friedlan4e sm ch09

8/10/2019 Friedlan4e SM Ch09

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John Friedlan,Financial Accounting: A Critical Approach, 4thedition Page 9-1Solutions Manual Copyright 2013 McGraw-Hill Ryerson Ltd.

CHAPTER 9

Liabilities

QUESTIONS

Q9-1.Liabilities are present obligations arising from past transactions or economic events that requirethe entity to sacrifice economic resources to settle. Taxes payable is a liability because:

Obligation: An entity is required to pay the taxes it owes to government.

Past transactions or economic event: The obligation arises from the entitys economicactivity during the period.

Economic sacrifice: The government has to be paid in cash.

Q9-2.A liability is an obligation to pay money or provide services at a future date. To satisfy thecriteria of IFRS, a liability must be a present obligation to the entity, require the sacrifice of

resources, and be the result of a past transaction or economic event. Not every obligation of anentity meets these criteria. Operating leases, commitments, and contingent liabilities arentreflected in the financial statements.

Q9-3.A current liability must be settled within one year or one operating cycle. Itsimportant to knowthe amount of current liabilities to assess the liquidity of the entity. The distinction betweencurrent and non-current liabilities is important to certain stakeholders, especially short-termcreditors because it helps them assess whether the entity has enough resources to fulfillobligations that are due within the next year.

Q9-4.The current portion of long-term debt is classified separately as a current liability because theamount must be paid within the coming year (or operating cycle). If separate presentation wasntmade stakeholders wouldntknow the payments that were required within the coming year. As aresult, assessing liquidity would be more difficult.

Q9-5.The retail store should record the $100 of merchandise sold as revenue. Although the store willcollect $113 from the customer, it must remit $13 to the government on behalf of the customer.The store has collected this amount but the money doesntbelong to the store, therefore the $13should be recorded as a current liabilityHST Payable.


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Q9-6.Itsnecessary to estimate many liabilities because of the accrual basis of accounting. An entitymay incur an economic obligation with no external event (such as the receipt of an invoice) totrigger recording it. Liabilities that must be estimated include accrued liabilities and provisions.Provisions are generally more difficult to estimate. Examples of liabilities that require estimates

include (this is only a partial list, other examples are possible): warranty costs, liabilities foraffinity programs, gift card redemption, utilities used (but not yet billed), and liabilities toredeem coupons.

Q9-7.Proceeds from gift card sales are recorded as liabilities because the entity issuing the gift cardhas received cash but has yet to provide the customer with goods or services in exchange for thatcash. A liability requires a probable sacrifice of economic resources and a past transaction. Thebusiness will have to provide goods or services when a customer redeems the gift card (which isthe sacrifice) and the past transaction is the purchase of the card. Gift card sales are classified asunearned revenue to an entity. When the gift card is redeemed by the customer the entity can

recognize revenue.

Q9-8.An accrued liability is a liability that is recognized and recorded in the financial statements butfor which the recording isnttriggered by an external event such as receipt of a bill or invoice. Aprovision is similar but there is more uncertainty about the timing and amount of the liability.

Example Cause of Recognition Estimate

Liability Account Payable Invoice from supplieris provided

No estimate isrequired

Accrued Liability Employee wages are

unpaid at the end ofthe year

Adjusting entry to

match revenues andexpenses

Estimate is required

but likely accurate

Provision Warranty Expense Obligation tocustomers that willoccur in the future atan unknown amount.

Estimate is requiredand more difficult tomake

Q9-9.Debt is risky for the issuing entity because the interest and principal payments have to be madewhen required by the loan agreement regardless of how well or poorly the entity is doing.

Defaulting on interest or principal payments (failing to make interest or principal payments whenthey are due) can have significant and costly economic and legal consequences for an entity. Theconsequences include losing assets pledged against the debt and bankruptcy.


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Q9-10.a. The effective rate of interest is the actual market rate of interest that investors require.

b. The coupon rate is the percentage of the face value of the bond that is paid to bondholderseach year as interest.

c. The maturity date is the date on which the bondholder will receive the principal amount of thebond.

d. The proceeds of the bond issue is the amount of money that is received by the entity issuingthe bonds at the date of the issue.

e. The face value of the bond is the amount that the bondholder will receive at maturity.

Q9-11.You would expect the unsecured loan to bear a higher interest rate because itsmore risky. Its

more risky because there is no security for the lender, which provides some insurance that someof the lenders investment will be recovered in the event of default. Also, if the first loan haspriority over the second, meaning that it must be paid before the second loan, that too willincrease the interest rate on the second loan, again because the second lender faces more risk.

Q9-12.When a zero interest loan is recorded on the balance sheet at its face value, the amount recordedexceeds the present value of the payments to be made by the borrower a portion of the amountreflects interest expense that will be paid for the use of the money. When the expense isntrecorded, income is overstated (expenses are too low). A zero interest loan ignores the time valueof money. Even though the loan agreement states that the loan is interest-free, the economicreality is that there is a cost to borrowing; people dont lend money interest-free.

Q9-13.A bond discount is the difference between the face value of the bond and the proceeds of issuingthe bond when the market (effective) rate of interest is greater than the coupon rate. A bondpremium is the difference between the face value of the bond and the proceeds of issuing thebond when the market rate of interest is less than the coupon rate. Bonds are often sold at adiscount or premium because the rate of interest at the date of issue can be different from thatexpected when the terms of the bond were specified.


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Q9-14.A restrictive covenant is an agreement made by the borrower that restricts its ability to takecertain actions such as additional borrowing or otherwise limits its behaviour in some way. Theyare sometimes included to reduce the risk to the lender. The benefit to the lender is that theborrower is restricted from taking action that would adversely affect the position of the lender

and thereby lower risk. The borrower benefits from the lower risk with a lower interest rates onthe loan. The borrower would prefer not to have the restriction, everything else being equal,because the covenant may constrain the actions of the borrower. Covenants are the cost of alower borrowing cost.

Q9-15.Bond discounts or premiums affect the interest expense because they are amortized over the lifeof the bonds against income. The amount amortized is debited or credited to the interest expenseaccount. The amortization of a premium decreases the interest expense from the cash actuallypaid during a period (so the interest expense is less than the cash paid) and the amortization of adiscount increases the interest expense above the amount paid in cash for interest during a

period.

Q9-16.Gains and losses arise if the redemption value of the bond at the date the bonds are redeemeddiffers from the carrying amount of the bond at that time. A gain is recognized when theredemption amount is less than the carrying amount of the bond and a loss is recognized whenthe redemption amount is greater than the carrying amount of the bond.

Q9-17.Off-balance sheet liabilities are financing arrangements that allow an entity incur obligationswithout the obligations appearing on the balance sheet (operating leases, commitments). Sucharrangements can be attractive because the entities appear to be less levered than they would ifthey had arranged financing that would be on the balance sheet. The ability of financial statementusers to interpret financial statements is impaired when a company has off-balance sheetobligations because they may not be able to make a good assessment of the amount of debt orobligations the entity has from the balance sheet alone. Itspossible to keep some liabilities offthe balance sheet because IFRS doesntrequire certain obligations, which meet (or dontmeet)certain criteria, to be included on the balance sheet. Operating leases, for example, are leases thatdonttransfer the risks and rewards of ownership and therefore arentincluded on the balancesheet.


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Q9-18.Managers have incentives to understate liabilities to persuade users of financial statements thatthe company is more creditworthy, more liquid, more solvent, and less risky. For example, alender may be misled regarding the riskiness of a potential loan and might offer better terms.There are also covenants based on or affected by liabilities and a manager might take steps to

avoid violating these covenants by understating liabilities. A manager could fail to accrue aliability for which an invoice has not been received, or choose not to record the purchase ofinventory, which was in transit at the balance sheet date. A manager could also make lowestimates of accrued liabilities and provisions (e.g. warranties, coupons) or could arrangetransactions in ways that legitimately allow an entity to avoid recording a liability (operatinginstead of capital lease).

Q9-19.A capital lease transfers the benefits and risks of ownership to the lessee and an operating leasedoesnt. A capital lease results in an asset and a liability on the balance sheet of the lessee and adepreciation expense and interest expense on the income statement of the lessee. The treatment is

equivalent to the entity having borrowed money to purchase the asset rather than leasing it. Anoperating lease doesntresult in an asset or a liability on the balance sheet and the only expenseon the income statement is the lease payment (or the accrual thereof) to the lessor.

Q9-20.For a capital lease the amount recorded on the balance sheet at the start of the lease is the presentvalue of the lease payments (Dr. Asset, Cr. Lease Liability). On subsequent balance sheets, therecorded asset and liability are accounted for separately. The asset is depreciated over its usefullife and the liability is reduced by the principal component of each lease payment. There is noreason why the principal payments should match the method used to match the cost of the assetto revenue over its useful life (the period that itsavailable to depreciate it).

