MGCR 211 All Sections, Midterm Exam (version A), February 20, 2015, 12pm-2pm

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1 McGill University Desautels School of Management MGCR 211 INTRODUCTION TO FINANCIAL ACCOUNTING Winter 2015 Professor: Jorien Pruijssers MIDTERM EXAM Friday - February 20, 2015 VERSION A LAST NAME FIRST NAME STUDENT # SOLUTIONS This is a closed book, closed notes exam. Only non-text storing calculators are allowed. The exam is to be completed individually. The McGill Code of Conduct is in effect. This exam consists of 4 parts on a total of 10 pages. All questions are to be answered on this examination paper. Answer the question in the space provided. Do not exceed the space allowed. Show your calculations and explain your reasoning. All companies are expected to be IFRS compliant unless stated otherwise and all amounts are material unless otherwise noted in the question. You must return this examination. This examination is property of McGill University. You have 2 hours to complete this exam, use your time wisely. GOOD LUCK! Marks PART 1 Multiple Choice 12 Grade PART 2 Journal Entries 18 PART 3 Adjusting Entries 39 PART 4 Revenue Recognition Mini Case 1 24 Mini Case 2 7 TOTAL 100 1

2 PART 1: MULTIPLE CHOICE (12 points) Each question is worth 1 point (unless stated otherwise). 1. Penguin Inc. sells merchandise on account for $2,000 to Cliff Corp., terms 2/10, n/30. Cliff returns $800 worth of merchandise that was damaged, along with a cheque to settle the account within the discount period. What entry does Penguin make upon receipt of the cheque? (2pts) a. Dr. Cash. $1,200 Cr. Accounts Receivable..$1,200 b. Dr. Cash $1,160 Dr. Sales Returns and Allowances.. $784 Dr. Sales Discounts. $32 Cr. Accounts Receivable $2,000 c. Dr. Cash.$1,176 Dr. Sales Returns and Allowances.. $800 Dr. Sales Discounts..$24 Cr. Accounts Receivable. $2,000 d. Dr. Cash. $1,160 Dr. Sales Discounts. $40 Dr. Sales Returns and Allowances $800 Cr. Accounts Receivables..$2, Which of the following statements best describes the concept recognition? a. Recognition is the process of reporting an item that is due within 12 months in the current section of the statement of financial position b. Recognition guides the choice between using fair value and historical cost in the financial statements. c. Recognition is the process of reporting an item in the notes to the financial statements d. Recognition is the process of presenting an item on the financial statements 3. A decline in a company s gross profit could be caused by all of the following, except: (2pts) a. Paying lower prices to suppliers b. Clearance of discontinued inventory c. Increased competition resulting in lower selling prices d. Selling products with a lower markup 2

3 4. Sally s Skateboard Shop has a weekly payroll of $9,000 and pays its employees every Friday. None of the staff works on weekends. This year, the last day of the company s fiscal year-end is a Thursday. What is the correct adjusting entry to accrue salaries expense? a. Salaries Expense... 1,800 Salaries Payable... 1,800 b. Salaries Expense... 5,400 Cash... 5,400 c. Salaries Expense... 7,200 Salaries Payable... 7,200 d. Salaries Expense... 9,000 Salaries Payable... 9, Clooney Corporation had $275,000 in current assets and $105,000 in current liabilities before borrowing $75,000 from the bank for an 18 month period. What effect did the borrowing transaction have on the amount of Clooney s working capital? a. No effect b. $75,000 increase c. $105,000 increase d. $75,000 decrease 6. The Sayonara Corporation received a cheque for $21,000 on July 1 st, which represents a 6 month advance payment of rent on a building it rents to a client. Unearned rental revenue was credited for the full $21,000. Financial statements will be prepared on July 31 st. Sayonara Corporation should make the following adjusting entry on July 31 st : a. Debit Unearned Revenue for $3,500; Credit Rental Revenue for $3,500 b. Debit Rental Revenue for $3,500; Credit Unearned Rental Revenue for $3,500 c. Debit Unearned Rental Revenue for $21,000; credit Rental Revenue for $21,000 d. Debit Cash for $3,500; Credit Rental Revenue for $3, Accrued expenses are: a. Paid an recorded in an asset account before they are used or consumed b. Paid and recorded in an asset account after they are used or consumed c. Expenses that have not yet been paid but have been incurred and have been recorded as a liability d. Incurred and already paid and recorded 8. If ABC Corp. fails to adjust the Prepaid Rent account for rent that has expired, what effect will this have on that month's financial statements? a. This will have no effect on the financial statements. b. Expenses will be overstated and profit and shareholders equity will be understated. c. Assets will be overstated and profit and shareholders equity will be understated. d. Assets will be overstated and profit and shareholders equity will be overstated. 9. Inventory becomes part of the cost of goods sold when a company: a. Pays for the inventory b. Purchases the inventory c. Sells the inventory d. Receives payment from the customer 3

