the common shares of Morrison Telecommunications Inc., with the intent of purchasing at least 10% more of

the common shares because Gleason has already been allowed to appoint one of its executives to a seat on Morrison’s

board of directors

  1. 100% of the 15-year bonds issued by Li Internet Ltd., intended to be held for 15 years
  2. 95% of the common shares of Barlow Internet Services Inc.
  3. 120-day treasury bills, purchased for interest income
  4. 10% of the common shares of Talk to Us Ltd., to be sold if the share price increases

Instructions

Indicate whether each of the above investments is a (a) debt or equity investment, and (b) non-strategic or strategic

investment.

E12–2 Kroshka Holdings Corporation has several investments in debt and equity securities of other companies:

  1. 10-year BCE bonds, intended to be held until the bonds mature
  2. 10-year GE bonds, intended to be sold if interest rates go down
  3. 5-year Government of Canada bonds, intended to be sold if cash is needed, which is likely
  4. 180-day treasury bill
  5. Bank of Montreal preferred shares, purchased for the dividend income
  6. TMX common shares, purchased to sell in the near term at a profi t. Th ese shares are part of an investment portfolio

that is actively traded.

Instructions

(a) Indicate whether each of the above investments is a non-strategic or strategic investment.

(b) For each investment that you classifi ed as non-strategic in part (a), indicate whether it is a trading investment, an investment

that will be held until maturity to earn interest, or an investment that does not relate to these two categories.

(c) Indicate whether each of the above investments would be classifi ed as a current or non-current asset on Kroshka

Holdings’ statement of fi nancial position.

E12–3 Matthews Ltd. purchased $700,000 of 10-year, 10% bonds on July 1, 2015, at 106.5 (this means 106.5%

of maturity value). Th e purchase price was based on a market interest rate of 9%. Interest is received semi-annually on

January 1 and July 1. Th e bonds were trading at 107 at December 31, 2015. Matthews intends to trade the bonds in the near

future and is using the fair value through profi t or loss model.

Instructions

(a) Record the purchase of the bonds.

(b) Record any required adjusting journal entries at December 31.

E12–4 During the year ended December 31, 2015, McCormick Inc. had the following transactions for its trading

investments:

Jan. 1 Purchased 2,000 Starr Corporation $5, preferred shares for $210,000 cash.

Apr. 1 Received quarterly cash dividend.

July 1 Received quarterly cash dividend.

2 Sold 500 Starr shares for $57,000 cash.

Oct. 1 Received quarterly cash dividend.

Nov. 22 Starr declared the quarterly dividend on November 22, to preferred shareholders

of record on December 15, payable on January 1.

Dec. 31 Starr’s shares were trading at $115 per share.

Instructions

(a) Record the above transactions, using the fair value through profi t or loss model.

(b) Prepare any required adjusting entries at December 31. If no adjusting entries are required, explain why.

(c) On February 15, 2016, McCormick sold 500 Starr shares for $117 per share. Record the sale of the shares.

E12–5 At December 31, 2015, the trading investments for Yanik Inc. are as follows:

Security Cost Fair Value

A $18,500 $21,000

B 12,500 14,000

C 21,000 19,000

Totals $52,000 $54,000

Instructions

(a) Prepare the adjusting entry at December 31 to report the trading investment portfolio at fair value.

(b) Show the fi nancial statement presentation of the trading investments and any related accounts at December 31, 2015.

(c) On March 22, 2016, Yanik sold security A for $22,000 cash. Record the sale of the security.

E12–6 Aurora Cosmetics Ltd. acquired 40% of Diner Corporation’s 30,000 common shares for $16 per share on January 1,

  1. On June 15, Diner paid a cash dividend of $70,000 and Aurora received its share of the dividend on the same day. On

December 31, Diner reported profi t of $150,000 for the year. At December 31, Diner’s shares were trading at $20 per share.

Aurora accounts for this investment using the equity method.

Aurora Cosmetics also acquired 15% of the 200,000 common shares of Bell Fashion Ltd. for $28 per share on March 18, 2015.

On June 30, Bell paid a $150,000 dividend. On December 31, Bell reported profi t of $320,000 for the year. At December 31,

Bell’s shares were trading at $26 per share. Aurora intends to hold onto the Bell shares as a long-term investment for the

dividend income. Aurora uses the fair value through profi t or loss model for this investment.

Instructions

Record the above transactions for the year ended December 31, 2015.

E12–7 Lovell Corporation purchased 200,000 of the 1 million common shares of Abacus Ltd. on October 1, 2015, at

$2.50 per share. Near the end of the fourth quarter, Abacus declared and paid dividends on its common shares of $80,000.

Lovell received its share of the dividends on December 29. Abacus also announced that it had profi t for the quarter ending

December 31, 2015, of $200,000.

Instructions

Record the journal entries that Lovell would make during the last quarter ending December 31, 2015, under the following

assumptions:

(a) Lowell has signifi cant infl uence over Abacus and uses the equity method to account for this investment.

(b) Lowell does not have signifi cant infl uence over Abacus and uses the cost model to account for this investment.

E12–8 Grimsby Holdings Ltd., a publicly traded company, has two portfolios of investments: trading investments using

the fair value through profi t or loss model and investments in associates using the equity method. Information regarding

these two portfolios is shown below:

Trading

Investments

Investment

in Associates

Balance, beginning of year $100,000 $300,000

Purchases of investments during the year 30,000 40,000

Proceeds from sale of investments during the year 55,000 32,000

Realized gain (loss) on sale of investments 12,000 (10,000)

Dividends received 3,000 8,000

Share of associates’ profi t 43,000

Fair value of portfolio, end of year 94,000 350,000

(a) Calculate the ending balance for each investment category at the end of the year.

(b) Record the journal entries for each event described in the table above.

(c) Present the amounts that would be reported on the income statement and statement of fi nancial position at year end.

E12–9 Cameco Corp., a publicly traded company and the world’s largest producer of uranium concentrates, has several

long-term investments, including a 100% investment in Cameco Europe, a 23.3% investment in UEX Corporation (a publicly

traded company that Cameco does not want to trade), and a 24% interest in GE-Hitachi Global Laser Enrichment LLC

(a private corporation with no determinable fair value that Cameco does not wish to trade).

Instructions

(a) Indicate whether each of the above investments should be accounted for using the cost model, the fair value through

profi t or loss model, or the equity method, and explain why.

(b) Which of the above investments, if any, should be consolidated with Cameco’s operations?

*E12–10 On June 30, 2015, Imperial Inc. purchased $500,000 of Acme Corp. 5% bonds at a price to yield a market interest

rate of 6%. Th e bonds pay interest semi-annually on June 30 and December 31, and mature on June 30, 2025. Imperial

plans to hold this investment until it matures. At December 31, 2015, which is the year end for both companies, the bonds

were trading at 93 (this means 93% of maturity value).

Instructions

(a) Calculate the present value (issue price) of the bonds on June 30, 2015.

(b) For Imperial, the investor, record

  1. the purchase of the bonds on June 30, 2015,
  2. the receipt of interest on December 31, 2015, and
  3. the receipt of interest on June 30, 2016.

(c) For Acme, the investee (issuer), record

  1. the issue of the bonds on June 30, 2015,
  2. the payment of interest on December 31, 2015, and
  3. the payment of interest on June 30, 2016.

(d) Explain how your responses to parts (a) and (b) would diff er if Imperial classifi ed the bond investment as a trading

investment instead of one that would be held until maturity.

Problems: Set A

P12–1A Th e following Givarz Corporation transactions are for bonds that were purchased as trading investments for the

year ended December 31, 2015:

Feb. 1 Purchased $100,000 of Leslye Corporation 9% bonds at 104 (this means 104% of maturity value).

Interest is received semi-annually on August 1 and February 1. Th e bonds mature on February 1, 2017.

Aug. 1 Received interest on Leslye bonds.

2 Sold $40,000 of the Leslye bonds at 102.

Dec. 31 Accrued interest on the remaining bonds.

31 Th e fair value of the remaining bonds was 100 on this date.

Instructions

(a) Record the above transactions, using the fair value through profi t or loss model including required adjusting entries (if any).

(b) Show how the investments would be presented on the statement of fi nancial position at December 31, 2015.

(c) Determine the balance in each of the income statement accounts that are aff ected in the transactions above and indicate

how they would be presented on the income statement for the year ended December 31, 2015.

P12–2A During 2015, Kakisa Financial Corporation had the following trading investment transactions:

Feb. 1 Purchased 600 CBF common shares for $36,000.

Mar. 1 Purchased 800 RSD common shares for $24,000.

Apr. 1 Purchased 7% MRT bonds at face value, for $60,000. Interest is received semi-annually on April 1

and October 1.

July 1 Received a cash dividend of $3 per share on the CBF common shares.

Aug. 1 Sold 200 CBF common shares at $58 per share.

Sept. 1 Received a cash dividend of $1.50 per share on the RSD common shares.

Oct. 1 Received the semi-annual interest on the MRT bonds.

1 Sold the MRT bonds for $62,000.

Dec. 31 Th e market prices of the CBF and RSD common shares were $55 and $31 per share, respectively.

Instructions

(a) Record the above transactions, including any required adjusting entries, using the fair value through profi t or loss

model.

(b) Show how the investments would be presented on the statement of fi nancial position at December 31, 2015.

(c) Determine the balance in each of the income statement accounts that are aff ected in the transactions above and indicate

how they would be presented on the income statement for the year ended December 31, 2015.

P12–3A Data for Kakisa Financial’s trading investments in 2015 are presented in P12–2A. Kakisa had the following trading

investment transactions in 2016:

Mar. 1 Sold 400 CBF common shares for $23,600.

June 1 Purchased 2,000 KEF common shares for $28,000.

Sept. 1 Received a cash dividend of $1.50 per share on the RSD common shares.

Oct. 1 Sold 400 RSD common shares for $12,500.

Dec. 1 Th e market prices of the RSD and KEF common shares were $33 and $11

per share, respectively.

Instructions

(a) Record the above transactions including any required adjusting entries, continuing the use of the fair value through

profi t or loss model.

(b) Show how the investments would be presented on the statement of fi nancial position at December 31, 2016.

(c) Determine the balance in each of the income statement accounts that are aff ected in the transactions above and indicate

how they would be presented on the income statement for the year ended December 31, 2016.

P12–4A On December 31, 2015, Val d’Or Ltée held the following debt and equity investments:

Quantity Cost per Unit Fair Value per Unit

Debt Securities

Dominion bonds 2,000 $100 $ 97

Government of Canada bonds 1,000 100 135

Equity Securities

Bank of Calgary 2,000 55 61

Matco Inc. 5,000 29 32

Argenta Corp. 5,000 36 40

Instructions

(a) Calculate the cost and fair value of Val d’Or’s investment portfolio at December 31.

(b) If Val d’Or considers its entire portfolio to be trading investments, at what value should the investments be reported

on the statement of fi nancial position at December 31 if it uses the fair value through profi t or loss model? At what

amount, and where, should any unrealized gains or losses on the debt securities be reported?

(c) If Val d’Or intends to hold the debt securities until maturity and uses the amortized cost model, at what value should

the debt investments be reported on the statement of fi nancial position at December 31? At what amount, and where,

should any unrealized gains or losses be reported?

(d) If all of the investments held by Val d’Or related to private companies and no fair value information relating to these securities

could be obtained, what would be the impact on the income statement and on the statement of fi nancial position?

P12–5A Lai Inc. had the following investment transactions:

  1. Purchased Chang Corporation preferred shares as a trading investment and accounts for them using the fair value

through profi t or loss model.

  1. Received a cash dividend on the Chang preferred shares.
  2. Purchased Government of Canada bonds for cash, intending to hold them until maturity and account for them using

the amortized cost model.

  1. Accrued interest on the Government of Canada bonds.
  2. Sold half of the Chang preferred shares at a price less than originally paid.
  3. On the fi rst day of the year, purchased 25% of Xing Ltd.’s common shares, which was enough to achieve signifi cant

infl uence and account for the investment using the equity method.

  1. Received Xing’s fi nancial statements, which reported a net loss for the year.
  2. Received a cash dividend from Xing.
  3. Th e fair value of Chang’s preferred shares was lower than cost at year end.
  4. Th e fair value of the Government of Canada bonds was higher than amortized cost at year end and the fair value of

Xing Ltd.’s common shares is unknown

Instructions

(a) Using the following table format, indicate whether each of the above transactions would result in an increase (1), a

decrease (2), or have no eff ect (NE) on the specifi c element in the statement. Th e fi rst one has been done for you as

an example.

Statement of Financial Position Income Statement

Assets Liabilities

Shareholders’

Equity

Revenues

and Gains

Expenses

and Losses Profi t

  1. (1/2) NE NE NE NE NE NE

(b) If the company were reporting under IFRS, would any alternative(s) to the models chosen be allowed? Explain.

(c) If the company were reporting under ASPE, would any alternative(s) to the models that were initially chosen be

allowed? Explain.

P12–6A Drummond Services Ltd. acquired 25% of the common shares of Bella Roma Ltd. on January 1, 2015, by paying

$1.8 million for 100,000 shares. Bella Roma paid a $0.50-per-share cash dividend in each quarter that was received on

March 15, June 15, September 15, and December 15. Bella Roma reported profi t of $1.1 million for the year. At December 31,

the market price of the Bella Roma shares was $17 per share.

Instructions

(a) Prepare the journal entries for Drummond Services for 2015, assuming Drummond cannot exercise signifi cant infl uence

over Bella Roma and uses the fair value through profi t or loss model.

(b) Prepare the journal entries for Drummond Services for 2015, assuming Drummond can exercise signifi cant infl uence

over Bella Roma and uses the equity method.

(c) What factors help determine whether a company has signifi cant infl uence over another company?

(d) Prepare the journal entries for Drummond Services for 2015, assuming that the company reports under ASPE and has

chosen to account for its investment using the cost model.

(e) Under ASPE, why do you think companies can choose to use the cost model?

(f) For parts (a), (b), and (d) above, track the movement in all accounts aff ected by this investment throughout 2015 in

columnar format, showing the balance in the accounts at the beginning of the year and the amount of each transaction

aff ecting the accounts during the year to arrive at the balance in the accounts at the end of the year.

P12–7A Hat Limited has a total of 200,000 common shares issued. On October 3, 2014, CT Inc. purchased a block of

these shares in the open market at $50 per share to hold as a long-term equity investment. Hat reported profi t of $575,000

for the year ended September 30, 2015, and CT received a $0.25-per-share dividend on that date. Hat’s shares were trading

at $53 per share at September 30, 2015.

Th is problem assumes three independent situations related to the accounting for this investment by CT:

Situation 1: CT purchased 25,000 Hat common shares.

Situation 2: CT purchased 70,000 Hat common shares.

Situation 3: CT purchased 200,000 Hat common shares.

Instructions

(a) For situation 1, is it likely that signifi cant infl uence has been achieved? If it has not been achieved, record all journal entries

relating to the investment for the year ended September 30, 2015, using the fair value through profi t or loss model.

If signifi cant infl uence is met, use the equity method to record these transactions. Track the movement throughout the

year in the investment account and any related investment revenue accounts in columnar format beginning with the

balance in these accounts at the beginning of the fi scal year and then listing transactions relating to these accounts to

arrive at the balance in these accounts at the end of the fi scal year.

(b) For situation 2, is it likely that signifi cant infl uence has been achieved? If it has not been achieved, record all journal entries

relating to the investment for the year ended September 30, 2015, using the fair value through profi t or loss model.

If signifi cant infl uence is met, use the equity method to record these transactions. Track the movement throughout the

year in the investment account and any related investment revenue accounts in columnar format beginning with the

balance in these accounts at the beginning of the fi scal year and then listing transactions relating to these accounts to

arrive at the balance in these accounts at the end of the fi scal year.

(c) When signifi cant infl uence is achieved, does the investment have to be accounted for using the equity method if the

investor is reporting under IFRS? Does this change if the investor is reporting under ASPE?

(d) For situation 3, is consolidation required? Why or why not? Do options to consolidation exist under IFRS? Do options

exist under ASPE?

(e) What does consolidation mean? What happens to the investment account when consolidation occurs? Whose name

will be on the consolidated fi nancial statements?

(f) What accounting models would most likely be used for each of the situations listed above if CT Inc. reported under

ASPE and the fair value of the Hat shares was unknown?

P12–8A Sandhu Travel Agency Ltd. has 400,000 common shares authorized and 120,000 shares issued on December 31,

  1. On January 2, 2015, Kang Inc. purchased shares of Sandhu Travel Agency for $40 per share. Kang intends to hold

these shares as a long-term investment.

Kang’s accountant prepared a trial balance as at December 31, 2015, under the assumption that Kang could not exercise

signifi cant infl uence over Sandhu Travel Agency. Under this assumption, the trial balance included the following

accounts and amounts related to the Sandhu investment:

Long-term investment $1,320,000

Dividend revenue 90,000

Unrealized gain on long-term investment 120,000

Instructions

(a) How many shares of Sandhu Travel Agency did Kang purchase on January 2? (Hint: Subtract the unrealized gain from

the investment account.)

(b) What percentage of Sandhu Travel Agency’s shares does Kang own?

(c) What was the amount of the cash dividend per share that Kang received from Sandhu Travel Agency in 2015?

(d) What was the fair value per share of the Sandhu Travel Agency shares at December 31, 2015?

(e) Assume that, aft er closely examining the situation, Kang’s auditors determine that Kang does have signifi cant infl uence

over Sandhu Travel Agency and the equity method should be used. Accordingly, the investment account balance

is adjusted to $1.4 million at December 31, 2015. What was the profi t reported by Sandhu Travel Agency for the year

ended December 31, 2015?

(f) Assuming that Kang does use the equity method, what amount will Kang report on its income statement for 2015 with

regard to this investment?

(g) How would your answer to part (f) change if Kang reported under ASPE and chose to use the cost model when

accounting for its investment in Sandhu because the shares did not trade in an active market?

*P12–9A On January 1, 2015, Jackson Corp. purchased $1.6 million of 10-year, 7% bonds for $1,658,157. Th e purchase

price was based on a market interest rate of 6.5%. Interest is received semi-annually on July 1 and January 1. Jackson’s year

end is September 30. Jackson intends to hold the bonds until January 1, 2025, the date the bonds mature. Th e bonds’ trading

value was $1,660,000 on September 30, 2015.

