UNIVERSITY OF ALBERTA, FACULTY OF BUSINESS



UNIVERSITY OF ALBERTA, FACULTY OF BUSINESS

DEPARTMENT OF ACCOUNTING AND MIS

ACCOUNTING 311, FALL TERM 2003, SECTIONS D1 & F1

FINAL EXAMINATION, December 15, 2003: 120 minutes

MARK SUMMARY

Question Page Marks Available Marks Awarded

1 2 15

2 3 16

3 4 15

4 5 21

5 6 19

6 7 19

7 8 15

TOTAL MARKS 120

Question 1 (15 marks and minutes)

Threadbare Clothing Inc. has been having a difficult time financially. You are a marketing person, but have been asked to help with the year-end accounting since the company's bookkeeper was laid off. Write a balanced journal entry to make each of the adjustments below. Threadbare's accounts have not yet been closed for the current fiscal period. Journal entry narratives or explanations are not required, but state any assumptions you think are necessary.

(a) (3 marks) A review of the accounts receivable shows that the allowance for doubtful accounts, now $14,200, should be raised to $31,600.

(b) (2 marks) Accounts receivable totalling $2,900, previously considered doubtful, are now considered hopeless so management has decided to write them off.

(c) (3 marks) Desperate to increase sales, the company bought a shipment of cheap clothes made in Appolonia. The clothes are mostly still on hand because no one likes them, and their market value is well below cost. The cost of the clothes still in inventory is $8,200; the clothes should be written down to $2,400 market value.

(d) (3 marks) Over the year, the company spent $53,000 cash to provide warranty service. The bookkeeper had added those cash payments to warranty expense, even though the company had already estimated warranty costs for the year and had recorded those estimated costs by recording a $58,000 warranty expense and liability. The accounts have to be fixed.

(e) (4 marks) The company refinanced a bank loan, in order to get a lower interest rate. The old loan, with $165,000 still owing, carried an interest rate of 9%, but the company was able to get a new loan of $180,000 at a rate of 6%, though it had to prepay $10,000 interest to close the deal. The company therefore received a net of $5,000 from the bank, which the bookkeeper had debited to cash and credited to sales revenue.

Question 2 (16 marks and minutes)

(a) (5 marks) W Inc. reports its bonded debt net of a discount. The resulting net amount can be described as the present value of the bonds’ future interest and face value payments, discounted at the current market interest rate for such bonds. Present value is not used for such other liability figures as bank loans and accounts payable, so is accounting for such bonded debt inconsistent in principle with accounting for other liabilities? Briefly, why, or why not?

(b) (6 marks) Calculate the cost of a new brew kettle recently installed by Big Stone Brewery, using the following data. Item descriptions not needed in your answer – just the numbers.

Brewmaster’s trip to the manufacturer’s plant to select the right kettle $ 5,000

Price quoted by the kettle manufacturer 320,000

Price agreed to by Big Stone and the manufacturer 305,000

Further discount obtained by Big Stone for paying for the kettle in advance 4,000

Cost of shipping the kettle to Big Stone’s brewery 23,000

Cost of repainting and brightening the brewery’s kettle area 38,000

Cost of developing a beer formula to be brewed in the new kettle 14,000

Cost of installing the new kettle 27,000

Cost of batches of unusable beer brewed to get the kettle ready for production 13,000

Cost of medical treatment for an employee scalded during kettle testing 7,000

Cost of photos featuring the new kettle, to be used in advertising 1,000

(c) (5 marks) At the beginning of this year, SQRZ Inc. had share capital of $2,000,000 (500,000 shares) and retained earnings of $3,500,000, total equity $5,500,000. Calculate retained earnings at the end of the year, after taking into account the following information. Item descriptions not needed in your answer – just the numbers.

Net income for the year $786,000 10% stock dividend on 550,000 shares,

Cash dividends declared $230,000 valued at $420,000

Cash dividends paid $185,000 2 for 1 stock split on 605,000 shares (price

50,000 shares issued for cash $500,000 of shares $10.50 before split)

Share issue costs $ 11,000 Year-end share price $6.20

Question 3 (15 marks and minutes)

Answer briefly any three of the following questions. If you answer more than three, only the first three answers will be marked.

(a) It has been said that inventories and prepaid expenses are very similar assets, arising from conceptually the same kind of event. Explain why this is true.

(b) Many companies use the perpetual inventory method, or similar methods like the retail method, which produce an expected inventory asset amount. However, if, when the inventory is counted, the amount on hand doesn’t agree with the expected amount, the asset amount is adjusted to equal the count. So the balance sheet figure is the same as it would be if the company just used the periodic method. Why then bother with the perpetual methods?

(c) We established earlier in the course that the book value (balance sheet amount) for equity is almost certainly different from the market value of the equity. All owners would be interested in the market value (e.g. the current value of shares on the stock market). What then is the purpose of accounting for equity on the balance sheet?

(d) If you own a car, a house, an art collection or other such asset, you are probably interested in what such an asset would be worth if you sold it or had to insure it. Such worth is largely ignored by financial accounting, which instead records these assets’ cost. Why does financial accounting focus on the cost of noncurrent assets rather than their current worth?