Q9-21.IFRS requires a lease to be classified as a capital lease if any of the three criteria are met: (i)ownership: likely transfer of ownership of the asset to the lessee at the end of the lease, (ii)economic life: lessee receives most of the economic benefits of the asset over its useful life, (iii)consideration: PV of lease payments covers substantially all of the fair value of the leased asset.If a lease meets none of the criteria listed above, itsclassified as an operating lease. Theproblem of providing these principle-based criteria is that the generality allows for flexibility inreporting and requires preparer judgement. Lease classification can materially affect financialstatements. The benefits include the promotion of substance over form and that guidelines existto prevent managers from abusing off balance sheet financingthrough operating leaseclassification.


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Q9-22.IFRS requires disclosure of operating lease obligations and significant purchase commitmentsbecause they arentrecorded on the balance sheet as liabilities. The two items are unrecognizedagreements that will affect the entities future cash flows, therefore disclosure of thecommitments is required.

Q9-23.In a defined-contribution plan the pension benefits an employee receives upon retirement dependon the amount contributed to the plan on behalf of that employee (by the employer and theemployee) and on the performance of the investments made with the funds in the pension plan.The employers obligation is limited to making the required contribution each year. Theemployee is entitled only to his or her share of what is in the plan on retirement.

In a defined-benefit plan the employer promises to provide employees with certain specifiedbenefits in each year they are retired. The contribution by the employer isntdefined and dependson the return earned by the plan, the amount contributed, the amount that must be paid to

employees, and so on.

The defined benefit plan is more attractive to employees because the amount of their pension isguaranteed. They dontface uncertainty about how the investments of the funds will perform.The defined-contribution plan is less risky for employers because the amount they have tocontribute is specified. They dontface variable payments based on the performance of theinvestments in the plan.

Q9-24.The assets of the pension plan arentreported on the balance sheet because the funds dontbelong to the entity, they belong to the pension fund that manages them on behalf of theemployees. The sponsoring entitys assets arent understated since the assets of the pension planarent reflected in the sponsors financial statements. The underfunding is reflected on thesponsors balance sheet as a liability.

Q9-25.A problem with expensing pension costs when cash is paid to beneficiaries is that the cost of thepension wouldntbe matched appropriately to revenues. The matching concept requiresrecognizing the expense and recognizing the liability is required for representational faithfulness.A pension is earned by an employee as he/she works for the company. Expensing the pensionwhen paid means the cost is being recognized after the employee has retired and is no longerworking for the company. As a result, the profitability of the company is overstated in thoseperiods when employees work for the company and become entitled to the future benefits and noexpenses are recorded because the payment of those benefits will be at a time in the distantfuture. The leverage of the company is also all understated because no liability appears in thebalance sheet.


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Q9-26.A subsequent event is an event that occurs after the balance sheet date but before the financialstatements are approved by the board of directors. There are two categories of subsequent events:some that provide additional information about circumstances that existed at the year end andsome simply events that occurred subsequent to the balance sheet date (unrelated to the year-end

financial statements). If the information is about circumstances that existed at year-end, thefinancial statements should be adjusted to reflect the new information. If the event occurred afterthe balance sheet date and doesnt provide information about circumstances that existed at yearend there is no impact on the financial statements but the event should be disclosed in a note tothe financial statements.

Q9-27.A commitment is a contractual agreement to enter into a transaction in the future. Commitmentsare executory contracts and, under IFRS, these contracts are generally not recorded in thefinancial statements. If significant, disclosure in the notes to the financial statements isappropriate, as commitments may provide important information to stakeholders.

Q9-28.A contingent liability is: (i) a possible obligation whose existence will be confirmed by theoccurrence of uncertain future events or, (ii) a present obligation arising from past events thatisntrecognized because an outflow of resources isntprobable or the amount cantbesufficiently measured.

Contingent liabilities are disclosed only, unless the probability of occurrence is remote, in whichcase note disclosure isntrequired. If a contingent liability becomes measurable it should beaccrued (and its then called a provision).

Q9-29.The interest coverage ratio is designed to measure the ability of an entity to meet its fixedfinancing charges. In particular, the interest coverage ratio indicates the ease with which anentity can meet its interest payments. The interest coverage ratio is income before interestexpense and tax expense divided by interest expense. The ratio indicates the number of timesincome covers the interest expense. In the short run, however, itsreally cash that determineswhether or not the company can meet its obligations, not income. A cash interest coverage ratiois also used in which cash from operations plus interest paid is divided by interest paid.

Q9-30.The actual cost of borrowing is usually lower than the stated rate of interest because interestexpense is deductible from income in determining the amount of income tax owed. As a result,the after-tax borrowing rate is lower than the stated rate. The actual cost and the stated rate willbe the same if a company doesntpay income taxes, which may be the case if the company hasnot been profitable and isntexpected to be for some time, or if an entity isntsubject to tax, suchas a not-for-profit organization.


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Q9-31.Itsreally not possible to definitively assess the riskiness of this company without knowing theindustry and the events that have occurred during this period. The acceptable amount of debt in acompany's capital structure depends on factors such as the riskiness of the industry and thequality of the assets provided as collateral. However, an increase in the ratio means the amount

of debt relative to equity in the capital structure has increased, which could imply increasing risk.However, the previous capital structure could have contained less debt than optimal.

Q9-32 (Appendix).Views such as these reflect a misperception regarding what deferred (future) taxes actuallyrepresent. Future taxes arentowed to the government and arenta liability in that sense. Theysimply represent differences between accounting for tax purposes and accounting for financialreporting purposes. If financial reporting used the rules required for tax purposes the amount oftax payable the entity would report would be the same in both cases and there would be no futuretaxes. Future income taxes arise because of the accounting choices made by an entity and arentthe result of a government policy that provides deferrals to tax payers.

Q9-33 (Appendix).Deferred (future) income tax assets and liabilities arise because the accounting methods used toprepare the general purpose financial statements are sometimes different from the methods usedto calculate taxable income and the amount of income tax an entity must pay. Future incometaxes reflect the difference between the book value of assets and liabilities and their tax values,multiplied by the tax rate.

Q9-34 (Appendix).With the taxes payable method the income tax expense on the income statement is equal to theamount of income taxes that must actually be paid to the government for the period. With thefuture income tax method of accounting for income taxes, the income tax expense on the incomestatement is the effective income tax rate times the income before income taxes for financialreporting purposes (although the income tax expense is actually a plug that balances the entrythat includes the tax liability for the period and the adjustment to the balance sheet amounts offuture income taxes).

Q9-35 (Appendix).The current expense represents the tax liability for the current period (the amount paid or payableto the government). The future portion of the income tax expense represents the adjustmentneeded to have the appropriate balances in the future income tax accounts on the balance sheet.


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EXERCISES

E9-1.a. b. c.

Issue date 15-Jul-18 15-Jul-18 15-Jul-18

Maturity date 14-Jul-25 14-Jul-25 14-Jul-25

Annual Annual Annual

Face Value (FV) 40,000,000 40,000,000 40,000,000

Number ofperiods

7 7 7

Effective rate (i) 3.00% 4.00% 5.00% market /discount

Coupon rate (c) 4.00% 4.00% 4.00% nominal/stated/contract

Annuity Payment 1,600,000 1,600,000 1,600,000 interest payments

Proceeds (P) = PV (all cash flows)

PV (Principal) $32,523,660 $30,396,713 $28,427,253

PV (annuity) $9,968,453 $9,603,287 $9,258,197

Proceeds (P) = $42,492,113 $40,000,000 $37,685,450

E9-2.a. b. c.