Instructions

(a) Record the purchase of the bonds on January 1, 2015.

(b) Prepare a bond amortization schedule for the term of the bonds.

(c) Prepare the entry to record the receipt of interest on July 1, 2015.

(d) Prepare any adjusting entries required at September 30, 2015.

(e) Prepare the entry to record the repayment of the bonds on January 1, 2025.

(f) Show the fi nancial statement presentation of the bonds at September 30, 2015.

*P12–10A Th e following bond transactions occurred during 2015 for the University of Higher Learning (UHL) and

Otutye Ltd.:

Feb. 1 UHL issued $10 million of fi ve-year, 8% bonds at 98 (this means 98% of maturity value). Th e

bonds pay interest semi-annually on August 1 and February 1 and were sold at a discount

because the market interest rate was 8.5%.

1 Otutye Ltd. purchased $3 million of UHL’s bonds at 98 as a long-term investment that was to be

held to maturity.

Aug. 1 Th e semi-annual interest on the bonds was paid.

1 Aft er paying the semi-annual interest on the bonds on this date, UHL decided to repurchase $3

million of its bonds and retire them. UHL repurchased all $3 million of the bonds from Otutye

at 99.

Instructions

(a) Prepare all required journal entries for Otutye Ltd., the investor, to record the above transactions.

(b) How would the journal entries for Otutye Ltd. change if the investment had been purchased for trading purposes?

(c) Prepare all required entries for UHL, the investee, to record the above transactions.

(d) Comment on the diff erences in recording that you observe between the investor and the investee.

 

Problems: Set B

P12–1B Th e following Liu Corporation transactions are for bonds that were purchased as trading investments for the

year ended December 31, 2015:

Jan. 1 Purchased $100,000 of RAM Corporation 8% bonds at 96 (this means 96% of maturity value).

Interest is received semi-annually on July 1 and January 1. Th e bonds mature on January 1, 2017.

July 1 Received interest on the RAM bonds.

2 Sold $25,000 of RAM bonds at 100.

Dec. 31 Accrued interest on the remaining bonds.

31 Th e fair value of the remaining bonds was 101 on this date.

Instructions

(a) Record the above transactions, including any required adjusting entries, using the fair value through profi t or loss

model.

(b) Show how the investments would be presented on the statement of fi nancial position at December 31, 2015.

(c) Determine the balance in each of the income statement accounts that are aff ected in the transactions above and indicate

how they would be presented on the income statement for the year ended December 31, 2015.

P12–2B During 2015, Cheque Mart Ltd. had the following trading investment transactions:

Feb. 1 Purchased 1,000 IBF common shares for $30,000.

Mar. 1 Purchased 500 RST common shares for $29,000.

Apr. 1 Purchased 6% CRT bonds at face value, for $90,000. Interest is received semi-annually on April 1

and October 1.

July 1 Received a cash dividend of $2 per share on the IBF common shares.

Aug. 1 Sold 350 IBF common shares at $33 per share.

Sept. 1 Received a cash dividend of $1.50 per share on the RST common shares.

Oct. 1 Received the semi-annual interest on the CRT bonds.

1 Sold the CRT bonds for $86,000.

Dec. 31 Th e market prices of the IBF and RST common shares were $28 and $62 per share, respectively.

Instructions

(a) Record the above transactions, including any required adjusting entries, using the fair value through profi t or loss

model.

(b) Show how the investments would be presented on the statement of fi nancial position at December 31, 2015.

(c) Determine the balance in each of the income statement accounts that are aff ected in the transactions above and indicate

how they would be presented on the income statement for the year ended December 31, 2015.

P12–3B Data for Cheque Mart’s trading investments in 2015 are presented in P12–2B. Cheque Mart had the following

trading investment transactions in 2016:

Mar. 1 Sold 650 IBF common shares for $22,100.

June 1 Purchased 2,000 DEF common shares for $18,000.

Sept. 1 Received a cash dividend of $1.50 per share on the RST common shares.

Oct. 1 Sold 250 RST common shares for $14,250.

Dec. 31 Th e market prices of the RST and DEF common shares were $56 and $12 per share, respectively.

Instructions

(a) Record the above transactions, including any required adjusting journal entries, continuing the use of the fair value

through profi t or loss model.

(b) Show how the investments would be presented on the statement of fi nancial position at December 31, 2016.

(c) Determine the balance in each of the income statement accounts that are aff ected in the transactions above and indicate

how they would be presented on the income statement for the year ended December 31, 2016.

P12–4B On January 1, 2015, Sturge Enterprises Inc. held the following debt and equity investments:

Security Quantity Cost per Unit

Ajax Ltd. shares 1,500 $12

Beta Corp. shares 2,000 7

During the year, Sturge made the following purchases:

Security Quantity Cost per Unit

Ajax Ltd. shares 1,200 $ 11

Ajax Ltd. shares 1,000 9

Ajax Ltd. shares 1,000 10

Beta Corp. shares 500 8

Citrus Inc. bonds 300 100

Th ere were no diff erences between cost and fair value at January 1, 2015. Th e market prices of the various securities at

year end, December 31, 2015, were as follows: Ajax shares $6; Beta shares $9; and Citrus bonds $107 (this means 107% of

maturity value).

Instructions

(a) Calculate the cost and fair value of Sturge Enterprises’ investment portfolio at December 31.

(b) If Sturge Enterprises considers its entire portfolio to be trading investments and uses the fair value through profi t or

loss model, at what value should these investments be reported on the statement of fi nancial position at December 31?

At what amount, and where, should any unrealized gains or losses be reported?

(c) If Sturge Enterprises intends to hold the Citrus bonds until they mature and uses the amortized cost model, at what

value should these bonds be reported on the statement of fi nancial position at December 31? At what amount, and

where, should any unrealized gains or losses on the bonds be reported?

(d) If all of the investments held by Sturge Enterprises related to private companies and no fair value information related

to these securities could be obtained, what would be the impact on the income statement and on the statement of

fi nancial position?

P12–5B Olsztyn Inc. had the following investment transactions:

  1. Purchased Arichat Corporation common shares as a trading investment and accounts for them using the fair value

through profi t or loss model.

  1. Received a cash dividend on Arichat common shares.
  2. Purchased Bombardier bonds intending to hold them to maturity and account for them using the amortized cost

model.

  1. Received interest on Bombardier bonds.
  2. Sold half of the Bombardier bonds at a price greater than originally paid.
  3. On the fi rst day of the year, purchased 40% of LaHave Ltd.’s common shares, which was enough to achieve signifi cant

infl uence and account for the investment using the equity method.

  1. Received LaHave’s fi nancial statements, which reported profi t for the year.
  2. Received a cash dividend from LaHave.
  3. Th e fair value of Arichat’s common shares was higher than cost at year end.
  4. Th e fair value of Bombardier’s bonds was lower than their amortized cost at year end and the fair value of LaHave

Ltd.’s common shares is unknown.

Instructions

(a) Using the following table format, indicate whether each of the above transactions would result in an increase (1), a

decrease (2), or have no eff ect (NE) on the specifi c element on the statement. Th e fi rst one has been done for you as

an example.

Statement of Financial Position Income Statement

Assets Liabilities

Shareholders’

Equity

Revenues

and Gains

Expenses

and Losses Profi t

  1. (1/2) NE NE NE NE NE NE

(b) If the company were reporting under IFRS, would any alternative(s) to the models chosen above be allowed? Explain.

(c) If the company were reporting under ASPE, would any alternative(s) to the models that were initially chosen be

allowed? Explain.

P12–6B Cassidy Concrete Corp. acquired 20% of Enda Inc.’s common shares on January 1, 2015, by paying

$3 million for 100,000 shares. Enda paid a $0.50-per-share cash dividend, which Cassidy received on June 30 and again

on December 31. Enda reported profi t of $1,680,000 for the year. At December 31, the market price of the Enda shares

was $31 per share.

Instructions

(a) Prepare the journal entries for Cassidy Concrete for 2015, assuming Cassidy cannot exercise signifi cant infl uence over

Enda and uses the fair value through profi t or loss model.

(b) Prepare the journal entries for Cassidy Concrete for 2015, assuming Cassidy can exercise signifi cant infl uence over

Enda and uses the equity method.

(c) What factors help determine whether a company has signifi cant infl uence over another company?

(d) Prepare the journal entries for Cassidy Concrete for 2015, assuming that the company reports under ASPE and has

chosen to account for its investment using the cost model because the shares did not trade in an active market.

(e) Under ASPE, why do you think companies can choose to use the cost model?

(f) For parts (a), (b), and (d) above, track the movement in all accounts affected by this investment throughout

2015 in columnar format, showing the balance in the accounts at the beginning of the year and the amount of

each transaction affecting the accounts during the year to arrive at the balance in the accounts at the end of the

year.

P12–7B Sub Corporation has a total of 500,000 common shares issued. On January 2, 2015, Partridge Inc. purchased a

block of these shares in the open market at $10 per share to hold as a long-term equity investment. At the end of 2015, Sub

Corporation reported profi t of $350,000 and Partridge received a $0.50-per-share dividend from Sub. Sub Corporation’s

shares were trading at $12 per share at December 31, 2015.

Th is problem assumes three independent situations related to the accounting for this investment by Partridge:

Situation 1: Partridge purchased 60,000 Sub common shares.

Situation 2: Partridge purchased 125,000 Sub common shares.

Situation 3: Partridge purchased 500,000 Sub common shares.

Instructions

(a) For situation 1, is it likely that signifi cant infl uence has been achieved? If it has not been achieved, record all journal entries

relating to the investment for the year ended December 31, 2015, using the fair value through profi t or loss model.

If signifi cant infl uence is met, use the equity method to record these transactions. Track the movement throughout the

year in the investment account and any related investment revenue accounts in columnar format beginning with the

balance in these accounts at the beginning of the fi scal year and then listing transactions relating to these accounts to

arrive at the balance in these accounts at the end of the fi scal year.

(b) For situation 2, is it likely that signifi cant infl uence has been achieved? If it has not been achieved, record all journal entries

relating to the investment for the year ended December 31, 2015, using the fair value through profi t or loss model.

If signifi cant infl uence is met, use the equity method to record these transactions. Track the movement throughout the

year in the investment account and any related investment revenue accounts in columnar format beginning with the

balance in these accounts at the beginning of the fi scal year and then listing transactions relating to these accounts to

arrive at the balance in these accounts at the end of the fi scal year.

(c) When signifi cant infl uence is achieved, does the investment have to be accounted for using the equity method if the

investor is reporting under IFRS? Does this change if the investor is reporting under ASPE?

(d) For situation 3, is consolidation required? Why or why not? Do options to consolidation exist under IFRS? Do options

exist under ASPE?

(e) What does consolidation mean? What happens to the investment account when consolidation occurs? Whose name

will be on the consolidated fi nancial statements?

(f) What accounting models would most likely be used for each of the situations listed above if Partridge Corporation

reported under ASPE and the fair value of the Sub shares was unknown?

P12–8B On January 2, 2015, Hadley Inc. purchased shares of Letourneau Cycles Corp. for $10 per share. Hadley intends

to hold these shares as a long-term investment. During 2015, Letourneau Cycles reported profi t of $1 million and paid cash

dividends of $200,000. Th e investment’s fair value at December 31, 2015, was $950,000.

Hadley’s accountant prepared a trial balance as at December 31, 2015, under the assumption that Hadley should use

the equity method because it could exercise signifi cant infl uence over Letourneau Cycles. Under this assumption, the trial

balance included the following accounts and amounts:

Investment in associates $960,000

Investment revenue 200,000

Instructions

(a) What percentage of the Letourneau Cycles shares does Hadley own? (Hint: Th e ownership percentage can be determined

using the investment revenue and Letourneau’s profi t.)

(b) What was the amount of the cash dividend that Hadley received from Letourneau Cycles during 2015?

(c) How many shares of Letourneau Cycles did Hadley purchase on January 2?

(d) What questions need to be asked to determine if Hadley has signifi cant infl uence over Letourneau Cycles?

(e) Assume that, aft er closely examining the situation, Hadley’s auditors determine that Hadley does not have signifi cant

infl uence over Letourneau Cycles. What amount should be reported on Hadley’s statement of fi nancial position at

December 31 for its investment in Letourneau Cycles assuming that the fair value through profi t and loss model was

used? What will be reported on Hadley’s income statement for 2015?

(f) How would your answer to part (e) change if Hadley reported under ASPE and chose to use the cost model when

accounting for its investment in Letourneau assuming that the shares did not trade in an active market?

*P12–9B On January 1, 2015, Morissette Inc. purchased $800,000 of 10-year, 6% bonds for $770,921. Th e purchase price

was based on a market interest rate of 6.5%. Interest is received semi-annually on July 1 and January 1. Morissette’s year

end is October 31. Morissette intends to hold the bonds until January 1, 2025, the date the bonds mature. Th e bonds’ fair

value on October 31, 2015, was $790,000.

Instructions

(a) Record the purchase of the bonds on January 1, 2015.

(b) Prepare a bond amortization schedule for the term of the bonds.

(c) Prepare the entry to record the receipt of interest on July 1, 2015.

(d) Prepare any adjusting entries required at October 31, 2015.

(e) Prepare the entry to record the repayment of the bonds on January 1, 2025.

(f) Show the fi nancial statement presentation of the bonds at October 31, 2015.

*P12–10B On January 1, 2015, CASB Incorporated issued $1 million of 10-year, 8% bonds at 102 (this means 102% of

maturity value). Th ey were sold at a premium because the market interest rate was 7.7%. Th e bonds pay interest semiannually

on June 30 and December 31. On January 1, Densmore Consulting Ltd. purchased $200,000 of CASB bonds at

102 as a trading investment. On July 1, aft er receiving the bond interest, Densmore Consulting sold its CASB bonds at 103.

Both companies have a December 31 year end.

Instructions

(a) Prepare all required entries for Densmore Consulting, the investor, to record the above transactions.

(b) How would the journal entries for Densmore Consulting change if the investment had been purchased with the intent

of holding it to maturity?

(c) Prepare all required entries for CASB, the investee, to record the above transactions.

(d) Comment on the diff erences in recording that you observe between the investor and the investee

 

=======================================================================

 

CHAPTER 13 Statement of Cash Flows

 

Questions

(SO 1) 1. What is a statement of cash fl ows and why is it

useful?

(SO 1) 2. What are “cash equivalents”? Should a company

combine cash equivalents with cash when preparing

the statement of cash fl ows? Explain why

or why not.

(SO 1) 3. Explain the diff erences among the three categories

of activities—operating, investing, and fi nancing—

reported in the statement of cash fl ows.

(SO 1) 4. Private companies following ASPE can classify

interest and dividends diff erently than can

companies following IFRS. Explain how these

classifi cations can diff er and identify the most

commonly used classifi cation(s).

(SO 1) 5. Masood and Adriana were discussing where they

should report signifi cant noncash investing and

fi nancing transactions in Rock Candy Corp.’s

statement of cash fl ows. Give two examples

of these transactions and describe where they

should be reported.

(SO 2) 6. (a) Identify whether each of the following is used

in the preparation of a statement of cash fl ows:

(1) the adjusted trial balance, (2) the statement

of fi nancial position, (3) the income statement,

(4) the statement of comprehensive income, and

(5) the statement of changes in equity. (b) Explain

how each of the items identifi ed in part (a) is

used in the preparation of the statement of cash

fl ows.

(SO 2) 7. Goh Corporation changed its method of

reporting operating activities from the indirect

method to the direct method in order to make

its statement of cash fl ows more informative to

its readers. Will this change increase, decrease,

or not aff ect the net cash provided (used) by

operating activities?

(SO 2) 8. In 2012, Clearwater Seafoods Incorporated,

one of Canada’s largest seafood companies,

reported $22,704 thousand of profi t. During the

same period of time, its cash provided by operating

activities, of $48,141 thousand, was more

than twice the amount of profi t. Explain how this

could occur.

(SO 2a) 9. Describe the indirect method for determining

net cash provided (used) by operating activities.

(SO 2a) 10. Why and how is depreciation and amortization

expense reported in the operating activities

section of a statement of cash fl ows prepared

using the indirect method?

(SO 2a) 11. Th e gain on the disposal of equipment is deducted

from profi t when calculating net cash

provided (used) by operating activities in the indirect

method. Jacques doesn’t understand why

gains aren’t added, rather than deducted, on the

statement of cash fl ows since they result in an

increase in profi t on the income statement. He

also doesn’t understand why only the gain and

not the proceeds from the entire disposal of the

equipment is reported in the operating activities

section. Help Jacques understand the reporting

of the disposal of equipment on the statement of

cash fl ows.

(SO 2b) 12. Describe the direct method for determining net

cash provided (used) by operating activities.

(SO 2b) 13. Under the direct method, why is depreciation

and amortization expense not reported in the

operating activities section?

(SO 2, 3) 14. Denis says, “I understand that operating activities

are aff ected by changes in current asset and

current liability accounts. I also know that

trading investments are current assets and that

the purchase and sale of trading investments are

recorded as operating activities. What I don’t

understand is why the purchase and sale of

investments that are not held for trading are usually

classifi ed as investing activities.” Help Denis

understand the classifi cation of investments.

  1. Explain how (a) the disposal of equipment at a gain,

and (b) the loss on disposal of land are reported on

a statement of cash fl ows using the direct method.

(SO 2, 4) 16. Laurel says, “I understand that operating activities

are aff ected by changes in current asset and

current liability accounts. I also know that

short-term loans payable are current liabilities.

What I don’t understand is why short-term loans

are not always classifi ed as operating activities.

Occasionally they are classifi ed as operating activities

but mostly they are classifi ed as fi nancing

activities.” Help Laurel understand the classifi cation

of short-term loans payable.

  1. In general, would you expect a growing company to

report positive or negative cash fl ows from its operating,

investing, and fi nancing activities? Explain.

(SO 5) 18. Explain how the statement of cash fl ows interrelates

with the other fi nancial statements.

(SO 6) 19. Give examples of cash- and accrual-based ratios

that measure (a) liquidity, and (b) solvency.

