ACCT10002 Introductory Financial Accounting Lecture 12: Part 3 Discussion of Semester 2, 2020 Exam Question 1 20 multiple choice questions – randomly selected from a pool. Examples: 1.1 Fantastic Fan Pty Ltd purchased second-hand equipment for its operations for $30,000. The equipment was worth $40,000. Applying the cost principle, how much should the equipment be recorded in Fantastic Fan’s statement of financial position A $30,000 B $40,000 C The company could choose either $30,000 or $40,000. D $35,000 (which is the average of the two prices) 1.8 Vagabond Ltd manufactures handbags and provides a six-month quality warranty. The provision for warranty account has a credit balance of $50,000 and the estimated future obligations for warranty work is $190,000. The adjustment necessary to update the provision account is a A debit of $140,000 B debit of $240,000 C credit of $140,000 D credit of $240,000 Question 2 Cash Flow Statement: File to be downloaded Snow White Ltd Statement of Financial Position as at 30 June 2020 2020 2019 $’000 $’000 Assets Current assets Cash 247.5 120 Accounts receivable 285 315 Allowance for doubtful debts -30 -18 Inventory 300 255 Prepaid rent 30 90 Total current assets 832.5 762 Non-current assets Land 630 540 Buildings 765 705 Accumulated depreciation — buildings -345 -315 Equipment 375 420 Accumulated depreciation — equipment -165 -135 Patents 45 60 Total non-current assets 1305 1275 Total assets 2077.5 1977 Liabilities and equity Current liabilities Accounts payable 255 285 Accrued expenses 120 112.5 Income tax payable 138 67.5 Final dividend payable 75 60 Total current liabilities 588 525 Non-current liabilities Borrowings 465 615 Total liabilities 1053 1140 Equity Share capital 600 525 Revaluation surplus 162 72 General reserve 67.5 52.5 Retained earnings 195 187.5 Total equity 1024.5 837 Total liabilities and equity 2077.5 1977 Question 2 (cont.) Snow White Ltd Statement of Profit or Loss for the year ended 30 June 2020 Revenue $’000 $’000 Sales revenue 930 Profit on sale of land 30 Total revenue 960 Less expenses Cost of sales 360 Rent expense 60 Bad debts expense 18 Depreciation and amortisation 135 Other expenses 42 Loss on sale of office equipment 30 645 Profit before income tax 315 Income tax expense 165 Profit for the period 150 Additional information (dollar amounts expressed in full units): 1. Equipment with an original cost of $135, 000 and accumulated depreciation of $60, 000 was sold. The firm also paid cash for some new equipment. 2. Land with a cost of $120,000 was sold for $150, 000. The remaining land was Revalued upwards by $90, 000. 3. Equipment to the value of $30, 000 and buildings to the value of $60, 000 were acquired with the additional borrowing from the bank. REQUIRED: Complete the following cash flow statement using the direct method. Question 2 Snow White Ltd Cash Flow Statement for the year ended 30 June 2020 OPERATING ACTIVITIES Cash receipts from customers 954,000 Cash payments to suppliers 435,000 Cash payments for operating costs 34.500 Income tax 94,500 (564,000) Net cash flow from operating activities 390,000 INVESTING ACTIVITIES Purchase of land (120,000) Sale of land 150,000 Sale of equipment 45,000 Purchase of equipment (60,000) Net cash flow from investing activities 15,000 FINANCING ACTIVITIES Proceeds of share issue 75,000 Payment of cash dividends (112,500) Repayment of borrowings (240,000) Net cash flow from financing activities (277,500) TOTAL CHANGE IN CASH HELD 127,500 CASH AT BEGINNING 120,000 CASH AT END 247,500 Note: the template will be partially completed. The items in bold were not given. Question 3 4 x 3 = 12 marks Examine the selected data over the 5-year period as shown in the table below for Handsome Prince Ltd. Year Item 2021 2020 2019 2018 2017 2016 $m $m $m $m $m $m Sales 286.41 280.80 275.29 269.89 264.60 252.00 Cost of sales 180.03 166.69 154.35 142.91 134.19 126.00 EBIT 51.18 51.08 50.98 50.88 49.88 48.90 Interest 37.07 33.70 30.64 27.85 25.32 24.00 NPAT 35.13 35.10 35.06 35.03 34.51 34.00 Current assets 43.85 43.20 42.56 41.93 41.31 40.70 Total assets 226.18 221.75 217.40 213.13 206.93 200.90 current liabilities 55.99 53.58 51.27 49.06 47.40 45.80 Total liabilities 98.99 91.66 84.87 78.58 74.48 70.60 Equity 127.19 130.09 132.53 134.56 132.44 130.30 Gross margin 0.37 0.41 0.44 0.47 0.49 0.50 Interest coverage 1.38 1.52 1.66 1.83 1.97 2.04 Current ratio 0.78 0.81 0.83 0.85 0.87 0.89 Debt ratio 0.44 0.41 0.39 0.37 0.36 0.35 Inventory 18.86 18.13 17.44 16.76 16.12 15.50 Inventory in days 38.23 39.70 41.23 42.82 43.85 44.90 Receivables 27.21 25.43 23.77 22.21 20.76 19.40 Receivables in days 34.68 33.06 31.51 30.04 28.63 28.10 Payables 34.09 28.41 23.67 19.73 16.44 13.70 Payables in days 69.12 62.20 55.98 50.39 44.72 39.69 Cash Conversion Cycle 