22.7 Exercises
Chapter 22
Exercise 22.1
Determine if a related party relationship exists in each of the cases below and describe what disclosures would be required under IAS 24.
- Kessel Ltd. sells goods on credit to Sterling Inc., a company owned by the daughter of Ms. Bender (Ms. Bender is a director of Kessel Ltd.). On December 31, 2021, trade receivables of $50,000, owing from Sterling Inc., were reported on Kessel Ltd’s books. Management of Kessel Ltd. decided to write off $20,000 of this receivable and provide a full allowance against the remaining balance.
- During 2021, Kessel Ltd. purchased goods from Saunders Ltd. for $175,000. Saunders Ltd. indicated that this amount represents the normal price it would charge to arm’s length customers. Kessel Ltd. owns 35% of the shares of Saunders Ltd.
- In late December 2021, a vacation property owned by Kessel Ltd. was sold to one of its directors, Mr. Chiang, for $325,000. The property had a carrying value of $150,000 and an estimated market value of $360,000. Kessel Ltd. also provided a guarantee on the mortgage that Mr. Chiang took out to acquire the property.
- On December 31, 2021, Kessel Ltd. owed $120,000 to its major supplier, Rickert Ltd., for purchases made on account at regular commercial terms.
Exercise 22.2
In each of the cases below, determine if the relationships should be considered related party relationships under IAS 24.
- Mr. Fowler is a director of both Goss Ltd. and Link Inc. Are these two companies related?
- Rosen Ltd. and Chabon Inc. are both associated companies of Lethem Ltd. Are Rosen Ltd. and Chabon Inc. related parties?
- Abernathy Ltd. and Beron Inc. each have a board containing seven directors, five of who are common. There are no common shareholdings. Are the two companies related?
Exercise 22.3
The following events occurred between December 31, 2022 (the reporting date) and March 22, 2023, the date that Ealing Inc.’s financial statements were approved for issue:
- January 8, 2023: The local government approved the expropriation of one of the company’s manufacturing facilities for construction of a new motorway. On December 31, 2022, the carrying value of the property, land and building, was $2,750,000. The company has determined that they will be able to move most of the manufacturing machines to other facilities. The company was not previously aware of the local government’s plan, as the council discussions had been held in camera. The local government has not yet proposed a compensation amount. The appropriation will occur later in 2023.
- January 27, 2023: The board of directors approved a staff bonus of $250,000. The terms of this bonus were included in the employment contracts of key management personnel and the bonus calculation was based on the reported financial results of the December 31, 2022 fiscal year.
- February 3, 2023: The company received notice from the federal income tax authority that additional income taxes of $75,000 for the 2020 and 2021 fiscal years were payable. The company had previously disputed the calculation of these taxes, and had reported an accrual $30,000 on December 31, 2022.
- February 21, 2023: The accounts receivable clerk was fired after it was discovered she had perpetrated a fraud in the accounts. The accounts receivable balance was overstated by $75,000 on December 31, 2022. The company has consulted legal counsel to determine if any action can be brought to recover the stolen funds, but no action has yet been filed.
- March 16, 2023: The board of directors declared a dividend of $550,000 based on the results reported on the December 31, 2022 financial statements.
- March 18, 2023: A fire completely destroyed one of the company’s production machines. It is not expected that any insurance proceeds will be received on this asset.
Required:
Determine what adjustments or disclosures, if any, should be made on the December 31, 2022 financial statements for the above items.
Exercise 22.4
On January 15, 2023, several pieces of plaster fell from the ceiling in the offices of Satterlee LLP, a firm of professional accountants, crushing several pairs of green eye shades. Luckily, no accountants were injured. The management of the firm hired professional engineers to examine the problem. The engineers determined that there were, in fact, more serious problems in the overall structure of the building, and, in particular, the foundation. The engineers indicated that it appeared the foundation had been sinking for several years, although the evidence of the cracked ceiling only just appeared. The engineers indicated that the repair work to the foundation was essential to keep the building safe for occupation.
Required:
Determine how this event should be dealt with on Satterlee LLP’s financial statements for the year ended December 31, 2022.
