INTRODUCTION TO FINANCIAL ACCOUNTING MGCR211 - All sections October 16 th, 215 12:PM - 2:PM SOLUTION October 16, 215 Midterm Examination Please pick your professor: Professor: Jorien Pruijssers Seda Oz Ralph Cecere Day & Time of your class: Student Name: McGill ID: INSTRUCTIONS: This is a CLOSED BOOK, CLOSED NOTES examination. SPACE IS PROVIDED on the examination to answer all 5 parts of the exam. CALCULATOR WITHOUT GRAPH FEATURES permitted ONLY. Translation dictionaries are allowed. This examination consists of 5 parts on a total of 13 pages, including the cover and extra sheet pages. All questions are to be answered on this examination paper. Answer the question in the space provided. Do not exceed the space allowed. Read each question carefully. 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. This examination is PRINTED ON BOTH SIDES of the paper. This examination paper MUST BE RETURNED. Marks PART A Multiple Choice Questions 2 Grade PART B Basic Accounting Equation Tiger, Inc. 17 Monkey, Inc. 15 PART C Adjusting Entries Hawk, Co. 22 PART D Ratio Analysis Starbucks Corp 8 Part E Revenue Recognition 18 TOTAL 1 1 / 13
Part A: Multiple Choices. 1 X Select the best answer for each of the following unrelated items (unless otherwise noted). Answer each of these items directly on your examination paper by circling your choice. If more than one answer is given for an item than that item will not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations. 1. In which section of the annual report does management comment on the company and its operating results? a) report to the shareholders b) management's discussion and analysis c) corporate profile d) selected financial data 2. Which of the following is an internal user of annual report information? a) creditors b) board of directors c) regulators d) shareholders 3. Which of the following statements best describes a proprietorship? a) can be single or multiple owners b) taxed separately c) most expensive to establish d) owner is responsible for debt of the company 4. A company received a $6,5 deposit from a customer for goods to be delivered the following month. Under the accrual and cash basis of accounting respectively, the deposit would be recorded as Accrual basis Cash basis a) a liability a liability b) a liability income c) income a liability d) income income 5. An accrual refers to an event: a) where the expense or revenue is recorded after the cash settlement b) where the liability is recorded after the cash settlement c) where the expense or revenue is recorded before the cash settlement. d) where the asset is recorded after the cash settlement 6. At the end of 214, Whiteberry Company has total assets and liabilities at $42, and $11,, respectively. Whiteberry reported net income for 215 in the amount of $12,. How much is shareholders equity at the end of 215? a) $3, b) $22, c) $31, d) $43, 7. If the debit amount of an entry to record the purchase of supplies on account was not posted: a) liabilities would be understated b) liabilities would be overstated c) assets would be overstated d) assets would be understated 2 / 13
8. On the financial statements, an item is deemed material if: a) Its nature and magnitude are significant b) it overstates liabilities c) It represents the economic substance rather than the legal form of an event d) It affects shareholders wealth Use the following data of Ankara, Co for questions 9 and 1: Cash $15,2 Accounts receivable $29,5 Accounts payable $34,5 Note payable $5, Inventory $17, Dividends payable $5,2 Equipment $22, Short-term investments $6,4 Net Income $35, Accumulated Depreciation $1, Common shares $4, Beginning Retained earnings $23,4 Prepaid rent expense $1,6 Salaries payable $12, 9. Total assets amounted to: a) $189,7 b) $288,1 c) $289,7 d) $389,7 1. Total liabilities amounted to: a) $11,7 b) $98,1 c) $196,5 d) $198,1 3 / 13
