SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 5.1
(a)
The statement of financial position provides information about a
company’s liquidity, solvency, and financial structure. If Wong has
poor liquidity, or poor coverage and solvency, or if Wong is
financed heavily by debt, lending funds to (and investing in) the
company has more risk.
(b) The statement of cash flows provides information about the
company’s sources and uses of cash during the period. If Wong
relies significantly on external financing as a result of negative
cash flows from operations, lending funds to (and investing in) the
company has more risk. The statement of cash flows also helps
users assess earnings quality. For example, if Wong’s net income
is significantly higher than cash flows from operations, this is a
sign of poor earnings quality, and a potential cause for concern to
a possible lender to the company.
LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.2
The main purpose of the statement of cash flows is to help users to
assess the enterprise’s capacity to generate cash and cash equivalents
and to enable users to compare the operating performance with other
entities. It also helps users evaluate the company’s liquidity, solvency,
and financial flexibility. Companies that are more financially flexible are
better able to survive economic downturns, and have lower risk of
business failure.
Users of Gator Printers’ statement of cash flows include shareholders,
creditors, potential bondholders, management, employees, and
customers. Shareholders, creditors, and potential bondholders will
analyze the company’s liquidity, solvency, and financial flexibility in
making their investment decisions. Management will use the statement
of cash flows to analyze sources and uses of cash in deciding whether
or not to expand, and in deciding how to fund the expansion, if any.
Employees and customers may use the statement of cash flows to
assess the company’s liquidity, solvency, and financial flexibility, if
they are seeking a long-term employer or supplier.
LO 1 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.3
Three examples of financial statement items which are omitted from
the statement of financial position because they cannot be objectively
measured, and therefore not recorded, include:
1. Internally-generated goodwill
2. Intellectual capital developed from research
3. Contingent liabilities that cannot be reasonably estimated
Note to instructor: This list is not a comprehensive list and other
acceptable options should be considered.
LO 2 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.4
Current assets
Cash and cash equivalents
FV-NI investments
Accounts receivable
Less allowance for expected credit
losses
Inventory
Prepaid insurance
Total current assets
$7,000
11,000
$90,000
(4,000)
86,000
40,000
5,200
$149,200
Cash and cash equivalents and accounts receivable are monetary
assets. Fair value-net income investments could be monetary assets
depending on the nature of the investments.
LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.5
Long-term investments
FV-OCI investments
Land held for speculation
Total investments
Fair Value-OCI investments are financial instruments.
LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
$ 62,000
119,000
$181,000
BRIEF EXERCISE 5.6
Property, plant, and equipment
Land
Buildings
Less accumulated depreciation
Equipment
Less accumulated depreciation
Equipment under lease
Less accumulated depreciation
Total property, plant, and equipment
$71,000
$207,000
(45,000)
190,000
(19,000)
229,000
(103,000)
162,000
171,000
126,000
$530,000
LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.7
Intangible assets
Intangible assets - patents
Intangible assets - franchises
Intangible assets - trademarks
Total intangible assets
$33,000
47,000
10,000
$90,000
Note: Goodwill would be shown separately from intangibles.
LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.8
(a)
Current liabilities
Accounts payable
Unearned revenue
Salaries and wages payable
Interest payable
Income tax payable
Notes payable
Total current liabilities
$251,000
141,000
127,000
42,000
9,000
__97,000
$667,000
All of the above with the exception of unearned revenue are monetary
liabilities. Unearned revenue is non-monetary as it will generally be
satisfied by delivery of goods or services, rather than monetary
amounts.
Note: Any current portion for the Obligation under Lease and the
current portion of long term debt, such as Notes Payable, would
be included if listed in the balances.
Note: For the notes payable, as at statement of financial position date,
there is no unconditional right to defer payment of the financial
liability beyond one year. Therefore, under IFRS, the financial
liability must be shown as a current liability.
(b)
Under ASPE, since the notes payable are refinanced by the issue
date of the financial statements, with payment terms beyond one
year as at the statement of financial position date, the notes
payable may be presented as a non-current liability. As a result,
current liabilities would total $570,000 ($667,000 - $97,000).
LO 3,10 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.9
(a) Under IFRS
Non-current liabilities
Bonds payable
Obligations under lease
Total non-current liabilities
$ 480,000
175,000
$655,000
In each case, these amounts would be shown net of current portion, if
any.
(b) Under ASPE
Non-current liabilities
Bonds payable
Obligations under lease
Notes payable
Total non-current liabilities
$480,000
175,000
__97,000
$752,000
In each case, these amounts would be shown net of current portion, if
any.
LO 3,10 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.10
Shareholders’ equity
Share capital
Preferred shares
Common shares
Contributed surplus
Total share capital
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
LO 3 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
$50,000
700,000
200,000
950,000
120,000
(150,000)
$920,000
BRIEF EXERCISE 5.11
The purpose of a statement of cash flows is to provide relevant
information about the cash receipts and cash payments of an
enterprise during a period, in order for users to determine the
significant operating, investing and financing items and amounts. It
differs from the statement of financial position and the income
statement in that it reports the sources and uses of cash by operating,
investing, and financing activity classifications. While the income
statement and the statement of financial position are accrual basis
statements, the statement of cash flows is a cash basis statement—
non-cash items are omitted.
LO 7 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.12
Only the operating activities section of the statement of cash flows
differs if the statement is prepared using the indirect method compared
to one prepared using the direct method. If the operating activities
section of the statement is prepared under the direct method, it reports
the actual gross cash collections from customers, cash payments to
suppliers, cash payments to employees, etc. It adjusts most of the
individual items on the statement of income from the accrual basis to
the cash basis. The indirect method arrives at the same total cash flow
from operations but starts with the net income for the period and
adjusts it for all non-cash items such as depreciation or amortization
and changes in the related current asset and current liability accounts
(working capital adjustments).
LO 8 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.13
Investing activities:
Purchase of fair value through other
comprehensive income investments
(47,000)
($120,000 - $96,000 + $23,000) = $47,000
Note: The fair value through OCI unrealized loss of $23,000 is not an
operating activity as it does not appear on the income statement,
and so net income need not be adjusted for this non-cash item.