Exercise 22.5
On November 12, 2022, the federal government filed a lawsuit against Magus Corp. The lawsuit contends that one of Magus Corp.’s factories has been dumping unfiltered effluent into a local river, resulting in contamination that has required the water treatment plant downstream to commit to additional procedures to keep the water safe for community residents. The lawsuit not only seeks compensation for the damage done, but also seeks a remedy that would force the company to install filtration equipment at the factory to clean the effluent before it reaches the river. The company has not accrued any provision for this lawsuit on December 31, 2022, as the company’s legal counsel has indicated that the outcome cannot currently be determined. Management of the company has indicated that if they are forced to install the filtration equipment, that they will, instead, shut down the factory as the required equipment would render the entire operation economically infeasible. The factory in question is one of three factories that the company operates, producing approximately 40% of the company’s output.
Required:
Discuss the potential impact of the above situation on the auditor’s report for the year ended December 31, 2022.
Exercise 22.6
Arburator Inc. has six business lines with the following information:
| Business Line |
Total Revenue |
Operating Profit/(Loss) |
Assets |
|---|---|---|---|
| 1 | $90,000 | $18,000 | $150,000 |
| 2 | 25,000 | (7,000) | 20,000 |
| 3 | 20,000 | (4,000) | 15,000 |
| 4 | 140,000 | 30,000 | 266,000 |
| 5 | 10,000 | 4,000 | 15,000 |
| 6 | 4,000 | (3,000) | 12,000 |
| $289,000 | $38,000 | $478,000 |
Required:
If Arburator Inc. follows IFRS, determine which business lines, if any, qualify as a reportable operating segment for purposes of financial reporting.
Exercise 22.7
Regarding interim reporting, what accounting issues can occur? Is there a difference between IFRS and ASPE regarding interim reporting?
EXERCISE 22.8
The condensed income statement for Egor Inc. is shown below:
| 2021 | 2020 | 2019 | |
|---|---|---|---|
| Net sales | 25,000 | 22,500 | 21,000 |
| Cost of goods sold (COGS) | 16,250 | 13,500 | 13,230 |
| Gross profit | 8,750 | 9,000 | 7,770 |
| Selling and administration expenses | 5,000 | 4,800 | 4,600 |
| Income from continuing operations before income taxes | 3,750 | 4,200 | 3,170 |
Required:
- Analyze Egor Inc.’s statement using vertical and horizontal techniques.
- What are some of the limitations of this type of analysis?
Exercise 22.9
Presented below is the balance sheet, including disclosures, of Hibertia Corp. for the year 2020:
| Hibertia Corp. Balance Sheet December 31, 2020 |
||||||
|---|---|---|---|---|---|---|
| Assets | ||||||
| Current assets | ||||||
| Cash | $60,000 | |||||
| Accounts receivable | $215,500 | |||||
| Less allowance for doubtful accounts | 2,400 | 213,100 | ||||
| Inventory* | 210,500 | |||||
| Prepaid insurance | 15,900 | |||||
| Total current assets | $499,500 | |||||
| Long-term investments* | ||||||
| Investments in shares* | 320,000 | |||||
| Property, plant, and equipment | ||||||
| Cost of uncompleted plant facilities: | ||||||
| Land | $125,000 | |||||
| Building in process of construction | 220,000 | 345,000 | ||||
| Equipment | 325,000 | |||||
| Less accumulated depreciation | 180,000 | 145,000 | 490,000 | |||
| Intangible assets | ||||||
| Patents* | 60,000 | |||||
| Total assets | $1,369,500 | |||||
| Liabilities and Shareholders’ Equity | ||||||
| Current liabilities | ||||||
| Notes payable to bank* | $112,000 | |||||
| Accounts payable | 215,000 | |||||
| Accrued liabilities | 66,200 | |||||
| Total current liabilities | $393,200 | |||||
| Long-term liabilities | ||||||
| Bonds payable, 11%, due Jan. 1, 2031 | 250,000 | |||||
| Less discount on bonds payable | 22,000 | 228,000 | ||||
| Total liabilities | 621,200 | |||||
| Shareholders’ equity | ||||||
| Capital shares | ||||||
| Common shares; 600,000 shares authorized, | ||||||
| 400,000 shares issued and outstanding | 400,000 | |||||
| Retained earnings | 203,300 | |||||
| Accumulated other comprehensive income | 145,000** | 748,300 | ||||
| Total liabilities and shareholders’ equity | $1,369,500 | |||||
Disclosures:
- Inventory — at lower of FIFO cost/NRV
- Long-term investments – fair value through OCI
- Investments in shares, of which investments costing $140,000 have been pledged as security for notes payable to bank.
