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Joseph L. Rotman School of Management
MGT426 - Advanced Financial Accounting
Midterm Examination
Wednesday October 27, 2004
Time:
Marks:
Weighting:
Parts :
Pages:
100 minutes (one hour and 40 minutes)
45
30% of course grade
2
3
Instructions:
1. Record your name, student number, and all answers on all exam booklets
provided.
2. ALL ANSWERS ARE TO BE RECORDED IN THE EXAM BOOKLETS, not on
this text paper.
3. Only exams written in non-erasable ink will be considered for re -marking.
Re-mark requests must be submitted by the end of class the week
following this test.
4. Silent non-programmable calculators are the only aid allowed.
5. CLEARLY LABEL YOUR WORK AND SHOW ALL CALCULATIONS FOR
FULL MARKS.
6. The exam is 100 minutes (one hour and 40 minutes) in length. Budget your
time wisely.
7. Marks will be subtracted from students who continue to write in their exam
booklets after the end of the examination.
8. THIS TEST PAPER MUST BE HANDED IN WITH YOUR EXAM BOOKLETS.
You are reminded that cheating is a serious offence, which can result in expulsion
from the University.
Name
Student #
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PART I – 10 MARKS
Peter Corp. purchased 75% of the outstanding common shares of Saint Ltd. For $2,500,000 on January 1,
Year 2, when Saint’s common stock was $1,600,000 and its retained earnings were $400,000. The
purchase discrepancy on that date was allocated as follows:
• 30% to undervalued inventory
• 40% to undervalued equipment with a remaining life of 8 years
• Balance to goodwill
Peters accounts for its investment in Saint using the equity method. During Year 3 the following
transactions occurred:
• Peters sold Saint a building for $100,000. The building had a net book value of $32,000 and a
remaining life of 10 years.
• Saint sold inventory to Peters for $20,000 and recorded a 25% gross margin on the sale. Peters
sold 70% of this inventory by the end of Year 3.
During Year 4 the following occurred:
• Peters charged a $40,000 management fee to Saint.
• Saint’s after-tax net income was $40,000.
Both companies are subject to a 40% tax rate.
Prepare the journal entries that Peters would record in Year 4 with respect to its investment in Saint.
PART II – 35 MARKS
Massive purchased 85% of the common shares of Tiny on January 1, Year 1, paying $490,000 in cash
when Tiny’s retained earnings was $42,000, its common shares were $50,000, and fair values were equal to
book except for inventory the fair value of which was $20,000 lower than its book value, and accrued
liabilities that were on the books for $25,000 but had a fair value of $29 ,000. Tiny also had an internally
developed patent (with a remaining life of 15 years) the fair value of which was estimated at $45,000.
Tiny’s goodwill balance was recorded three years before the acquisition by Massiv e. Reflected in
Massive’s opening retained earnings was the $10,000 of legal fees it paid to complete the purchase of
Tiny’s shares in Year 1.
The following financial information was available on December 31, Year 3:
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BALANCE SHEETS
Cash
Accounts receivable
Inventory
Land
Plant and equipment, net
Goodwill
Investment in Tiny
Accounts payable and accrued
liabilities
Capital lease obligations
Common shares
Retained earnings - opening
Net income
Dividends
INCOME STATEMENTS
Sales and other revenues
Dividends
Gain on disposal of assets
Cost of goods sold
Interest expense
Income taxes and other expense
Net income
Massive
Tiny
173,750
148,250
214,820
180,000
336,480
490,000
$1,543,300
123,000
36,800
38,350
130,000
143,000
10,000
$481,150
92,660
130,000
520,000
663,640
227,000
(90,000)
$1,543,300
276,150
50,000
156,750
13,250
(15,000)
$481,150
1,400,000
12,750
37,000
1,449,750
240,000
40,000
280,000
750,000
7,75 0
465,000
$1,222,75 0
160,000
2,250
104,500
$266,750
$227,00 0
$13,250
Other information is as follows:
• The December 31, Year 2 inventory of Tiny included purchases of $38,000 from Massive, which sold
the items to Tiny for 120% of its normal gross margin (Year 3 reflects Massive’s normal gross
margin).
• Depreciation is recorded on the straight-line basis.
During Year 3, the following transactions took place:
• Tiny paid management fees of $33,000 to Massive.
• Massive sold inventory to Tiny for $38,000 at a gross profit rate of 61%. Tiny resold 80% of this to its
customers.
• Tiny sold land with a book value of $145,000 to Massive for cash proceeds of $180,000.
• On December 31, Year 3 Tiny sold equipment, with 10 years of life remaining, to Massive for
$40,000. The equipment had originally cost $45,000 and accumulated depreciation at the time of sale
was $10,000.
• On December 31, Year 3 Tiny owed a non-interest-bearing debt of $15,000 to Massive.
• During Year 3, Massive determined the existence of a $40,000 goodwill impairment.
• For several years Massive has paid income taxes at a rate of 46%; Tiny has paid income taxes at a rate
of 42%.
REQUIRED:
Prepare Year 3 consolidated income statement, retained earnings statement, and balance sheet.