LO 8 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.14
Operating activities:
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization expense
Loss on impairment
$6,000
20,000
LO 8 BT: AP Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.15
Cash flows from operating activities
Net income*
Adjustments to reconcile net income to
net cash provided by operating activities
Increase in accounts receivable
Decrease in accounts payable
Net cash used by operating activities
* Increase in Retained Earnings ($500 - $300)
LO 8 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
$200
(150)
(400)
(550)
$(350)
BRIEF EXERCISE 5.16
Cash flows from operating activities
Net income
$151,000
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation expense
$44,000
Increase in accounts receivable
(15,000)
Increase in accounts payable
9,000
38,000
Net cash provided by operating activities
$189,000
LO 8 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.17
Cash flows from operating activities
Cash received from customers (1)
$585,000
Cash paid to suppliers (2)
$191,000
Cash paid to employees
157,000
Taxes paid
48,000 (396,000)
Net cash provided by operating activities
$ 189,000
Computations:
(1) Cash received from customers
Sales
Less: Increase in accounts receivable
Cash received from customers
(2)
Cash paid to suppliers
Cost of goods sold
Less: Increase in accounts payable
Cash paid to suppliers
LO 8 BT: AP Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting
$600,000
(15,000)
$585,000
$200,000
(9,000)
$191,000
BRIEF EXERCISE 5.18
Proceeds from sale of land and building
Purchase of land
Purchase of equipment
Net cash provided by investing activities
$176,000
(44,000)
(35,000)
$ 97,000
LO 8 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 5.19
(a) Under ASPE, because payments of cash dividends are charged to
retained earnings, it would be treated as a financing activity.
Issuance of common shares
Repurchase of company’s own shares
Payment of cash dividend
Retirement of bonds
Net cash used by financing activities
$140,000
(25,000)
(58,000)
(200,000)
$(143,000)
(b) Under IFRS
Issuance of common shares
Repurchase of company’s own shares
Retirement of bonds
Net cash used by financing activities
LO 8,10 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
$140,000
(25,000)
(200,000)
$ (85,000)
BRIEF EXERCISE 5.20
Free Cash Flow Analysis
Net cash provided by operating activities
Less: Purchase of equipment
Purchase of land
Dividends
Free cash flow
$400,000
(35,000)
(44,000)
(58,000)
$263,000
LO 8 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 5.21
(a)
Operating Activities
Net income
Depreciation expense
4,000
Increase in accounts receivable
(10,000)
Increase in accounts payable
7,000
Net cash provided by operating activities
$40,000
___1,000
41,000
Investing Activities
Purchase of equipment
(8,000)
Financing Activities
Issuance of notes payable
20,000
Dividends paid
(5,000)
Net cash provided by financing activities
15,000
Net change in cash ($41,000 – $8,000 + $15,000)
$48,000
Free Cash Flow = $41,000 (Net cash provided by operating activities) –
$8,000 (Purchase of equipment) – $5,000 (Dividends paid) = $28,000.
(b)
Cash Flow per share = $41,000/100,000 = $0.41
(c)
Midwest would be prohibited from providing cash flow per share
in its financial statements under ASPE. Under IFRS, there is no
explicit requirement that prohibits cash per share information, so
an entity could choose to voluntarily report it.
LO 8,10,11 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: CPA: cpa-t001 cpa-t005 CM: Reporting and
Finance
BRIEF EXERCISE 5.22
Melbourne’s liquidity is improving. The current and acid-test ratios
have current liabilities as the denominator in the calculation. A higher
multiple of the balance of current liabilities is preferable for liquidity
purposes. In the case of the acid-test ratio, both inventory and prepaid
expenses are omitted from the numerator. This is because they are
assets that are not available to settle current liabilities. Therefore the
result is a lower multiple.
LO 11 BT: AN Difficulty: S Time: 5 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
BRIEF EXERCISE 5.23
(a)
2021
2022
2023
Current Assets
$3,000 $5,000 $6,000
Current Liabilities
$1,500 $3,000 $9,000
Current Ratio
2.00
1.67
0.67
A step-by-step solution for this section of the problem can be found
in the student resources section of the online course.
(b)
2,50
2,00
1,50
1,00
0,50
2021
2022
2023
Current Ratio
A step-by-step solution for this section of the problem can be found
in the student resources section of the online course.
(c) The current ratio has deteriorated year-over-year
(d) The current ratio deteriorated more from 2022 to 2023 in
comparison to 2021 to 2022. This can be seen through the plotted
line graph in part (b) as the slope becomes steeper from 2022 to
2023 in comparison to 2021 to 2022.
LO 11 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 cpa-t007 CM: Reporting, Finance
and DAIS
SOLUTIONS TO EXERCISES
EXERCISE 5.1
1.
Long-term investment. Fair Value-OCI investments are not held
with the intention of realizing direct investment gains. They are
acquired for longer term strategic purposes.
Nonmonetary and Financial Instrument.
2.
Capital shares in shareholders’ equity.
Nonmonetary and Financial Instrument.
3.
Current liability.
Monetary and Financial Instrument.
4.
Property, plant, and equipment (as a deduction or contra asset
account).
Nonmonetary and not a Financial Instrument.
5.
Property, plant, and equipment as a separate item
Nonmonetary and not a Financial Instrument.
6.
Current asset.
Monetary and Financial Instrument.
7.
Current liability.
Monetary and Financial Instrument.
8.
Retained Earnings with a debit balance in shareholders’ equity.
Nonmonetary and not a Financial Instrument.
9.
Current asset.
Nonmonetary and Financial Instrument. Fair value-net income
investments could be monetary depending on the nature of the
investments. Some FV-NI investments could be classified as
long-term investments if management’s intention it to hold them
for the long-term, but they are usually classified as current.
EXERCISE 5.1 (CONTINUED)
10.
Current liability.
Monetary and not a Financial Instrument. The income tax payable
is an obligation that stems from regulatory requirements and is
not contractual in nature.
11.
Property, plant, and equipment.
Nonmonetary and not a Financial Instrument.
12.
Current asset.
Nonmonetary and not a Financial Instrument.
13.
Current liability.
Monetary and Financial Instrument.
14.
Current liability.
Nonmonetary and not a Financial Instrument. Could be seen as a
Monetary Financial Instrument in the event that the company
does not provide the goods or services (in which case, the
company owes the deposit back to the customer in cash).
15.
Current liability.
Nonmonetary and not a Financial Instrument. This is a provision
accrual for a likely loss.