4 Use the following information to answer question 10 MARCOTTE MASONARY LTD. Statement of Financial Position December 31, 2015 Cash $ 50,000 Accounts payable $ 40,000 Prepaid insurance 5,000 Salaries payable 5,000 Accounts receivable 75,000 Bonds payable 190,000 Inventory 110,000 Total liabilities 235,000 Land 90,000 Building $220,000 Common shares 200,000 Less: Accumulated Retained earnings 105,000 depreciation 60, ,000 Total shareholders equity 305,000 Trademark $ 75,000 Less: Accumulated 25,000 50,000 Total liabilities and amortization Total assets $540,000 shareholders equity $540, The total amount in the contra-asset accounts is: a. $60,000 b. $85,000 c. $210,000 d. $235,000 4

5 PART 2: JOURNAL ENTRIES (18 points) Selected transactions for YAY consulting Inc. are presented below. January 3 A $15,000 cash advance is received from Mr. Fox, a client, for consulting services that are expected to be completed in February. 4 Performed $6,000 worth of services for J&H (a loyal client of YAY Consulting Inc.). YAY consulting Inc. collected $2,000 in cash and billed the remainder to be paid 30 days from today. 5 Purchased office equipment for $15,000, paying $5,000 cash and the balance on account. 28 Paid $6,000 on the balance owed for office equipment Required: a. Journalize the transactions of January for YAY consulting. (10 pts) Jan 3 Dr. cash $15,000 Cr. Unearned revenue $15,000 Jan 4 Dr. cash $2,000 Dr. Accounts receivable $4,000 Cr. Service revenue $6,000 Jan 5 Dr. Equipment $15,000 Cr. Cash $5,000 Cr. Accounts Payable $10,000 Jan 28 Dr. Accounts payable $6,000 Cr. Cash $6,000 b. Based only on these transactions, what amount would YAY consulting report as total assets in the January 31 st statement of financial position? (4pts) Cash: +15,000+2,000-5,000-6,000 = 6,000 Accounts receivable: +4,000 Equipment: +15,000 Total assets: $25,000 c. Based only on these transactions, what amount would YAY consulting report as total liabilities in the January 31 st statement of financial position? (4pts) Accounts payable: +10,000-6,000 = 4,000 Unearned revenue: 15,000 Total liabilities: $19,000 5

6 PART 3: ADJUSTING ENTRIES (39 points) The following lists the adjustment data for Sontas Bar & Lounge for the month ended May 31 st. 1. Revenue of $7,800 collected in advance has been earned. 2. Interest on a 5 month $25,000 loan accrues every month. The annual interest rate is 8%. 3. Prepaid rent of $3,500 has expired. 4. Hydroquebec billed Sontas $4,500 for the second quarter of the calendar year. The bill is due June 30 th. Sontas recognizes its electricity use every month. 5. Sontas employs 6 bartenders. They each work 4 weeks per month and earn $300 per week. 6. On May 1 st, $1,500 worth of supplies were on hand. A count at the end of the month revealed that $500 worth of supplies are still available. 7. Every month Sontas extends credit to its loyal and creditworthy customers. Revenue earned but unbilled totals $8,500. Required: a. For each of the above items, complete every box of the following table by indicating (31.5 points): i. The type of adjustment (prepaid expense, accrued expense etc) ii. The accounts that are affected: Assets (A), Liabilities (L), Share Capital (SC), Revenue (R), Expenses (E), Dividends (D) iii. The status of the account balances before the adjustment. That is, prior to your adjustments, were the accounts overstated (O) or understated (U)? Example: if prior to the adjustment liabilities were overstated and revenues understated, fill in: L: U R: O iv. The adjusting journal entry (you may omit the explanations of the transactions) 1. Type of Adjustment Unearned revenue/ deferral Affected Accounts L/R Account balances before adjustment L:O R:U Adjusting journal entry Unearned revenue $7,800 Revenue $7,800 2 Accrued Expense E/L E:U L:U Interest expense $167 Interest payable $167 (25,000x0.08x1/12) 3. Prepaid expense/ deferral E/A E:U A:O Rent expense $3,500 Prepaid Rent $3,

7 Accrued expense E/L E:U L:U Utilities expense $1,500 Utilities payable $1,500 (4,500/3) 5. Accrued expense E/L E:U L:U Salary expense $7,200 Salary payable $7,200 (300x4x6) 6. Prepaid expense/ deferral E/A E:U A:O Supplies expense $1,000 Supplies $1, Accrued revenue A/R A:U R:U Accounts receivable $8,500 Revenue $8,500 b. Assume Net Income before the adjustments listed above was $17,000. What is the adjusted net income? Please show every detail in your calculation (in words and numbers) (7.5 points) Net income before adjustments... $17,000 Add: Unearned revenue (1) $7,800 Accrued revenue (7). $8,500 $16,300 $33,300 Less: Accrued salaries(5) $7,200 Prepaid rent (3). $3,500 Supplies (6)... $1,000 Accrued utilities (4).. $1,500 Accrued interest (2).. $167 $13,367 Adjusted net income. $19,933 7