(SO 6) 20. In 2012, Leon’s Furniture Limited reported a

current ratio of 2.9:1 and a cash current debt

coverage ratio of 0.4 times. Explain why Leon’s

cash current debt coverage is likely so much

lower than its current ratio.

(SO 6) 21. In 2012, Rogers Communications Inc. reported

a debt to total assets ratio of 81% and a cash total

debt coverage ratio of 0.2 times. Its competitor,

Shaw Communications Inc., reported a debt

to total assets ratio of 68% and a cash total debt

coverage ratio of 0.1 times in the same year.

Based only on this information, which company

is more solvent?

(SO 6) 22. A company’s cash total debt coverage ratio and

free cash fl ow have been declining steadily over

the last fi ve years. What does this decline likely

mean to creditors and investors?

(SO 6) 23. How is it possible for a company to report positive

net cash provided by operating activities but

have a negative free cash fl ow?

 

Brief Exercises

BE13–1 For each of the following transactions, indicate whether it will result in an increase (1), decrease (2), or have

no eff ect (NE) on cash fl ows:

Indicate impact of

transactions on cash.

(SO 1)

Brief Exercises

(a) ______ Repayment of mortgage payable

(b) ______ Payment of interest on mortgage

(c) ______ Purchase of land in exchange for common shares

(d) ______ Issue of preferred shares

(e) ______ Purchase of a trading investment that is not a

cash equivalent

(f) ______ Collection of accounts receivable

(g) ______ Declaration of cash dividend

(h) ______ Payment of cash dividend (see item [g]

above)

(i) ______ Purchase of merchandise inventory

(j) ______ Recording of depreciation expense

BE13–2 Classify each of the transactions listed in BE13–1 as an operating (O), investing (I), fi nancing (F), or signifi cant

noncash investing and fi nancing (NC) activity. If a transaction does not belong in any of these classifi cations, explain why.

BE13–3 Mega Brands Inc. reported the following items on its statement of cash fl ows:

Classify activities.

(SO 1)

Classify activities.

(SO 1, 2a)

(a) ______ Depreciation expense

(b) ______ Increase in accounts receivable

(c) ______ Decrease in merchandise inventory in the

perpetual inventory system

(d) ______ Increase in accounts payable

(e) ______ Decrease in income tax payable

(f) ______ Gain on disposal of equipment

(g) ______ Loss on sale of long-term investment

(h) ______ Decrease in dividend payable

(i) ______ Impairment loss for goodwill

BE13–5 Th e comparative statement of fi nancial position for Dupigne Corporation shows the following noncash current

asset and liability accounts at March 31:

2015 2014

Accounts receivable $60,000 $40,000

Merchandise inventory 75,000 70,000

Prepaid expenses 6,000 4,000

Accounts payable 35,000 40,000

Interest payable 5,000 7,500

Income tax payable 17,000 12,000

Dupigne’s income statement reported the following selected information for the year ended March 31, 2015: profi t was

$275,000, depreciation expense was $60,000, and a loss on the disposal of land was $15,000. Dupigne uses a perpetual

inventory system. Calculate net cash provided (used) by operating activities using the indirect method.

BE13–6 Idol Corporation has accounts receivable of $14,000 at January 1, and of $24,000 at December 31. Sales revenues

were $170,000 for the year. What amount of cash was received from customers?

BE13–7 Columbia Sportswear Company reported cost of goods sold of U.S. $953,169 thousand on its 2012 income

statement. It also reported a decrease in merchandise inventory of U.S. $1,874 thousand and a decrease in accounts payable

of U.S. $6,733 thousand. What amount of cash was paid to suppliers, assuming that the company uses a perpetual inventory

system and that accounts payable relate to merchandise creditors?

BE13–8 Excellence Corporation reports operating expenses of $100,000, including depreciation expense of $15,000,

amortization expense of $2,500, and a gain of $500 on the disposal of equipment during the current year. During this same

period, prepaid expenses increased by $6,600 and accrued expenses payable decreased by $2,400. Calculate the cash payments

for operating expenses.

BE13–9 Home Grocery Limited reported income tax expense of $90,000 for the year. (a) Calculate the cash payments

for income tax assuming income tax payable increased by $2,000 during the year. (b) Repeat part (a), assuming income tax

payable decreased by $2,000 during the year.

BE13–10 Th e comparative statement of fi nancial position for Baird Corporation shows the following noncash current

asset and liability accounts at March 31:

2015 2014

Accounts receivable $60,000 $40,000

Merchandise inventory 64,000 70,000

Prepaid expenses 6,000 4,000

Accounts payable 35,000 40,000

Interest payable 4,000 5,000

Income tax payable 10,000 5,000

Baird’s income statement reported the following selected information for the year ended March 31, 2015: sales were

$850,000, cost of goods sold was $475,000, operating expenses were $230,000 (which included depreciation expense

of $20,000), interest expense was $50,000, and income tax expense was $15,000. Calculate net cash provided (used) by

operating activities using the direct method.

BE13–11 Th e T accounts for equipment and accumulated depreciation for Trevis Ltd. are shown here:

Equipment Accumulated Depreciation—Equipment

Beg. bal. 80,000 Disposals 20,000 Disposals 5,500 Beg. bal. 44,500

Acquisitions 40,000 Depreciation 20,000

End bal. 100,000 End bal. 59,000

In addition, Trevis’s income statement reported a $1,500 loss on the disposal of equipment. (a) What amount was reported

on the statement of cash fl ows as “cash provided by disposal of equipment”? (b) In what section of the statement of cash

fl ows would this transaction be reported?

BE13–12 Holmes Corporation reported the following information (in thousands) at December 31, 2015:

2015 2014

Long-term investments $150 $100

Land 200 200

Buildings 300 300

Accumulated depreciation—buildings 90 75

Equipment 500 400

Accumulated depreciation—equipment 200 200

Additional information:

  1. Long-term investments were purchased during the year; none were sold.
  2. Equipment was purchased during the year. In addition, equipment with a cost of $100 and a carrying amount of $50

was sold at a gain of $10.

Prepare the investing activities section of Holmes’s statement of cash fl ows for the year.

BE13–13 Canadian Tire Corporation, Limited reported a profi t of $499.2 million for the year ended December 29,

  1. Its retained earnings were $3,686.4 million at the beginning of the year and $4,074.4 million at the end of the year. It

had no dividends payable at the beginning or end of the year. Assuming no other changes to retained earnings, what amount

of dividends did Canadian Tire pay during the year? Would your answer change if you knew that the Dividends Payable

account increased during the year?

BE13–14 Nicoloff Corporation reported the following information (in thousands) at December 31, 2015:

2015 2014

Dividends payable $ 15 $ 10

Bank loan payable—current portion 200 200

Bank loan payable—non-current portion 400 300

Common shares 600 400

Retained earnings 700 500

Additional information:

  1. Th e bank loan was increased by additional borrowings of $300 to partially fi nance the purchase of new equipment

that cost $500. Th e bank loan was decreased by repayments.

  1. Common shares were issued during the year. None were reacquired.
  2. Dividends were paid during the year.
  3. Profi t for the year was $400.

Prepare the fi nancing activities section of Nicoloff ’s statement of cash fl ows for the year.

BE13–15 Jain Corporation reported net cash provided by operating activities of $325,000, net cash used by investing activities

of $250,000, and net cash provided by fi nancing activities of $70,000. In addition, cash spent for net capital expenditures during

the period was $200,000, and $25,000 of dividends were paid. Average current liabilities were $215,000 and average total liabilities

were $360,000. Calculate these values: (a) cash current debt coverage, (b) cash total debt coverage, and (c) free cash fl ow.

BE13–16 Big Rock Brewery reported the following selected liquidity ratios:

2012 2011

Current ratio 1.7:1 1.1:1

Cash current debt coverage 1.8 times 1.2 times

Both the current and cash current debt coverage ratios increased in 2012. What does this mean?

BE13–17 Bombardier Inc. reported the following selected solvency ratios:

2012 2011

Debt to total assets 94.7% 97.2%

Cash total debt coverage 0.1 times 0.0 times

Based on the above, has Bombardier’s solvency improved or deteriorated? Explain.

Exercises

E13–1 Eng Corporation had the following transactions:

(a) (b)

Cash Eff ect Classifi cation

  1. Issued common shares for $50,000.
  2. Purchased a machine for $30,000. Made a $5,000 down payment and issued

a long-term note payable for the remainder.

  1. Collected $16,000 of accounts receivable.
  2. Paid a $25,000 cash dividend.
  3. Sold a long-term investment with a carrying amount of $15,000 for $18,000.
  4. Sold merchandise inventory for $1,000.
  5. Paid $18,000 on accounts payable.
  6. Purchased a trading investment (equity securities) for $100,000.
  7. Purchased merchandise inventory for $28,000 on account.
  8. Collected $1,000 in advance from customers.

Instructions

(a) In the above table, indicate by how much each transaction increases (1) or decreases (2) cash. If the transaction has

no eff ect (NE) on cash, say so.

(b) Identify whether the transaction should be classifi ed as an operating activity (O), investing activity (I), fi nancing

activity (F), or noncash investing and fi nancing activity (NC).

E13–2 Crown Point Limited reports the following noncash transactions:

  1. Recorded an impairment loss on goodwill
  2. Recorded depreciation expense
  3. Recorded an unrealized gain on a trading investment carried at fair value through profi t or loss
  4. Purchased a new vehicle by signing a bank loan payable
  5. Declared and distributed a stock dividend
  6. Eff ected a 2-for-1 stock split
  7. Converted an account receivable to a note receivable
  8. Acquired equipment by issuing common shares

Instructions

For each of the above transactions, explain why it does not involve cash and where it should be reported, if at all, on the

statement of cash fl ows or accompanying notes.

E13–3 He Corporation had the following transactions:

(a) (b)

Profi t

Cash Provided (Used)

by Operating Activities

  1. Sold merchandise inventory for cash at a higher price than its cost. 1 1
  2. Collected cash in advance from a customer for a service to be

provided in the future.

  1. Purchased merchandise inventory on account in a perpetual

inventory system.

  1. Declared and paid dividends.
  2. Recorded and paid salaries.
  3. Recorded income tax payable.
  4. Accrued interest receivable.
  5. Recorded depreciation expense.
  6. Paid an amount owing on account to a supplier.
  7. Collected an amount owing from a customer.

Instructions

Complete the above table indicating whether each transaction will increase (1), decrease (2), or have no eff ect (NE) on

(a) profi t and (b) cash provided (used) by operating activities. Th e fi rst one has been done for you as an example.

E13–4 Th e following is a list of transactions that occurred during the year.

Operating

Activities

Investing

Activities

Financing

Activities

Noncash

Activities

  1. Purchased merchandise inventory for cash. 2 NE NE NE
  2. Sold merchandise inventory on account.
  3. Sold equipment for cash at a loss.
  4. Recorded depreciation on equipment.
  5. Paid dividends.
  6. Recorded an unrealized loss on a long-term equity

investment carried at fair value through profi t or

loss.

  1. Collected an account from a customer.
  2. Signed and received a mortgage payable.
  3. Paid, in full, the current portion of a mortgage

payable.

  1. Purchased land by issuing common shares.

Instructions

Complete the above table, indicating in which classifi cation(s) each transaction would appear in a statement of cash fl ows

prepared using the indirect method, and whether the transaction would be added to (1), deducted from (2), or have no

eff ect (NE) on the category you have chosen. Th e fi rst one has been done for you as an example.

E13–5 Selected information from Juno Ltd.’s statement of financial position and income statement is shown on

the following page:

JUNO LTD.

Statement of Financial Position (partial)

December 31

2015 2014

Current assets

Accounts receivable $7,000 $12,000

Merchandise inventory 5,900 4,500

Prepaid expenses 3,000 2,500

Current liabilities

Accounts payable 3,750 2,500

Income tax payable 1,200 800

Accrued liabilities 2,500 1,500

Bank loan payable—current portion 5,000 10,000

JUNO LTD.

Income Statement

Year Ended December 31, 2015

Net sales $190,000

Cost of goods sold 114,000

Gross profi t 76,000

Operating expenses 50,000

Profi t from operations 26,000

Interest expense 1,200

Profi t before income tax 24,800

Income tax expense 3,800

Profi t $ 21,000

Additional information:

  1. Th e bank loan was issued to fi nance the purchase of equipment.
  2. Operating expenses included depreciation expense of $11,000 and a loss of $5,000 on the disposal of equipment.

Instructions

Prepare the operating activities section of the statement of cash fl ows, using the indirect method.

E13–6 Th e following is a list of income statement accounts that must be converted from the accrual basis to the cash basis

in order to calculate cash provided (used) by operating activities using the direct method:

(a) (b)

Income Statement

Account

Change in Current Asset/

Current Liability Account

Add to (1) or Deduct

from (2) Income

Statement Account

Related Cash

Receipt or Payment

  1. Sales revenue Increase in accounts receivable _ Cash receipts from customers
  2. Dividend revenue Decrease in dividends receivable
  3. Interest revenue Increase in interest receivable
  4. Rent revenue Increase in unearned rent
  5. Cost of goods sold Increase in merchandise inventory
  6. Cost of goods sold Increase in accounts payable
  7. Insurance expense Increase in prepaid insurance
  8. Salaries expense Increase in salaries payable
  9. Interest expense Decrease in interest payable
  10. Income tax expense Increase in income tax payable

Instructions

For each of the above changes in a current asset or current liability account listed beside the related income statement

account, identify if (a) the change should be added to (1) or deducted from (2) the income statement account in order to

convert the accrual-based number to a cash-based number; and (b) the title of the resulting cash receipt or payment on the

statement of cash fl ows. Th e fi rst one has been done for you as an example.

E13–7 Th e following selected information is taken from the general ledger of Carnival Limited:

Convert operating

activities from accrual

to cash basis—direct

method.

(SO 2b)

Calculate cash fl ows—

direct method.

(SO 2b)

(a) Sales revenue $160,000

Accounts receivable, January 1 16,000

Accounts receivable, December 31 14,000

(b) Cost of goods sold $96,000

Merchandise inventory, January 1 9,200

Merchandise inventory, December 31 10,900

Accounts payable, January 1 11,500

Accounts payable, December 31 10,700

(c) Salaries expense $35,000

Salaries payable, January 1 500

Salaries payable, December 31 675

(d) Operating expenses $50,000

Accrued expenses payable, January 1 4,200

Accrued expenses payable, December 31 3,900

Prepaid expenses, January 1 2,600

Prepaid expenses, December 31 2,150

Instructions

Using the above information and the direct method, calculate the (a) cash receipts from customers, (b) cash payments to

suppliers, (c) cash payments to employees, and (d) cash payments for operating expenses.

E13–8 Th e comparative statement of fi nancial position for Charmaine Retailers Ltd. follows:

CHARMAINE RETAILERS LTD.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 18,000 $ 9,000

Accounts receivable 50,000 42,000

Merchandise inventory 168,000 143,000

Furniture 163,000 80,000

Accumulated depreciation (45,000) (24,000)

Total assets $354,000 $250,000

Liabilities and Shareholders’ Equity

Accounts payable $ 45,000 $ 35,000

Bank loan payable (noncurrent) 103,000 76,000

Common shares 60,000 55,000

Retained earnings 146,000 84,000

Total liabilities and shareholders’ equity $354,000 $250,000

Additional information:

  1. Profi t was $62,000 in 2015.
  2. Depreciation expense was $21,000 in 2015.
  3. Payments made to the bank pertaining to the bank loan were $10,000 in 2015. Some new loans were obtained that year.
  4. Common shares were issued in 2015 and no shares have been bought back by the company.
  5. In 2015, no furniture was sold.

Instructions

Prepare a statement of cash fl ows using the indirect method for 2015. Assess the strength of the company’s cash fl ows for

that year.

E13–9 Th e comparative statement of fi nancial position for Dagenais Retailers Ltd. follows:

DAGENAIS RETAILERS LTD.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 1,000 $ 18,000

Accounts receivable 76,000 50,000

Merchandise inventory 219,000 168,000

Furniture 130,000 163,000

Accumulated depreciation (35,000) (45,000)

Total assets $391,000 $354,000

Liabilities and Shareholders’ Equity

Accounts payable $ 58,000 $ 45,000

Bank loan payable (noncurrent) 100,000 103,000

Common shares 60,000 60,000

Retained earnings 173,000 146,000

Total liabilities and shareholders’ equity $391,000 $354,000

Additional information:

  1. Profi t was $32,000 in 2015.
  2. Depreciation expense was $19,000 in 2015.
  3. In 2015, no new bank loans were received.
  4. In 2015, no furniture was purchased, but some furniture was sold for $6,000, which resulted in a gain on this disposal

of $2,000.

  1. In 2015, dividends were declared and paid.

Instructions

Prepare a statement of cash fl ows using the indirect method for 2015. Assess the strength of the company’s cash fl ows for

that year.

E13–10 Selected information from Juno Ltd.’s statement of fi nancial position and income statement is found in E13–5.

In addition to the information contained in these statements, note the following:

  1. Prepaid expenses and accrued liabilities relate to operating expenses.
  2. Accounts payable relate to purchases of merchandise.
  3. Operating expenses included depreciation expense of $11,000 and a loss of $5,000 on the disposal of equipment.

Instructions

Prepare the operating activities section of the statement of cash fl ows, using the direct method.

E13–11 Th e following selected accounts are from Dupré Corp.’s general ledger:

Additional information:

July 31 Equipment with a cost of $70,000 was purchased for cash.

Sept. 2 Equipment with a cost of $53,000 was purchased and partially fi nanced through the issue of a

long-term bank loan payable.

Aug. 23 A $4,000 cash dividend was paid.

Nov. 10 A loss of $3,000 was incurred on the disposal of equipment.

Dec. 1 Acquired a small parcel of adjoining land.

31 Depreciation expense of $48,000 was recorded for the year.

31 Profi t for the year was $60,000.

Instructions

From the postings in the above accounts and additional information provided, indicate what information would be

reported in the investing and/or fi nancing activities sections of, and notes to, the statement of cash fl ows.