Issue date 01-Dec-17 01-Dec-17 01-Dec-17

Maturity date 30-Nov-29 30-Nov-29 30-Nov-29

Annual Annual Annual

Face Value (FV) 15,000,000 15,000,000 15,000,000

Number ofperiods

12 12 12

Effective rate (i) 9.00% 9.00% 9.00%Coupon rate (c) 10.00% 9.00% 8.00%

Annuity Payment 1,500,000 1,350,000 1,200,000


PV (Principal) $5,333,021 $5,333,021 $5,333,021

PV (annuity) $10,741,088 $9,666,979 $8,592,870

Proceeds (P) = $16,074,109 $15,000,000 $13,925,891


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E9-3.a.Dr. Cash (A+) 50,000

Cr. Working Capital Loan (L+) 50,000To record the short-term bank loan

Dr. Working Capital Loan (L-) 50, 000Dr. Interest Expense (E+) 1,250

Cr. Cash (A-) 51,250To record the repayment of the short-term bank loan and interest

b.Dr. Cash (A+) 9,950,000Dr. Bond Discount (CL+) 50,000

Cr. Long-term debtbonds (L+) 10,000,000To record issuance of long-term bonds

c.Dr. Mortgage Loan (L-) 2,538Dr. Interest Expense (E+) 8,212

Cr. Cash (A-) 10,750To record monthly loan payments

E9-4.For this question (# of days/365) may be used instead of months, thus a slightly different answermay be given.a.Dec. 31Dr. Interest Expense (E+) 2,083

Cr. Interest Payable (L+) 2,083Accrued interest for five months ($100,000*.05*(5/12) = $2,083)

b.Dec. 31Dr. Interest Expense (E+) 250

Cr. Interest Payable (L+) 250Accrued interest for two months ($25,000*.06*(2/12) =$250)

c. No adjusting entry is required as payments are made on the last day of each quarter, includingthe last day of the year.

d.Dec. 31Dr. Interest Expense (E+) 12,250

Cr. Interest Payable (L+) 12,250Accrued interest for three months ($700,000*.07*3/12)


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Note that a payment would have been made on October 2 for $12,500 so that amount doesnthave to be accrued on December 31.

E9-5.

a.Dr. Cash 62,000Cr. Unearned revenuegift certificates 62,000

b.Dr. Unearned revenuegift certificates 24,000

Cr. Revenue earned 24,000

Assuming a perpetual inventory system:Dr. Cost of Sales 15,000

Cr. Inventory 15,000

c. The amount of the unused gift certificates would be a current liability of $38,000 ($62,000 -$24,000) because the outstanding certificates can be redeemed at any time.

d. The transaction increases current assets and current liabilities by an equal amount. The effecton the current ratio would depend on the current ratio before. If the ratio was below 1, thetransaction would increase the ratio, and if the current ratio was above 1, it would decrease it.When the gift certificates are redeemed the current ratio would increase because the amount ofunearned revenue would decrease and there would be an increase in current assets as cash wouldincrease and inventory would decrease (inventory would likely decrease by less than the increasein cash /accounts receivable).

e. The sale of a gift certificate isntconsidered revenue because Juno has yet to provide goods orservices to the customer. Gift card sales are considered unearned revenue because the entity hasreceived cash but has not fulfilled the obligation to provide goods or services for that cash.Unearned revenue is recognized as a liability for the amount received. The revenue recognitioncriteria arent satisfied when the gift cards are sold.


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E9-6.a.Dr. Cash 4,875,000

Cr. Unearned revenuegift certificates 4,875,000

Dr. Unearned revenuegift certificates 4,189,000Cr. Revenue earned 4,189,000

Assuming a perpetual inventory system:Dr. Cost of Sales 3,375,000

Cr. Inventory 3,375,000

Dr. Unearned revenuegift certificates 198,440Cr. Revenue earned 198,440

To record revenue for the gift cards that arentexpected to be redeemed ($4,275,000 (openingbalance) + $4,875,000 (gift cards sold) - $4,189,000 (gift cards redeemed) = $4,961,000

(outstanding) *4% = $198,440)

b. The amount of the unused gift certificates would be a current liability of $4,762,560[$4,961,000 - $198,440 (from part a)] because the outstanding certificates can be redeemed atany time.

c. The transaction increases current assets and current liabilities by an equal amount. The effecton the current ratio would depend on the current ratio before. If the ratio was below 1, thetransaction would increase the ratio, and if the current ratio was above 1, it would decrease it.When the gift certificates are redeemed the current ratio would increase because the amount ofunearned revenue would decrease and there would be an increase in current assets ascash/accounts receivable would increase and inventory would decrease (inventory would likelydecrease by less that the increase in cash /accounts receivable).

d. The sale of a gift certificate isntconsidered revenue because Pages has yet to provide goodsto the customer. Gift card sales are considered unearned revenue because the entity has receivedcash but has not fulfilled the obligation to provide goods for that cash. Unearned revenue isrecognized as a liability for the amount received. The revenue recognition criteria arent satisfiedwhen the gift cards are sold.


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E9-7.Year-end September 30, 2017a. The principle portion of the mortgage payment ($293,650interest) would be classified as acurrent liability because itsdue within the coming year. The remainder of the balance (due in 20years) would be a non-current liability. (Remember that the payment is a blend of interest and

principal.)

b. The $125,200 withheld taxes would be a current liability because itspayable to thegovernment and is due within the coming year.

c. The $2,500 deposit would be a current liability because the obligation will be fulfilled withinthe next fiscal year (the deposit is unearned revenue).

d. The $150,000 due in December is a current liability because itsdue in the next fiscal year.The remaining balance of $150,000 would be a non-current liability because itsdue more thanone year past the balance sheet date.

e. The $325,000 demand loan would be a current liability because it can be recalled by the bankat any time.

f. Since the $3,000,000 total provision is divided equally over 3 years, $1,000,000 of the totalwarranty provision would be classified as a current liability. The remaining $2,000,000 notexpected to be realized within the next fiscal year is a non-current liability.


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E9-8.a.Dr. Corporate Jet 3,352,707

Cr. Loan payable 3,102,707Cr. Cash $250,000

Issue date 31-Mar-17

Maturity date 31-Mar-21

Annual

Future Value 3,500,000

Number of

periods4

Effective rate 5.00%

AnnuityPayment

875,000

Annual

PV (annuity) $3,102,707

Cash payment 250,000

Cost of plane $3,352,707

Despite being interest free the present value of the payments needs to be determined toproperly determine the value of the jet and loan. Value of jet = cash payment + present value ofloan payments.

b. The allocation of the payment between interest and reduction of principal is shown in the tablebelow. Assuming a 5% discount rate,

Rate Discounted value method

5% [1] [2] [3] [4]

Cash Interest Loan

Date Payment Expense payable Net Liability

[1]-[2] pre[4]-[3]

31-Mar-17 3,102,707

31-Mar-18 875,000 155,135 719,865 2,382,842

31-Mar-19 875,000 119,142 755,858 1,626,984

31-Mar-20 875,000 81,349 793,651 833,333

31-Mar-21 875,000 41,667 833,333 0

The journal entry on March 31, 2018:Dr. Interest expense 155,135Dr. Loan payable 719,865

Cr. Cash 875,000

The journal entry on March 31, 2019:Dr. Interest expense 119,142


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Dr. Loan payable 755,858Cr. Cash 875,000

The journal entry on March 31, 2020:Dr. Interest expense 81,349

Dr. Loan payable 793,651Cr. Cash 875,000

The journal entry on March 31, 2021:Dr. Interest expense 41,667Dr. Loan payable 833,333

Cr. Cash 875,000

c.

The liability would initially be recorded at the present value of the lease payments and would

decrease each year thereafter, as shown in column 4 of the table in part b. Assuming that March31stis the companies year end, no accruals are necessary.

d. The liability couldnt be reported using the nominal value (the total of the payments,$3,500,000) if Etzikom was following IFRS or ASPE. IFRS and ASPE require the present valuemethod to be used. The present value method requires that a discount rate be used therefore thenominal method overstates the cost of the asset because the time value of money is ignored. Byignoring the time value of money the actual liability is overstated.


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E9-9.a.Dr. Cash 152,250

Cr. Sales 145,000Cr. GST payable 7,250

December 10, 2017Dr. GST payable 7,250

Cr. Cash 7,250

b.Dr. Wages and salaries expense 42,000

Cr. Income tax withholdings payable 13,000Cr. CPP payable 4,105Cr. EI payable 1,860Cr. Pension plan contributions 1,450

Cr. Union dues payable 750Cr. Disability insurance payable 1,000Cr. Charitable contributions payable 200Cr. Cash 19,635

December 10, 2017Dr. Income tax withholdings payable 13,000Dr. CPP payable 4,105Dr. EI payable 1,860Dr. Pension plan contributions 1,450Dr. Union dues payable 750Dr. Disability insurance payable 1,000Dr. Charitable contributions payable 200

Cr. Cash 22,365


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E9-10.Year-end December 31, 2017a. The pension withholdings are due within ten days and thus they are a current liability (pensionplan contribution = $4,000).

b. Normally payments for inventory are due long before a year unless there is a specialarrangement. This is a current liability ($68,000accounts payable).

c. The $50,000 note payable is due and will be paid in March, thus itsrecorded as a currentliability. However, because the note is to be replaced with a long-term bank loan it could beclassified as a non-current liability, as long as the financing arrangement is secured. ($50 000note payable)

d. This is a current liability because the service is to be provided in 2018 (less than one year fromcurrent balance sheet date), (Unearned revenue = $10,000).

e. The $25,000 to be paid in 2018, is a current liability. The remaining amount of $75,000 isntdue within one year is a non-current liability ($25,000 = loan payable).

f. The amount of $120,000 declared as dividends is to be paid in the next fiscal year therefore itsa current liability ($120 000 = dividends payable).

g. Because the bank can demand repayment at any time, the $300,000 demand loan would beclassified as a current liability ($300,000 = current loan payable).