- Patents (net of accumulated amortization of $20,000). Amortization is on a straight-line basis.
- Notes payable to bank, due 2021 and secured by investments which cost $140,000.
Additional information:
Net sales for 2020 are $550,000; Cost of goods sold is $385,000; Net Income is $125,000.
Required:
Based on the information available above, identify and calculate:
- One liquidity ratio
- One activity ratio
Briefly discuss the results for this company. Also, use ending balances in lieu of averages when calculating ratios.
Exercise 22.10
Below is the balance sheet for Great Impressions Ltd. as at December 31, 2020.
| Great Impressions Ltd. Balance Sheet As at December 31, 2020 |
||||||
|---|---|---|---|---|---|---|
| Assets | ||||||
| Current assets: | ||||||
| Cash | $300,000 | |||||
| Accounts receivable | $900,000 | |||||
| Allowance for doubtful accounts | (13,000) | 887,000 | ||||
| Inventory | 55,000 | |||||
| Spare parts supplies | 1,500 | |||||
| Prepaid insurance | 53,000 | |||||
|
Total current assets |
$1,296,500 | |||||
| Property, plant, and equipment: | ||||||
| Land | 300,000 | |||||
| Equipment | $143,000 | |||||
| Accumulated depreciation, equipment | (62,000) | 81,000 | 381,000 | |||
| Intangible assets: | ||||||
| Patent | 300,000 | |||||
| Total assets | $1,977,500 | |||||
| Liabilities | ||||||
| Current liabilities: | ||||||
| Accounts payable | 265,200 | |||||
| Unearned consulting fees | 25,500 | |||||
| Current portion of long-term note payable | 100,000 | |||||
|
Total current liabilities |
390,700 | |||||
| Long-term liabilities | ||||||
| Long-term note payable | 93,800 | |||||
| Total liabilities | $484,500 | |||||
| Equity | ||||||
| Contributed capital: | ||||||
| Preferred shares, authorized 5,000 shares; | ||||||
|
issued and outstanding 3,744 shares |
93,600 | |||||
| Common shares, unlimited authorized; | ||||||
|
issued and outstanding, 15,900 shares |
159,000 | |||||
| Total contributed capital | 252,600 | |||||
| Retained earnings | 1,240,400 | |||||
| Total equity | 1,493,000 | |||||
| Total liabilities and equity | $1,977,500 | |||||
Additional information:
Net sales for 2020 are $1,100,000; Cost of goods sold is $500,000; Net income is $544,960.
Market price per common share is currently $97.
| Industry average ratios: | ||
|---|---|---|
| Accounts payable turnover | 2 times | |
| Current ratio | 2:1 | |
| Days’ sales in inventory | 28 days | |
| Debt ratio | 26% | |
| Profit margin | 45% | |
| Total asset turnover | 1 times |
Required:
Calculate all the ratios listed above and comment on this company’s performance. Identify each ratio as either being a liquidity, activity, solvency or profitability, or coverage ratio. Explain the purpose of the ratio selected and comment on the company’s performance. Round your answers to the nearest two decimal places. Use the current year closing account balances in lieu of averages when calculating ratios requiring averages.