LO 3 BT: K Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.2
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
8
4
6
6
3
1
6
6
1
1
7
l.
m.
n.
o.
p.
q.
r.
s.
t.
u.
v.
6
1
7
3
2
1
1
6
6
11
10
LO 3 BT: K Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.3
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
s.
Classification
1.
2.
6.
1.
7.
4.
1.
6.
1.
6.
1.*
3.
2.
6.
X.
3.
11.
6.
5.
Monetary
Financial
Instrument
X
X
X
X
X
X
**
X
X
X
X
X
X
X
X
* Under IFRS, a non-current asset would typically be reclassified as a
current asset when it meets the criteria to be classified as held for sale.
** Financial instruments are contracts between two or more parties that
create a financial asset for one party and financial liability or equity
instrument for the other. Therefore, non-contractual items such as
taxes payable and HST payable are not financial instruments.
LO 3 BT: K Difficulty: S Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.4
a.
Bruno Corp.
Statement of Financial Position
December 31, 2023
Assets
Current assets
Cash
FV - NI Investments
Accounts receivable
Less allowance for expected credit losses
Inventory, at lower of cost and net realizable value
Prepaid expenses
Total current assets
Long-term investments
Land held for future use
Investment in bonds to collect cash flows
Property, plant, and equipment
Buildings
Less accumulated
depreciation—buildings
Equipment
Less accumulated
depreciation—equipment
Goodwill
Total assets
$ 290,000
120,000
$357,000
17,000
175,000
90,000
340,000
401,000
12,000
1,163,000
265,000
$730,000
160,000
265,000
570,000
105,000
160,000
730,000
80,000
$2,238,000
EXERCISE 5.4 (CONTINUED)
a. (continued)
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable
Bank overdraft
Notes payable
Rent payable
Total current liabilities
Long-term debt
Bonds payable
Pension obligation
Total liabilities
Shareholders’ equity
Common shares, unlimited authorized
issued 290,000 shares
Contributed surplus
Retained earnings*
Total shareholders’ equity
Total liabilities and shareholders’ equity
$ 195,000
30,000
125,000
49,000
399,000
$553,000
82,000
635,000
1,034,000
290,000
180,000
734,000
*$2,238,000 – $1,034,000 – $290,000 – $180,000 = $734,000
1,204,000
$2,238,000
EXERCISE 5.4 (CONTINUED)
*b.
The bank overdraft is classified as a current liability, as there is
no legal right to offset the bank overdraft against the positive
cash balance. The bank accounts are at different banks. Had the
bank overdraft been offset (netted) against the cash balance as
originally prepared by the bookkeeper, there would have been no
effect on working capital. The net amount of current assets, less
current liabilities would not change in absolute amount.
However, the classification change does affect the current ratio
(current assets / current liabilities):
Overdraft netted
$1,163 – $30
$399 – $30
= 3.07
Proper classification
$1,163
$399
= 2.91
Those who prepared the statement of financial position likely did
not do the misclassification of the bank overdraft on purpose. The
bank account in overdraft is likely one of several bank accounts
used by Bruno Corp. This particular account happens to fall in a
temporary overdraft position, as allowed by the bank, as of the
fiscal year end of the business.
LO 3,4,11 BT: AP Difficulty: M Time: 40 min. AACSB: Ethics CPA: cpa-t001 cpa-e0001 CM: Reporting and Ethics
EXERCISE 5.5
a.
Garfield Corp.
Statement of Financial Position
As at July 31, 2023
Assets
Current assets
Cash
Accounts receivable
Less allowance for expected credit
losses
Inventory
Total current assets
$ 66,000*
$ 46,700**
3,500
Long-term investments
Bond sinking fund investment
Property, plant, and equipment
Equipment
Less accumulated depreciation—
equipment
43,200
65,300***
174,500
12,000
112,000
28,000
84,000
Intangible assets
Patents, net of accumulated amortization
Total assets
21,000
$291,500
Liabilities and Shareholders’ Equity
Current liabilities
Notes and accounts payable
Income tax payable
Total current liabilities
$ 52,000****
9,000
61,000
Bonds payable
Total liabilities
75,000
136,000
Shareholders’ equity
Common shares
105,000
Retained earnings
50,500 __155,500
Total liabilities and shareholders’ equity
$291,500
* ($69,000 – $12,000 + $9,000)
*** ($60,000 + $5,300)
** ($52,000 – $5,300)
****($44,000 + $8,000)
EXERCISE 5.5 (CONTINUED)
*b. Since there is no legal right to offset the credit balances in accounts
receivable against any other amounts owing from customers, these
balances need to be classified as a current liability, unless the
amounts are deemed to be immaterial. Had the credit balances in
accounts receivable been offset (netted) against other debit
balances as originally presented, there would have been no effect
on working capital. The net amount of current assets, less current
liabilities would not change in absolute amount.
However, the classification change does affect the current ratio
(current assets / current liabilities) as demonstrated below:
Credit balances netted
$174,500 – $8,000
$61,000 – $8,000
= 3.14
Proper classification
$174,500
$61,000
= 2.86
The persons preparing the statement of financial position likely did
not feel that the credit balances in accounts receivable warranted a
reclassification. They likely were not aware of the impact the credit
balances would have on the current ratio. Materiality would also be
a basis for leaving the credit balances to offset the debit balances
in accounts receivable.
The credit balances in accounts receivable represent amounts
owing to specific customers. Following are possible conditions or
situations that would give rise to a credit balance in accounts
receivable:
1.
Customers have returned goods after paying for a shipment
and credit memorandums for the sales returns have been
applied subsequent to collection on account.
EXERCISE 5.5 (CONTINUED)
b. (continued)
2.
3.
4.
A customer has inadvertently overpaid an account.
Garfield’s policy on returned items does not allow a cash
refund. Instead the policy calls for the credit to be applied to
a future purchase on account.
Some accounting software packages treat customer
prepayments (unearned revenues) as credit balances in
accounts receivable, since the customer information is part
of the accounts receivable subsidiary ledger.
LO 3,4,11 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
EXERCISE 5.6
Lee Inc.