E9-11.a.Debt-to-Equity Ratio = total liabilities / total shareholdersequityInterest Coverage Ratio = [(net income + interest expense + income tax expense) / interestexpense]

Debt-to-Equity Interest CoverageNaicam Ltd. 2.413 3.366Riverton Inc. 1.258 6.403

b. Riverton Inc., would be considered a safer investment by a long-term lender. The debt-to-equity ratio is lower, meaning that this entity carries proportionally less debt than Naicam and istherefore less risky. An entity with relatively little debt is able to assume more if needed.Rivertonsinterest coverage ratio is higher meaning that it has a better ability to meet interestpayments from its current income. This gives lenders more assurance that the borrower will beable to make debt repayments.


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E9-12.a.Debt-to-Equity Ratio = total liabilities / total shareholdersequityInterest Coverage Ratio = [(net income + interest expense + income tax expense) / interestexpense]

Debt-to-Equity Interest CoverageLombardy Ltd. .595 3.923Savona Inc. 1.350 5.438

b. Itsdifficult to perform a complete ratio analysis without industry and trend information. Theinformation provided provides mixed evidence as to credit risk. Lombardy has a debt-to-equityratio of below 1, which means that itsmainly financed with equity. Savona has a debt-to-equityof above 1, which means that itsfinanced with more debt than equity. This means thatLombardy is financed less by debt and therefore there are fewer fixed charges. Savona reports ahigher interest coverage ratio, which means that it has more income per dollar of interest and sois less risky insofar as meeting its interest payments. That said, Lombardys interest coverage

ratio is lower but it isnt too low.

E9-13.a.Dec. 31, 2017Dr. Pension expense (E+, OE) 200,000

Cr. Cash (asset) 200,000To record the pension contribution for 2017

b.In addition, it would be necessary to accrue a liability for the unpaid part of the requiredcontribution:

Dr. Pension expense (E+, OE) 30,000Cr. Pension liability (liability +) 30,000

To accrue the liability for the unpaid portion of the pension contribution for 2017 (230*$1,000 =$230,000 - $200,000 = $30,000).

The $30,000 pension liability would be reported on Iskut Inc. December 31, 2017 balance sheet.

When Iskut makes its payment it would recorded the following journal entry:Dr. Pension liability (liability +) 30,000

Cr. Cash (asset) 30,000To record the final payment to the defined contribution pension plan


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E9-14.a.March 31, 2017Dr. Pension expense ( E+, OE) 150,000

Cr. Cash (asset) 150,000

To record the funding contribution to the defined benefit pension plan

b.While this could be a much more complicated answer, the idea is to have students recognize thatthe unfunded portion of the pension obligation is a liability.

Dr. Pension expense (E+, OE) 100,000Cr. Pension liability (liability +) 100,000

To accrue the liability for the unfunded portion of the pension expense for 2017

E9-15.a. The contract is a commitment that will have a substantial impact on business over the nextthree years. It would be appropriate to disclose the contract in the notes to the financialstatements so that users are aware of Sayabecs future purchase commitments. According toIFRS, when neither party in a contract agreement has performed its part of the bargain, anyassets and liabilities associated with that contract arentrecorded, but are disclosed.

b. The arrangement is a contingent liability, which involves a risk that the guarantee couldbecome a liability if the other company doesntmake the payments. There is no liability at thepresent moment but full disclosure requires that the users of the financial statements be aware ofthe arrangement as it substantially affects the risks faced by Sayabec. The existence of theguarantee should be disclosed.

c. The bankruptcy is a subsequent event because the event occurred after year end, but before thefinancial statements were issued. This event provides information about circumstances thatexisted at year end because the customer was in financial distress at that time. The financialstatements should be adjusted to reflect the new information as a 75% decrease in accountsreceivable from a major customer will impact current assets reported.

d. The dividends declared are a subsequent event because the event occurred after year end, butbefore the financial statements were approved by the board of directors. This event is unrelatedto circumstances that existed at year-end but may provide useful information to statement users.The declaration should be note disclosed. No adjusting entries are made to the financialstatements.

e. The taxes stated as payable by the CRA would be a contingent liability because itsa possibleobligation to the entity whose existence must be confirmed by a future event (the appeal andpossibly court). Unless itslikely that Sayabec will have to pay, this should be disclosed in thenotes to the financial statements to make users aware of a possible future obligation that Sayabecmay face.


20/83


E9-16.

a. The contract is a subsequent event because the event occurred after year end but before thefinancial statements were issued. This event is unrelated to circumstances that existed at year-end

but will provide useful information to statement users since Langham will pay above marketprices to guarantee supply. Its also a commitment because it commits the company topurchasing raw materials for five years. The contract should be note disclosed (if its material).No adjusting entries are made to the financial statements for the 2017 year-end.

b. The claim is a contingent asset. The future outcome of this event is unknown to Langham andthe amount received, if any, cantbe measured with certainty. Although there is muchuncertainty surrounding this transaction, the entity may potentially experience a gain, which maybe useful information to financial statement users. This event should be disclosed in the notes.

c. The contract for equipment is a commitment. Langham has committed to a future purchase

however the payment isntdue until 2020 (on delivery). Stakeholders should be aware of thepurchase commitment as it will result in a future outflow of resources, however the entity wontrealize an outflow of resources in the current period. This event should be note disclosed,assuming the purchase of capital equipment is material.

d. The customers bankruptcy is a subsequent event. The event is unrelated to events that existedat year end so only note disclosure is required, if the uncollectability of the receivables ismaterial. This event doesntprovide information about circumstances that existed at year endbecause the customer wasnt at risk of bankruptcy at year end.


21/83


E9-17a.

Issue date 31-Dec-17

Maturity date 31-Dec-21

Annual

Future Value 16,000,000

Number of periods 4

Effective rate 5.00%

Annuity Payment 4,000,000

Annual

PV (annuity) $14,183,802

A liability of $14,183,802 would be reported on the Dec 31, 2017 balance sheet.

The following table provides the liability amount and interest expense for each year end:rate Discounted value method

5% [1] [2] [3] [4]

DateAnnual

payment

Interest

expense

Decrease in loan

payable at yearend

Liability at

year end

31-Dec-17 $14,183,802

31-Dec-18 4,000,000 709,190 3,290,810 10,892,992

31-Dec-19 4,000,000 544,650 3,455,350 7,437,642

31-Dec-20 4,000,000 371,882 3,628,118 3,809,524

31-Dec-21 4,000,000 190,476 3,809,524 0

b.Recording the liability at $16,000,000 wouldntreflect the time value of money. As a result theasset and liability would be overstated.


22/83


E9-18.a.The proceeds of the bond issue are $4 594 455.

Issue date 01-Nov-17

Maturity date 31-Oct-22

Semi-Annual

Face Value (FV) 5,000,000

Number of periods 10 - 5 periods is 10 semi-annual periods

Effective rate (i) 4.00% - 8% annually is 4% semi-annually

Coupon rate (c) 3.00% - 6% annually, 3% semi-annually

Annuity Payment 150,000 - $300 000 annually, $150 000 semi-annually


Annual

PV (Principal) $3,377,821

PV (annuity) $1,216,634

Proceeds (P) = $4,594,455

b.Dr. Cash 4,594,455Dr. Discount on bonds payable 405,545

Cr. Bonds payable 5,000,000

c.Semi-

AnnualC1 C2 C3 C4 C5 C6 C7

Carrying

Amt

Beginning

of period

Interest

Expense

C1 x 4%

Interest

Payment

Discount

Amortized

C2 - C3

Carrying Amt

Bond, end

C1 + C4

Bond Disc.

beginning

Bond Disc.

end

C6 - C4

01-Nov-17 $4,594,455 $405,545

30-Apr-18 $4,594,455 $183,778 $150,000 $33,778 4,628,233 405,545 $371,767

31-Oct-18 4,628,233 185,129 150,000 35,129 4,663,363 371,767 336,637

30-Apr-19 4,663,363 186,534 150,000 36,534 4,699,897 336,637 300,103

31-Oct-19 4,699,897 187,996 150,000 37,996 4,737,893 300,103 262,107

30-Apr-20 4,737,893 189,516 150,000 39,516 4,777,409 262,107 222,591

31-Oct-20 4,777,409 191,096 150,000 41,096 4,818,505 222,591 181,495

30-Apr-21 4,818,505 192,740 150,000 42,740 4,861,245 181,495 138,755

31-Oct-21 4,861,245 194,450 150,000 44,450 4,905,695 138,755 94,305

30-Apr-22 4,905,695 196,228 150,000 46,228 4,951,923 94,305 48,077

31-Oct-22 4,951,923 198,077 150,000 48,077 5,000,000 48,077 0


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d. Record interest expense on April 30 and October 31, 2018 and 2020

April 30, 2018Dr. Interest Expense 183,778

Cr. Bond Discount 33,778

Cr. Cash 150,000

October 31, 2018Dr. Interest Expense 185,129

Cr. Bond Discount 35,129Cr. Cash 150,000

April 30, 2020Dr. Interest Expense 189,516


October 31, 2020Dr. Interest Expense 191,096


e. Record retirement of the bond on maturity

Dr. Bonds Payable 5,000,000Cr. Cash 5,000,000


24/83


E9-19.a.