E13–12 Th e comparative unclassifi ed statement of fi nancial position for Puff y Ltd. follows:

PUFFY LTD.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 53,000 $ 22,000

Accounts receivable 80,000 76,000

Merchandise inventory 185,000 189,000

Land 70,000 100,000

Equipment 265,000 200,000

Accumulated depreciation (66,000) (32,000)

Total assets $587,000 $555,000

Liabilities and Shareholders’ Equity

Accounts payable $ 39,000 $ 47,000

Bank loan payable 150,000 200,000

Common shares 199,000 174,000

Retained earnings 199,000 134,000

Total liabilities and shareholders’ equity $587,000 $555,000

Additional information:

Prepare statement of

cash fl ows—indirect

and direct methods.

(SO 2a, 2b, 3, 4, 5)

  1. Profi t was $115,000.
  2. Sales were $978,000.
  3. Cost of goods sold was $751,000.
  4. Operating expenses were $43,000, exclusive of

depreciation expense.

  1. Depreciation expense was $34,000.
  2. Interest expense was $14,000.
  3. Income tax expense was $26,000.
  4. Land was sold at a gain of $5,000.
  5. No equipment was sold during the year.
  6. $50,000 of the bank loan was repaid during the year.
  7. Common shares were issued for $25,000.

Instructions

Prepare a statement of cash flows using (a) the indirect method, or (b) the direct method, as assigned by your

instructor.

E13–13 Condensed profi t and cash fl ow information follow for three companies operating in the same industry:

Company A Company B Company C

Profi t $ 75,000 $ 25,000 $(50,000)

Net cash provided (used) by operating activities 100,000 (25,000) (25,000)

Net cash provided (used) by investing activities (50,000) (25,000) 35,000

Net cash provided (used) by fi nancing activities (25,000) 75,000 15,000

Net increase in cash 25,000 25,000 25,000

Instructions

Which company is in better fi nancial condition? Explain the reasoning behind your decision.

E13–14 Information for two companies in the same industry, Ria Corporation and Les Corporation, is presented here:

Ria Corporation Les Corporation

Net cash provided by operating activities $200,000 $200,000

Average current liabilities 50,000 150,000

Average total liabilities 200,000 200,000

Net capital expenditures 20,000 35,000

Dividends paid 24,000 18,000

Instructions

(a) Calculate the cash current debt coverage ratio, cash total debt coverage ratio, and free cash fl ow for each company.

(b) Compare the liquidity and solvency of the two companies.

Problems: Set A

P13– 1A Th e following is a list of transactions that took place during the year:

(a)

Classifi cation

(b)

Cash Flow

(c)

Profi t

  1. Paid salaries to employees. O 2 2
  2. Sold land for cash, at a gain.
  3. Purchased a building by making a down payment in cash

and signing a mortgage payable for the balance.

  1. Made a principal repayment on the mortgage.
  2. Paid interest on the mortgage.
  3. Issued common shares for cash.
  4. Purchased shares of another company to be held as a

long-term non-strategic investment.

  1. Paid dividends to shareholders.
  2. Sold merchandise inventory on account, at a price greater

than cost. Th e company uses a perpetual inventory system.

  1. Wrote down the cost of the remaining inventory to its net

realizable value.

Instructions

(a) Classify each of the above transactions as an operating activity (O), investing activity (I), fi nancing activity (F), or

noncash investing and fi nancing activity (NC). If it does not fi t into one of these classifi cations, indicate that there is

no eff ect (NE). Th e fi rst one has been done for you as an example.

(b) Specify if the transaction will result in a cash receipt (1), cash payment (2), or have no eff ect on cash (NE).

(c) Indicate if the transaction will increase (1), decrease (2), or have no eff ect (NE) on profi t.

(d) Explain how it is possible for the same transaction to aff ect cash and profi t diff erently.

P13–2A Th e income statement for Whistler Ltd., a publicly traded company following IFRS, is presented here:

WHISTLER LTD.

Income Statement

Year Ended November 30, 2015

Sales $8,000,000

Cost of goods sold 5,000,000

Gross profi t 3,000,000

Operating expenses 2,000,000

Profi t from operations 1,000,000

Interest expense 100,000

Profi t before income tax 900,000

Income tax expense 300,000

Profi t $ 600,000

Additional information:

  1. Operating expenses include $75,000 of depreciation

expense and a $100,000 impairment loss on property,

plant, and equipment.

  1. Accounts receivable increased by $190,000.
  2. Merchandise inventory decreased by $50,000.
  3. Prepaid expenses related to operating expenses

increased by $40,000.

  1. Accounts payable to suppliers of merchandise decreased

by $180,000.

  1. Accrued liabilities related to operating expenses

decreased by $90,000.

  1. Interest payable decreased by $10,000.
  2. Unearned revenue that was received from customers

decreased by $17,000.

  1. Income tax payable increased by $20,000.

Instructions

(a) Prepare the operating activities section of the statement of cash fl ows, using either (1) the indirect method or (2) the

direct method, as assigned by your instructor.

(b) Would your answer in part (a) change if Whistler were a private company following ASPE?

P13–3A Th e income statement for Tremblant Limited is presented here:

TREMBLANT LIMITED

Income Statement

Year Ended December 31, 2015

Service revenue $925,000

Operating expenses 701,000

Profi t from operations 224,000

Interest expense 75,000

Profi t before income tax 149,000

Income tax expense 37,250

Profi t $111,750

Tremblant’s statement of fi nancial position contained these comparative data at December 31:

2015 2014

Accounts receivable $57,000 $47,000

Prepaid expenses 12,000 15,000

Accounts payable 36,000 41,000

Salaries payable 19,500 20,000

Unearned revenue 12,000 9,000

Interest payable 6,250 5,000

Income tax payable 4,000 9,250

Additional information:

  1. Operating expenses include depreciation expense, $50,000; amortization expense, $15,000; administrative expenses,

$110,000; salaries expense, $500,000; and loss on the disposal of equipment, $26,000.

  1. Unearned revenue is received from customers.
  2. Prepaid expenses and accounts payable relate to operating (administrative) expenses.

Instructions

(a) Prepare the operating activities section of the statement of cash fl ows, using either (1) the indirect method or (2) the

direct method, as assigned by your instructor.

(b) Which method—indirect or direct—do you recommend that this company use to prepare its operating activities section?

Explain your reasoning.

P13–4A Th e following selected account balances relate to the property, plant, and equipment accounts of Katewill Inc.:

2015 2014

Accumulated depreciation—buildings $337,500 $300,000

Accumulated depreciation—equipment 144,000 96,000

Depreciation expense—buildings 37,500 37,500

Depreciation expense—equipment 60,000 48,000

Land 100,000 60,000

Buildings 750,000 750,000

Equipment 300,000 240,000

Gain on disposal of equipment 5,000 0

Additional information:

  1. Purchased $40,000 of land for cash.
  2. Purchased $75,000 of equipment for a $10,000 down payment, fi nancing the remainder with a bank loan. Equipment

was also sold during the year.

Instructions

(a) Calculate any cash receipts or payments related to the property, plant, and equipment accounts in 2015.

(b) Indicate where each of the cash receipts or payments identifi ed in part (a) would be classifi ed on the statement of cash

fl ows or accompanying notes.

(c) Would you expect a growing company to be generating or using cash for its investing activities? Explain.

P13–5A Th e following selected account balances relate to the shareholders’ equity accounts of Valerio Corp.:

2015 2014

Preferred shares, 3,250 shares in 2015; 2,750 in 2014 $325,000 $275,000

Common shares, 50,000 shares in 2015; 40,000 in 2014 600,000 400,000

Retained earnings 500,000 300,000

Cash dividends—preferred 11,250 13,750

Dividends payable 2,812 3,438

Additional information:

  1. During the year, 500 preferred shares were issued. No preferred shares were repurchased.
  2. During the year, 10,000 common shares were issued. No common shares were repurchased.

Instructions

(a) Determine the amounts of any cash receipts or payments related to the shareholders’ equity accounts in 2015.

(b) Indicate where each of the cash receipts or payments identifi ed in part (a) would be classifi ed on the statement of cash

fl ows or accompanying notes.

(c) Would you expect a growing company to be generating or using cash for its fi nancing activities? Explain.

P13–6A Financial statements for E-Perform, Inc. follow:

E-PERFORM, INC.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 97,800 $ 48,400

Trading investments 128,000 114,000

Accounts receivable 75,800 43,000

Inventories 122,500 92,850

Prepaid expenses 18,400 26,000

Property, plant, and equipment 270,000 242,500

Accumulated depreciation (50,000) (52,000)

Total assets $662,500 $514,750

Liabilities and Shareholders’ Equity

Accounts payable $ 93,000 $ 77,300

Accrued liabilities 11,500 7,000

Bank loan payable 110,000 150,000

Common shares 200,000 175,000

Retained earnings 248,000 105,450

Total liabilities and shareholders’ equity $662,500 $514,750

E-PERFORM, INC.

Income Statement

Year Ended December 31, 2015

Sales $492,780

Cost of goods sold 185,460

Gross profi t 307,320

Operating expenses 116,410

Profi t from operations 190,910

Other revenues and expenses

Unrealized gain on trading investments $14,000

Interest expense (4,730) 9,270

Profi t before income tax 200,180

Income tax expense 45,000

Profi t $155,18

Additional information:

  1. Prepaid expenses and accrued liabilities relate to operating expenses.
  2. An unrealized gain on trading investments of $14,000 was recorded.
  3. New equipment costing $85,000 was purchased for $25,000 cash and a $60,000 long-term bank loan payable.
  4. Old equipment having an original cost of $57,500 was sold for $1,500.
  5. Accounts payable relate to merchandise creditors.
  6. Some of the bank loan was repaid during the year.
  7. A dividend was paid during the year.
  8. Operating expenses include $46,500 of depreciation expense and a $7,500 loss on disposal of equipment.

Instructions

(a) Prepare the statement of cash fl ows, using either (1) the indirect method or (2) the direct method, as assigned by

your instructor.

(b) E-Perform’s cash position doubled between 2014 and 2015. Identify the primary reason(s) for this signifi cant increase.

P13–7A Th e fi nancial statements of Resolute Inc. are presented here:

RESOLUTE INC.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 13,000 $ 5,000

Accounts receivable 38,000 24,000

Merchandise inventory 27,000 20,000

Property, plant, and equipment 80,000 78,000

Accumulated depreciation (30,000) (24,000)

Goodwill 5,000 16,000

Total assets $133,000 $119,000

Liabilities and Shareholders’ Equity

Accounts payable $ 17,000 $ 15,000

Salaries payable 1,900 2,100

Income tax payable 1,000 4,000

Bank loan payable 34,100 50,650

Common shares 18,000 14,000

Retained earnings 56,000 28,250

Accumulated other comprehensive income 5,000 5,000

Total liabilities and shareholders’ equity $133,000 $119,000

RESOLUTE INC.

Income Statement

Year Ended December 31, 2015

Sales $256,000

Cost of goods sold 140,000

Gross profi t 116,000

Operating expenses 78,250

Profi t from operations 37,750

Interest expense 4,000

Profi t before income tax 33,750

Income tax expense 6,000

Profi t $ 27,750

Additional information:

  1. Equipment was sold during the year for $8,500 cash. Th e equipment originally cost $12,000 and had a carrying

amount of $8,500 at the time of sale.

  1. Equipment costing $14,000 was purchased in exchange for $4,000 cash and a $10,000 long-term bank loan.
  2. Accounts payable relate to merchandise creditors.
  3. Some of the bank loan was repaid during the year.
  4. Operating expenses are composed of $9,500 of depreciation expense, $7,750 of administrative expenses, $50,000 of

salaries expense, and an $11,000 impairment loss on goodwill.

Instructions

(a) Prepare the statement of cash fl ows, using either (1) the indirect method or (2) the direct method, as assigned by your

instructor.

(b) Resolute’s cash position more than doubled between 2014 and 2015. Identify the primary reason(s) for this signifi cant increase.

P13–8A Th e comparative statement of fi nancial position for Sylvester Ltd. shows the following balances at December 31:

2015 2014

Assets

Cash $ 23,000 $ 6,000

Accounts receivable 25,000 30,000

Merchandise inventory 34,000 55,000

Land 100,000 110,000

Buildings 527,000 263,000

Accumulated depreciation—buildings (67,000) (100,000)

Equipment 85,000 40,000

Accumulated depreciation—equipment (18,000) (10,000)

Total assets $709,000 $394,000

Liabilities and Shareholders’ Equity

Accounts payable $ 46,000 $ 35,000

Income tax payable 3,000 2,000

Interest payable 6,000 7,000

Bank loan payable—current portion 26,000 20,000

Bank loan payable—non-current portion 380,000 212,000

Common shares 198,000 88,000

Retained earnings 50,000 30,000

Total liabilities and shareholders’ equity $709,000 $394,000

Additional information regarding 2015:

  1. Profi t was $57,000.
  2. A gain of $7,000 was recorded on the disposal of a small parcel of land. No land was purchased during the year.
  3. A gain on the disposal of an old building of $38,000 was recorded when it was sold for $50,000 cash. A new building

was purchased for $364,000 and depreciation expense on buildings for the year was $55,000.

  1. Equipment costing $65,000 was purchased while a loss of $4,000 was recorded on equipment that was sold for $5,000.

Th e equipment that was sold late in the year had accumulated depreciation of $11,000.

  1. Th e company took out $210,000 of new bank loans during the year.
  2. Dividends were declared and paid and no common shares were bought back by the company.

Instructions

(a) Prepare the statement of cash fl ows using the indirect approach.

(b) Did the company manage its noncash working capital eff ectively?

(c) How could the company aff ord to buy a new building?

P13–9A Selected information (in thousands) for Reitmans (Canada) Limited and Le Château Inc. for fi scal 2012 follows:

Reitmans Le Château

Net cash provided by operating activities $ 51,797 $ 6,602

Average current liabilities 95,474 44,871

Average total liabilities 147,724 85,550

Net capital expenditures 84,433 8,723

Dividends paid 52,068 0

Instructions

(a) Calculate the cash current debt coverage ratio, cash total debt coverage ratio, and free cash fl ow for each company.

(b) Using the ratios calculated in part (a), compare the liquidity and solvency of the two companies.

P13–10A Selected ratios for two companies are as follows:

Grenville Portage

Current ratio 1.7:1 1.2:1

Receivables turnover 10 times 20 times

Inventory turnover 4 times 2 times

Cash current debt coverage 0.4 times 0.3 times

Debt to total assets 60% 20%

Times interest earned 5 times 20 times

Cash total debt coverage 0.2 times 0.1 times

Instructions

(a) Which company is more liquid? Explain.

(b) Which company is more solvent? Explain.

P13–11A Condensed profi t and cash fl ow information follow for a recent year for three coff ee companies, Tim Hortons

Inc., Th e Second Cup Ltd., and Starbucks Corporation:

Tim Hortons

(in C$ millions)

Second Cup

(in C$ millions)

Starbucks

(in U.S. $ millions)

Profi t (loss) $407.8 $ (9.4) $1,383.8

Net cash provided by operating activities $ 559.3 $ 5.1 $ 1,750.3

Net cash used by investing activities (242.2) (1.3) (974.0)

Net cash used by fi nancing activities (323.5) (5.4) (735.8)

Net increase (decrease) in cash (6.4) (1.6) 40.5

Cash, beginning of year 126.5 5.5 1,148.1

Cash, end of year $ 120.1 $ 3.9 $ 1,188.6

Instructions

(a) Compare the provision and use of cash in each of the three activities by each company.

(b) Based on the information provided above, which company appears to be in the strongest position? Explain the reasoning

behind your decision.

Problems: Set B

P13–1B Th e following is a list of transactions that took place during the year:

(a) (b) (c)

Classifi cation Cash Flow Profi t

  1. Collected an account receivable. O 1 NE
  2. Sold equipment for cash, at a loss.
  3. Recorded an unrealized gain on a trading investment.
  4. Acquired land by issuing common shares.
  5. Expired prepaid insurance.
  6. Paid dividends to preferred shareholders.
  7. Recorded depreciation expense.
  8. Issued preferred shares for cash.
  9. Purchased inventory for cash. Th e company uses a

perpetual inventory system.

  1. Provided services on account.

Instructions

(a) Classify each of the above transactions as an operating activity (O), investing activity (I), fi nancing activity (F), or

noncash investing and fi nancing activity (NC). If it does not fi t into one of these classifi cations, indicate that there is

no eff ect (NE). Th e fi rst one has been done for you as an example.

(b) Specify if the transaction will result in a cash receipt (1), cash payment (2), or have no eff ect on cash (NE).

(c) Indicate if the transaction will increase (1), decrease (2), or have no eff ect (NE) on profi t.

(d) Explain how it is possible for the same transaction to aff ect cash and profi t diff erently.

P13–2B Th e income statement for Gum San Ltd., a publicly traded company following IFRS, is presented here:

GUM SAN LTD.

Income Statement

Year Ended December 31, 2015

Sales $4,500,000

Cost of goods sold 2,390,000

Gross profi t 2,110,000

Operating expenses 1,070,000

Profi t from operations 1,040,000

Interest 12,000

Profi t before income tax 1,028,000

Income tax expense 260,000

Profi t $ 768,00

Additional information:

  1. Operating expenses include $150,000 of depreciation expense and a $12,000 gain on disposal of equipment.
  2. Accounts receivable increased by $500,000.
  3. Merchandise inventory decreased by $220,000.
  4. Prepaid expenses related to operating expenses increased by $170,000.
  5. Accounts payable to suppliers of merchandise increased by $50,000.
  6. Accrued liabilities related to operating expenses decreased by $165,000.
  7. Interest payable increased by $5,000.
  8. Unearned revenue that is received from customers increased by $8,000.
  9. Income tax payable decreased by $16,000.

Instructions

(a) Prepare the operating activities section of the statement of cash fl ows, using either (1) the indirect method or (2) the

direct method, as assigned by your instructor.

(b) Would your answer in part (a) change if Gum San were a private company following ASPE?

P13–3B Th e income statement for Hanalei International Inc. is presented here:

HANALEI INTERNATIONAL INC.

Income Statement

Year Ended December 31, 2015

Fee revenue $565,000

Operating expenses 365,000

Profi t from operations 200,000

Interest expense 10,000

Profi t before income tax 190,000

Income tax expense 47,500

Profi t $142,500

Hanalei’s statement of fi nancial position contained the following account balances:

2015 2014

Accounts receivable $50,000 $60,000

Prepaid insurance 5,000 8,000

Accounts payable 40,000 31,000

Unearned revenue 10,000 14,000

Salaries payable 10,000 7,000

Interest payable 1,000 1,000

Income tax payable 4,000 3,000

Additional information:

  1. Operating expenses include depreciation expense, $45,000; amortization expense, $5,000; administrative expenses,

$40,000; salaries expense, $300,000; and gain on disposal of equipment, $25,000.