3.79 10.56 16.76 22.47 27.76 33.31 REQUIRED: Using the above data, prepare an analysis of the firm under the following headings: a) Handsome Prince’s short- term liquidity position b) Handsome Prince’s operating performance c) Handsome Prince’s solvency d) Handsome Prince’s Return on Equity (calculate ROE for 2021 and 2017) a) Liquidity: Students should note key measurements that indicate liquidity: current ratio and cash conversion cycle. Current ratio: deteriorated from 89cents per $1 debt to 78 cents per $1 debt. Explain why. Cash conversion: improving from negative 33.4 days to 3.8 days when a shortfall of cash is required to fund operations. Explanation: Better inventory turnover; slightly poorer receivables turnover; but taking an extra month to pay payables. Students may also mention: Working capital: CA-CL = deteriorated from – $5m to -$12m. and/or Quick Ratio but unlikely to have calculated the ratio. Overall, the firm is in a deteriorating liquidity position. b) Profitability: Students should discuss the Gross margin by identifying changes in Sales and Cost of Sales. Gross margin deteriorating as COS increasing at greater rate than sales even though both are increasing. EBIT is increasing slightly indicating that other expenses are not changing to any great extent. A discussion of NPAT may also be provided. NPAT slight increase only over the period but, interest costs and other costs are rising so, NPAT is basically not increasing at all. Overall, performance is stagnant but concerning as the Gross margin is falling. c) Solvency: Solvency should include a discussion of Interest Coverage ratio and the Debt ratio. Interest coverage ratio is deteriorating from 2.04 times to 1.38 times as a result of interest cost increasing at a faster rate than EBIT. Debt ratio is increasing slightly from 35% to 44% indicating a higher level of debt relative to assets. i.e. liabilities are increasing at a greater rate than the increase in assets. Although debt is 44% of assets, the increase of debt is not significant and, solvency should not be a great concern. d) Return on Equity (calculate ROE for 2021 and 2017 The Return on Equity for 2017 is 34/131.37 = 25.88%; for 2021 is 35.13/128.64 = 27.30%. The reason for the increase in ROE is that the increase in NPAT is not as great as the decrease in equity resulting is a higher ROE despite NPAT remaining almost stable. Question 4 Question 4 5 marks The following transactions are for Bashful’s Pet Supplies Ltd: 1. On 21 March, Bashful’s Pet Supplies Ltd sold 2 deluxe dog kennels for $4,500 each (including GST) to Friendly Doc Ltd, terms 2.5/7, n/30. The cost of the kennels was $1,500 each. 2. On 23 March, Friendly Doc Ltd was granted an allowance of $200 for a small scratch on one of the kennels purchased on 21 March. 3. On 27 March, Bashful’s Pet Supplies Ltd received the balance due from Friendly Doc Ltd. Required: Prepare the journal entries to record all these transactions (including GST where appropriate) in the records of Bashful’s Pet Supplies Ltd. Assume Bashful’s Pet Supplies Ltd uses the perpetual inventory recording method. (NOTE: Round your calculations to the nearest dollar.) (2+1+2 = 5 marks) Question 4 March 21 Accounts receivable $9,000 Sales $8,182 GST Payable 818 Cost of sales $3,000 Inventory $3,000 March 23 Sales Returns & Allow $182 GST Payable 18 Accounts receivable $200 March 27 Cash $8,580 Discount expense 200 GST Payable 20 Accounts receivable $8,800 Question 5 (a) Question 5 4 + 5 = 9 marks a) Preparing for balance day, 30 June 2020, Grumpy, the chief accountant for Happy Ltd had the following information: The Provision for Warranty at the beginning of the year was $10,000. The actual costs of warranty repairs during the year were $15,000. Grumpy estimated that the Provision for Warranty at the end of the year would be based on: Total sales $240,000 of which 85% would have no warranty claims and 15% would have only minor claims and no major claims. Grumpy estimates that the Provision for Warranty at 30 June 2020 would be $6,000. Required: i) Calculate the Warranty expense for the year. ii) Provide reasons why the end of year provision is less than the beginning of the year even though the cost of warranty was greater than the provision at the beginning of the year. iii) Explain the effect of the provision at the end of the year on the profit result for the year ended 30 June 2020. i) Calculate the Warranty expense for the year. Provision for Warranty OB $10,000 Claims $15,000 Warranty expense $11,000 CB $6,000 ii) Provide reasons why the end of year provision is less than the beginning of the year even though the cost of warranty was greater than the provision at the beginning of the year. Improved new product line Problem of claims/faults resolved iii) Explain the