Statement of Financial Position
December 31, 20–
Assets
Current assets
Cash
$XXX
Less cash restricted for plant expansion
XXX $XXX
Accounts receivable
XXX
Less allowance for expected credit losses XXX
XXX
Notes receivable
XXX
Accounts receivable—officers
XXX
Inventory
Finished goods
XXX
Work in process
XXX
Raw materials
XXX
XXX
Total current assets
$XXX
Long-term investments
FV - OCI Investments
Land held for future plant site
Cash restricted for plant expansion
Total long-term investments
Property, plant, and equipment
Buildings
Less accumulated depreciation—buildings
XXX
XXX
XXX
XXX
XXX
XXX
XXX
Intangible assets
Copyrights
XXX
Goodwill
XXX
Total assets
$XXX
EXERCISE 5.6 (CONTINUED)
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable
Salaries and wages payable
Unearned revenue
Unearned rent revenue
Total current liabilities
$XXX
XXX
XXX
XXX
$XXX
Long-term liabilities
Bonds payable, due in four years
Total liabilities
Shareholders’ equity
Common shares
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
XXX
XXX
$XXX
XXX
XXX
$XXX
Note to instructor: The question notes that cash includes the cash
restricted for plant expansion. If it did not, then a subtraction from cash
would not be necessary, or the cash balance would be “grossed up”
and then the cash restricted for plant expansion would be deducted.
Alternatively, only cash that is not restricted can be shown in current
assets without presenting it on a gross basis with a subtraction for
cash restricted for plant expansion.
LO 3,4 BT: AP Difficulty: S Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.7
a.
1.
Dividends payable of $1,500,000 will be reported as a current
liability (1,000,000 X $1.50).
2.
No amounts are reported as a current or long-term liability. Stock
dividends distributable are reported in the shareholders' equity
section.
3.
Bonds payable of $25,000,000 and interest payable of $1,750,000
($100,000,000 X 7% X 3/12) will be reported as
a current liability. Bonds payable of $75,000,000 will be reported
as a long-term liability.
4.
Customer advances of $27,000,000 will be reported as a current
liability ($12,000,000 + $40,000,000 – $25,000,000).
5.
Demand bank loans must be classified as current liabilities.
6.
Although the terms and condition of the guarantee for the DD
Ross Ltd. bank loan must be disclosed in the notes to the
financial statements, no amount of liability is reportable on
Samson’s statement of financial position.
b.
Liabilities are a present duty or responsibility that obligates the
entity, arising from a past transaction or event. When Samson
accepts an advance from a customer, a duty or responsibility
arises that will be satisfied when Samson provides the related
goods or services. The obligation is a present and enforceable
until the related goods or services are delivered. Samson has no
practical ability to avoid the obligation. Earned customer
advances of $25 million no longer represent a liability because
the obligation has been satisfied.
EXERCISE 5.7 (CONTINUED)
c.
Samson may have a much stronger financial position than its
associate and by providing the guarantee the bank would be more
confident that the loan and related interest will be fully repaid on
a timely basis. The guarantee would typically lead to lower
interest rates being charged on the loan. Since Samson is
associated with DD Ross, increased income of the associate will
benefit Samson indirectly.
LO 4 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.8
a.
Zhang Ltd.
Statement of Financial Position
December 31, 2023
Assets
Current assets
Cash
FV - NI investments
Accounts receivable
Less allowance for expected
credit losses
Inventory
Total current assets
$205,000
153,000
$515,000
(25,000)
Long-term investments
Bond investments at amortized cost
FV - OCI Investments
Total long-term investments
Property, plant, and equipment
Land
Buildings
1,040,000
Less accumulated depreciation
(152,000)
Equipment
600,000
Less accumulated depreciation
(60,000)
Total property, plant, and equipment
Intangible assets
Intangible Assets-Franchises (net)
Intangible Assets-Patents (net)
Total intangible assets
Total assets
490,000
687,000
$1,535,000
299,000
345,000
644,000
260,000
888,000
540,000
1,688,000
160,000
195,000
355,000
$4,222,000
EXERCISE 5.8 (CONTINUED)
a. (continued)
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable
Dividends payable
Notes payable
Income tax payable
Total current liabilities
Long-term liabilities
Notes payable
Bonds payable
Total long-term liabilities
Total liabilities
$ 645,000
36,000
98,000
96,000
$ 875,000
900,000
1,000,000
1,900,000
2,775,000
Shareholders’ equity
Common shares
$ 809,000
Retained earnings**
490,000
Accumulated other comprehensive income
148,000*
Total shareholders’ equity
1,447,000
Total liabilities and shareholders’ equity $4,222,000
* Unrealized gain or loss-OCI
($345,000–$277,000)
Add opening balance
**Calculation of Retained Earnings:
Sales revenue
Investment income or loss
Gain on disposal of land
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Net income
Beginning retained earnings
Net income (above)
Dividends
Ending retained earnings
$68,000
80,000
$148,000
$8,010,000
13,000
60,000
(4,800,000)
(1,860,000)
(900,000)
(211,000)
$ 312,000
$ 218,000
312,000
(40,000)
$ 490,000
EXERCISE 5.8 (CONTINUED)
b.
A classified statement of financial position requires the reporting
of current assets and liabilities, and the classifications are used
for measurement of liquidity. The length of the operating cycle or
one year (whichever is longer) determines what items are
classified as current. Brookfield Asset Management Inc. has
several segments including: asset management, property
operations, renewable power, infrastructure operations,
residential development and others. The operating cycles for
these segments are very different. Applying one cycle length to
all business segments becomes meaningless. In cases such as
this, the consolidated statement of financial position may not be
classified.
LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.9
1.
Because the likelihood of payment is remote, accrual of a liability
is not required. Case by case examination is required with respect
to all lawsuits.
2.
A current liability of $150,000 should be recorded and reported for
the year ended December 31, 2023.
3.
A current liability for accrued interest of $3,750 ($900,000 X 5% X
1/12) should be reported. Any portion of the $900,000 note that is
payable within one year from the statement of financial position
date should be shown as a current liability. Otherwise, the $900,000
note payable would be a long-term liability.
4.
Although bad debts expense of $200,000 should be debited and
the allowance for doubtful accounts credited for $200,000, this
does not result in a liability. The allowance for bad debts is a
valuation account (contra asset) and is deducted from accounts
receivable on the statement of financial position.
5.
A current liability of $80,000 ($2 X 40,000) should be reported for
the dividends payable. The liability is recorded on the date of the
declaration of the dividend.
6.