Date 01-Sep-17

Maturity date 31-Aug-23

Annual

Face Value (FV) 2,000,000Number of periods 6

Effective rate (i) 7.00%

Coupon rate (c) 9.00%

Annuity Payment 180,000


Annual


PV (annuity) $857,977

Proceeds (P) = $2,190,661

b.Dr. Cash 2,190,661

Cr. Premium on bonds payable 190,661Cr. Bonds payable 2,000,000

c.Effective Interest Method

C1 C2 C3 C4 C5 C6 C7

Carrying Amt Interest Interest PremiumCarrying

AmtBondPrem. Bond Prem.

Beginning Expense Payment Amortized Bond, end beginning end

Annual of period C1 x 7% C2 - C3 C1 + C4 C6 - C4

01-Sep-17 $2,190,661 $190,661

31-Aug-18 $2,190,661 $153,346 $180,000 $26,654 2,164,007 $190,661 $164,007

31-Aug-19 2,164,007 151,481 $180,000 28,519 2,135,488 $164,007 135,488

31-Aug-20 2,135,488 149,484 $180,000 30,516 2,104,972 135,488 104,972

31-Aug-21 2,104,972 147,348 $180,000 32,652 2,072,320 104,972 72,320

31-Aug-22 2,072,320 145,062 $180,000 34,938 2,037,382 72,320 37,382

31-Aug-23 2,037,382 142,618 $180,000 37,382 2,000,000 37,382 0

d. Record interest expense on August 31st, 2018, 2019, 2022

Aug 31, 2018Dr. Interest Expense 153,346Dr. Bond Premium 26,654

Cr. Cash 180,000


25/83



Cr. Cash 180,000


Cr. Cash 180,000

e.Dr. Bonds Payable 2,000,000

Cr. Cash 2,000,000To record retirement of the bond on maturity


26/83


E9-20.

Date 01-Feb-17

Maturity date 31-Jan-23

Annual

Face Value (FV) 8,000,000Number of periods 6

Effective rate (i) 7.00%

Coupon rate (c) 7.00%

Annuity Payment 560,000


Annual


PV (annuity) $2,669,262

Proceeds (P) = $8,000,000

b.Dr. Cash 8,000,000

Cr. Bond Payable 8,000,000

c.No premium or discount exists on the bond because the coupon rate is the same as the effectiveinterest rate.

d.Jan 31, 2018

Dr. Interest Expense 560,000Cr. Cash 560,000

Jan 31, 2020Dr. Interest Expense 560,000

Cr. Cash 560,000

Jan 31, 2022Dr. Interest Expense 560,000

Cr. Cash 560,000

e.Dr. Bond Payable 8,000,000

Cr. Cash 8,000,000To record the retirement of the bond at maturity


27/83


E9-21.a.Dr. Bonds payable 6,000,000Dr. Premium on bonds payable 140,000Dr. Loss on redemption of bonds 260,000

Cr. Cash 6,400,000

b.Dr. Bonds payable 6,000,000Dr. Premium on bonds payable 140,000

Cr. Cash 5,600,000Cr. Gain on redemption of bonds 540,000

c. The gain or loss is simply the difference between the book value and the redemption value ofthe bonds at the date of redemption. It simply reflects that the cost of borrowing is actuallygreater or less than has been reflected on the income statement over the term of the bonds. The

loss or gain should be reported separately so that stakeholders will understand that this amount isa non-recurring event and has no relation to the main business activities of the entity.

E9-22.a.Dr. Bonds payable 10,000,000Dr. Loss on redemption of bonds 800,000

Cr. Cash 10,500,000Cr. Discount on bonds payable 300,000

b.Dr. Bonds payable 10,000,000

Cr. Cash 9,500,000Cr. Discount on bonds payable 300,000Cr. Gain on redemption of bonds 200,000

c. The gain or loss is simply the difference between the book value and the market value of thebonds at the date of redemption. It simply reflects that the cost of borrowing is actually greater orless than has been reflected on the income statement over the term of the bonds. The loss or gainshould be reported separately so that users will understand that this amount is a non-recurringevent and has no relation to the performance of the firm or of management.


28/83


E9-23.a. The after-tax cost of borrowing is 8% (1-.25) = 6% or $300,000

b. The after-tax cost of borrowing is 5% (1-.13) = 4% or $21,750

c. Since not-for-profit organizations arentsubject to taxes, the after-tax cost of borrowing is thesame as the cost of borrowing, or 5.5%.

d. The after-tax cost of borrowing is lower when the tax rate is higher, but it isntbeneficial for afirm to face a higher tax rate because the amount of tax the entity will pay on its income will behigher and so its net income will be lower. Also, it will have to pay more dollars out in cash intaxes.


29/83


E9-24.a. Operating Leasei. If the lease is treated as an operating lease, no leased asset is reported on the balance sheet, asoperating leases qualify for off balance sheet financing.

ii. The same entry will be made each year.Dr. Lease expense 87,500Cr. Cash 87,500

b. Capital Leasei. The asset recorded would be $312,996. This includes the present value of the lease payments(289,811), plus the full amount of the payment due at the inception of the lease (87,500).

npr 4

rate 8.00%

pmt 87,500

PV (annuity) 312,996Note: The annuity period is four years but it begins right

now (Feb 2017). This is the same as a three year annuity

beginning in one year plus the amount of the payment on

February 1, 2017. The present value of the annuity includes

the payment made on February 1, 2017

ii. February 1, 2017Dr. Asset under capital lease 312,996

Cr. Lease Liability 312,996To initially record the capital lease as an asset

Dr. Lease Liability 87,500Cr. Cash 87,500

To record the first lease payment at the start of the lease.

iii. January 31, 2018Dr. Lease Liability 69,460Dr. Interest Expense 18,040

Cr. Cash 87,500To record the lease payment ($225,496 x 8% = $18,040. $87,500$18,040 = $69,460).

iv. January 31, 2018Dr. Depreciation Expense 78,249

Cr. Accumulated Depreciation 78,249To record depreciation on the leased asset ($312,996/4 years = $78,249)

v.Carrying amount of lease liability2018: $156,036 2020: $0


30/83


*See below for calculations.

Carrying amount of leased asset2018: $234,747 2020: $78,249*See below for calculations.

Lease liability:

Date

[1]Beginning

Balance

(Net - Liability)

[2]Interest

Expense

[pre 1]*rate

[3]

Payments(Cash)

[4]Lease

Liability

[3]-[2]

Balance on

indicated date[1]+[4]

01-Feb-17 $312,996 $- ($87,500) ($87,500) $225,496

31-Jan-18 225,496 (18,040) (87,500) (69,460) 156,036

31-Jan-19 156,036 (12,483) (87,500) (75,017) 81,019

31-Jan-20 81,019 (6,481) (87,500) (81,019) 0

31-Jan-21 0 0 0 0 0

*Note: values slightly off due to rounding

Asset:

Date

[5]Carrying amount

on the previous

indicated date

[6]Depreciation

Expense

(straight-line)

Carrying

amount of leased

asset; on

indicated date

Accumulate

Amortization

4 Yrs

01-Feb-17 $312,996 $ $312,996 $

31-Jan-18 312,996 (78,249) 234,747 78,249

31-Jan-19 234,747 (78,249) 156,498 156,498

31-Jan-20 156,498 (78,249) 78,249 234,74731-Jan-21 78,249 (78,249) - 312,996

*Assuming Jan31is the year-end.


31/83


E9-25.a, b & c.

