SOLUTION. JRE300H1F: Fundamentals of Accounting and Finance. MIDTERM EXAMINATION (30% of Final Grade): Fall Time Allowed: 1 hour and 50 minutes

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1 JRE300H1F: Fundamentals of Accounting and Finance MIDTERM EXAMINATION (30% of Final Grade): Fall 2017 Time Allowed: 1 hour and 50 minutes SOLUTION LAST NAME: FIRST NAME: STUDENT NUMBER: Instructions: Write all of your answers on the examination paper. If you need additional space, use the back of the page facing the question and clearly identify the question being answered. This is a closed book exam. One double-sided 8.5'x11' hand-written or typed aid sheet containing formulas/notes is permitted. Non-programmable calculators are permitted. Pencil or pen may be used. However, papers written in pencil or papers with white outs will not be re-marked. Question # Possible Marks Marks Awarded TOTAL 100

2 QUESTION 1 (30 marks) PART 1: (18 marks) Toto Technology Ltd. started business operations on Sept 1 st, The company s president, Terry Yates, envisions the company becoming the leading provider of information technology services in the Greater Toronto Area. Below is a summary of the transactions and events that occurred during the first month of operations at Toto Technology Ltd.: September 1 Terry purchased 100 common shares at $100 each September 1 Received a $200,000 bank loan from the Royal Bank of Toronto. Terms of the loan were interest only payments for 2 years, payable on the 1 st of every month, with the principal portion of the loan due on January 1, The stated annual interest rate on the loan was $6%, compounded monthly. September 2 Purchased a commercial property (i.e. land and building) for $200,000. The value of the land was $150,000 and the building was valued at $50,000. All capital assets at Toto are depreciated on a straight-line basis. The building and land have an expected useful life of 50 years. September 2 Paid in advance a one year insurance policy premium of $3,000; paid in cash September 3 Hired two IT consultants September 4 Various office supplies purchased for $2,000; paid cash September 6 Performed IT services for a local manufacturer and immediately invoiced the customer for $6,000 September 7 Paid $2,500 for salaries that were incurred to date September 15 Payment of $6,000 received for September 6 invoice September 17 Performed IT services for 3 customers, receiving $2,500 in cash and immediately invoiced the remaining amount (i.e. $4,500) September 19 Purchased a car on credit for $20,000. The loan was provided by the car dealer at 0% interest. The amount will be paid over 4 years with monthly payments due on the 19 th of every month. The car has an expected useful life of 6 years, with an expected salvage value of $3,000 after 6 years. September 24 Received $5,000 from client in advance of work being performed. September 30 - Dividends of $2,000 are paid to Terry Page 2

3 Salaries of $2,500 were paid on October 1st. The salaries were for work performed up to September 30 th. Terry has approached the bank and is looking for another bank loan to further expand his business. The bank has asked Terry to provide a set of financial statements prepared in accordance with generally accepted accounting principles for the month ended September 30, Required Journalize the above transactions, as well as any adjusting entries you think are required for the month of September. A sample of what the journal entry should look like is provided. Date Accounts Debit Credit Sample Dr. Account Name $ Cr. Account Name $ Sept 1 Dr. Cash Cr. Common Shares 10,000 10,000 Sept 1 Dr. Cash Cr. Bank Loan 200, ,000 Sept 2 Dr. Building Dr. Land Cr. Cash 50, , ,000 Sept 2 Dr. Prepaid Insurance Cr. Cash 3,000 3,000 Sept 3 NOT AN ECONOMIC EVENT Sept 4 Dr. Office Supplies Cr. Cash 2,000 2,000 Sept 6 Dr. Accounts Receivable Cr. Revenue 6,000 6,000 Sept 7 Dr. Salaries Expense Cr. Cash 2,500 2,500 Sept 15 Dr. Cash Cr. Accounts Receivable 6,000 6,000 Page 3

4 Sept 17 Dr. Cash Dr. Accounts Receivable Cr. Revenue 2,500 4,500 7,000 Sept 19 Dr. Car Cr. Loan payable 20,000 20,000 Sept 24 Dr. Cash Cr. Unearned Revenue 5,000 5,000 Sept 30 Dr. Dividends Declared (or Retained Earnings) Cr. Cash 2,000 2,000 Sept 30 Dr. Salaries Expense Cr. Salaries Payable 2,500 2,500 Sept 30 Dr. Deprecation Expense Cr. Accumulated Depreciation (50,000/50/12) + ( )/6*11/ Sept 30 Dr. Interest Expense Cr. Interest Payable (200,000*6%/12) 1,000 1,000 Sept 30 Dr. Insurance Expense Cr. Prepaid Insurance (3000/12) PART 2 (12 marks) Prepare the Statement of Earnings (i.e. Income Statement) and Statement of Financial Position (i.e. Balance Sheet) for Toto Technology Ltd. for the month ended September 30, Statement of Earnings (for the period September 1 st to September 30 th ) 4 marks Revenue $13,000 Expenses Salaries $5,000 Insurance Expense $ 250 Page 4