  1. Unearned revenue is received from customers.
  2. Prepaid insurance and accounts payable relate to operating (administrative) expenses.

Instructions

(a) Prepare the operating activities section of the statement of cash fl ows, using either (1) the indirect method or (2) the

direct method, as assigned by your instructor.

(b) Which method—indirect or direct—do you recommend that this company use to prepare its operating activities section?

Explain your reasoning.

P13–4B Th e following selected account balances relate to the property, plant, and equipment accounts of Bird Corp.

2015 2014

Accumulated depreciation—buildings $ 675,000 $ 600,000

Accumulated depreciation—equipment 288,000 192,000

Depreciation expense—buildings 75,000 75,000

Depreciation expense—equipment 128,000 96,000

Land 250,000 200,000

Buildings 1,250,000 1,250,000

Equipment 500,000 480,000

Loss on disposal of equipment 4,000 0

Additional information:

  1. Purchased land for $50,000, making a $20,000 down payment and fi nancing the remainder with a mortgage payable.
  2. Equipment was purchased for $80,000 cash. Equipment was also sold during the year.

Instructions

(a) Calculate any cash receipts or payments related to the property, plant, and equipment accounts in 2015.

(b) Indicate where each of the cash receipts or payments identifi ed in part (a) would be classifi ed on the statement of cash

fl ows or accompanying notes.

(c) Would you expect a growing company to be generating or using cash for its investing activities? Explain.

P13–5B Th e following selected account balances relate to the shareholders’ equity accounts of Mathur Corp. at year end:

2015 2014

Preferred shares, 6,000 shares in 2015, 5,000 shares in 2014 $150,000 $125,000

Common shares, 10,000 shares in 2015, 9,000 in 2014 176,000 136,000

Retained earnings 240,000 250,000

Cash dividends—preferred 7,500 6,250

Stock dividends—common 40,000 0

Additional information:

  1. During 2015, the company sold 1,000 preferred shares. No shares were reacquired by the company.
  2. All cash dividends were declared and paid during the same year. Th ere were no dividends payable at the end of 2014 or 2015.
  3. During the year, 1,000 common shares were issued as a stock dividend. Th e fair value of the shares at the time of

declaration was $40 per share.

  1. Profi t was $37,500 in 2015.

Instructions

(a) Determine the amounts of any cash receipts or payments related to the shareholders’ equity accounts in 2015.

(b) Indicate where each of the cash receipts or payments identifi ed in part (a) would be classifi ed on the statement of cash

fl ows or accompanying notes.

(c) Would you expect a growing company to be generating or using cash for its fi nancing activities? Explain.

P13–6B Financial statements for Nackawic Inc. follow:

NACKAWIC INC.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 82,700 $ 47,250

Accounts receivable 80,800 37,000

Inventories 131,900 102,650

Long-term investments 94,500 107,000

Property, plant, and equipment 290,000 205,000

Accumulated depreciation (49,500) (40,000)

Total assets $630,400 $458,900

Liabilities and Shareholders’ Equity

Accounts payable $ 62,700 $ 48,280

Accrued liabilities 12,100 18,830

Bank loan payable 140,000 70,000

Common shares 240,000 200,000

Retained earnings 175,600 121,790

Total liabilities and shareholders’ equity $630,400 $458,900

NACKAWIC INC.

Income Statement

Year Ended December 31, 2015

Sales $317,500

Cost of goods sold 99,460

Gross profi t 218,040

Operating expenses 82,120

Profi t from operations 135,920

Other revenues and expenses

Interest expense $12,940

Realized loss on sale of long-term investments 7,500 20,440

Profi t before income tax 115,480

Income tax expense 27,670

Profi t $ 87,810

Additional information:

  1. Long-term investments were sold for $5,000, resulting in a realized loss of $7,500.
  2. New equipment costing $141,000 was purchased for $71,000 cash and a $70,000 bank loan payable.
  3. Equipment costing $56,000 was sold for $15,550, resulting in a gain of $8,750.
  4. Accounts payable relate to merchandise creditors; accrued liabilities relate to operating expenses.
  5. A dividend was paid during the year.
  6. Operating expenses include $58,700 of depreciation expense and an $8,750 gain on disposal of equipment.

Instructions

(a) Prepare the statement of cash fl ows, using either (1) the indirect method or (2) the direct method, as assigned by

your instructor.

(b) Nackawic’s cash position increased by 75% between 2014 and 2015. Identify the primary reason(s) for this signifi cant

increase.

P13–7B Th e fi nancial statements of Wetaskiwin Limited are presented here:

WETASKIWIN LIMITED

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 9,000 $ 10,000

Trading investments 14,000 23,000

Accounts receivable 28,000 14,000

Merchandise inventory 29,000 25,000

Property, plant, and equipment 73,000 78,000

Accumulated depreciation (30,000) (24,000)

Total assets $123,000 $126,000

Liabilities and Shareholders’ Equity

Accounts payable $ 32,000 $ 58,000

Income tax payable 2,000 10,000

Bank loan payable 15,000 20,000

Common shares 25,000 25,000

Retained earnings 64,000 28,000

Accumulated other comprehensive loss (15,000) (15,000)

Total liabilities and shareholders’ equity $123,000 $126,000

WETASKIWIN LIMITED

Income Statement

Year Ended December 31, 2015

Sales $286,000

Cost of goods sold 154,000

Gross profi t 132,000

Operating expenses 74,000

Profi t from operations 58,000

Other revenues and expenses

Unrealized loss on trading investments $9,000

Interest expense 3,000 12,000

Profi t before income tax 46,000

Income tax expense 10,000

Profi t $ 36,000

Additional information:

  1. Recorded an unrealized loss of $9,000 on trading investments.
  2. Equipment was sold during the year for $8,000 cash. Th is equipment originally cost $15,000 and had a carrying

amount of $10,000 at the time of sale.

  1. Equipment costing $10,000 was purchased in exchange for $5,000 cash and a bank loan for the balance.
  2. Accounts payable relate to merchandise creditors.
  3. Operating expenses are composed of $11,000 of depreciation expense, $12,000 of administrative expenses, $49,000 of

salaries expense, and a $2,000 loss on the disposal of equipment.

Instructions

(a) Prepare the statement of cash fl ows, using either (1) the indirect method or (2) the direct method, as assigned by your

instructor.

(b) Wetaskiwin’s cash position declined by $1,000 between 2014 and 2015. Identify the reason(s) for this decrease.

P13–8B The comparative statement of financial position for Anderson Ltd. shows the following balances at

December 31:

2015 2014

Assets

Cash $ 3,000 $ 36,000

Accounts receivable 35,000 20,000

Merchandise inventory 49,000 35,000

Land 95,000 110,000

Building 477,000 263,000

Accumulated depreciation—building (67,000) (100,000)

Equipment 135,000 40,000

Accumulated depreciation—equipment (18,000) (10,000)

Total assets $709,000 $394,000

Liabilities and Shareholders’ Equity

Accounts payable $ 14,000 $ 35,000

Income tax payable 3,000 2,000

Interest payable 6,000 7,000

Bank loan payable—current portion 26,000 20,000

Bank loan payable—non-current portion 520,000 212,000

Common shares 90,000 88,000

Retained earnings 50,000 30,000

Total liabilities and shareholders’ equity $709,000 $394,000

Additional information regarding 2015:

  1. Profi t was $53,000.
  2. A gain of $14,000 was recorded on the disposal of a small parcel of land. No land was purchased during the year.
  3. A gain on the disposal of an old building of $28,000 was recorded when it was sold for $40,000 cash. A new building

was purchased for $304,000 and depreciation expense on buildings for the year was $45,000.

  1. Equipment costing $125,000 was purchased while a loss of $5,000 was recorded on equipment that originally cost

$30,000 and was sold for $4,000.

  1. Th e company took out $350,000 of new bank loans during the year.
  2. Dividends were declared and paid and common shares were issued during the year.

Instructions

(a) Prepare the statement of cash fl ows using the indirect approach.

(b) Did the company manage its noncash working capital eff ectively?

(c) Th e company’s banker is worried. Why?

P13–9B Selected information (in U.S. $ millions) for Google Inc. and Yahoo! Inc. for 2012 follows:

Google Yahoo!

Net cash provided (used) by operating activities $16,619 $(281.6)

Average current liabilities 11,625 1,248.8

Average total liabilities 18,256 2,349.5

Net capital expenditures 3,273 505.5

Dividends paid 0 0

Instructions

(a) Calculate the cash current debt coverage ratio, cash total debt coverage ratio, and free cash fl ow for each company.

(b) Using the ratios calculated in part (a), compare the liquidity and solvency of the two companies.

P13–10B Selected ratios for two companies are as follows:

Barrington Ste-Croix

Current ratio 1:1 0.8:1

Receivables turnover 6 times 4 times

Inventory turnover 5 times 4 times

Cash current debt coverage 0.5 times 0.4 times

Debt to total assets 75% 50%

Times interest earned 6 times 2 times

Cash total debt coverage 0.4 times 0.3 times

Instructions

(a) Which company is more liquid? Explain.

(b) Which company is more solvent? Explain.

P13–11B Condensed profi t and cash fl ow information (in U.S. $ millions) for a recent year follow for three fast food

companies: McDonald’s Corporation, Burger King Holdings, Inc., and Wendy’s/Arby’s Group, Inc.:

McDonald’s Burger King Wendy’s

Profi t $5,464.8 $117.7 $ 9.5

Net cash provided by operating activities $6,966.1 $224.4 $190.4

Net cash provided (used) by investing activities (3,167.3) 33.6 (189.4)

Net cash used by fi nancing activities (3,849.8) (174.6) (24.1)

Other (foreign exchange gain [loss]) 51.4 4.3 1.2

Net increase in cash and cash equivalents 0.4 87.7 (21.9)

Cash and cash equivalents, beginning of year 2,335.7 459.0 475.2

Cash and cash equivalents, end of year $2,336.1 $546.7 $ 453.3

Instructions

(a) Compare the provision and use of cash in each of the three activities by each company.

(b) Based on the information provided above, which company appears to be in the strongest position? Explain.

 

 

CHAPTER 14 Performance Measurement

 

Questions

(SO 1) 1. Explain the concept of sustainable income.

(SO 1) 2. (a) What are discontinued operations? (b) What

is a component of an entity?

(SO 1) 3. Explain how discontinued operations are reported

on the (a) statement of fi nancial position,

and (b) income statement.

(SO 2) 4. Explain how a horizontal analysis is aff ected if an

account (a) has no value in a base year and a value

in the next year, or (b) has a negative value in the

base year and a positive value in the next year.

  1. Two methods of fi nancial statement analysis are

horizontal analysis and vertical analysis. Explain

how these two methods are similar, and how they

diff er.

  1. Explain how the (a) horizontal percentage of a

base-period amount, (b) horizontal percentage

change for a period, and (c) vertical percentage

of a base amount is calculated.

  1. Facebook became a public corporation in May
  2. Can a meaningful horizontal and vertical

analysis be prepared for its fi rst two years of

operations as a public company, the years ended

December 31, 2012 and 2013? Why or why not?

(SO 3) 8. What base amount is usually assigned a 100%

value in a vertical analysis of the (a) statement of

fi nancial position and (b) income statement?

(SO 3) 9. Can vertical analysis be used to compare two

companies of diff erent sizes and using diff erent

currencies, such as Anheuser-Busch InBev

SA/NV, the world’s largest brewer, headquartered

in Belgium, and SABMiller plc, the second-largest

brewer, headquartered in the United Kingdom?

Explain.

  1. (a) Distinguish among the following bases of

comparison: intracompany, intercompany, and

industry average. (b) Explain which analysis

technique(s)—horizontal analysis, vertical analysis,

or ratio analysis—is normally used with each

base of comparison.

(SO 4) 11. Is a high current ratio always a good indicator of

a company’s liquidity? Describe two situations

in which a high current ratio might be hiding

liquidity problems.

(SO 4) 12. Identify for which liquidity ratios a lower result

might be better, and explain why.

(SO 5) 13. Identify for which solvency ratios a lower result

might be better, and explain why.

(SO 5) 14. Tim Hortons Inc. reported a debt to total assets

ratio of 32.2% and times interest earned ratio

of 41.1 times at the end of its second quarter in

  1. Th e industry averages at the time were

39.3% and 55.6 times, respectively. Is Tim

Hortons’ solvency better or worse than that of

the industry?

  1. Which ratio(s) should be used to help answer

each of these questions?

(a) How effi cient is the company in using its

assets to produce sales?

(b) How near to sale is the inventory on hand?

(c) How profi table was the company relative to

the amount invested by shareholders?

(d) How able is the company to pay interest

charges as they come due?

(e) How able is the company to repay a shortterm

loan?

(SO 6) 16. CIBC’s return on assets was 0.8%. During the

same year, CIBC reported a return on common

shareholders’ equity of 21.8%. Has CIBC made

eff ective use of leverage? Explain.

(SO 6) 17. Explain how the profi t margin, asset turnover,

and debt to total assets ratios help explain the

return on common shareholders’ equity ratio.

  1. In 2014, Lai Inc. reported a profi t margin of 5%

before discontinued operations and a profi t margin

of 8% aft er discontinued operations. In 2015,

the company had no discontinued operations

and reported a profi t margin of 6.5%. Has Lai’s

profi tability improved or weakened? Explain.

(SO 6) 19. (a) If you were an investor interested in buying

the shares of a company with growth potential,

what ratio(s) would you primarily look at to help

you make your decision? (b) How would your

answer change if you were interested in buying

shares with an income potential?

  1. In 2012, Yum Brands Inc. reported a profi t

margin of 11.8% using profi t in the numerator.

Had the profi t margin been based on total comprehensive

income, instead of profi t, the revised

profi t margin would have increased to 12.6%. In

2011, its profi t margin was 10.6% using profi t

and 10.5% using total comprehensive income.

(a) Has Yum Brands’ profi tability improved or

deteriorated in 2012? (b) Which profi t margin—

without other comprehensive income or with

other comprehensive income—is the most

appropriate ratio to use in this particular case for

analysis purposes? Explain.

(SO 7) 21. Identify and explain the factors that can limit the

usefulness of fi nancial analysis.

(SO 7) 22. Explain how management must use professional

judgement in fi nancial reporting and how this

can aff ect fi nancial analysis.

(SO 7) 23. McCain Foods and Cavendish Farms are both

private companies. McCain Foods uses IFRS

and Cavendish Farms uses ASPE. What impact

do these diff ering standards have on fi nancial

analysis?

Brief Exercises

BE14–1 Avondale Inc. reported the following information from its income statement for the current year:

Profi t from continuing operations before income tax $1,040,000

Interest expense 125,000

Income tax expense 260,000

Loss on operations of discontinued chemical division,

net of $60,000 income tax savings

140,000

Loss on disposal of chemical division, net of $30,000

income tax savings

70,000

Based on the above information, what is Avondale’s sustainable income?

BE14–2 A numbered list of income statement classifi cations for a merchandising company follows. Write the number

of the appropriate classifi cation beside each item in the lettered list below to show in what section the item would be

reported.

  1. Gross profi t section 4. Discontinued operations section
  2. Operating expenses section 5. Not reported on income statement
  3. Other revenues and expenses section

(a) _______ A realized gain on the sale of trading investments

(b) _______ Sales revenue

(c) _______ Salaries expense

(d) _______ Cost of goods sold

(e) _______ Dividend revenue

(f) _______ A loss from operations of a discontinued wholesale business

(g) _______ Interest expense

(h) _______ A writedown of obsolete inventory

(i) _______ A gain on the disposal of assets of a discontinued wholesale business

BE14–3 Selected data from the comparative statement of fi nancial position of Rioux Ltd. are shown below:

2015 2014 2013

Cash $ 150,000 $ 175,000 $ 75,000

Accounts receivable 600,000 400,000 450,000

Inventory 780,000 600,000 700,000

Property, plant, and equipment 3,130,000 2,800,000 2,850,000

Intangible assets 90,000 100,000 0

Total assets $4,750,000 $4,075,000 $4,075,000

(a) Using horizontal analysis, calculate the percentage of a base-year amount, assuming 2013 is the base year.

(b) Using horizontal analysis, calculate the percentage change for each year.

BE14–4 Selected horizontal percentages of a base-year amount from Coastal Ltd.’s income statement are listed here:

2015 2014 2013

Net sales 110% 101% 100%

Cost of goods sold 105% 111% 100%

Operating expenses 99% 112% 100%

Income tax expense 136% 60% 100%

Assuming that Coastal did not have any non-operating or irregular items, did its profi t increase, decrease, or remain

unchanged over the period 2013 to 2015? Explain.

BE14–5 Identify the appropriate basis of comparison—intracompany or intercompany—and better tool of analysis—

horizontal or vertical—to use for each of the following fi nancial situations.

Basis of Comparison Tool of Analysis

(a) Analysis of a company’s dividend history

(b) Comparison of diff erent-sized companies

(c) Comparison of gross profi t to net sales

among competitors

(d) Calculation of a company’s sales growth

over time

BE14–6 Comparative data from the statement of fi nancial position of Elke Ltd. are shown below. (a) Using horizontal

analysis, calculate the percentage of the base-year amount, using 2013 as the base year. (b) Using vertical analysis, calculate

the percentage of the base amount for each year.

2015 2014 2013

Current assets $1,530,000 $1,175,000 $1,225,000

Property, plant, and equipment 3,130,000 2,800,000 2,850,000

Goodwill 90,000 100,000 0

Total assets $4,750,000 $4,075,000 $4,075,000

BE14–7 Selected data (in thousands) from the income statement of JTI Inc. are shown below. Using vertical analysis,

calculate the percentage of the base amount for each year.