Summary:

8% 10% 12%

Lease equipment/liability $924,576 $871,052 $822,281Depreciation expense 154,096 145,175 137,047

Interest expense 73,966 87,105 98,674*See calculations below.

i) 8%

a. Number of payments 6

Discount rate 8.00%

Payment 200,000

PV (annuity) 924,576 - Recorded as lease asset and lease liability

b. Useful Life 6 - (924,576 / 6 = 154,096)

Amortization - SL 154,096 - Annual Depreciation Expense assumingstraight-line depreciation

c. Net liability - June 1, 2017 924,576

Rate 8.00%

Interest Expense - May 31, 2018

(previous Net liability * rate) = 73,966 - Interest expense

ii) 10%


Discount rate 10.00%

Payment 200,000


b. Useful Life 6 - (871,052 / 6 = 145,175)

Amortization - SL 145,175 - Annual Depreciation Expense assumingstraight-line depreciation


Rate 10.00%



iii) 12%


Discount rate 12.00%


32/83


Payment 200,000


b. Useful Life 6 - (822,281 / 6 = 137,047)

Amortization - SL 137,047 - Annual Depreciation Expense assuming

straight-line depreciation


Rate 12.00%



E9-26.a. There would be no effect on cash flow. It would be subtracted when reconciling from net

income to CFO using the indirect method.

b. The proceeds would be a cash inflow from financing.

c. The payment would be an operating cash outflow or a financing cash outflow under IFRS.Under ASPE it would be an operating cash outflow.

d. The repayment would be a financing cash outflow.

e. The loss isnta cash flow but would be added to net income to determine cash flow fromoperations on the statement of cash flows.

f. The amortization isnta cash flow. The amortization of the discount is added back whenreconciling from net income to CFO using the indirect method.


33/83


E9-27.a. Current Ratio and Debt-to-Equity Ratio before accounting for the lease:i) Current Ratio = 1.26 (628,000/496,800)ii) Debt-to-Equity Ratio = 4.17 [(496,800 + 3,400,000)/935200)

A lease accounted for as an operating lease isntrecorded on the statement of financial positionand only the lease payments are recorded when payable. Since we are ignoring the effects oflease payments, the current ratio and debt-to-equity ratio would be unchanged. There would beno effect on the income statement on the date of inception of the lease.

b. A capital lease is initially accounted for by debiting assets and crediting a liability for thepresent value of the lease payments.

Number of Periods 8

Rate 6.00%

Payment 475,000

PV (annuity) 3,126,631

Non-current assets will increase by 3,126,631. The current liability is the principal portion of thefirst payment $475,000(6% of 2,651,631) = 315,602 and the non-current liability is thedifference between the asset recorded and the current liability.

Amounts before Accounting for

accounting for lease capital lease Leases

Assets Capital Operating

Current 628,000 -475,000 153,000 628,000

Non-Current 4,204,000 3,126,631 7,330,631 4,204,000

Total Assets: 4,832,000 7,483,631 4,832,000

Liabilities - -

Current 496,800 315,902 812,702 496,800

Non-Current 3,400,000 2,335,729 5,735,729 3,400,000

Total Liabilities: 3,896,800 6,548,431 3,896,800

Share Equity 935,200 935,200 935,200

Total L & SE: 4,832,000 7,483,631 4,832,000

Ratio's - -

Current 1.26 0.19 1.26

Debt to Equity 4.17 7.00 4.17

Note that current assets decrease for the capital lease because the lease hasnt been accounted forso all elements of the transaction, including cash, have to be adjusted. Current assets dontchange under the operating lease treatment because the lease payment is a prepaid so while cashdecreases, prepaids increase.

c. The capital lease method better reflects the leverage of the company. The lease clearly createsan obligation for the entity so including the lease as a liability better captures the obligations of


34/83


the firm. The lease payment that is due in one year represents a current obligation. Not includingit on the balance sheet overstates the current ratio. Excluding the entire liability understates thetotal obligations and understates the debt-to-equity ratio.

d. Assuming that the information regarding the lease payments is provided in the financial

statements one could argue that well-informed stakeholders will respond to the financialstatements in the same way in either case. The treatment affects the accounting numbers, whichcan affect the outcome of contracts and decisions that are based strictly on the numbers.


35/83


E9-28.a.

Issue date 01-Jun-17

Maturity date 30-May-27

Annual

Face Value (FV) $6,000,000Periods 10

Effective rate 7%

Coupon rate 8%

Annual Payment 480,000

Proceeds (P) = $6,421,415

Premium 421,415

Dr. Cash 6,421,415Cr. Bonds Payable 6,000,000

Cr. Premium on Bonds Payable 421,415To record the issuance of bonds

b.Dr. Interest expense (449,499 x 7/12) 262,208Dr. Premium on bonds payable (30,501 x 7/12) 17,792

Cr. Interest payable (480,000 x 7/12) 280,000To record accrued interest at December 31, 2017

c.Dr. Interest Payable 280,000

Dr. Premium on bonds payable 12,709Dr. Interest Expense 187,291

Cr. Cash 480,000To record interest payment on May 31, 2018

Effective Interest Method

Annual

C1

Carrying Amt

Beginning

of period

C2

Interest

Expense

C1 x 7%

C3

Interest

Payment

C4

Premium

Amortized

C2 - C3

C5

Carrying Amt

Bond, end

C1 - C4

01-Jun-17 $6,421,415

31-Dec-17 $6,421,415 $449,499 $480,000 $30,501 6,390,914

The effective interestrate must be calculated


36/83


E9-29.

UCC = Cost - CCA

$5,000,000 $2,305,000

= 2,695,000

Carrying amount = Cost - AccumulatedAmortization

5,000,000 1,787,500

= 3,212,500

[1] [2] [3] Tax rate [4]

Tax Basis Accounting basis Temporary Difference Future tax

UCC Carrying amount deductible & (taxable) Asset (liability)

[1]-[2] [3]* tax rate

$2,695,000 $3,212,500 ($517,500) 45% ($232,875)

The balance in the future income tax account is a liability of $232,875.

E9-30.

UCC = Cost CCA

$1,400,000 - $820,000

= 580,000

Carrying amount = Cost

Accumulated

Amortization

1,400,000 - 1,150,000

= 250,000

[1] [2] [3] Tax rate [4]

Tax Basis Accounting basis Temporary Difference Future tax

UCC Carrying amount deductible & (taxable) Asset (liability)[1]-[2] [3]* tax rate

$580,000 $250,000 $330,000 20% $66,000

The balance in the future income tax account is an asset of $66,000.


37/83


E9-31a.

[3] [4] [5] [6] [7] [8]

Temp Diff Tax Future tax Beg Adj. Taxable Taxes Tax Exp Future

ded &

(tax)rate asset (liab) Bal

(Cr.)

&Dr.Income Payable

(Cr.)

&Dr.Current Expense

Year [1]-[2] [3]* taxrate

Pre [4] [4]-[5] [-7]*taxrate

[-6]-[8] Expense (benefit)

2016 -$150,000

2017 $400,000 25% 100,000 -$150,000 $250,000 $2,475,000 -$618,750 $368,750 $618,750 -250,000

Vibank should report a future income tax asset of $100,000 on its November 30, 2017 balancesheet. ($400,000 * 25%)

*The opening balance on the balance sheet in the future income tax account was a credit or afuture tax liability $150,000. The ending balance needs to be a debit or future tax asset of$100,000 (Tax basis > accounting basis by $400,000, therefore 25% * $400,000). To obtain a

debit balance of $100,000, a debit to future income taxes of $250,000 ($100,000 + $150,000) isrequired.

b.

Income before taxes $2,250,000

Income tax expenseCurrent 618,750Future (250,000)

Net Income $1,881,250

Vibanks 2017 net income would be $1,881,250.

c. If the taxes payable method were used, the income tax expense would be equal to the currentincome tax expense.

Income before taxes $2,250,000Income tax expense 618,750

Net Income $1,631,250

d. The amounts differ because the deferred tax method requires that the income tax expense bebased accounting for financial reporting purposes, while the taxes payable method the incometax expense is the amount of tax owed for the period, which is based on the requirements of the

Income Tax Act.

e.Dr. Income tax expense 368,750Dr. Future income taxes 250,000

Cr. Income taxes payable 618,750To record income tax expense for fiscal 2017


38/83


E9-32.a.

Year

[3]

Temp Diffded &

(tax)

[1]-[2]

Tax

rate

[4]

Future taxasset (liab)

[3]* tax

rate

[5]

Beg

Bal

Pre [4]

[6]

Adj.(Cr.)/

Dr.

[4]-[5]

[7]Taxable

Income

[8]

TaxesPayable

[-7]*tax

rate

Tax Exp(Cr.)

&Dr.