8 PART 4: REVENUE RECOGNITION The following two cases are independent of each other. Mini Case 1 (24 points): Canada Duck Manufacturing makes winter coats that are sold to retailers throughout Canada on the following terms: each coat has a fixed wholesale price, is shipped F.O.B. shipping point, and retailers have 30 days after the shipment to pay Canada Duck. Retailers can return up to a maximum of 35% of an order at the retailers expense up to 9 months after delivery. Canada Duck is very strict on its credit policy and therefore only sells on account to its most creditworthy retailers. Throughout its corporate life, Canada Duck has experienced a return rate of about 10% and an average collection period of 60 days. Canada Duck provides its management with a bonus based on annual revenues net of returns. Required: a. Identify four different revenue recognition points that Canada Duck could use to record revenue. Make sure to tailor and explain these recognition points in relation to the specific case of Canada Duck. (8 points) 1. Record revenues at time of production: at the time of manufacture of the coats of Canada Duck. 2. Record revenues at time of sale/shipment: record revenues at shipping point (FOB shipping point). 3. Record revenues at time of collection: 30 days after shipment when payment is due. 4. Record revenues after the return period of 9 months. b. What revenue recognition criteria should Canada Duck use to determine when revenue should be recorded? (4 points) Measurement: reliably measure revenue and costs, reasonable assurance of collectability Performance: performance is substantially complete, risks and rewards of ownership have been transferred to the buyer. c. Discuss the advantages and disadvantages of each of the recognition points mentioned in b. Remember to tailor your answer to the specific case of Canada Duck. (12 points) 1. Record revenues at time of production/manufacture of the coats Advantages: The wholesale price is fixed, therefore the measurability of the revenue is assured. This would maximize the bonus for management. Disadvantages: Canada Duck has not transferred the risks and rewards of ownership. Meaning that Canada Duck is still liable if the coats were to be damaged or destroyed. Canada Duck does not have a receivable/asset due from the retailer at this point. 2. Record the revenues at time of sale: record revenues at shipping point Advantages: Terms: FOB shipping point: the risks and rewards of ownership have been transferred (the retailer is now liable if the goods get damaged, lost, or destroyed). There is still a possibility of returns, but Canada Duck has operating history that could help establishing reasonable estimates of returns. Measurability is assured. Disadvantages: 8

9 The retailer can return up to 35% of the items. The return period is significant: 9 months. The measurability of revenue is not assured. 3. Record revenues at time of collection/ after 30 days. Advantages: Customer is legally liable to pay (invoice terms). A customer paying the invoice is unlikely to return some of the merchandise. Canada Duck only extends credit to its creditworthy customers, so they can make very good predictions/estimates of the amounts that may not be paid. Disadvantages: The collection date is not critical as Canada Duck can make estimates of the bad debts/ any potential non-payment. 4. Record revenues after the return period of 9 months: Advantages: Measuring revenue is most reliable. Disadvantages: Too conservative The financial statement information will not be timely anymore: information is relevant but not reliable. Bonus would be paid later.! EXTRA CREDIT QUESTION! 2 BONUS POINTS! For the month of August, 2014, retailers returned 150 coats that were purchased on account. Canada Duck received the 150 coats which were sold for $850 each and cost Canada Duck $480 each. 67% of the returned merchandise can be resold. For this case, assume Canada Duck uses the periodic inventory system. Prepare a journal entry for this transaction in proper format. Dr. Sales returns and Allowances $127,500 Cr. Accounts Receivable $127,500 Calculation: Sales returns and allowances/ar: 150x850 = 127,500 2 points if all correct If not entirely correct: 0 pts 9

10 Mini Case 2 (7 points): Pecan Property Development Inc. has agreed to construct a building for $500,000 (this is the total revenue Pecan Property Development Inc. estimated). The works started in 2012 and were completed in Find below relevant information regarding the project. Pecan Property Development Inc. uses the percentage of completion method Costs incurred during the year $100,000 $250,000 $50,000 Billings during the year $150,000 $280,000 $70,000 Collections during the year $130,000 $275,000 $89,000 Required a. What amount of revenues would Pecan Property Development record in 2013? (2 points) % completion: 250,000/400,000= Revenue: x 500,000 = 312,500 b. What amount of gross profit would Pecan Property Development record in 2013? (2 points) Gross profit: 312, ,000 = 62,500 c. For 2014, determine the accounts receivable balance. (3 points) Receivables: beginning balance + billings during the year collections during the year Receivables: 25,000+70,000-89,000= 6,000 10