effect of the provision at the end of the year on the profit result for the year ended 30 June 2020. Effect on profit is that expense is lower than the actual cost Profit will be higher. Question 5 (b) (b) After long deliberations, the CEO of The Magic Mirror Ltd decided to buy a small company that would provide another level in achieving the vertical integration objective that he planned for the company. He borrowed $5 million with the expectation of Earnings Before Interest and Tax of $1,400,000 per annum. However, he had not expected a pandemic to affect his business plans and the EBIT figure for the year was only 50% of his projected figure. The borrowing cost is 5% pa and the tax rate is 25%. The company has 5 million shares issued at a cost of $1 per share. Retained earnings are $2 million and Reserves are $1 million. Required: i) Calculate the expected ROE of the purchase of the other company and the ROE based on the impact of the pandemic. ii) Assume you are were consulted prior to the pandemic and asked to prepare a note to the Board of Directors about the issues to consider when contemplating a takeover or expansion of a business. (3 + 2 = 5 marks) Equity: $8,000,000 Before After EBIT 1,400,000 700,000 Interest 250,000 250,000 EBT 1,150,000 450,000 Tax 287,500 112,500 Net profit 862,500 337,500 If did not add Net Profit to Equity ROE 10.78% 4.2% If added Net Profit to Equity ROE 9.7% 4.0% ii) Assume you are were consulted prior to the pandemic and asked to prepare a note to the Board of Directors about the issues to consider when contemplating a takeover or expansion of a business. How reliable is the estimate of EBIT Can EBIT be shock proofed What if interest rates were increased What if taxes were changed Question 6 Question 6 5 marks On 28 July 2020, Dopey, the chief accountant discovers a note that he wrote on 15 June 2020 that he needs o record some items into the journal before the last day of the financial year. Unfortunately, Dopey fell ill later that day and did not tell the junior accountant to process the items. The list includes: Major overhaul of plastics fabricating machine $30,000 (bank loan). Training cost of operator for updated plastics fabricating machine $2,500. Purchase of new letterhead stationery $200 and printing costs of business cards for new sales representative $120 (invoice received for both). Dopey recovered from his illness and returned to work on 15 Jul
y 2020, discovered his note and attended to the overlooked items. Required: i) Discuss the accounting principle that Dopey should adopt to decide how to record the missing items. Use examples to illustrate your answer. ii) The junior accountant has drafted the correcting journal as follows: Dr. Depreciation $3,000 because the overhaul is expected to last 10 years with no residual value Dr. Plastic fabricating machine $30,000 Dr. Stationery expense $320 Dr. Wages expense $2,500 Cr. Accumulated depreciation of plastics fabricating machine $3,000 Cr. Accounts payable $30,000 Cr. Wages payable $2,500 Cr. Cash $320 Correct the suggested journal entry as prepared by the junior accountant and explain briefly why you have made your changes. (2 + 3 = 5 marks) Question 6 Accounting principle is materiality: it is material if its omission would affect an investor’s decision-making. The plastic fabricating machine (PFB) and training cost material. To be recorded immediately The stationery items not material. Record in current year. 15 July Debit Retained earnings $4,500 Plastic Fab Machine $30,000 Credit Bank loan $30,000 Accumulated depn PFM $3,000 Wages payable $1,500 Debit Stationery expense $420 Credit Accounts payable $420 Explain why you have made your changes. Need make changes to the permanent accounts for material items with prior period errors. Immaterial items may be recorded in current year. Question 7 Question 7 i) Assuming the firm uses the First-in-First-Out Method: Calculate: (i) the total sales for the quarter sales = 1,450 x $100 = $145,000 (ii) the Cost of Sales for the quarter 400 x $55 = $22,000 500: 100 x 55 400 x 50 = $25,500 550: 50 x 55 500 x 45 = 25,250 Total = $72,750 (iii) the Gross Profit = $145,000 – $72,750 = $75,250 ii) Calculate the Gross Profit Margin as it was for 9 July and 23 September and explain any change. 9 July Price $100 – Cos $55 = gross margin $45 = 45% 23 July $100 – $45 = $55 = 55% Explanation: GM has increased because the COS has gone down but the sales price remains the same. iii) Suppose the physical stocktake on 30 September showed that there were 30 units on hand yet the inventory record showed there were more units on hand. Prepare the general journal entry to record the difference. A narration is required. Inventory loss 70 units x $45 = $3,150 Debit Inventory loss $3,150 Credit Inventory $3,150 (To record loss of 70 units of inventory) iv) Following an accident in the warehouse it was assessed that five (5) of the items of the ending inventory could only be sold for $35 after making some repairs (which cost $5 per unit. Show how this assessment would be journalised. A narration is required. 