2015 2014

Net sales $1,914 $2,073

Cost of goods sold 1,612 1,674

Gross profi t 302 399

Operating expenses 218 210

Profi t before income tax 84 189

Income tax expense 17 38

Profi t $ 67 $ 151

BE14–8 Vertical analysis percentages from Waubon Corp.’s income statement are listed here:

2015 2014 2013

Net sales 100.0% 100.0% 100.0%

Cost of goods sold 59.4% 60.5% 60.0%

Operating expenses 19.6% 20.4% 20.0%

Income tax expense 4.2% 3.8% 4.0%

Assuming that Waubon did not have any non-operating or irregular items, did its profi t as a percentage of sales increase,

decrease, or remain unchanged over the three-year period? Explain.

BE14–9 Selected fi nancial data for Shumway Ltd. are shown below. (a) Calculate for each of 2015 and 2014 the (1) current

ratio, (2) receivables turnover ratio, and (3) inventory turnover ratio. (b) Based on these ratios, what conclusion(s) can

be drawn about the company’s liquidity?

2015 2014 2013

Accounts receivable (gross) $ 850,000 $ 750,000 $ 650,000

Merchandise inventory 1,020,000 980,000 840,000

Total current assets 2,100,000 2,000,000 1,700,000

Total current liabilities 1,000,000 1,100,000 1,250,000

Net credit sales 6,420,000 6,240,000 5,430,000

Cost of goods sold 4,540,000 4,550,000 3,950,000

BE14–10 Holysh Inc. reported a current ratio of 1.5:1 in the current fi scal year, which is higher than its current ratio last

year of 1.2:1. It also reported a receivables turnover of 9 times, which is less than last year’s receivables turnover

of 12 times, and an inventory turnover of 6 times, which is less than last year’s inventory turnover of 9 times. Is Holysh’s

liquidity improving or deteriorating? Explain.

BE14–11 Manulife Financial Corporation reported the following measures for 2012 and 2011:

2012 2011

Debt to total assets 94.6% 94.6%

Times interest earned 0.8 times 1.0 times

Cash total debt coverage 0.2 times 0.2 times

Free cash fl ow (in millions) $10,347 $10,151

Is Manulife’s solvency improving or deteriorating? Explain.

BE14–12 Wolastoq Corp. reported the following ratios for 2015 and 2014:

2015 2014

Return on common shareholders’ equity 8.6% 13.6%

Return on assets 7.4% 11.8%

Debt to total assets 13.8% 13.8%

Profi t margin 37.0% 58.8%

Asset turnover 0.2 times 0.2 times

(a) Is Wolastoq’s profi tability improving or deteriorating? (b) What is the key reason driving the change in Wolastoq’s

return on common shareholders’ equity in 2015? Explain.

BE14–13 Recently, the price-earnings ratio of Loblaw Companies Limited was 17.9 times, and the price-earnings ratio

of Bank of Montreal was 10.9 times. Th e dividend yield of each company was 2.1% and 4.5%, respectively. Which company’s

shares would you purchase for growth? For income? Explain.

BE14–14 Th omson Reuters Corporation reported the following selected information (in U.S. $ millions):

2012 2011 2010

Revenues $13,278 $13,807 $13,070

Profi t 2,123 (1,392) 933

Other comprehensive loss (255) (298) (117)

Total comprehensive income (loss) 1,868 (1,690) 816

(a) Calculate the profi t margin with and without the other comprehensive loss for each year. (b) Which of the two profi t

margin ratios that you calculated in part (a) should you rely upon for your fi nancial analysis? Explain.

Exercises

E14–1 Th e following independent events occurred at Ike Inc. during the year:

  1. A realized gain on the sale of long-term investments
  2. A loss caused by a labour strike
  3. Current assets of a discontinued component of an entity being held for immediate and probable sale
  4. An operating loss from a discontinued component of an entity, held for immediate and probable sale
  5. An impairment loss on goodwill

Instructions

(a) Identify which of the above items are sustainable (regular) items and which are irregular items.

(b) Indicate on which fi nancial statement each of the above items would be reported, and where.

E14–2 Condensed data from the comparative statement of fi nancial position of Dressaire Inc. follow:

2015 2014 2013

Current assets $120,000 $ 80,000 $100,000

Non-current assets 400,000 350,000 300,000

Current liabilities 70,000 90,000 65,000

Non-current liabilities 165,000 105,000 150,000

Common shares 150,000 115,000 100,000

Retained earnings 135,000 120,000 85,000

Instructions

(a) Using horizontal analysis, calculate the percentage of a base-year amount, using 2013 as the base year.

(b) Using horizontal analysis, calculate the percentage change for each year.

E14–3 Condensed data from the income statement for Fleetwood Corporation follow:

2015 2014

Net sales $800,000 $600,000

Cost of goods sold 550,000 375,000

Gross profi t 250,000 225,000

Operating expenses 175,000 125,000

Profi t before income tax 75,000 100,000

Income tax expense 15,000 20,000

Profi t $ 60,000 $ 80,000

Instructions

Using vertical analysis, calculate the percentage of the base amount for each year.

E14–4 Th e income statement for Postmedia Network Canada Corp. follows:

POSTMEDIA NETWORK CANADA CORP.

Income Statement

Year Ended August 31

(in thousands)

2012 2011 2010

Revenues $831,877 $898,888 $122,094

Operating expenses 792,619 819,921 133,650

Other expenses 76,533 91,121 33,062

Loss from continuing operations before income tax (37,275) (12,154) (44,618)

Income tax expense — — —

Loss from continuing operations (37,275) (12,154) (44,618)

Income from discontinued operations, net of income tax 14,053 2,565 —

Loss $(23,222) $ (9,589) $(44,618)

Instructions

(a) Using horizontal analysis, calculate the horizontal percentage of a base-year amount, assuming 2010 is the base year.

(b) Using vertical analysis, calculate the percentage of the base amount for each year.

(c) Identify any signifi cant changes from 2010 to 2012, including the impact of discontinued operations on your analysis.

E14–5 Th e following is a list of the ratios and values we have calculated in this text:

(a) (b)

__________ __________ Asset turnover

__________ __________ Average collection period

__________ __________ Cash current debt coverage

__________ __________ Cash total debt coverage

__________ __________ Current ratio

(a) (b)

__________ __________ Days in inventory

__________ __________ Debt to total assets

__________ __________ Dividend yield

__________ __________ Earnings per share

__________ __________ Free cash fl ow

__________ __________ Gross profi t margin

__________ __________ Inventory turnover

__________ __________ Payout ratio

__________ __________ Price-earnings ratio

__________ __________ Profi t margin

__________ __________ Receivables turnover

__________ __________ Return on assets

__________ __________ Return on common shareholders’ equity

__________ __________ Times interest earned

__________ __________ Working capital

Instructions

(a) Classify each of the above ratios as a liquidity (L), solvency (S), or profi tability (P) ratio.

(b) For each of the above ratios, indicate whether a higher result is generally considered better (B) or worse (W).

E14–6 Selected comparative fi nancial statement data for Kigio Inc. are shown below.

KIGIO INC.

Statement of Financial Position (partial)

December 31

(in thousands)

2015 2014 2013

Current assets

Cash $ 30 $ 91 $ 60

Trading investments 55 60 40

Accounts receivable, net 676 586 496

Inventory 628 525 575

Prepaid expenses 41 52 29

Total current assets $1,430 $1,314 $1,200

Total current liabilities $ 890 $ 825 $ 750

Additional information:

(in thousands) 2015 2014 2013

Allowance for doubtful accounts $ 50 $ 45 $ 40

Net credit sales 4,190 3,940 3,700

Cost of goods sold 2,900 2,650 2,350

Instructions

(a) Calculate all possible liquidity ratios for 2015 and 2014.

(b) Indicate whether each of the liquidity ratios calculated in part (a) is better or worse in 2015.

E14–7 Th e following selected ratios are available for Pampered Pets Inc. for the three most recent years:

2015 2014 2013

Current ratio 2.7:1 2.4:1 2.1:1

Receivables turnover 6.7 times 7.4 times 8.2 times

Inventory turnover 7.7 times 8.6 times 9.9 times

Instructions

(a) Has the company’s collection of its receivables improved or deteriorated over the last three years?

(b) Is the company selling its inventory faster or slower than in past years?

(c) Overall, has the company’s liquidity improved or deteriorated over the last three years? Explain.

E14–8 Th e following selected information (in thousands) is available for Tukai Limited:

2015 2014

Total assets $3,890 $3,700

Total liabilities 2,175 1,960

Interest expense 15 25

Income tax expense 175 150

Profi t 405 375

Cash provided by operating activities 850 580

Cash used by investing activities 400 300

Instructions

(a) Calculate all possible solvency ratios for 2015 and 2014.

(b) Indicate whether each of the solvency ratios calculated in part (a) is better or worse in 2015.

E14–9 Th e following selected ratios are available for Ackabe Inc. for the three most recent years:

2015 2014 2013

Debt to total assets 50.0% 45.5% 40.3%

Times interest earned 1.8 times 1.4 times 1.0 times

Cash total debt coverage 0.7 times 0.5 times 0.3 times

Instructions

(a) Has the debt to total assets improved or deteriorated over the last three years?

(b) Has the times interest earned improved or deteriorated over the last three years?

(c) Overall, has the company’s solvency improved or deteriorated over the last three years? Explain.

E14–10 Th e following selected information is for Karatu Corporation:

2015 2014 2013

Total assets $350,000 $275,000 $274,000

Total shareholders’ equity 133,500 100,000 50,000

Net sales 500,000 400,000 300,000

Cost of goods sold 375,000 290,000 180,000

Profi t 33,500 30,000 20,000

Karatu had no preferred shares.

Instructions

(a) Calculate the gross profi t margin, profi t margin, asset turnover, return on assets, and return on common shareholders’

equity ratios for 2015 and 2014.

(b) Indicate whether each of the profi tability ratios calculated in part (a) is better or worse in 2015.

E14–11 Th e following selected profi tability ratios are available for two companies, BetaCom Corporation and Top

Corporation, for a recent fi scal year:

BetaCom Top Industry

Gross profi t margin 37.5% 48.2% 37.9%

Profi t margin 5.2% 4.9% 4.8%

Asset turnover 1.1 times 1.1 times 1.0 times

Return on assets 5.7% 5.4% 4.8%

Return on common shareholders’ equity 9.5% 6.4% 6.0%

Instructions

Which company is more profi table? Explain, making sure to refer to the industry ratios where appropriate.

E14–12 Selected information for Teck Resources Limited for the most recent three years is as follows:

2012 2011 2010

Return on common shareholders’ equity 4.6% 15.8% 12.2%

Return on assets 2.5% 7.2% 6.3%

Debt to total assets 28.6% 28.6% 23.7%

Asset turnover 0.3 times 0.3 times 0.3 times

Profi t margin 8.4% 24.0% 21.1%

Instructions

(a) What was the main driver of the company’s return on assets over the last three years? Explain.

(b) What was the main driver of the company’s return on common shareholders’ equity over the last three years? Explain.

E14–13 Th e following selected ratios are available for a recent year for Archers Post Limited and Nyarboro Corporation:

Archers Post Nyarboro Industry Average

Liquidity

Current ratio 0.8:1 0.6:1 1.0:1

Receivables turnover 8.7 times 10.4 times 15.2 times

Inventory turnover 6.7 times 29.9 times 65.3 times

Solvency

Debt to total assets 66.7% 59.0% 68.9%

Times interest earned 4.1 times 3.4 times 3.6 times

Profi tability

Gross profi t margin 88.2% 45.2% 55.8%

Profi t margin 12.6% 11.2% 2.0%

Return on assets 8.7% 3.9% 1.0%

Return on common shareholders’ equity 32.8% 16.2% 4.6%

Price-earnings ratio 13.8 times 20.6 times 26.5 times

Instructions

(a) Which company is more liquid? Explain.

(b) Which company is more solvent? Explain.

(c) Which company is more profi table? Explain.

(d) Which company do investors favour? Is this consistent with your fi ndings in parts (a) to (c)? Investors would be more

interested in buying the shares of which company?

Problems: Set A

P14–1A ClubLink Enterprises Limited is Canada’s largest golf course and resort owner. Th e following selected information

is available for three recent fi scal years:

CLUBLINK ENTERPRISES LIMITED

Statement of Financial Position

December 31

(in thousands)

2012 2011 2010

Assets

Current assets $ 9,530 $ 13,891 $ 11,731

Non-current assets 643,059 648,241 599,681

Total assets $652,589 $662,132 $611,412

Liabilities and Shareholders’ Equity

Liabilities

Current liabilities $ 51,194 $ 61,488 $ 48,631

Non-current liabilities 419,123 411,102 406,984

Total liabilities 470,317 472,590 455,615

Shareholders’ equity 182,272 189,542 155,797

Total liabilities and shareholders’ equity $652,589 $662,132 $611,412

CLUBLINK ENTERPRISES LIMITED

Income Statement

Year Ended December 31

(in thousands)

2012 2011 2010

Revenue $215,160 $ 216,254 $ 205,195

Operating expenses 174,795 179,289 167,630

Profi t from operations 40,635 36,965 37,565

Other revenues and expenses

Interest expense 21,189 21,709 22,108

Other 427 (6,777) (344)

Profi t before income tax 18,749 22,033 15,801

Income tax expense 4,198 5,645 3,959

Profi t $ 14,551 $ 16,388 $ 11,842

ClubLink had 18,192, 18,939, and 18,917 golf club members as at December 31, 2012, 2011, and 2010, respectively.

Instructions

(a) Using horizontal analysis, calculate the percentage of the base-year amount for each of the statement of fi nancial

position and income statement items, assuming 2010 is the base year.

(b) Identify the key components in Club Link’s statement of fi nancial position and income statement that are primarily

responsible for the change in the company’s fi nancial position and performance over the three-year period.

P14–2A Th e following condensed information is available for Big Rock Brewery Inc.:

BIG ROCK BREWERY INC.

Statement of Financial Position

December 31

(in thousands)

2012 2011 2010

Assets

Current assets $10,895 $ 8,089 $ 7,426

Non-current assets 35,405 37,081 27,035

Total assets $46,300 $45,170 $34,461

Liabilities and Shareholders’ Equity

Liabilities

Current liabilities $ 6,318 $ 5,575 $ 4,322

Non-current liabilities 7,911 7,146 4,786

Total liabilities 14,229 12,721 9,108

Shareholders’ equity 32,071 32,449 25,353

Total liabilities and shareholders’ equity $46,300 $45,170 $34,461

BIG ROCK BREWERY INC.

Income Statement

December 31

(in thousands)

2012 2011 2010

Net sales $46,057 $45,183 $45,130

Cost of goods sold 21,149 21,385 19,418

Gross profi t 24,908 23,798 25,712

Operating expenses 19,290 20,455 20,054

Profi t from operations 5,618 3,343 5,658

Other revenues and expenses

Interest expense 93 141 147

Other income (204) (288) (327)

Profi t before income tax 5,729 3,490 5,838

Income tax expense (recovery) 1,594 957 (279)

Profi t $ 4,135 $ 2,533 $ 6,117

Instructions

(a) Using vertical analysis, calculate the percentage of the base amount for the statement of fi nancial position and income

statement for each year.

(b) Identify the key components in Big Rock’s statement of financial position and income statement that are

primarily responsible for the change in the company’s financial position and performance over the three-year

period.

  • How has Big Rock primarily fi nanced its assets—through debt or equity—over the last three years?

 

P14–3A A horizontal and vertical analysis of the income statement for a service company providing consulting services

is shown below:

SERVICE CORPORATION

Horizontal Income Statement

Year Ended December 31

2015 2014 2013 2012

Revenue 120.0% 110.0% 114.0% 100.0%

Operating expenses 118.6% 111.4% 114.3% 100.0%

Profi t from operations 123.3% 106.7% 113.3% 100.0%

Other revenues and expenses

Interest expense 40.0% 60.0% 80.0% 100.0%

Other revenue 240.0% 140.0% 140.0% 100.0%

Profi t before income tax 166.8% 130.2% 131.7% 100.0%

Income tax expense 166.8% 130.2% 131.7% 100.0%

Profi t 166.8% 130.2% 131.7% 100.0%

SERVICE CORPORATION

Vertical Income Statement

Year Ended December 31

2015 2014 2013 2012

Revenue 100.0% 100.0% 100.0% 100.0%

Operating expenses 69.2% 70.9% 70.2% 70.0%

Profi t from operations 30.8% 29.1% 29.8% 30.0%

Other revenues and expenses

Interest expense 3.3% 5.4% 7.0% 10.0%

Other revenue (1.0)% (0.6)% (0.9)% (0.5)%

Profi t before income tax 28.5% 24.3% 23.7% 20.5%

Income tax expense 5.7% 4.9% 4.8% 4.1%

Profi t 22.8% 19.4% 18.9% 16.4%

Instructions

(a) How eff ectively has the company controlled its operating expenses over the four-year period?

(b) In a horizontal analysis, the company’s income tax expense has changed exactly the same as profi t (66.8%) over the

four-year period. Yet, in a vertical analysis, the income tax percentage is diff erent than the profi t percentage in each

period. Explain how this is possible.

(c) Identify any other key fi nancial statement components that have changed over the four-year period for the company.

(d) Identify any additional information that might be helpful to you in your analysis of this company over the four-year

period.

P14–4A Nexen Inc. reported the following selected information for the last fi ve years (in millions, except earnings per

share):

2012 2011 2010 2009 2008

Net sales $ 6,430 $ 6,169 $ 5,411 $ 4,203 $ 6,576

Average common shareholders’ equity 8,589 8,094 8,218 7,418 6,374

Average total assets 20,302 19,858 22,404 22,528 20,115

Average total assets (excluding

discontinued assets held for sale) 20,302 19,493 22,030 22,528 20,115

Profi t from continuing operations 333 395 572 512 1,602

Profi t from discontinued operations — 302 625 24 113

Profi t 333 697 1,197 536 1,715

Earnings per share from continuing operations 0.61 0.75 1.09 0.98 3.05

Total earnings per share 0.61 1.32 2.28 1.03 3.26

Instructions

(a) Calculate Nexen’s profi t margin, return on assets, and return on common shareholders’ equity (for this calculation,

note that the company has no preferred shares) before and aft er discontinued operations for each of the last fi ve years.

(b) Evaluate Nexen’s profi tability over the last fi ve years before and aft er discontinued operations.