Part B: Basic Accounting Equation. In this part, there are two independent questions. Please use the allocated space for each question. 1. Tiger Inc. reports the following transactions for May 215. Analyze the effect of each transaction on the accounting equation. For each transaction determine the account type (e.g. asset, liability, shareholder s equity), account name (e.g. accounts receivable, cash) and the change (e.g. increase, decrease) in each account you state. Do not leave any box blank. A blank answer will receive zero marks. Tiger, Inc: a) On May 1, 215, bought land with a value of $25, by issuing 1, shares. b) On May 1, 215, purchased a new 2-year insurance policy for $4,8. The new insurance policy starts on May 1, 215 and ends on April 3, 217. c) On May 1, 215, bought a building for $1,. Paid one-fourth in cash and the balance on a 1-year, 1% interest note payable. d) On May 5, 215, purchased $9, of inventory on account. e) On May 1, 215, received a utility bill for $75 covering month of April (no payment has been made). f) On May 15, 215, paid $2,5 for the inventory previously purchased in transaction d. g) On May 12, 215, declared a $1, dividend. h) On May 31, 215, recognized that 1 month of the insurance coverage had expired (ref: transaction b). NO MARKS WILL BE TAKEN OFF FOR NOT SPECIFYING AMOUNTS Item a) Complete the Expanded Accounting Equation for each item in the space provided Land: +25, >>> Total Asset +25, Common Shares: +25, >>> Total Equity +25, b) Cash -4,8 >>> Total Asset -4,8 Prepaid Expense: +4,8 >>> Total Asset: -4,8 c) Cash -25, >>> Total Asset: -25, Building +1, >>> Total Asset: + 1, Long-term Debt: +75, >>> Total Liability +75, d) Inventory +9, >>> Total Asset: +9, Accounts Payable: +9, : Total Liability: +9, e) Utility Payable: +75 >>> Total Liability: +75 Retained Earnings: -75 >>> Total Equity: +75 4 / 13
f) Cash: -25 >>> Total Asset: -2,5 Accounts Payable: -25 >>> Total Liability: -2,5 g) Dividend Payable: +1 >>> Total Liability: +1, Retained Earnings: -1 >>> Total Equity: -1, h) Prepaid Expense: -2 >>> Total Asset: -2 Retained Earnings: -2 >>> Total Equity: -2 5 / 13
2. Monkey Inc. made some errors during the posting process. Indicate the exact dollar impact each error would have on total assets, total liabilities, and shareholders' equity. Complete the chart below by using (OVER) to indicate overstated, (UNDER) to indicate understated, and (ZERO) to indicate no effect. Don t forget to indicate exact dollar amount. Following is the list of errors made by Monkey Inc. Fill in every box of the table. Boxes left blank will be given marks. a. A $2 credit to the Accounts Payable account was posted as $2,. b. A $5 debit to Cash was never posted. c. A $55 credit to the Revenue account was credited to the Accounts Receivable account. d. A $45, debit to the Land account was debited to an expense account. e. A $2 payment on an account payable was credited to Accounts Receivable instead of Cash. Item TOTAL ASSETS TOTAL LIABILITIES SHAREHOLDERS EQUITY a) Over 1,8 b) Under 5 c) Under 55 Under 55 d) Under 45, Under 45, e) 6 / 13
Part: C: Adjusting Entries Hawk Corporation is a furniture company and it prepares quarterly financial statements. The company s fiscal year end is December 31st. Below is the unadjusted trial balance at its 2nd quarter end, June 3, 214. HAWK CORPORATION Unadjusted Trial Balance June 3, 214 ------------------------------------------------------ Debit Credit Cash... $1,6 Accounts receivable... 13,2 Supplies... 1,95 Prepaid insurance... 4,75 Equipment... 38,5 Accumulated depreciation-equipment... $8,85 Accounts payable... 2,5 Unearned revenue... 6,7 Salary payable... 65 Interest Payable... 1 Bank Loan Payable... 4, Common shares... 15, Retained earnings... 1,1 Furniture revenue... 37,2 Salary expense... 11,85 Supplies expense... 45 Insurance expense... 75 Depreciation expense-equipment... 55 Interest Expense... 1 Utilities expense... 