30 units remaining but 5 are damaged. Net Realizable value $35 minus $5 costs = Net RV = $30 LCNRV = cost $45 NRV $30 = $15 write down per unit x 5 units = $75 Debit Inventory write down $75 Credit Inventory $75 (To record write down of 5 units based on LCNRV) Question 8 Question 8 i) What would be recorded as the cost of the machine to be shown in the Balance Sheet Cost $250,000 Insurance and freight $30,000 Installation 10,000 Net dismantle costs 12,000- 2,000 = 10,000 TOTAL $300,000 Residual value $50,000 Depreciable value $250,000 Units of production 200,000 Cost per unit = $1.25 Recorded as cost of machine = $300,000 ii) The accountant recommended using the Units of Production method for depreciation. Explain why AASB
116 par 60 requires that an asset be depreciated using he most
appropriate method that reflects the pattern in which the asse t’s
future economic benefits are expected to be consumed by the entity. Measurable by the number of units produced. iii) What is the depreciation expense for the period 1 July 2017 to 30 June 2018 Units produced: 10,000 x $1.25 = $12,500 depreciation expense. Question 8 (cont.) In September 2019, the management decided that the machine needed an upgrade to extend its useful life for additional production of another 90,000 units (290,000 units in total). The cost of the upgrade was $50,000 and was completed by 1 January 2020 and funded by a loan from Scrooge Bank. iv) Prepare the general journal entry to record the upgrade as at 1 January 2020. Include a narration. v) Prepare the journal entry to record the depreciation as at 30 June 2020 if 10,000 units were produced between I January 2020 and 30 June 2020. No change to the estimated residual value was made. On 30 June 2020 the directors obtained an independent valuation which indicated that the market value of the machine was $270,000. vi) Prepare the general journal to record the recognition of the valuation of the machine for 30 June 2020. Include a narration. vii) How would the machine be shown in the Balance Sheet at 30 June 2020 Show an extract from the Balance Sheet. (2+2+1+1+3+2+1 = 12 marks) iv) Prepare the general journal entry to record the upgrade as at 1 January 2020 Debit Machine $50,000 Credit Loan The Poisoned Apple bank $50,000 v) Prepare the journal entry to record the depreciation as at 30 June 2020 if 10,000 units were produced between I January 2020 and 30 June 2020. No change to the estimated residual value was made. Accumulated depreciation = epreciation Accum dep’n Units used: 2017-18 = 10,000 x 1.25 = 12,500 12,500 2018-19 = 15,000 x 1.25 = 18,750 31,250 July 19 to Dec 19 = 5,000 x 1.25 = 6,250 37,500 Jan 20 to June 20 = 10,000 At 1 January 2020 Cost $300,000 + 50,000 =350,000 Less Accumulated depreciation 37,500 = Carrying value 312,500 Less residual value 50,000 = Depreciable amount $262,500 Divided by remaining units to be produced: 200,000 – 30,000 + 90,000 = 260,000 New Depreciation amount per unit = $262,500/260,000 = $1.00 per unit. (Rounded) Debit Depreciation 1 Jan to 30 June 2020 10,000 x $1 = $10,000 Accumulated depreciation Machine $10,000 On 30 June 2020 the directors obtained an independent valuation which indicated that the market value of the machine was $270,000. vi) Prepare the general journal to record the recognition of the valuation of the machine for 30 June 2020. At 30 June 2020 the Carrying amount of the PFM = Cost $350,000 Minus Accum deprec $47,500 = $302,500 Less Recoverable amount $270,000 = Impairment of Machine = $32,500 Debit Impairment of Machine $32,500 Credit Accumulated Impairment of Machine $32,500 vii) How would the machine be shown in the Balance Sheet at 30 June 2020 Non-current assets Machine Cost $350,000 Less Accumulated dep’n 47,500 Less Accumulated Impairment 32,500 $270,000 Question 9 b) Chip ‘n Dale Ltd is a successful advertising business. It has regularly met shareholder expectations by paying regular dividends. The board of directors’ policy requires that for a dividend to be declared, net cash flow provided by operating activities must exceed $2 million. At the end of the current year, the accountant reports that the net cash provided by operating activities is calculated to be $1,940, 000. The managing director is keen to maintain shareholders’ approval and suggests to the accountant to find ways to report a cash flow from operating activities to be at least $2,000,000. The accountant considers the draft financial reports and concludes that he can get the operating cash flows