(c) Which analysis—before or aft er discontinued operations—is more relevant to investors? Explain.

P14–5A Condensed statement of fi nancial position and income statement data for Pitka Corporation follow:

PITKA CORPORATION

Statement of Financial Position

December 31

2015 2014 2013

Assets

Current assets

Cash $ 25,000 $ 20,000 $ 18,000

Accounts receivable (net) 55,000 45,000 48,000

Inventory 100,000 85,000 64,000

Total current assets 180,000 150,000 130,000

Long-term investments 55,000 70,000 45,000

Property, plant, and equipment (net) 500,000 370,000 258,000

Total assets $735,000 $590,000 $433,000

Liabilities and Shareholders’ Equity

Liabilities

Current liabilities $ 85,000 $ 80,000 $ 30,000

Non-current liabilities 155,000 85,000 20,000

Total liabilities 240,000 165,000 50,000

Shareholders’ equity

Common shares 330,000 300,000 300,000

Retained earnings 165,000 125,000 83,000

Total shareholders’ equity 495,000 425,000 383,000

Total liabilities and shareholders’ equity $735,000 $590,000 $433,000

PITKA CORPORATION

Income Statement

Year Ended December 31

2015 2014

Sales $740,000 $500,000

Less: Sales returns and allowances 40,000 50,000

Net sales 700,000 450,000

Cost of goods sold 450,000 300,000

Gross profi t 250,000 150,000

Operating expenses 150,000 84,000

Profi t from operations 100,000 66,000

Interest expense 10,000 4,000

Profi t before income tax 90,000 62,000

Income tax expense 18,000 12,400

Profi t $ 72,000 $ 49,600

Additional information:

  1. Th e allowance for doubtful accounts was $4,800 in 2013, $4,500 in 2014, and $5,000 in 2015.
  2. All sales were credit sales.
  3. Net cash provided by operating activities was $119,600 in 2014 and $102,000 in 2015.

Instructions

(a) Calculate the following ratios for each of 2014 and 2015:

  1. Current ratio 6. Cash total debt coverage
  2. Receivables turnover 7. Gross profi t margin
  3. Inventory turnover 8. Profi t margin
  4. Debt to total assets 9. Asset turnover
  5. Times interest earned 10. Return on assets

(b) Identify whether the change in each ratio calculated in part (a) was favourable, unfavourable, or unchanged between

2014 and 2015.

(c) Explain whether overall (1) liquidity, (2) solvency, and (3) profi tability improved, deteriorated, or remained the same

between 2014 and 2015.

P14–6A Condensed statement of fi nancial position and comprehensive income statement data for Clack Ltd. follow:

CLACK LTD.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 70,000 $ 65,000

Accounts receivable (net) 95,000 90,000

Merchandise inventory 130,000 125,000

Prepaid expenses 24,000 23,000

Long-term investments 45,000 40,000

Property, plant, and equipment (net) 390,000 305,000

Total assets $ 754,000 $ 648,000

Liabilities and Shareholders’ Equity

Liabilities

Accounts payable $ 45,000 $ 42,000

Accrued liabilities 30,000 40,000

Bank loan payable (current) 110,000 100,000

Bonds payable, due 2022 200,000 150,000

Total liabilities 385,000 332,000

Shareholders’ equity

Common shares (20,000 shares issued) 200,000 200,000

Retained earnings 172,000 116,000

Accumulated other comprehensive loss (3,000)

Total shareholders’ equity 369,000 316,000

Total liabilities and shareholders’ equity $ 754,000 $ 648,000

CLACK LTD.

Statement of Comprehensive Income

Year Ended December 31

2015 2014

Sales $900,000 $840,000

Cost of goods sold 600,000 575,000

Gross profi t 300,000 265,000

Operating expenses 184,000 160,000

Profi t from operations 116,000 105,000

Interest expense 30,000 20,000

Profi t before income tax 86,000 85,000

Income tax expense 22,000 20,000

Profi t 64,000 65,000

Other comprehensive loss (3,000) —

Total comprehensive income $ 61,000 $ 65,000

Additional information:

  1. Th e allowance for doubtful accounts was $4,000 in 2014 and $5,000 in 2015.
  2. Accounts receivable at the beginning of 2014 were $88,000, net of an allowance for doubtful accounts of $3,000.
  3. Merchandise inventory at the beginning of 2014 was $115,000.
  4. Total assets at the beginning of 2014 were $630,000.
  5. Total current liabilities at the beginning of 2014 were $180,000.
  6. Total liabilities at the beginning of 2014 were $371,000.
  7. Shareholders’ equity at the beginning of 2014 was $259,000.
  8. Seventy-fi ve percent of the sales were on account.
  9. Net cash provided by operating activities was $85,000 in 2014 and $96,000 in 2015.
  10. Net capital expenditures were $50,000 in 2014 and $125,000 in 2015.
  11. In each of 2014 and 2015, $8,000 of dividends were paid to the common shareholders.

Instructions

  • Calculate all possible liquidity, solvency, and profi tability ratios for each of 2014 and 2015.

 

(b) Identify whether the change in each ratio calculated in part (a) was favourable, unfavourable, or unchanged between

2014 and 2015.

(c) Explain whether overall (1) liquidity, (2) solvency, and (3) profi tability improved, deteriorated, or remained the same

between 2014 and 2015.

P14–7A Selected ratios for the current year for two companies in the offi ce supplies industry, Bureau Nouveau Inc. and

Supplies Unlimited Corp., follow:

Bureau Nouveau Supplies Unlimited

Asset turnover 2.6 times 2.2 times

Average collection period 31 days 35 days

Cash current debt coverage 0.3 times 0.1 times

Current ratio 1.7:1 2.0:1

Days in inventory 61 days 122 days

Debt to total assets 45.5% 30.8%

Dividend yield 0.3% 0.5%

Earnings per share $3.50 $2.40

Gross profi t margin 22.6% 30.7%

Payout ratio 8.0% 19.2%

Price-earnings ratio 29 times 45 times

Profi t margin 5.5% 4.7%

Return on assets 14.3% 10.3%

Return on common shareholders’ equity 26.1% 12.9%

Times interest earned 4.2 times 8.6 times

Instructions

(a) Both companies off er their customers credit terms of net 30 days. Indicate which ratio(s) should be used to assess how

well the accounts receivable are managed. Comment on how well each company appears to be managing its accounts

receivable.

(b) Indicate the ratio(s) used to assess inventory management. Which company is managing its inventory better?

(c) Supplies Unlimited’s current ratio is higher than that of Bureau Nouveau. Identify two possible reasons for this.

(d) Which company is more solvent? Identify the ratio(s) used to determine this, and defend your choice.

(e) You notice that Supplies Unlimited’s gross profi t margin is higher and its profi t margin lower than those of Bureau

Nouveau. Identify two possible reasons for this.

(f) What is mostly responsible for Bureau Nouveau’s higher return on assets: profi t margin or asset turnover? Explain.

(g) What is mostly responsible for Bureau Nouveau’s higher return on common shareholders’ equity: return on assets or

use of debt? Explain.

(h) Bureau Nouveau’s payout ratio is lower than Supplies Unlimited’s. Indicate one possible reason for this.

(i) What is the market price per share of each company’s common shares?

(j) Which company do investors appear to believe has greater prospects for growing in future? Indicate the ratio(s) you

used to reach this conclusion, and explain your reasoning.

P14–8A Th e following ratios are available for fast-food competitors and their industry, for a recent year:

Mac’s Burgers King’s Burgers Industry Average

Liquidity

Current ratio 1.5:1 0.9:1 1.2:1

Receivables turnover 21.5 times 28.3 times 34.8 times

Inventory turnover 33.6 times 42.3 times 35.2 times

Solvency

Debt to total assets 44.6% 40.1% 44.8%

Times interest earned 16.5 times 6.7 times 11.4 times

Profi tability

Gross profi t margin 40.0% 33.1% 36.9%

Profi t margin 20.6% 7.5% 10.8%

Asset turnover 0.8 times 0.9 times 1.2 times

Return on assets 16.5% 6.8% 13.0%

Return on common shareholders’ equity 34.5% 17.8% 22.4%

Price-earnings ratio 19.6 times 17.6 times 19.9 times

Dividend yield 3.0% 1.0% 1.6%

Instructions

(a) Which company is more liquid? Explain.

(b) Which company is more solvent? Explain.

(c) Which company is more profi table? Explain.

(d) Which company do investors favour? Is your answer consistent with your fi ndings in parts (a) to (c)?

P14–9A You are in the process of analyzing two similar companies in the same industry. You learn that they have diff erent

accounting practices and policies, as follows:

  1. Company A, which has the same type of inventory as Company B, uses the FIFO cost method while Company B uses

average. Prices have generally been rising in this industry.

  1. Company A uses the double-diminishing balance depreciation method for most of its buildings, while Company B

uses the straight-line method for its buildings.

Instructions

(a) Considering only the impact of the choice of inventory cost method, determine which company will report a higher

(1) current ratio, (2) debt to total assets ratio, and (3) profi t margin ratio, or whether the choice of cost method will

have no impact Th is is the fi rst year of operations for both companies.

(b) Considering only the impact of the choice of depreciation method, determine which company will report a higher

(1) current ratio, (2) debt to total assets ratio, and (3) profi t margin ratio, or whether the choice of depreciation

method will have no impact. Th is is the fi rst year of operations for both companies.

(c) Will the use of diff erent accounting estimates and policies aff ect your analysis? Explain.

(d) Identify two other limitations of fi nancial analysis that an analyst should watch for when analyzing fi nancial statements

Problems: Set B

P14–1B lululemon athletica inc. has seen a signifi cant amount of growth over the last three years. Th e following

selected information is available for three recent fi scal years:

LULULEMON ATHLETICA INC.

Statement of Financial Position

January 31

(in U.S. thousands)

2013 2012 2011

Assets

Current assets $ 787,053 $527,093 $389,279

Non-current assets 264,025 207,541 110,023

Total assets $1,051,078 $734,634 $499,302

Liabilities and Shareholders’ Equity

Liabilities

Current liabilities $ 133,357 $103,439 $ 85,364

Non-current liabilities 30,422 25,014 19,645

Total liabilities 163,779 128,453 105,009

Shareholders’ equity 887,299 606,181 394,293

Total liabilities and shareholders’ equity $1,051,078 $734,634 $499,302

LULULEMON ATHLETICA INC.

Income Statement

Year Ended January 31

(in U.S. thousands)

2013 2012 2011

Net revenue $1,370,358 $1,000,839 $711,704

Cost of goods sold 607,532 431,488 316,757

Gross profi t 762,826 569,351 394,947

Operating expenses 386,387 282,393 214,556

Profi t from operations 376,439 286,958 180,391

Other income 4,082 1,599 2,536

Profi t before income tax 380,521 288,557 182,927

Income tax expense 109,965 104,494 61,080

Profi t $ 270,556 $ 184,063 $121,847

Instructions

(a) Using horizontal analysis, calculate the percentage of the base-year amount for each of the statement of fi nancial

position and income statement, assuming 2011 is the base year.

(b) Identify the key components in lululemon’s statement of financial position and income statement that are

primarily responsible for the change in the company’s financial position and performance over the three-year

period.

P14–2B Th e following condensed information is available for Yellow Media Inc., Canada’s largest Internet media and

marketing company:

YELLOW MEDIA INC.

Statement of Financial Position

December 31

(in thousands)

2012 2011 2010

Assets

Current assets $ 369,361 $ 350,559 $ 443,370

Fixed assets 27,414 46,496 112,445

Intangible assets 1,312,148 1,658,051 2,123,776

Goodwill — 2,967,847 6,508,984

Other assets 47,553 25,979 111,673

Total assets $1,756,476 $5,048,932 $9,300,248

Liabilities and Shareholders’ Equity

Liabilities

Current liabilities $ 326,923 $ 634,613 $ 478,562

Non-current liabilities 1,143,393 2,329,292 2,871,617

Total liabilities 1,470,316 2,963,905 3,350,179

Shareholders’ equity 286,160 2,085,027 5,950,069

Total liabilities and shareholders’ equity $1,756,476 $5,048,932 $9,300,248

YELLOW MEDIA INC.

Income Statement

Year Ended December 31

(in thousands)

2012 2011 2010

Revenues $ 1,107,715 $ 1,328,866 $1,679,860

Operating expenses 686,331 843,950 1,164,104

Goodwill impairment 3,267,847 2,900,000 —

Profi t (loss) from operations (2,846,463) (2,415,084) 515,756

Other revenues and expenses

Interest expense (146,265) (130,582) (144,796)

Other 962,788 (75,307) (36,398)

Profi t (loss) from continuing

operations before income tax (2,029,940) (2,620,973) 334,562

Income tax expense (recovery) (75,935) 87,149 60,527

Profi t (loss) from continuing

operations (1,954,005) (2,708,122) 274,035

Discontinued business loss — 120,877 —

Profi t (loss) $(1,954,005) $(2,828,999) $ 274,035

Instructions

(a) Using vertical analysis, calculate the percentage of the base amount for the statement of fi nancial position and income

statement for each year.

(b) Identify the key components in Yellow Media’s statement of financial position and income statement that are

primarily responsible for the change in the company’s financial position and performance over the three-year

period. Include in your answer a specifi c comment on the impact the company’s discontinued operations had on

your analysis.

  • How has Yellow Media primarily fi nanced its assets—through debt or equity—over the last three years?

 

P14–3B A horizontal and vertical analysis of the income statement for a retail company selling a wide variety of general

merchandise is shown below:

RETAIL CORPORATION

Horizontal Income Statement

Year Ended January 31

2015 2014 2013 2012

Revenue 140.0% 111.0% 114.0% 100.0%

Cost of goods sold 148.3% 113.3% 116.7% 100.0%

Gross profi t 127.5% 107.5% 110.0% 100.0%

Operating expenses 171.4% 133.1% 126.9% 100.0%

Profi t from operations 93.3% 87.6% 96.9% 100.0%

Interest expense 40.0% 60.0% 80.0% 100.0%

Other revenue 240.0% 140.0% 200.0% 100.0%

Profi t before income tax 140.0% 110.8% 113.8% 100.0%

Income tax expense 160.0% 116.0% 124.0% 100.0%

Profi t 135.2% 109.5% 111.4% 100.0%

RETAIL CORPORATION

Vertical Income Statement

Year Ended January 31

2015 2014 2013 2012

Revenue 100.0% 100.0% 100.0% 100.0%

Cost of goods sold 63.6% 61.2% 61.4% 60.0%

Gross profi t 36.4% 38.8% 38.6% 40.0%

Operating expenses 21.4% 21.0% 19.5% 17.5%

Profi t from operations 15.0% 17.8% 19.1% 22.5%

Interest expense (2.9%) (5.4%) (7.0%) (10.0%)

Other revenue 0.9% 0.6% 0.9% 0.5%

Profi t before income tax 13.0% 13.0% 13.0% 13.0%

Income tax expense 2.9% 2.6% 2.7% 2.5%

Profi t 10.1% 10.4% 10.3% 10.5%

Instructions

(a) How eff ectively has the company controlled its cost of goods sold over the four-year period?

(b) In a vertical analysis, the company’s profi t before income tax has remained unchanged at 13% of revenue over the fouryear

period. Yet, in a horizontal analysis, profi t before income tax has grown 40% over that period of time. Explain

how this is possible.

(c) Identify any other key fi nancial statement components that have changed over the four-year period for the company.

(d) Identify any additional information that might be helpful to you in your analysis of this company over the four-year

period.

P14–4B Th e Home Depot Inc. reported the following selected information for the last fi ve years ending on the Saturday

closest to January 31 (in U.S. $ millions, except earnings per share):

2013 2012 2011 2010 2009

Net sales $74,754 $70,395 $67,997 $66,176 $71,288

Average common shareholders’ equity 17,837 18,394 19,141 18,585 17,746

Average total assets 40,801 40,321 40,501 41,020 42,744

Profi t from continuing operations 4,535 3,883 3,338 2,620 2,312

Net loss (gain) from discontinued operations — — — 41 (52)

Profi t 4,535 3,883 3,338 2,661 2,260

Earnings per share from continuing operations 3.03 2.49 2.01 1.55 1.37

Total earnings per share 3.03 2.49 2.01 1.57 1.34

Instructions

(a) Calculate Home Depot’s return on common shareholders’ equity (for this calculation, note that the company has no

preferred shares), return on assets, and profi t margin ratios before and aft er discontinued operations for each of the

last fi ve years.

(b) Evaluate Home Depot’s profi tability over the last fi ve years before and aft er discontinued operations.

(c) Which analysis—before or aft er discontinued operations—is more relevant to investors? Explain.

P14–5B Condensed statement of fi nancial position and income statement data for Colinas Corporation follow:

COLINAS CORPORATION

Statement of Financial Position

December 31

2015 2014 2013

Assets

Cash $ 30,000 $ 24,000 $ 10,000

Accounts receivable (net) 80,000 50,000 53,000

Inventory 85,000 45,000 50,000

Other current assets 70,000 75,000 62,000

Long-term investments 100,000 76,000 50,000

Property, plant, and equipment (net) 595,000 345,000 315,000

Total assets $ 960,000 $ 615,000 $ 540,000

Liabilities and Shareholders’ Equity

Liabilities

Current liabilities $ 63,500 $ 51,000 $ 65,000

Non-current liabilities 245,000 65,000 70,000

Total liabilities 308,500 116,000 135,000

Shareholders’ equity

Common shares 416,500 319,000 275,000

Retained earnings 235,000 180,000 130,000

Total shareholders’ equity 651,500 499,000 405,000

Total liabilities and shareholders’ equity $ 960,000 $ 615,000 $ 540,000

COLINAS CORPORATION

Income Statement

Year Ended December 31

2015 2014

Sales $950,000 $840,000

Less: Sales returns and allowances 60,000 40,000

Net sales 890,000 800,000

Cost of goods sold 490,000 450,000

Gross profi t 400,000 350,000

Operating expenses 266,000 260,000

Profi t from operations 134,000 90,000

Interest expense 27,750 8,750

Profi t before income tax 106,250 81,250

Income tax expense 21,250 16,250

Profi t $ 85,000 $ 65,000

Additional information:

  1. Th e allowance for doubtful accounts was $2,400 in 2013, $2,750 in 2014, and $3,650 in 2015.
  2. Assume all sales were credit sales.
  3. Net cash provided by operating activities was $91,000 in 2014 and $107,500 in 2015.