2,4 $85,1 $85,1 An analysis of the account balances provided the following additional information: i. A two-year insurance policy costing $6, was purchased on October 31, 213. ii. Salaries owed to employees on June 3, 214, amount to $4,6 which has not yet been paid or recorded. iii. A physical count of supplies reveals $9 of supplies on hand on June 3, 214. iv. Bank loan was incurred on February 1, 214. Loan carries monthly fixed interest of $5. The interest and principal are due on February 1, 216. v. Customers must pay a $75 deposit when they order hand-carved furniture. On June 5, 214, a customer gave an order of 5 hand-carved furniture and made the deposit payment of $3,75. Hawk Co. promised to deliver all 5 items on June 3th. On June 3th, Hawk only delivered 2 items, the remaining to be delivered on August 1st, 214. None of these transactions were recorded. vi. During the month of June, $2, of common shares were issued in exchange for cash. The accountant forgot to record this transaction. vii. Hawk Corporation is considering of purchasing $2, worth of product placement on TV. Using the above additional information, prepare the adjusting entries that should be made by Hawk Co. on June 3, 214. Indicate if no adjusting journal entry is required by stating 'No Journal entry required'. 7 / 13
ANSWER: i. June. 3 Insurance Expense 75 Prepaid Insurance 75 ii. June 3 Salary Expense 4,6 Salary Payable 4,6 iii. June 3 Supplies Expense 15 Supplies 15 iv. June 3 Interest Expense 15 Interest Payable 15 v. June 5 Cash 375 Unearned Revenue 375 June 3 Unearned Revenue 1,5 Furniture Revenue 1,5 vi. June 3 Cash 2, Common Shares 2, vii. No adjusting entry is required 8 / 13
Part D: Ratio Analysis STARBUCKS CORP Condensed Consolidated Balance Sheets - USD ($) $ in Millions Jun. 28, 215 Sep. 28, 214 Current assets: Cash and cash equivalents $ 2,8.5 $ 1,78.4 Short-term investments 94.7 135.4 Accounts receivable, net 672.7 631 Inventories 1,166 1,9.9 Prepaid expenses and other current assets 413.8 285.6 Deferred income taxes, net 333 317.4 Total current assets 4,76.7 4,168.7 Long-term investments 39.1 318.4 Equity and cost investments 359.4 514.9 Property, plant and equipment, net 3,977.7 3,519 Deferred income taxes, net 851.2 93.3 Other long-term assets 443.3 198.9 Other intangible assets 525.8 273.5 Goodwill 1,56.6 856.2 TOTAL ASSETS 12,868.8 1,752.9 Current liabilities: Accounts payable 63.2 533.7 Accrued liabilities 1,656.9 1,514.4 Insurance reserves 214.7 196.1 Stored value card liability 1,24.6 794.5 Current Portion of Long-Term Debt 549.8 Total current liabilities 4,49.2 3,38.7 Long-term debt 2,347.4 2,48.3 Other long-term liabilities 613.9 392.2 Total liabilities 7,1.5 5,479.2 Shareholders' equity: Common stock ($.1 par value) authorized, 2,4. shares; issued and outstanding, 1.5.7 1,49.8 shares and 1,499.1 shares, respectively Additional paid-in capital 41.1 39.4 Retained earnings 5,945 5,26.6 Accumulated other comprehensive income/(loss) (131.1) 25.3 Total shareholders' equity 5,856.5 5,272 Noncontrolling interests 1.8 1.7 Total equity 5,858.3 5,273.7 TOTAL LIABILITIES AND EQUITY $ 12,868.8 $ 1,752.9 Using the information provided in the above balance sheet, answer the following questions: 1. Compute the current ratio for both years presented and provide your comments regarding this ratio year over year. Round your answer to two decimal places. Current ratio = current assets / current liabilities Current ratio (215) = 4,76.7 / 4,49.2 = 1.18 Current ratio (214) = 4,168.7 / 3,38.7 = 1.37 The company's 215 current ratio is lower when compared to the one in 214. It indicates that the company's liquidity is weakening. The current ratio deals with the relationship between current assets and current liabilities. It is calculated by dividing current assets by current liabilities. The current ratio measures the ability to pay current liabilities with current assets. A high current ratio is preferable to a low current ratio. A high current ratio means a company has plenty of current assets to pay current liabilities. An increasing current ratio from one period to the next indicates an improvement in financial position. Calculation of ratio: Explanation: 9 / 13