Customer advances of $110,000 ($160,000 – $50,000) will be
reported as a current liability if the advances are expected to be
earned within one year.
7.
Income tax payable in the amount of $6,000 should be recorded
and reported as a current liability.
LO 4,5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.10
a.
Current assets
Cash
Less cash restricted for plant expansion
FV - NI investments
Accounts receivable (of which $50,000 is
pledged as collateral on a bank loan)
Less allowance for expected credit losses
Notes receivable
Interest receivable **
Inventory at lower of FIFO cost and
net realizable value
Finished goods
Work-in-process
Raw materials
Total current assets
$ 92,000*
(50,000)
161,000
(12,000)
152,000
34,000
187,000
$42,000
29,000
149,000
40,000
1,600
373,000
$634,600
*($50,000 + $50,000 – $8,000)
** [($40,000 X 6%) X 8/12]
b.
An alternative to the presentation of the details (for example of
the three categories of inventory) as shown above is to provide
disclosure in a table within the notes to the financial
statements. This provides a more condensed format of the
statement of financial position. This allows easier
comparisons of balances, especially when presented on a
comparative basis. References to the notes containing the
detail would be added to the captions appearing on the face of
the statement of financial position as a cross-reference.
EXERCISE 5.10 (CONTINUED)
(b) (continued)
A second possible alternative to the presentation of information
is parenthetical disclosure on the face of the statement of
financial position. Although not a required disclosure, the
balance of accounts receivable could be presented: “net of
allowance for expected credit losses of $12,000.”
An acceptable alternative for cash is to report cash of $42,000 and
report the cash restricted for plant expansion in the non-current
investments section of the statement of financial position.
LO 4,5,6 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.11
a.
Uddin Corp.
Statement of Financial Position
December 31, 2023
Assets
Current assets
FV – OCI Investments
Property, plant, and equipment
Land
Buildings ($1,120,000 + $31,000)
$1,151,000
Less accumulated depreciation
($130,000 + $4,000)
(134,000)
Equipment ($320,000 – $20,000)
300,000
Less accumulated depreciation
($11,000 – $8,000 + $9,000)
(12,000)
Total
Intangible assets
Patents, net ($40,000 – $3,000)
$1,380,500a
20,500
$ 30,000
1,017,000
288,000
1,335,000
37,000
Total assets
$2,773,000
Liabilities and Shareholders’ Equity
Current liabilities ($1,020,000 + $13,000)
Long-term liabilities
Bonds payable ($1,100,000 + $75,000)
Total liabilities
Shareholders’ equity
Common shares
Retained earnings*
Total shareholders’ equity
Total liabilities and shareholders’ equity
$1,033,000
1,175,000
2,208,000
$180,000
385,000
565,000
$2,773,000
* ($174,000 + $391,000 – $180,000)
a
The amount determined for current assets is calculated last and
is a derived or “plug” figure. That is, total liabilities,
shareholders’ equity and other asset balances are calculated
because information is available to determine these amounts.
EXERCISE 5.11 (CONTINUED)
b.
Uddin Corp.
Statement of Cash Flows
For the Year Ended December 31, 2023
Cash flows from operating activities
Net income
$391,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Loss on disposal of equipment
[($20,000 – $8,000) – $10,000]
$ 2,000
Depreciation expense
($4,000 + $9,000)
13,000
Amortization expense
3,000
Increase in current liabilities
13,000
Increase in current assets (other
than cash)
(29,000)
2,000
Net cash provided by operating activities
393,000
Cash flows from investing activities
Proceeds from sale of equipment
Addition to buildings
Purchase of FV-OCI investments
Net cash used by investing activities
Cash flows from financing activities
Issuance of bonds
Payment of dividends
Net cash used by financing activities
Net increase in cash
b
10,000
(31,000)
(20,500)
(41,500)
75,000
(180,000)
(105,000)
$246,500b
An additional proof to arrive at the increase in cash follows:
Total current assets—end of period [from part (a)]
Total current assets—beginning of period
Increase in current assets during the period
Increase in current assets other than cash
Increase in cash during year
LO 4,8 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting
$1,380,500
1,105,000
275,500
29,000
$ 246,500
EXERCISE 5.12
a.
Agincourt Corp.
Partial Statement of Financial Position
As at December 31, 2023
Current assets
Cash1
Accounts receivable2
Less allowance for expected
credit losses
Inventory3
Prepaid expenses
Total current assets
$30,476
$91,300
Current liabilities
Accounts payable4
Notes payable5
Total current liabilities
1
Cash balance
Add: Cash disbursement
Less: Cash sales in January
($30,000 – $21,500)
Cash collected on account
Bank loan proceeds ($35,324 – $23,800)
Adjusted cash
2
Accounts receivable balance
Add: Accounts reduced from January
collection
Deduct: Accounts receivable in January
Adjusted accounts receivable
7,000
84,300
161,000
9,000
$284,776
$112,300
55,476
$167,776
$ 40,000
34,300
74,300
(8,500)
(23,800)
(11,524)
$30,476
$ 89,000
23,800
112,800
(21,500)
$ 91,300
EXERCISE 5.12 (CONTINUED)
a. (continued)
3
Inventory
Less: Consignment inv. included in count
Adjusted inventory
4
Accounts payable balance
Add: Cash disbursements
Purchase invoice omitted
($27,000 – $10,000)
Adjusted accounts payable
5
$171,000
(10,000)
$161,000
$ 61,000
$34,300
17,000
Notes payable balance
Less: Proceeds of Jan. 2024 bank loan
Adjusted notes payable
51,300
$112,300
$ 67,000
(11,524)
$ 55,476
Current ratio – Deteriorated dramatically
*b.
Before Restatement
Restated
$302,000
$284,776
$128,000
$167,776
= 2.36
= 1.70
Current assets decreased by $17,224 and current liabilities
increased by $39,776.
50 000
40 000
30 000
20 000
10 000
(10 000)
(20 000)
(30 000)
Current Asset
Current Liability
A step-by-step solution for this section of the problem can be found
in the student resources section of the online course.
EXERCISE 5.12 (CONTINUED)
For current liabilities, Accounts Payable had the greatest impact
increasing by $51,300.
For current assets, Inventory had the greatest impact decreasing
by $10,000.