[-6]-[8]

Current

Expense

Future

Expense

(benefit)

2017 -$20,000

2018 ($150,000( 15% (22,500) ($20,000) ($2,500) $550,000) ($82,500) $85,000 $82,500 2,500

Rossland should report a future income liability of $22,500 on the December 31, 2018 balancesheet.

Note: the opening balance on the balance sheet in the future income tax account was a credit or afuture tax liability $20,000. The ending balance needs to be a credit or future tax liability of$22,500 (Tax basis < accounting basis by $150,000, therefore 15% * $150,000). To obtain a

credit balance of $22,500, a credit to future income taxes of $2,500 ($20,000 + $2,500) isrequired.

b.

Income before taxes $650,000

Income tax expense

Current 82,500

Future 2,500

Net Income 565,000

c. If the taxes payable method were used, the income tax expense would be equal to taxespayable.

Income before taxes 650,000Income tax expense 82,500

Net Income 567,500

d. The amounts differ because the deferred tax method requires that the income tax expense bebased accounting for financial reporting purposes, while the taxes payable method the incometax expense is the amount of tax owed for the period, which is based on the requirements of theIncome Tax Act.

e.Dr. Income tax expense (income statement) 85,000

Cr. Future income taxes (balance sheet) 2,500Cr. Income taxes payable (15% of $550,000) 82,500


39/83


E9-33.a.

UCC = Cost - CCA200,000 30,000

= 170,000

Carrying amount = Cost - Depreciation

200,000 20,000= 180,000

The accounting depreciation will be $200,000/10 = $20,000.

Year

[1]

Tax Basis

UCC

[2]

Accounting basis

Carrying amount

[3]

Temporary Difference

deductible & (taxable)

[1]-[2]

Tax rate

[4]

Future tax

Asset (liability)

[3]* tax rate

2017 170,000 180,000 (10,000) 16% (1,600)

There is a future tax liability of $1,600 to be reported on the balance sheet.

b.

UCC = Cost - CCA

200,000 30,000= 170,000

Carrying amount = Cost - Depreciation

200,000 40,000= 160,000

The accounting depreciation will be $200,000/5 = $40,000.

Year

[1]

Tax Basis

UCC

[2]

Accounting basis

Carrying amount

[3]

Temporary Difference

deductible & (taxable)

[1]-[2] Tax rate

[4]

Future

Asset (liab

[3]* tax

2017 170,000 160,000 10,000 16% 1

There is a future tax asset of $1,600 to be reported on the balance sheet.

c.

UCC = Cost - CCA

200,000 30,000= 170,000


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Carrying amount= Cost - Depreciation

200,000 60,000= 140,000

The accounting depreciation will be 30% of 200,000 = $60,000.

Year

[1]

Tax

Basis

UCC

[2]

Accounting

basis

Carrying

amount

[3]

Temporary

Difference

deductible &

(taxable)

[1]-[2]

Tax

rate

[4]

Future tax

Asset

(liability)

[3]* tax

rate

2017 170,000 140,000 30,000 16% 4,800

There is a future tax asset of $4,800 to be reported on the balance sheet.

d.

*The accounting depreciation will be =$30,000; the same used for taxes.

Year

[1]Tax Basis

UCC

[2]

Accounting

basisCarrying

amount

[3]

Temporary Differencedeductible & (taxable)

[1]-[2] Tax rate

[4]

Future taxAsset (liability)

[3]* tax rate2017 170,000 170,000 - 16% -

There is no future tax reported on the balance sheet since the asset will have the same accountingand tax values.

e. An income tax liability does indicate that cash will have to be paid at some future date but itsa tax effect that is relative to expenses and revenues recognized for accounting purposes (that is,future income tax balances give information about how assets and liabilities have been accounted

for differently for tax and accounting purposes; they arentan actual amount of liability orbenefit). Another way of thinking about this is that future income taxes give information aboutthe amount of CCA available on assets (and the deductibility of expenses) relative to theaccounting used for these assets and liabilities. The payment isntreally unavoidable, since itspossible that the firm may never pay the amount indicated or at least not in the foreseeable future(and the amount changes with tax rates and accounting policies). If the company continues toacquire capital assets, as would be the case for a growing company, or if the company incurslosses, no payments of cash will occur for a long time. Another difficulty is the fact that no

UCC = Cost (-) - CCA200,000 30,000

= 170,000

Carrying amount= Cost (-) - Depreciation

200,000 30,000= 170,000


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indication is provided regarding when the future cash flows are expected to occur. A future taxliability could represent a cash outflow that is expected in one year or over the next six years. Inthis situation, because itssimple, a user can infer the amount of tax benefit (CCA available) onthe asset in question. This information is helpful for predicting cash flows. As the situationbecomes more complexmore assets, different assets, liabilities that are accounted for

differently for accounting and taxit becomes much more difficult to understand the timing ofthe impact of future tax amounts on cash flow.


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PROBLEMS

P9-1.a. Yes, there is a liability, because providing the warranty service will require a sacrifice of

resources (labour, inventory, pay someone to do the work), the obligation is unavoidable (if

warranty work is required it must be provided), and results from a past transaction (sale ofproduct). Intuitively this is a liability as well because there is an obligation to provide theservice. (Note that different people will have different intuitions.)

b. Yes, there is a liability but not on the balance sheet date of December 31, 2017. This loanwould be reported as a liability on December 31, 2018 because repaying the loan will requirea sacrifice of resources (cash to repay), the obligation is unavoidable (the bank has to be paidor there will be legal repercussions), and results from a past transaction (a loan was made).Intuitively this is a liability because money is owed to the bank, but only on a balance sheetprepared after January 8, 2018.

c. Under IFRS the lease isntconsidered a liability because itsan operating lease. Althoughthere is an obligation resulting from a past transaction (lease signing) that will require aneconomic sacrifice (lease payments), the lessee wonthave obtained the risks and rewards ofownership as a result of the lease. Since operating leases donttransfer the risks and rewardsof the lease to the lessee, they qualify for off-balance sheet financingand are recordeddirectly through profit/loss. Intuitively, the fact that there is a firm commitment to make thelease payments that cantbe avoided suggests that a liability exists.


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P9-2.a. Yes, there is a liability because paying the interest will require a sacrifice of resources (cash to

repay) the obligation is unavoidable (the bank has to be paid its interest or there will be legalrepercussions), and results from a past transaction (a loan was made and interest has beenearned by the bank). Different interpretations could be provided from the intuitive standpoint.

One is that since the money isnt owed as of the financial statement date there is no liability;that is, the liability doesnt come into effect until the money is actually due. The alternativeinterpretation would be consistent with the IFRS view that the interest has been earned by thebank and so is a liability even though it doesnt yet have to be paid (accrual).

b. The loan would be considered a liability because repayment will require a sacrifice ofresources, the entity has an obligation to repay and the loan was arranged in the past. Itdoesnt have a definite repayment date, but the shareholder certainly could request repaymentat any time. A user of the financial statements should probably view the claim as a currentliability unless the shareholder is prepared to commit not to request repayment during sometime period. Intuitively, this would be considered a liability because the entity must repay the

shareholder loan, although some might argue that repayment of a loan from a shareholdermight be more discretionary than a loan from a bank.

c. Environmental liabilities are accrued because a sacrifice of resources will be required (thecosts to clean up must be incurred), the obligation is binding (unless government regulationschange the company must meet its requirements or face sanctions), and is the result of pasttransactions (building the factory requires clean-up upon closing). Intuitively, since thefactory is expected to close in 25 years, some may think that its too earlyand the amount touncertain to record as a liability. However, since the liability legally binds the entity to restorethe land, the present value of estimated clean-up costs should be accrued.


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P9-3.D/E ratio = L/OE; Current ratio = CA/CL;Interest coverage ratio = (NI + interest expense + tax expense)/ Interest expense;Return on assets = (NI + ATI)/TA;

Year End: September 30, 2017Debt/Equity Current

Ratio

Interest

Coverage

Cash from

Operations

Return on

AssetsRatio

Ratio/Amount before taking thetransaction/ economic event intoaccount

1.25:1 1.25 2.5 425,000 4.30%

a.On Sept 30, 2017 Oskelaneoaccrued interest on a bank loan. Theinterest will be paid in Dec 2017

Increase Decrease Decrease No effect Decrease

b.Arranged new capital leaseSeptember 30, 2017. No cash is paidat the time

Increase Decrease No effect No effect Decrease

c.

Fire destroyed small building owned

by Oskelaneo on Oct 4, 2017 No effect No effect No effect No effect No effect

d.Cash received for services to beprovided in February 2018

Increase Decrease No effect Increase Decrease

e.