Instructions

(a) Calculate the following ratios for each of 2014 and 2015:

  1. Current ratio
  2. Receivables turnover
  3. Inventory turnover
  4. Debt to total assets
  5. Times interest earned
  6. Cash total debt coverage
  7. Gross profi t margin
  8. Profi t margin
  9. Asset turnover
  10. Return on assets

(b) Indicate whether the change in each ratio calculated in part (a) was favourable, unfavourable, or unchanged between

2014 and 2015.

P14–6B Condensed statement of fi nancial position and comprehensive income statement data for Track Ltd. follow:

TRACK LTD.

Statement of Financial Position

December 31

2015 2014

Assets

Cash $ 50,000 $ 42,000

Accounts receivable (net) 100,000 87,000

Inventories 400,000 300,000

Prepaid expenses 25,000 31,000

Long-term investments 80,000 50,000

Land 125,000 75,000

Buildings and equipment (net) 560,000 400,000

Total assets $ 1,340,000 $ 985,000

Liabilities and Shareholders’ Equity

Liabilities

Notes payable $ 150,000 $ 50,000

Accounts payable 245,000 190,000

Current portion of mortgage payable 48,750 25,000

Mortgage payable, due 2022 200,000 125,000

Total liabilities 643,750 390,000

Shareholders’ equity

Common shares (100,000 shares issued) 400,000 400,000

Retained earnings 292,250 195,000

Accumulated other comprehensive income 4,000 _

Total shareholders’ equity 696,250 595,000

Total liabilities and shareholders’ equity $ 1,340,000 $ 985,000

TRACK LTD.

Statement of Comprehensive Income

Year Ended December 31

2015 2014

Net sales $1,100,000 $950,000

Cost of goods sold 650,000 635,000

Gross profi t 450,000 315,000

Operating expenses 285,000 215,000

Profi t from operations 165,000 100,000

Interest expense 30,000 10,000

Profi t before income tax 135,000 90,000

Income tax expense 33,750 22,500

Profi t 101,250 67,500

Other comprehensive income 4,000 _

Total comprehensive income $ 105,250 $ 67,500

Additional information:

  1. Th e allowance for doubtful accounts was $5,000 in 2014 and $10,000 in 2015.
  2. Accounts receivable at the beginning of 2014 were $80,000, net of an allowance for doubtful accounts of $3,000.
  3. Inventories at the beginning of 2014 were $320,000.
  4. Total assets at the beginning of 2014 were $1,075,000.
  5. Current liabilities at the beginning of 2014 were $250,000.
  6. Total liabilities at the beginning of 2014 were $543,500.
  7. Total shareholders’ equity at the beginning of 2014 was $531,500.
  8. All sales were on account.
  9. Net cash provided by operating activities was $135,500 in 2014 and $223,000 in 2015.
  10. Net capital expenditures were $50,000 in 2014 and $92,000 in 2015.
  11. In each of 2014 and 2015, $4,000 of dividends were paid to the common shareholders.

Instructions

(a) Calculate all possible liquidity, solvency, and profi tability ratios for each of 2014 and 2015.

(b) Indicate whether the change in each ratio calculated in part (a) was favourable, unfavourable, or unchanged between

2014 and 2015.

(c) Explain whether Track’s overall (1) liquidity, (2) solvency, and (3) profi tability improved, deteriorated, or remained the

same between 2014 to 2015.

P14–7B Selected ratios for the current year for two companies in the beverage industry, Refresh Corp. and Flavour

Limited, follow:

Refresh Flavour

Asset turnover 1.0 times 1.0 times

Cash total debt coverage 30.2% 22.4%

Current ratio 2.2:1 1.6:1

Debt to total assets 56% 72%

Dividend yield 0.2% 1.1%

Earnings per share $0.98 $1.37

Gross profi t margin 73.8% 60.0%

Inventory turnover 5.8 times 9.9 times

Payout ratio 10.0% 20.5%

Price-earnings ratio 14.3 times 20.3 times

Profi t margin 9.3% 10.2%

Receivables turnover 9.8 times 10.4 times

Return on assets 9.3% 10.2%

Return on common shareholders’ equity 25.7% 29.8%

Times interest earned 12.3 times 6.9 times

Instructions

(a) Both companies off er their customers credit terms of net 30 days. Indicate which ratio(s) should be used to assess how

well the accounts receivable are managed. Comment on how well each company appears to be managing its accounts

receivable.

(b) Indicate the ratio(s) used to assess inventory management. Which company is managing its inventory better?

(c) Refresh’s current ratio is higher than that of Flavour. Identify two possible reasons for this.

(d) Which company, Refresh or Flavour, is more solvent? Identify the ratio(s) used to determine this, and defend your

choice.

(e) You notice that Refresh’s gross profi t margin is higher and its profi t margin lower than those of Flavour. Identify two

possible reasons for this.

(f) What is mostly responsible for Flavour’s higher return on assets: profi t margin or asset turnover? Explain.

(g) What is mostly responsible for Flavour’s higher return on common shareholders’ equity: return on assets or use of

debt? Explain.

(h) Refresh’s payout ratio is signifi cantly lower than that of Flavour. Indicate one possible reason for this.

(i) What is the market price per share of each company’s common shares?

(j) Which company, Refresh or Flavour, do investors appear to believe has greater prospects for future growth? Indicate

the ratio(s) you used to reach this conclusion, and explain your reasoning.

P14–8B Th e following ratios are available for toolmakers Best Tools, Inc. and Snappy Tools Incorporated, and their

industry, for a recent year:

Best Tools Snappy Tools Industry Average

Liquidity

Current ratio 1.8:1 2:1 2.6:1

Receivables turnover 8.7 times 6.1 times 7.4 times

Inventory turnover 6.7 times 4.8 times 3.9 times

Solvency

Debt to total assets 32.9% 45.7% 22.5%

Times interest earned 3.2 times 6.1 times 7.6 times

Profi tability

Gross profi t margin 35.1% 45.7% 33.3%

Profi t margin 2.4% 7.0% 3.0%

Asset turnover 0.8 times 0.7 times 0.9 times

Return on assets 1.9% 4.9% 2.7%

Return on common shareholders’ equity 4.4% 13.9% 4.9%

Price-earnings ratio 8.1 times 19.2 times 15.4 times

Payout ratio 11.5% 38.2% 17.4%

Dividend yield 0.8% 2.0% 1.2%

Instructions

(a) Which company is more liquid? Explain.

(b) Which company is more solvent? Explain.

(c) Which company is more profi table? Explain.

(d) Which company do investors favour? Is your answer consistent with your fi ndings in parts (a) to (c)? Explain.

P14–9B You are in the process of analyzing two similar companies in the same industry. You learn that they have

diff erent accounting practices and policies, as follows:

  1. Company A, which has the same type of equipment as Company B, uses the straight-line method of depreciation

while Company B uses diminishing-balance. Th is is the fi rst year of operations for both companies.

  1. Company A is a private company and does not report other comprehensive income. Company B is a publicly traded company

that generates and reports other comprehensive income from the revaluation of property, plant, and equipment.

Instructions

(a) Considering only the impact of the choice of depreciation method, determine which company will report a higher (1)

current ratio, (2) debt to total assets ratio, and (3) profi t margin ratio, or if the depreciation method will have no impact.

(b) Considering only the impact of total comprehensive income, determine which company will report a higher (1) current

ratio, (2) debt to total assets ratio, and (3) profi t margin ratio, or if the other comprehensive income will have no impact.

(c) Will the use of diff erent accounting practices and policies aff ect your analysis? Explain.

(d) Identify two other limitations of fi nancial analysis that an analyst should watch for when analyzing fi nancial statements.

Broadening Your Perspective

Financial Reporting: Shoppers Drug Mart

BYP14–1 Th e fi nancial statements of Shoppers Drug Mart are presented in Appendix A at the end of this book. Th e following

selected condensed information (in thousands) has been taken from these, and the prior years’, fi nancial statements:

2012 2011 2010

Income statement

Sales $10,781,848 $10,458,652 $10,192,714

Cost of goods sold 6,609,229 6,416,208 6,283,634

Gross profi t 4,172,619 4,042,444 3,909,080

Operating expenses 3,291,698 3,131,539 3,011,758

Profi t from operations 880,921 910,905 897,322

Interest expense 57,595 64,038 60,633

Income tax expense 214,845 232,933 244,838

Profi t 608,481 613,934 591,851

Statement of fi nancial position

Current assets $2,764,997 $2,695,647 $2,542,820

Non-current assets 4,708,724 4,604,663 4,501,377

Current liabilities 2,334,917 1,776,238 1,527,567

Non-current liabilities 815,477 1,256,242 1,413,995

Shareholders’ equity 4,323,327 4,267,830 4,102,635

Instructions

(a) Using horizontal analysis, calculate the percentage of the base-year amount for the information shown above, assuming

2010 is the base year.

(b) Using vertical analysis, calculate the percentage of a base amount for each of the (1) income statement and (2) statement

of fi nancial position, shown above for each year.

(c) Comment on any signifi cant changes you observe from your calculations in parts (a) and (b).

Comparative Analysis: Shoppers Drug Mart and Jean Coutu

BYP14–2 Th e fi nancial statements of Jean Coutu are presented in Appendix B following the fi nancial statements for

Shoppers Drug Mart in Appendix A.

Instructions

(a) Calculate the liquidity ratios for 2012 that you believe are relevant for each company. Which company is more liquid?

(b) Calculate the solvency ratios for 2012 that you believe are relevant for each company. Which company is more solvent?

(c) Calculate the profi tability ratios for 2012 that you believe are relevant for each company. For the return on common

shareholders’ equity ratio, note that neither company has any preferred shares. Which company is more profi table?

(d) What information that is not included in the fi nancial statements might also be useful for comparing Jean Coutu and

Shoppers Drug Mart?

Comparing IFRS and ASPE

BYP14–3 Fine Leather Ltd. (FLL) is a retailer of various leather goods. Its major competitor is Deluxe Leatherwear Ltd.

(DLL). During the past year, Fine Leather has recorded a large loss in other comprehensive income while DLL reported no

other comprehensive income or loss. FLL has also reversed an impairment loss on some equipment, accrued a provision

relating to a salary dispute, and adjusted some of its equipment up to fair value. DLL has recorded no similar transactions.

FLL uses the FIFO inventory cost method while DLL uses average. Both companies are experiencing rising costs for

merchandise inventory and both companies have more current assets than current liabilities.

Instructions

(a) One of the companies described above prepares fi nancial statements using IFRS while the other uses ASPE. Which one

complies with IFRS and which one with ASPE?

(b) Do all of the diff erences between the two companies relate to IFRS and ASPE diff erences?

(c) For each of the following ratios, determine if FLL could be expected to have a higher or lower ratio based on the diff erent

approach that it takes when preparing fi nancial statements: current ratio, inventory turnover, debt to total assets, profi t

margin, and asset turnover.

Critical Th inking Case

BYP14–4 Listed below is a vertical analysis of selected information from the fi nancial statements of fi ve publicly

traded Canadian companies:

A B C D E

Sales 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of goods sold (82.3)% (58.1)% (76.5)% (43.2)% (60.1)%

Gross profi t 17.7% 41.9% 23.5% 56.8% 39.9%

Selling and administrative expenses (1.4)% (19.1)% (17.2)% (10.3)% (31.4)%

Research and development — (13.6)% — — —

Interest (1.4)% — (1.4)% (2.3)% —

Depreciation (5.4)% (6.5)% (2.5)% (26.7)% (2.1)%

Other 0.3% (13.7)% 0.3% (1.4)% 3.2%

Profi t before income tax 9.8% (11.0)% 2.7% 16.1% 9.6%

Income tax (2.9)% 5.2% (0.7)% (4.4)% (2.5)%

Profi t 6.9% (5.8)% 2.0% 11.7% 7.1%

Cash 37.6% 20.2% 10.0% 0.1% 37.9%

Accounts receivable 1.0% 24.5% 15.4% 2.4% 5.2%

Inventories 1.0% 4.6% 11.2% 1.1% 14.7%

Other current assets 4.1% 4.7% 0.6% 0.3% 0.8%

Total current assets 43.7% 54.0% 37.2% 3.9% 58.6%

Property, plant, and equipment 53.0% 18.2% 50.5% 95.2% 38.7%

Intangible assets 1.3% 26.2% 5.9% — 2.5%

Other non-current assets 2.0% 1.6% 6.4% 0.9% 0.2%

Total assets 100.0% 100.0% 100.0% 100.0% 100.0%

Current liabilities 31.7% 26.2% 30.0% 8.1% 19.8%

Non-current liabilities 29.0% 2.0% 34.2% 42.3% 3.0%

Shareholders’ equity 39.3% 71.8% 35.8% 49.6% 77.2%

Total liabilities and shareholders’ equity 100.0% 100.0% 100.0% 100.0% 100.0%

One of the companies included in the vertical analysis above operates a chain of grocery stores and has its own private

labels. Th e other four companies include a furniture retailer that has operated for over 100 years, an oil and gas producer

with facilities in the oil sands in a year when oil prices were high, a discount airline, and a developer of high-tech communications

equipment that does not sell its products directly to consumers.

Instructions

By analyzing the relationship between the amounts shown, match the description of the companies provided to the applicable

company A through E shown above.

Ethics Case

BYP14–5 Vern Fairly, president of Flex Industries Inc., wants to issue a press release to boost the company’s image and its

share price, which has been gradually falling. As controller, you have been asked to provide a list of horizontal percentages

and fi nancial ratios for Flex Industries’ fi rst-quarter operations.

Two days aft er you provide the ratios and data requested, you are asked by Anne Saint-Onge, Flex’s vice-president of

communications, to review the accuracy of the fi nancial and operating data contained in the press release written by the

president and edited by Anne. In the news release, the president highlights the sales increase of 10% over last year’s fi rst

quarter and the positive change in the current ratio from 1.1:1 last year to 1.5:1 this year. He also emphasizes that production

was up 15% over last year’s fi rst quarter.

You note that the release contains only positive or improved ratios and none of the negative or worsening ratios. For

instance, there is no mention of the fact that although the current ratio improved, the cash current debt coverage ratio fell

from 0.2% to 0.1%, or that the debt to total assets ratio has increased from 35% to 45%. Nor is there any mention that the

reported profi t for the quarter would have been a loss if excess machinery had not been sold at a gain.

Instructions

(a) Who are the stakeholders in this situation?

(b) Is there anything unethical in President Fairly’s actions?

(c) As controller, should you remain silent? Why or why not? Does Anne have any responsibility?

BYP14–6 You have just won $2 million in a lottery. Realizing how fortunate you are, you have invested some of this money

in a car, a house, some low-risk, interest-bearing guaranteed investment certifi cates, and some highly diversifi ed mutual

funds. You would like to take $100,000 of the remaining money and invest that amount in the shares of one publicly traded

Canadian company. You seek advice on which company to invest in from one of your friends, who is a computer programmer.

She tells you to invest in a new soft ware company that just went public. It develops new on-line games and receives fees

from players along with advertising revenue. Th is company has not had very many sales yet, but expects to in the future due

to the popularity of its products. Its price earnings ratio is 80 times earnings, its return on common shareholders’ equity is

2.0%, and its return on assets is 1.8%. Your uncle, on the other hand, suggests that you purchase shares in a large bank that has

consistently paid dividends for over 100 years and has increased its dividend every year for the last 45 years. Th is bank has a

price earnings ratio of 11 times earnings but unlike the soft ware company, it has a dividend yield of 3.0%. Th e bank’s profi t has

barely risen over the last two years but its return on common shareholders’ equity is 10.2% while its return on assets is 2.7%.

Instructions

(a) Why would the price earnings ratio be higher for the soft ware company?

(b) Why would the bank have a dividend yield and the soft ware company would not?

(c) Why would the soft ware company have lower returns on both assets and equity?

(d) Why would a bank have such a large diff erence between its return on common shareholders’ equity and its return on assets?

(e) Which company would you invest in?

Serial Case

(Note: Th is is a continuation of the serial case from Chapters 1 through 13.)

BYP14–7 Janet, Brian, Natalie, and Daniel have sold their shares of Koebel’s Family Bakery Ltd. to Biscuits Ltd., a public

company. One of the terms of the sale agreement was that Natalie and Daniel had to become and remain employees of

Biscuits for the next two years and continue to operate the bakery. Natalie and Daniel are now operating Koebel’s Family

Bakery as a wholly owned subsidiary of Biscuits.

Daniel and Natalie have received a sizable amount of cash from the sale of their shares of Koebel’s Family Bakery. As a

result, they are considering where next to make an investment. Th ey recognize how profi table Koebel’s continues to be as a

subsidiary of Biscuits and are considering investing some of their excess cash in Biscuits. Th ey have accumulated a number

of ratios for Biscuits, Cookies Are for Us (a publicly traded competitor of Biscuits), and the overall industry to enable them

to make a decision on whether or not they should invest in Biscuits.

Ratio Biscuits Ltd.

Cookies Are

for Us Ltd. Industry Ratio

Current ratio 1.9:1 1.2:1 1.9:1

Receivables turnover 37.2 times 28.4 times 17.3 times

Inventory turnover 25.3 times 23.6 times 18.0 times

Debt to total assets 54.8% 52.5% 50.0% times

Times interest earned 23.8 times 21.7 times 17.4 times

Gross profi t margin 23.0% 21.0% 19.9%

Profi t margin 3.9% 3.0% 5.2%

Return on assets 5.3% 5.0% 6.6%

Return on common shareholders’ equity 11.9% 6.9% 9.5%

Price-earnings ratio 32.5 times 23.8 times 27.5 times

Instructions

(a) Which company is more liquid? Explain.

(b) Which company is more solvent? Explain.

(c) Which company is more profi table? Explain.

(d) Which company do investors favour? Explain.

(e) Natalie and Daniel are familiar with ASPE from their previous experience with Koebel’s as a private company. Biscuits

and Cookies Are for Us use IFRS. Are there any particular diff erences Natalie and Daniel should be aware of that might

aff ect their analysis of these two companies?

(f) What other factors must Natalie and Daniel consider before making an investment in any public company?