60 000
50 000
40 000
30 000
20 000
10 000
(10 000)
(20 000)
Inventory
Cash
Allowance for
expected credit
losses
Prepaid
expenses
Accounts
receivable
Notes payable
Current Asset
Accounts
payable
Current Liability
A step-by-step solution for this section of the problem can be found
in the student resources section of the online course.
c.
Adjustment to retained earnings balance:
Deduct:
January sales
December purchases
($27,000 – $10,000)
Consignment inventory
Decrease to retained earnings
$30,000
17,000
10,000
$57,000
EXERCISE 5.12 (CONTINUED)
d.
Agincourt’s bank manager is relying on the information in the
statement of financial position as at December 31, 2023 to assess
whether a new bank loan should be extended to the company.
Before restatement, Agincourt’s current ratio is 2.36, and after
restatement, Agincourt’s current ratio is 1.70. The adjustments
are material because they result in a current ratio that is much
closer to the minimum required current ratio, and would likely
affect the bank manager’s decision to extend a new bank loan to
Agincourt. In order for financial statements to be useful, relevant,
and faithfully representative, they must be free from error and
bias. Recording the adjustments is necessary in order to provide
financial statement users with useful and complete information
for their investment and credit decisions.
e.
The likelihood that the bank manager will suspect the statement
of financial position is incorrect is quite strong. Two of the
balances reported on the statement of financial position represent
accounts with the bank. One is the Cash balance and the other is
the Notes Payable balance which is a loan from the bank. Both
balances would not be in line with the records of the bank at
December 31, 2023, and the most noticeable one would be the
Notes Payable balance. This is the case because an additional
$12,000 loan was made in the first few days of January 2024 (refer
to part (a) above). In the case of the Cash account balance, it
would less noticeable as the bank understands that there are
outstanding cheques which make the bank and book balances
different. The manager is nonetheless aware and monitors the
flow of cash in the bank account.
LO 4,11 BT: AP Difficulty: C Time: 40 min. AACSB: None CPA: cpa-t001 cpa-t007 CM: Reporting and DAIS
EXERCISE 5.13
1. Contingency. Under IFRS, a provision is recognized in income and
as a liability if it is probable (more likely than not) that the confirming
future event will occur. In this example, it is not likely that damages
will be awarded to the plaintiff, and so it is considered a contingent
loss that is not accrued. However, the contingency would be
disclosed in the notes to financial statements if the possibility of an
outflow of company resources is not remote.
2. Subsequent event. This event provides evidence about conditions
that did not exist at the statement of financial position date, but
arose subsequent to that date, and therefore adjustment of the
statement of financial position as at December 31, 2023 is not
required. However, this event may have to be disclosed in the notes
to financial statements to keep the financial statements from being
misleading.
3. Provision. Under IFRS, a provision is recognized in income and as a
liability if it is probable (more likely than not) that the confirming
event will occur. According to Janix’s legal counsel, Janix will likely
lose the lawsuit; therefore a provision should be recognized. IFRS
requires that the “expected value” of the loss be used to measure
the liability. If $850,000 payout and $950,000 payout are equally
probable, the liability should be measured at $900,000.
4. Commitment. Under IFRS, if the unavoidable costs of completing the
contract are higher than the benefits expected from receiving the
contracted goods or services, a loss provision is recognized
(onerous contract). In this example, the cost per inventory unit has
decreased, therefore under IFRS, if the contract is non-cancellable,
or if the cancellation provisions are severe, a loss provision should
be recognized in the amount of $400,000 (200,000 X [$12 - $10]).
EXERCISE 5.13 (CONTINUED)
5. Commitment. Commitments that obligate a company must be
disclosed if they are material. A restriction on payment of dividends
should be disclosed in the notes to financial statements, because it
is likely to be considered material and potential shareholders would
be very interested in being aware of this restriction.
6. Subsequent event. This event provides evidence about conditions
that did not exist at the statement of financial position date, but
arose subsequent to that date, and therefore adjustment of the
statement of financial position as at December 31, 2023 is not
required. However, this event should be disclosed in the notes to
financial statements to keep the financial statements from being
misleading. Potential shareholders would be very interested in being
aware of the additional share issue and its effect on earnings per
share as the issuance of common shares is dilutive. In addition,
creditors would be interested in knowing of the additional financing
that will likely help Janix’s liquidity and solvency.
7. Subsequent event. Because the lump sum payment is for retroactive
pay that covers a period of time that involves an expense in the 2023
and 2024 fiscal periods, an accrual for the portion of the expense
that relates to 2023 must be reflected in the statement of
comprehensive income for 2023.
LO 5 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.14
a.
Carmichael Industries Inc.
Statement of Cash Flows
For the Year Ended December 31, 2023
Cash flows from operating activities
Net income
$129,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense
$27,000
Gain on disposal of land
(5,000)
Increase in accounts receivable
(50,000)
Increase in inventory
(31,000)
Decrease in accounts payable
(7,000) (66,000)
Net cash provided by operating activities
63,000
Cash flows from investing activities
Purchase of equipment
(60,000)
Proceeds from sale of land*
44,000
Net cash used by investing activities
(16,000)
Cash flows used by financing activities
Payment of cash dividends
(60,000)
Net cash used by financing activities
(60,000)
Net decrease in cash
(13,000)
Cash at beginning of year
34,000
Cash at end of year
$21,000
Note: During the year, Carmichael retired $50,000 in bonds payable by
issuing common shares. Disclosure for the amount paid for
interest and income tax would be included.
* ($110,000 - $71,000 + $5,000 gain) = $44,000
b.
Carmichael managed to generate sufficient cash from operations
to finance a strong dividend payout ratio of 46.5% ($60,000 divided
by $129,000). The cash generated from the sale of land was used
to purchase equipment. There are some indications that too much
cash is tied up in current assets, from the dramatic increase in both
the accounts receivable and the inventory balances over the year.
LO 8,9 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.15
Indirect method
a. 3.
b. 2.
c. 3.
d. 2.
e. 1.
f.
1.
g. 4.
h. 3.*
i.
4.
j.
1.
k. 1.
l.
1.
m. 1.*
n. 1.**
* Under ASPE, interest and dividends paid are operating activities if
recognized in net income. If charged directly to retained earnings, they
are presented as financing activities. (Under IFRS, interest and
dividends paid may be presented as either operating or financing
activities.)
** Under ASPE, interest and dividends received are presented as
operating activities. (Under IFRS, interest and dividends received may
be presented as either operating or investing activities.)