Question 4 (21 marks and minutes)

The Chief Executive Officer of Noxen Inc. today asked your advice about a proposed change in accounting policy. It has been proposed that the company should recognize revenue from sales of its medical equipment earlier than it has been doing. Payment terms and shipping dates for its customers would not change, just the point at which the revenue would be shown in the company’s income statement. The change would be implemented as of October 31, 2003.

(a) (4 marks) List the balance sheet accounts that would immediately be affected if Noxen Inc. made this change in accounting policy.

(b) (8 marks) Specify two conditions under which this change in policy would be ethical and appropriate, and two conditions under which it would not be ethical or appropriate.

(i) Ethical and appropriate if:

1.

2.

(ii) Not ethical or appropriate if:

1.

2.

(c) (5 marks) Noxen Inc. has a 35% income tax rate and its selling price is a 50% mark-up on its inventory cost. If revenue in 2003 were increased by $3,000,000 by this policy change, what would be the dollar effect on 2003 net income?

(d) (4 marks) An observer of Noxen Inc.’s industry commented that, aside from any ethical issues, such a policy change is stupid because it actually hurts the company or its shareholders. State two ways that the proposed policy change would, or might, hurt the company or its shareholders.

1.

2.

Question 5 (19 marks and minutes)

The new chief accountant of Cheng Industries is having difficulty deciding how to value the company’s inventory of goods for sale. You are given the following data:

Inventory cost, beginning of the year $ 782,500 Cost of goods sold:

Purchases for the year 5,492,260 FIFO basis $5,393,620

Net realizable value of inventory at end of year 843,000 LIFO basis 5,558,710

Replacement cost of inventory at end of year 885,000 Average basis 5,444,890

(a) (3 marks) Calculate the ending inventory cost on the FIFO basis.

(b) (3 marks) Ignoring market value, would LIFO cost produce a higher, or lower, income before income tax for the year than Average cost would? By how much?

(c) (5 marks) Suppose the company’s inventory accounting policy was “lower of average cost or net realizable value.” Show the resulting balance sheet inventory figure at the end of the year.

(d) (8 marks) Suppose the company is deciding between FIFO and Average for cost, and net realizable value or replacement cost for “market.” Explain each statement below.

(i) Choosing replacement cost for market would not affect net income this year.

(ii) Choosing net realizable value for market could affect net income this year.

Question 6 (19 marks and minutes)

At the beginning of 2001, Vice-Versa Inc. acquired a new machine for making Things. The machine cost $150,000 and is expected to be used for 20 years, with a salvage value of $5,000 at the end of that time. The company expected to make 2,000,000 Things during the 20 years. Production during the past three years has been: 200,000 Things in 2001; 250,000 Things in 2002; and 220,000 Things in 2003. The estimated resale market value of the machine at the end of each year has been: $120,000 end 2001; $100,000 end 2002; $85,000 end 2003.

(a) (5 marks) Calculate the net book value of the machine at the end of 2003, using straight-line amortization.

(b) (4 marks) Calculate the amortization expense on the machine for the year 2003, using units of production amortization.

(c) (3 marks) Given your answer to (a), calculate the gain or loss on sale if the machine were sold for its market value at the end of 2003. Be sure to specify if it is a gain or a loss.

(d) (3 marks) Does the gain or loss in item (c) represent a mistake in calculating amortization? Explain.

(e) (4 marks) Calculate the amortization expense on the machine for 2002, using double declining balance amortization.

Question 7 (15 marks and minutes)

Answer each of the following independent items regarding Dog Breath Candies Inc.

(a) (4 marks) Dog’s Breath Candies has liabilities of $16,240,000 and equity of $12,990,000. It is a corporate group, with some subsidiaries. Dog’s Breath management is considering buying 70% of Kitty Litter Inc. for $840,000 cash. Kitty Litter has assets of $5,200,000 and liabilities of $4,000,000, all of which have book values equal to fair values. Would this acquisition increase or decrease Dog’s Breath’s consolidated debt-equity ratio? Explain.

(b) (5 marks) Dog Breath Candies calculated its income before income tax for this year to be $1,340,000, but, largely because of the difference between the amortization expense recorded for accounting purposes and the capital cost allowance used for income tax purposes, the company’s taxable income for this year is only $960,000. The company’s income tax rate is 40% on this year’ income tax return. At the end of last year, the company’s income tax liabilities were: income tax payable, $152,000; future income tax liability, $789,000. At the end of this year, they are: income tax payable $344,000; future income tax liability, $978,000. Calculate Dog Breath’s total income tax expense for this year.

(c) (6 marks) Today, Dog Breath Candies signed a four-year lease on a new building, agreeing to four annual payments of $80,000, the first due a year from today and the other three due on this date each succeeding year. The company’s accountant said the lease is a capital lease, with the payments including interest of 7%. Write a journal entry, if any is required, to record the lease signing. (If no entry is required, explain why not.)

End of Exam

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This exam has a mixture of content from lectures, seminars, readings, exam practice questions and project work.

Please read these instructions:

• Check that you have a complete exam (7 questions on 8 pages, including this cover).

• The exam is closed-book. You may not bring any material to the exam.

• Your calculator must not be programmable.

• You have 120 minutes to complete the exam: no extra time will be provided.

• Answer each question in the space provided. State any assumptions you need, show clearly all calculations and explanations, and communicate clearly to the marker. Point-form answers are encouraged. GOOD LUCK!

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