5 Depreciation Expense $319 Interest Expense $1,000 $ 6,569 Net Income $6,430 Statement of Retained Earnings (for the period Sept 1 st to Sept 30 th ) information purposes only Retained Earnings, beginning of period $ 0 Net Earnings $6,430 Dividends $2,000 Retained Earnings, end of period $4,431 Statement of Financial Position (at Sept 30 th ) 8 marks Assets Current Assets Cash $ 14,000 Accounts Receivable $ 4,500 Prepaid Insurance $ 2,750 Office Supplies $ 2,000 Total Current Assets $ 23,250 Land $ 150,000 Building 49,917 Car $ 19,763 Total Assets $242,930 Liabilities and Shareholders Equity Current Liabilities Salaries payable $ 2,500 Unearned revenue $ 5,000 Interest payable $ 1,000 Loan payable (current portion) $ 105,000 Total Current Liabilities $ 113,500 Long-term Liabilities Loan payable (long-term portion) $ 115,000 Page 5

6 Common Stock $ 10,000 Retained Earnings $ 4,430 Total Liabilities and Shareholders Equity $ 242,930 QUESTION 2 (20 marks) A comparative Statement of Financial Position as at December 31st for Cassel Corporation is provided below: Cash $76,000 $27,000 Accounts Receivable 184,000 97,000 Inventory 167, ,000 Land 184,000 69,000 Equipment 127,000,000 Accumulated Depreciation (59,000) (40,000) $679,000 $423,000 Liabilities and Shareholders Equity Accounts Payable $42,000 $36,000 Bonds Payable 200, ,000 Common Shares 250, ,000 Retained Earnings 187,000 72,000 $679,000 $423,000 Additional Information: 1. Dividends paid in the year totalled $29, Land that had a carrying value of $100,000 was sold in the year for $137,000 in cash. 3. Equipment with a cost of $35,000 and accumulated depreciation of $31,000 was sold during the year for $2,000 cash. Required Prepare the Statement of Cash Flows for the year ended December 31, 2016 for Cassel Corporation using the indirect method. Cash Flow from Operating Activities: Net Income $144,000 Non-Cash items: Depreciation 50,000 Page 6

7 Gain on Sale of Land (37,000) Loss on Sale of Equipment 2,000 Non-Cash Changes to Working Capital: Increase in A/R (87,000) Decrease in Inventory 43,000 Increase in A/P 6,000 Net Cash Provided by Operating Activities 121,000 Cash Flow from Investing Activities: Proceeds on Sale of PPE 2,000 Proceeds on Sale of Land 137,000 Purchase of Land (215,000) Purchase of PPE (102,000) Net Cash Provided by Investing Activities (178,000) Cash Flow from Financing Activities: Proceeds on Issuance of Shares 135,000 Payment of Dividends (29,000) Net Cash Provided by Financing Activities 106,000 Net Increase in Cash $49,000 Cash, beginning of year 27,000 Cash, end of year $76,000 Page 7

8 QUESTION 3 (6 marks) For each of the items relating to Goldcorp Inc. and listed below, identify the conceptual framework component(s) that is most applicable. Make sure you identify only one that is most applicable, and explain your choice. GOLDCORP INC Information GOLDCORP INC. reports depreciation expense on the consolidated statements of income. Conceptual framework assumption Matching principle Explanation To assist in assessing performance for a given period, all expenses should be matched (same period) to the revenue they helped to generate GOLDCORP INC. consolidated Statement of Income and Statement of Financial Position includes information for fiscal years 2016 and Comparability For Goldcorp s financial statements to be useful in assessing performance, they must be compared (year-over-year) with the results of other recent years GOLDCORP INC. S financial statements include a Management Discussion and Analysis, as well as several pages of notes to consolidated financial statements. Full disclosure Any information that is relevant (i.e. would make a difference in the minds of the user) must be disclosed in the body of the financial statements and/or in the notes to the financial statements Page 8

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10 QUESTION 4 (15 Marks) Rover Ltd. sells many products. Woof is one of its popular items. Below is an analysis of the inventory purchases and sales of Woof for the month of March. Rover uses the perpetual inventory system. Purchases Sales Units Unit Cost Units Selling Price/Unit March 1 Beginning inventory 200 $ March 3 Purchase $75 March 4 Sales 70 $120 March 10 Purchase 200 $82 March 16 Sales 80 $130 March 19 Sales 80 $130 March 25 Sales 50 $130 March 30 Purchase 40 $90 (* Hint: You can show your calculations in a table format with the following headings.) Date Description Purchases Cost of Goods Sold Ending Inventory Mar 1 Units $/unit Subtotal Units $/unit Subtotal Units $/unit Subtotal Mar 31 Page 10

11 a) Using the FIFO cost assumption, calculate the cost of goods sold (COGS) for March. Show your calculations. b) Using the average cost assumption, calculate the cost of goods sold for March. Show calculations and use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer. c) Comparing your values of COGS for FIFO and Average Cost, does this make sense? (Note: No calculations are required here, just an explanation.) Answer: (a) FIFO Date Description Purchases COGS Ending Inventory Mar. 1 Beginning 200 $ $12,000 3 Purchase $75 $ 4, Sale 70 $ $ 4, Purchase , Sale 80 4, , , , , Sale , , Sale , ,7 30 Purchase , ,3 Page 11