LO 7 BT: K Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.16
a. 1.
Kneale Transport Inc.
Partial Statement of Cash Flows
For the Year Ended December 31, 2023
Cash flows from operating activities
Net income
$148,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense
$70,000
Gain on disposal of equipment
(25,000)
Decrease in accounts receivable
10,000
Increase in prepaid insurance
(3,000)
Decrease in accounts payable
(11,000)
Increase in interest payable
1,250
Increase in income taxes payable
3,500
Decrease in unearned revenue
(4,000) 41,750
Net cash provided by operating activities
$189,750
2.
Kneale Transport Inc.
Partial Statement of Cash Flows
For the Year Ended December 31, 2023
Cash flows from operating activities
Cash received from customers (1)
Cash payments
For operating expenses (2)
For interest (3)
For income tax (4)
Net cash provided by operating activities
$551,000
$314,000
8,750
38,500
361,250
$189,750
EXERCISE 5.16 (CONTINUED)
a. 2. (continued)
(1) Cash received from customers
Revenues from services
Add: Decrease in accounts receivable
($60,000 – $50,000)
Less: Decrease in unearned revenue
($14,000 – $10,000)
Cash receipts from customers
(2) Cash payments for operating expenses
Operating expenses
Add: Increase in prepaid insurance ($5,000 – $8,000)
Decrease in accounts payable ($41,000 – $30,000)
Cash payments for operating expenses
$545,000
$10,000
(4,000)
$551,000
$300,000*
3,000
11,000
$314,000
* $370,000 – $70,000 = $300,000
(3) Cash payments for interest
Interest expense
Less: Increase in interest payable ($2,000 – $750)
Cash payments for interest
$10,000
(1,250)
$ 8,750
(4) Cash payments for income tax
Income tax expense
$42,000
Less: Increase in income tax payable ($8,000 – $4,500)
(3,500)
Cash payments for income tax
$38,500
EXERCISE 5.16 (CONTINUED)
b.
Whether the operating activities of the statement of cash flows
are reported using the direct or the indirect method, the statement
of cash flows allows the external users to assess Kneale’s
capacity to generate cash and allows those users to compare the
operating performance and cash flows with other businesses.
The indirect method focuses on the differences between net
income and cash flow from operating activities. A user of
Kneale’s financial statements would find this information useful
in that it provides a useful link between the statement of cash
flows, the statement of income, and the statement of financial
position. The direct method shows operating cash receipts and
payments, which is more consistent with the objective of the
statement of cash flows (that is, to provide information about the
company’s sources and uses of cash). An external user of
Kneale’s financial statements would find this information useful
in estimating future cash flow from operating activities.
LO 8,9 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.17
a.
Dropafix Inc.
Statement of Cash Flows
For the Year Ended June 30, 2023
Cash flows from operating activities
Net income
$13,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense
$10,000
Increase in accounts receivable
(12,000)
Increase in inventory
(1,000)
Decrease in prepaid expenses
4,000
Increase in accounts payable
15,000
Decrease in income tax payable
(1,000)
15,000
Net cash provided by operating activities
28,000
Cash flows from investing activities
Purchase of equipment
(6,000)*
Net cash used by investing activities
(6,000)
Cash flows used by financing activities
Payment of cash dividends
(4,000)**
Repayment of notes payable
(43,000)***
Issuance of common shares
_7,000
Net cash used by financing activities
_(40,000)
Net decrease in cash
(18,000)
Cash at beginning of year
38,000
Cash at end of year
$20,000
Note: During the year, equipment with a cost of $8,000 was
purchased in exchange for a note payable.
Cash paid during the year for interest: $9,000
Cash paid during the year for income tax: $$7,000
* Increase in equipment $14,000 less $8,000 non-cash purchase
** Increase in retained earnings, less net income plus dividends
payable increase ($4,000 - $13,000 + $5,000) = ($4,000)
*** Decrease in notes payable plus non-cash purchase
($35,000 + $8,000) = $(43,000)
EXERCISE 5.17 (CONTINUED)
b.
Dropafix Inc.
Statement of Cash Flows
For the Year Ended June 30, 2023
Cash flows from operating activities
Cash received from customers (1)
$311,000
Cash paid to suppliers (2)
$161,000
Cash paid for operating expenses (3)
106,000
Interest paid
9,000
Taxes paid (4)
7,000 (283,000)
Net cash provided by operating activities
$ 28,000
Computations:
(1) Cash received from customers
Net sales
Less: Increase in accounts receivable
Cash received from customers
(2)
(3)
(4)
$323,000
(12,000)
$311,000
Cash paid to suppliers
Cost of goods sold
Add: Increase in inventory
Purchases
Less: Increase in accounts payable
Cash paid to suppliers
$175,000
1,000
176,000
(15,000)
$161,000
to and
on behalf
of employees
Cash paid for
operating
expenses
Operating expenses
Less: Depreciation expense
Decrease in prepaid rent
Cash paid for operating expenses
$120,000
(10,000)
(4,000)
$106,000
Taxes paid
Income tax expense
Decrease in income tax payable
Income taxes paid
$6,000
1,000
$ 7,000
EXERCISE 5.17 (CONTINUED)
c.
As one of Dropafix’s creditors, holding notes receivable of
substantial amounts, I would review the statement of cash flow
with particular attention to the amount of cash flows generated
from operating activities. This section of the cash flow statement
provides a perspective on the past performance of Dropafix in
generating cash from its main activities and provides some
predictive value in the likely amount of cash Dropafix will be able
to generate in the future to meet the payment deadlines on its
notes payable.
The second item of the statement of cash flow which would be of
particular interest to the creditor holding notes is the amount of
repayment of notes in the financing activities portion of the
statement of cash flows. In the case of Dropafix, the amount of
$43,000 for the repayment of notes payable stands out as the
largest amount on the statement of cash flows. This large
repayment was achieved, in part, by the reduction of cash
balances by about one third. Some cash was also obtained from
the issuance of common shares. If the amounts due on notes
payable for the next fiscal year are near the $43,000 level, Dropafix
will need to seriously look at the refinancing of the notes or the
issuance of additional common shares to meet those repayments.
The remaining cash should not be depleted to the point where
day-to-day operations are affected by cash shortages.