to be $2 million by removing $120,000 from unearned revenue on the basis that the work has almost been completed and can be recorded as revenue. In this way the cash receipts from clients will be increased by the required amount. The managing director is very grateful for the news and rewards the accountant with an extra week’s leave because the dividend policy can be maintained. Required: i) Explain how the accountant was able to manage the desired result. ii) Discuss ethical issues concerned with this scenario. (3 + 4 = 7 marks) Question 9 (a) AASB 15 Under the 5 step rule to determine when revenue may be recognised, Jetstar is not able to recognise revenue until the service has been delivered to the customer. i.e. when the entity satisfies the performance obligation. So, Jetstar cannot recognise revenue until the customer is provided with the flights. ii) Discuss why JetStar may have been reluctant to pay a refund but instead provided a voucher for flights to be taken at a later time. To withhold and preserve cash to pay for other costs To ensure that revenue will be counted sometime in the future rather than risk the customer deciding not to fly in the future. ii) Discuss ethical issues concerned with this scenario. Stakeholders (shareholders, banks, suppliers, investors) may be deceived by the increased recording of revenue. False recognition of revenue before the performance obligation has been satisfied AASB 15. It provides increased profit result and increased ROE ratio. The accountant has to decide to follow the MD request to keep shareholders happy or to follow: AASB rules regarding revenue recognition, Conceptual Framework of the qualitative characteristics of faithful representation.(b) i) Explain how the accountant was able to manage the desired result. Reconstruct T accounts for Accounts receivable to determine cash flow effect: Before After Assume OB 100 Cash 100 OB 100 Cash 160 Revenue 100 CB 100 venue 160 CB 100 Therefore, Cash received from customers increased by $60,000 By debiting Unearned revenue by $60,000 and crediting revenue by $60,000 the cash received from customers is calculated as increasing by $60,000. Question 10 Question 10 7 marks Westpac flags $1.2b hit to earnings on misconduct costs, write-downs By Charlotte Grieve, The Age, 27 October, 2020 Westpac has flagged a $1.2 billion hit to earnings caused by write-downs across its insurance businesses, a growing remediation bill and mounting costs related to the landmark legal case over anti-money laundering law breaches. The big four bank said on Monday that the value of its life insurance business would be written down by $406 million and the group’s disability insurance business would report a loss of $260 million, ahead of its full-year result next Monday. The losses were partly offset by an increased valuation of its holding of buy now, pay later platform Zip Co by $303 million, which became effective before Westpac sold its shares last week. Westpac has also put aside an additional $182 million to compensate customers who were sold incorrect loans, overcharged or provided with poor advice. As part of this increased provision, $104 million will pay for running the remediation program and $38 million will be used for settling legal disputes with customers. Last Wednesday, the Federal Court agreed Westpac should pay a fine of $1.3 billion, the largest civil penalty in Australian corporate history, after negotiations with financial crimes watchdog AUSTRAC over 23 million breaches of anti-money laundering and counter- terrorism financing laws. Australia’s second-largest bank said the asset write-downs were partly caused by COVID-19. Question 10 i) From your study of accounting this semester, explain the impact of the various items on Westpac’s Annual Report. Income Statement: Increase expenses (fines, write downs/impairments) Decrease profits Balance Sheet: Increased provisions (liabilities) Decreased cash (assets) Cash Flow Statement: Decreased cash from Operating activities (fines) Decreased cash flow – reduced insurance sales ii) Westpac’s board of directors has already stated that there would be no interim dividend in the financial year. However, they may consider issuing a share dividend at the end of the year instead of a cash dividend. Explain the difference in the two dividend types and what effect that a share dividend would have on the company. Cash dividend: payment of cash (decrease assets and decrease equity) Share dividend: Increase share capital and decrease Retained earnings (no effect on Equity) Share dividend effect on the company The share dividend assists to retain cash in the business. Shareholders may react and sell shares because no dividend is payable or, Future dividends may be less as profit is spread over more shareholders.