12 30 Ending 280 $18, , $18,3 Page 12

13 (b) Average Date Description Purchases COGS Ending Inventory Mar. 1 Beginning 200 $.00 $12, Purchase $75 $ 4, , Sale 70 $63.46 $ 4, , Purchase , , Sale , , Sale , , Sale , , Purchase , , Ending 280 $19, , $16, Please note that discrepancies may result in the above schedule due to rounding. (c) COGS for Average Cost is greater than FIFO due to incorporating higher unit costs. Page 13

14 QUESTION 5 (15 Marks) TabbyWorld makes and sells scratch posts for cats. Cost information for one scratch post is as follows: Direct Material $2.00 Direct Labour $1.00 Variable factory overhead $0.50 Variable selling expenses $0.10 Total Variable Costs $3. Total fixed factory overhead $388,800 Each scratch post sells for $9. Current annual production and sales volume is 75,000 posts. A predetermined fixed factory overhead rate can be computed based on this activity level. Please answer the following: a) Compute the contribution margin and contribution margin ratio. (2 marks) b) Compute the breakeven point in units using contribution margin. (1 mark) c) Compute the breakeven point in sales dollars using contribution margin ratio. (1 mark) d) What is the margin of safety in units? In sales dollars? (2 marks) e) If TabbyWorld wants to earn $43,200 of before-tax profits, how many posts will it have to sell? (2 marks) f) If TabbyWorld wants to earn $40,500 after taxes and is subject to a 25 percent tax rate, how many units will it have to sell? (2 marks) g) If TabbyWorld's fixed costs increased by $7,5, how many units would it need to sell to break even? (2 marks) h) TabbyWorld can sell an additional 6,000 scratch posts overseas for $8.50. Variable costs will increase by $0.30 for shipping expenses, and fixed costs will increase by $25,000 because of the purchase of a new machine. This is a one-time only sale and will not affect domestic sales this year or in the future. Should TabbyWorld sell the additional units? (3 marks) Page 14

15 Answer: a) CM = $ $3. = $5.40 and CM% = $5.40 / $9.00 = % b) BEP = $388,800 / $5.40 = 72,000 c) BEP = $388,800 / 0. = $648,000 d) MOS = 75,000-72,000 = 3,000 units and MOS = ($9 x 75,000) - $648,000 = $27,000 e) BEP = ($388,800 + $43,200) / $5.40 = 80,000 units f) Profit before tax = $40,500 / (1-0.25) = $54,000, so that BEP = ($388,800 + $54,000) / $5.40 = 82,000 units g) Additional units to break even = $7,5 / $5.40 = 1,400 units, so new BEP = 72, ,400 = 73,400 units h) New CM for these units = $ $3.90 = $4. so that the total CM = $4. x 6,000 = $27,0, which is $2,0 above the additional $25,000 fixed cost. Yes, TabbyWorld should sell the additional units. Page 15

16 QUESTION 6 (14 Marks) Part A (5 Marks) Streetsville Carrier collects 50 percent of its monthly sales immediately and the rest the following month; has production costs that are 80 percent of sales; pays 50 percent of its bills immediately and the rest the following month; and has 1.5 months of sales in inventory. a. Calculate the break-even sales growth rate. If the company's actual growth rate is larger than this break-even growth rate, what does this mean about the company's cash flows? (2 marks) b. If the company's actual growth rate is 25%, what level of inventory (in months of sales) would you need for the break-even sales growth rate to match this? (Assume other policies are held constant.) (3 marks) a.! = 1 & & ' + ) * = = If the company's actual growth rate is larger than 18.18% then the company's cash balance is decreasing (i.e. the company is growing too fast and is using up cash at a faster rate than generating cash) b.! = Solve for gamma: months 1 & & ' + ) * = ) 0.50 = 0.25 Page 16

17 Part B (5 Marks) There are two suppliers of one input for a factory. Supplier A offers a selling price of $3,500 with terms of 1/15 net 30, while Supplier B offers $3,800 with 2/10 net 50. Which supplier offers the lower effective annual cost? If the factory doesn't have enough cash on hand but can borrow funds, why would the factory's borrowing rate be important of whether to take on the supplier's discount? k = 1 + k = 1 + $3,500 x 0.01 $3,500 x $3,800 x 0.02 $3,800 x :7 1 = :8 1 = Supplier B offers the lower effective annual cost... If the factory's borrowing rate is less than the effective annual cost (i.e. discount forego) then the factory should take advantage of the discount by borrowing the funds and paying by the end of the "discount" period. Part C (4 Marks) You noticed that your company can do a better job in managing its working capital. It currently has a significant surplus of cash and is expecting to have this surplus for quite some time. What do you suggest the company should do? Solution The company should consider: o o o o Paying a special dividend or retire debt obligations Paying cash dividends or invest in longer-term maturity higher yielding investments Buying inventory in bulk if there is a significant discount Taking advantage of any discounts being offered by suppliers Page 17