LO 8,9 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting
EXERCISE 5.18
Sensify Corporation
Statement of Cash Flows
For the Year Ended December 31, 2023
Cash flows from operating activities
Net income
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense
$6,0001
Gain on disposal of equipment
(3,000)2
Increase in accounts receivable
(3,000)
Increase in accounts payable
5,000
Net cash provided by operating activities
Cash flows from investing activities
Proceeds from sale of equipment
Purchase of equipment
Net cash used by investing activities
$37,000
5,000
42,000
8,000
(17,000)3
Cash flows from financing activities
Issuance of common shares
20,000
Payment of cash dividends
(13,000)
Net cash provided by financing activities
Net increase in cash
Cash at beginning of year
Cash at end of year
1
$10,000 + $7,000 - $11,000
$8,000 - $5,000
3
$27,000 + $12,000 - $22,000
2
LO 8,9 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting
(9,000)
7,000
40,000
13,000
$53,000
*EXERCISE 5.19
a. Current Ratio :
2023
$53,000 + $91,000
$20,000
= 7.20
Debt to total assets ratio:
2023
$20,000
$161,000
= 12.4%
2022
$13,000 + $88,000
$15,000
= 6.73
2022
$15,000
$112,000
= 13.4%
Free cash flow:
Cash provided by operating activities
Less: Purchase of equipment
Dividends paid
Free cash flow
2023
$42,000
(17,000) *
(13,000)
$12,000
*Some companies may use the net investing cash outflow of
$9,000, which would increase the amount of free cash flow to
$20,000. It is important to understand how companies define free
cash flow when interpreting the ratio.
b. Sensify’s current ratio has increased slightly from 2022 to 2023, and
remains in excess of 6, which is very high. The debt to total assets
ratio has declined and remains at a very low percentage. The
accounts receivable are climbing slightly and could be
investigated. The company has excellent liquidity and financial
flexibility.
LO 11 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
*EXERCISE 5.20
a.
Current ratio*
Acid test ratio**
2023
6.63
2.40
2022
4.69
1.49
* 2023: ($21,000 + $104,000 + $220,000)/$52,000
2022: ($34,000 + $54,000 + $189,000)/$59,000
** 2023: ($21,000 + $104,000)/$52,000
2022: ($34,000 + $54,000)/$59,000
b. Current cash debt coverage – Net cash provided from operating
activities divided by average current liabilities:
$63,000
Its current cash debt coverage is 1.14 to 1
$55,500
($52,000 + $59,000) ÷ 2 = $55,500
c.
Carmichael’s current and acid test ratios are both in excess of 1
and they both exhibit an increasing trend from 2022 to 2023. Its
current cash debt coverage is excellent at 1.23 to 1. However, free
cash flow ($63,000 - $60,000 - $60,000) is negative in 2023. Note
also that accounts receivable and inventories have increased
substantially from 2022 to 2023. While these increases might be
an indication of growth in sales, if Carmichael has difficulty in
collecting receivables or if sales slow and the inventory is not
converted to cash, Carmichael’s liquidity and financial flexibility
will be negatively affected.
*EXERCISE 5.20 (continued)
d.
Carmichael’s payout ratio of 47% is too high.
Cash dividends
$60,000
Payout ratio
=
=
=
Net income
$129,000
47%
If we were to use net cash provided by operating activities of
$63,000 as the denominator, we would get close to 100% payout.
In other words, all of the cash generated by operating activities is
used up to satisfy shareholders. Very few growing businesses
can afford this high a ratio when inventory and accounts
receivable are increasing at such a high pace. A ratio of 30% to
40% is more reasonable.
LO 11 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and Finance
*EXERCISE 5.21
a.
Current ratio*
Acid test ratio**
2023
1.73
.87
2022
2.14
1.09
* 2023: ($20,000 + $86,000 + $103,000 +$2,000)/($115,000 + $2,000
+ $5,000)
2022: ($38,000 + $74,000 + $102,000 + $6,000)/($100,000 +
$3,000)
**2023: ($20,000 + $86,000)/($115,000 + $2,000 + $5,000)
2022: ($38,000 + $74,000)/($100,000 + $3,000)
b.
Current cash debt coverage – Net cash provided from operating
activities divided by average current liabilities:
$28,000
Its current cash debt coverage is .25 to 1
$112,500
($122,000 + $103,000) ÷ 2 = $112,500
c.
Cash debt coverage – Net cash provided from operating activities
divided by average total liabilities:
$28,000
Its cash debt coverage is .13 to 1
$214,000
[($122,000 + 84,000) + ($103,000 + $119,000)] ÷ 2 = $214,000
d.
Dropafix’s times interest earned ratio is 3.1 times.
Income before
Times interest
= interest and taxes = $28,000 = 3.1
earned
Interest expense
$9,000
e.
Dropafix’s current and acid test are not very strong and both
exhibit a decreasing trend from 2022 to 2023. Accounts receivable
have increased substantially from 2022 to 2023. While these
increases might be an indication of growth in sales, if Dropafix
has difficulty in collecting receivables or if sales slow and
accounts receivable are not converted to cash, Dropafix’s
liquidity and financial flexibility will be further negatively affected.
As at June 30, 2023, even if Dropafix collected all of its receivable,
it would not be in a position to pay all of its accounts payable.
*EXERCISE 5.21 (CONTINUED)
e.
(continued)
Dropafix’s ability to repay current and all liabilities from its
operations is very poor. Its current cash debt coverage is very low
at .25 to 1 and its cash debt coverage is extremely low at .13 to 1.
On the other hand, its times interest earned ratio is reasonable at
3.1 times.
f.
The following recommendation is based on the financial
statements as a whole, and the conclusions reached in the
analysis of parts (a) though (e) above. To improve Dropafix’s
financial performance and particularly its ability to pay liabilities
as they come due, Dropafix should consider maintaining its
investments as FV-NI rather than FV-OCI investments, changing
the intention to sell the investments in the near term. As at June
30, 2023 Dropafix has cumulative unrealized gains of $11,000.
This balance is taken from the accumulated other comprehensive
income balance of the statement of financial position. If the
maturity dates of the notes payable are large and imminent, it
would seem reasonable to actively manage its investments. If
these were actively managed and considered FV-NI then some (or
all) of the investments could be sold rather than refinancing debt
or having shareholders invest more cash into the business in
exchange for common shares.