Oskelaneo was sued in Jan 2017 buta court ruling wontbe made for 2years. The companies lawyers statethat losing the lawsuitsunlikely.

No effect No effect No effect No effect No effect

a.Dr. Interest Expense (E+)

Cr. Interest Payable (L+)To accrue interest on the bank loan

b.Dr. Asset under capital lease (A+)

Cr. Lease liability (L+)To record the lease arrangement onlyLease arranged on the last day of the year so there is noincome statement effect.

c.Subsequent event: the fire occurred after year-end and doesntreflect conditions that existed atyear-end. Therefore, financial statements arentadjusted and ratios arentaffected. The fire

should be note disclosed, if significant.

d.Dr. Cash (A+)

Cr. Unearned Revenue (L+)To record cash receipt of unearned revenue

e.


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Contingent Liabilitysince the court decision isntexpected for 2 years, the probability that anoutflow of resources will occur cantbe measured and isntcertain (i.e. That Oskelaneo will losethe lawsuit and have to pay). Therefore, the lawsuit is disclosed only and doesntimpact the2017 year-end ratios.

P9-4.D/E ratio = L/OE; Current ratio = CA/CL;Interest coverage ratio = (NI + interest expense + tax expense)/ Interest expense;Return on assets = (NI + ATI)/TA;

Note that assumptions are required for some of these items. This is by design. Students shouldlearn to explicitly state what they are assuming.

Year End: April 30, 2017Debt/Equity Current

Ratio

Interest

Coverage

Cash from

Operations

Return on

AssetsRatio

Ratio/Amount before taking the

transaction/ economic eventinto account.75:1 0.85 5.2 3,500,000 8.50%

a.Contract signed in Jan 2017 topurchase raw materialsbeginning fiscal 2018

No effect No effect No effect No effect No effect

b.Provided services paid for inthe previous fiscal year

Decrease Increase Increase No effect Increase

c.Contribution to defined-contribution pension plan inApril 2017

Increase Decrease Decrease Decrease Decrease

d.Repaid bond that was classifiedas current portion of long-termdebt in March 2017

Decrease Decrease No effect No effect Increase

e.

In Nov 2016, paid $1,000,000to settle a lawsuit that waslaunched 3 years ago. Theamount owed has been accruedearlier.

Decrease Decrease No effect Decrease Increase

a. This transaction represents a commitment and isntrecorded in the 2017 financial statements.The commitment may be disclosed in the notes if significant to the entity.

b.Dr. Unearned Revenue (L-)

Cr. Revenue (OE+)

c.Dr. Pension Expense (OE-)

Cr. Cash (A-)

d.Dr. Bond Payable (L-)

Cr. Cash (A-)


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e.Dr. Lawsuit Payable (L-)

Cr. Cash (A-)

P9-5.

Report to Management,

Based on the information provided and my calculations (below), it would appear that purchasingthe new operating room would be more economical than leasing. If you were to lease operatingroom, the present value of the payments would be $635,888.48. Purchasing the operating roomincurs a total cost of $500,000. If management is concerned about depleting the hospitalfoundation they should pay for the operating room and fundraise to replenish the foundation,which would be less costly than fundraising to cover the costs of monthly lease payments.

If you have any questions, please contact me.

C.A.

Cost to lease = $12,000 * 12 months * 5 years = $720,000PV of cost to lease = $635,888.48 ($12,000pmt, 60 months, .42% per month).

Cost to purchase = $500,000


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P9-6.

Kulas current financial situation:Income after taxes (combined) $108,000Expenses:

Mortgage payment (2,000 x 12) ($24,000)Lease payment (600 x 12) ($7,200)Household expenses (5,200 x 12) ($62,400)Vacations ($8,000)Total Operating Expenses ($101,600)Excess (Deficit) Income before interest $6,400Interest expense (5,000 x 15%) ($750)Total excess (deficit) income $5,650

Savings: $5,650 is available for savings.

Asset: Savings $35,000 ($7,000 cash)Liability: Credit card debt $5,000

Kulas financial situation after moving:Income after taxes (combined) $108,000Expenses:Mortgage payment (2,400 x 12) ($28,800)Lease payment (600 x 12) ($7,200)Household expenses (5,700 x 12) ($68,400)Vacations ($8,000)Total Operating Expenses ($112,400)Interest expense (5,000 x 15%) ($750)Moving expense ($10,000)Total expenses ($123,150)Total excess (deficit) income ($15,150)

Savings: since expenses are greater than income earned, there is no money available for savingsand the Kulas will have to finance the deficit by borrowing from past savings or increasing debt.However, the moving expenses are a one-time expense so in future years the deficit would onlybe $5,150.

Therefore: the Kulas cantcurrently afford to move because expenses exceed income earned.Steps the Kulas can take:

1.

Use savings available to cover moving expenses - $7,0002. Use saving to repay credit card balance and save interest cost3.

Reduce vacation expense - $8,0004. Examine household expenses to reduce expenditures; perhaps eating out, entertainment,

etc.If the above steps are implemented, the deficit could be eliminated although no money would besaved.


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P9-7.Report to Controller,

Your primary objective for financial reporting is to avoid violating your current debtcovenants and show good stewardship perhaps by paying dividends to shareholders. Maintaining

the debt covenants is crucial because if you violate them you have to repay the 1,500,000 debtand currently you have only $720,000 in current assets. In addition, money is needed for workingcapital. A violation of the covenants may result in a renegotiation of the loan arrangement, whichmay result in higher interest rates or at worst, receivership.

If nothing is done by year-end you are going to violate the current ratio covenant (exhibit1). If you fail to get the loan then you must use $370,000 of your current assets to pay down yourcurrent liabilities by the same amount (exhibit 1). This will prevent you from violating thecurrent ratio covenant.

With the new the long-term loan $750,000 will be used to purchase new equipment,

which will be accounted for as capital (non-current) assets. Before the balance sheet date, theremaining $250,000 can either be used to increase cash and current assets or pay off currentliabilities. The greater amount of this money that is used to pay down the current liabilities thegreater effect it will have on the current ratio (compare exhibit 3 & 4). The same effect willhappen with the dividend. If you declare and pay dividends before the year-end, it will have abetter impact on the current ratio than if you just declare the dividends and increase your currentliabilities (compare exhibit 2 & 3).

Your final decision should be based on how much cash Bedeque requires in the bank asworking capital and how much in dividends the company is planning on paying this year.$170,000 is the maximum amount of dividends you can pay (see exhibit 4). But depending onhow you balance your current assets compared to your current liabilities, this may reduce theamount of dividend that you can pay out this year because the current ratio cantbe violated.

In conclusion, itscrucial that your loan be long-term, not a demand loan, which wouldbe classified as a current liability. This would allow you to meet your current ratio covenant (thedebt-to-equity covenant isntat risk) and you would then have some flexibility to reduce youother current liabilities and pay dividends.

Exhibit 1 - Current situation - No loan

Bedeque Inc.

Projected Balance Sheet

As of December 31, 2017

Current assets $720,000 Current liabilities $600,000

Non-current assets 5,250,000 Non-current liabilities 1,500,000

Total liabilities 2,100,000

Common shares 2,000,000

Retained earnings 1,870,000

Total Shareholders' equity 3,870,000

Total assets $5,970,000 Total liabilities and shareholders' equity $5,970,000

Current ratio = CA/CL 1.20

Debt-to-equity = L/OE 0.54


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With no additional financingPay off $370,000 of current liabilities by using existing current assets to

maintain covenants



Exhibit 2 - Loan on a long term basis, $250,000 working capital asset & dividends declared but not paid

Increase in current assets (working capital) $250,000 Increase in non-current liabilities (Long-term loan) $1,000,000

Increase in non-current assets 750,000 Increase in current liabilities (Dividends payable) 40,000

Decrease in retained earnings (Declare dividends) (40,000)

Bedeque Inc.












Exhibit 3 - Loan on a long-term basis, $250,000 working capital asset, & dividends declared and paid

Increase in current assets (working capital) $250,000 Increase in non-current liabilities (Long-term loan)) $1,000,000

Increase in non-current assets 750,000

Decrease in current assets (Pay dividends) (65,000) Decrease in retained earnings (Declare dividends) (65,000)

Bedeque Inc.Projected Balance Sheet











Exhibit4 -Loan on a long-term basis, $250,000 reduction in current liabilities & dividends declared and paid

Increase in non-current assets 750,000 Decrease in current liabilities (250,000)

Decrease in current assets (Pay dividends) ($170,000) Increase in non-current liabilities (Long-term loan) 1,000,000

Decrease in retained earnings (Declare dividends) ($170,000)

Bedeque Inc.




8/10/2019 Friedlan4e SM Ch

friedlan4e sm ch09

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