2. Compute the company's debt to total assets ratio for both years presented and provide your comments regarding this ratio year over year. Debt to total assets = total liabilities / total assets Debt to total assets (215) = 7,1.5 / 12,868.8 =.54 Debt to total assets (214) = 5,479.2 / 1,752.9 =.51 The company's 215 debt-to-total assets is higher when compared to the one in 214. It appears that debt financing as opposed to equity financing has increased in 215. The debt ratio deals with the relationship between total debt and total assets. It is calculated by dividing total liabilities by total assets. The debt ratio indicates the proportion of a company's assets that are financed with debt and measures the ability of a business to pay both current and longterm debts. A low debt ratio is preferable to a high debt ratio. A company with a small amount of liabilities has low required payments on debt. Such a company is unlikely to get into financial difficulties. Calculation of ratio: Explanation: 3. For each of the actions listed below, determine what would happen to the current ratio. Assume nothing else on the balance sheet changes and that net working capital is positive. a. Accounts receivable are fully collected in cash Current ratio does not change b. Long-term debt are paid off with cash Current ratio decreases 1 / 13
Part E: Revenue Recognition Following are three independent situations that occurred for each of the companies described below. All transactions and events occurred between January 1, 214 and to the end of their accounting period December 31, 214. None of the events have been recorded in the books of the respective companies. Situation 1: On December 31, 214, AYSE Corporation sold a piece of equipment to one of its customers for $2, and collected $8, cash on that date. The remainder of $12, plus 1% interest is payable on December 31, 215. AYSE Corporation will deliver the piece of equipment the first week of January 215 because of a snowstorm which delayed delivery on December 31, 214. Situation 2: On January 5, 214, SeJo Corporation collected $45 cash for a three-year subscription to Kemosabe Magazine for a monthly magazine. SeJo Corporation published and delivered the first issue in March 214 and every month following as scheduled. Situation 3: On January 1, 214, the law firm of Vestale and Chester collected $3, from a client and agreed to provide legal services over a 3 year contract period (214 thru 216). The law firm has no reliable method of estimating the costs of providing the services nor the actual timing of the services. For each situation given above, answer the following questions: a. Describe the revenue recognition method that should be used and briefly explain the reasoning. Determine the amount of revenue to be recognized in 214. SITUATION 1 Delivery of goods would be the critical event and should be used as the revenue recognition method adopted by the company. The company would have to establish when the risk and rewards of ownership over the goods would be transferred to the customer. A delivery point will need to be selected. As for the interest on the loan, this would simply be recorded as a function of time. No revenue would be recorded for 214 as the delivery occurred after December 31, 214 despite the weather related delay and interest revenue will only be earned in 215. Revenue (214) = 11 / 13
SITUATION 2 Delivery of goods would be the critical event and should be used as the revenue recognition method adopted by the company. The company would recognize revenue as each monthly magazine is delivered to the subscriber. Revenue of $125 would be recorded for 214 as the delivery occurred for the March-December 214 issues. Computed as $45 x 1/36. Revenue (214) = 15 SITUATION 3 Percentage of completion Provision of services would be the critical event and should be used as the revenue recognition method adopted by the company. However, the company would recognize revenue as each year is fulfilled under the contract. The company has no other basis of estimating the cost of rendering the services or timing, a reasonable method would be to use the period of the contract. Revenue of $1, would be recorded for 214 as the one-third of the contract would be fulfilled. Computed as $3, x 1/3. Revenue (214) = 1, b. Prepare any entry(ies) that should be made in 214 to correctly reflect the above facts. SITUATION 1 Dr Cash 8, Cr Unearned Revenue 8, 12 / 13
SITUATION 2 Dr Cash 45 Cr Unearned Revenue 45 March to Dec Dr Unearned Revenue 125 Cr Revenue 125 OR Combined entry: Debit Cash $425 Credit Unearned Revenue $3 Credit Revenue $125 SITUATION 3 Dr Cash 3, Cr Unearned Revenue 3, Dr Unearned revenue 1, Cr Revenue 1, Or Combined entry: Debit Cash $3, Credit Unearned Revenue $2, Credit Revenue $1, 13 / 13