Exercise 22.11
Leo Creations Co. sells art supplies to retail outlets. Their financial statements are shown below:
| Leo Creations Co. Income Statement For the Year Ended December 31, 2020 |
||||
|---|---|---|---|---|
| Sales | $1,500 | |||
| Cost of goods sold | 980 | |||
| Gross profit | $520 | |||
| Operating expenses: | ||||
| Depreciation expense | $48 | |||
| Other expenses | 221 | 269 | ||
| Operating income | $251 | |||
| Other revenues and expenses | ||||
| Interest expense | $12 | |||
| Loss on sale of equipment | 16 | 28 | ||
| Net income | $223 | |||
| Leo Creations Co. Comparative Account Information December 31, 2020 and 2019 |
||
|---|---|---|
| 2020 | 2019 | |
| Accounts payable | $129 | $115 |
| Accounts receivable (net) | 310 | 180 |
| Bonds payable (due 2030) | 610 | 100 |
| Cash | 75 | 42 |
| Common shares | 850 | 450 |
| Equipment | 1,360 | 500 |
| Inventory | 250 | 210 |
| Accumulated depreciation | 206 | 282 |
| Long-term investment | 400 | 400 |
| Retained earnings | 500 | 310 |
| Salaries payable | 100 | 75 |
Following are industry averages:
| Current ratio | 2.5:1 |
| Inventory turnover | 5.5 times |
| Acid-test (quick) ratio | 1.4:1 |
| Return on assets | 13.4% |
| Accounts receivable turnover | 8.2 times |
| Return on common shareholders’ equity | 18.3% |
Required:
(Round all calculations to two decimal places.)
-
- Calculate the acid-test ratio for 2020. What type of ratio is this and what is its purpose?
- Is the company’s acid-test ratio favourable or unfavourable, as compared to the industry average?
-
- Calculate the accounts receivable turnover for 2020.
- Is the company’s accounts receivable turnover favourable or unfavourable, as compared to the industry average in 2020?
- Do Leo Creations Co.’s assets generate profits favourably or unfavourably, as compared to the industry average in 2020?
EXERCISE 22.12
The following information appeared on the alphabetized adjusted trial balance of Jill’s Used Books Inc. for the year ended June 30, 2020. Assume all accounts have a normal balance.
| Accounts payable | $1,800 | |
| Accounts receivable | 29,000 | |
| Accumulated depreciation, equipment | 3,800 | |
| Advertising expense | 20,000 | |
| Allowance for doubtful accounts | 1,400 | |
| Cash | 10,000 | |
| Cost of goods sold | 123,900 | |
| Delivery expense | 4,875 | |
| Depreciation expense | 5,000 | |
| Equipment | 15,000 | |
| Interest income | 2,000 | |
| Common shares | 49,325 | |
| Preferred shares | 40,000 | |
| Retained earnings | 50,000 | |
| Cash dividends | 46,000 | |
| Merchandise inventory | 17,000 | |
| Notes payable ($3,000 is due by June 30, 2021) | 7,000 | |
| Notes receivable (due in 2023) | 14,000 | |
| Office supplies | 750 | |
| Long-term investment | 75,000 | |
| Copyright | 25,000 | |
| Office supplies expense | 1,200 | |
| Patent | 2,500 | |
| Petty cash | 500 | |
| Rent expense | 17,900 | |
| Salaries expense | 41,750 | |
| Salaries payable | 950 | |
| Sales | 314,000 | |
| Sales returns and allowances | 22,000 | |
| Unearned sales | 1,100 |
Additional information:
Assume total assets, liabilities, and equity at June 30, 2019 for Jill’s Used Books Inc. were $120,000, $75,000, and $45,000, respectively.
Required:
Explain whether the balance sheet was strengthened or not from June 30, 2019 to June 30, 2020.
Exercise 22.13
The following selected financial statement information is available for Yeo Company.
| (000’s) | ||
| December 31, | ||
| 2020 | 2019 | |
|---|---|---|
| Cash | 60 | 10 |
| Accounts receivable (net) | 80 | 70 |
| Merchandise inventory | 240 | 50 |
| Equipment (net) | 490 | 520 |
| Accounts payable | 180 | 75 |
| Notes payable, due 2022 | 300 | 300 |
Required: Comment on the change in Yeo Company’s ability to pay short-term debt. As part of your answer, include an explanation of the relationship between short-term debt paying ability and cash flow. Round to two decimal places.
Exercise 22.14
The following are comparative debt ratios for two companies in the same industry:
| 2020 | 2019 | |
|---|---|---|
| Dilly Inc. | 40% | 35% |
| Kevnar Corporation | 70% | 83% |
Required:
Which company has strengthened its balance sheet? Explain your answer.
