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Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

CHAPTER 23

OTHER MEASUREMENT AND DISCLOSURE


ISSUES

ASSIGNMENT CLASSIFICATION TABLE


Topics

Brief
Writing
Exercises Exercises Problems Assignments

1.

Disclosure from a
business
perspective.

2.

Full disclosure
principle.

2, 3, 4

3.

Accounting policy
notes.

4.

Segment reporting; 5, 6, 7, 8
diversified firms.

5.

1, 5, 7

2, 3, 4, 5, 2
6, 7, 8
1, 2, 3, 4,
5, 8
2

1, 6, 9

Interim reporting.

9, 10

6.

Related-party
transactions.

11, 12,
3, 4
13, 14, 15

7.

Subsequent events. 16, 17

8.

Auditors report.

9.

Financial statement 19, 20


analysis.

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2, 3

5, 6

2, 3, 4, 5,
7, 10

7, 8

11

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Intermediate Accounting, Tenth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE


Description

Level of
Time
Difficulty (minutes)

E23-1
E23-2
E23-3
E23-4
E23-5
E23-6
E23-7
E23-8

Illegal acts and accounting policy notes.


Segmented reporting.
Related party transaction.
Related party transaction.
Post-statement of financial position events.
Post-statement of financial position events.
Percentage analysis.
Ratio analysis.

Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate

15-20
5-10
20-25
20-25
10-15
15-20
20-30
20-30

P23-1
P23-2
P23-3
P23-4
P23-5
P23-6
P23-7

Segmented reporting.
General disclosures.
Subsequent events.
Disclosures required in various situations.
Disclosures required in various situations.
Segment reportingtheory.
Disclosures, conditional and contingent
liabilities.
General disclosures, inventories, property,
plant, and equipment.
Segment reporting.
Subsequent events.
Ratio analysis and projections.

Moderate
Moderate
Complex
Moderate
Moderate
Simple
Simple

25-30
30-40
40-50
20-25
20-25
20-25
25-30

Simple

10-20

Moderate
Moderate
Moderate

30-35
20-25
35-45

Item

P23-8
P23-9
P23-10
P23-11

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Intermediate Accounting, Tenth Canadian Edition

SOLUTIONS TO BRIEF EXERCISES


BRIEF EXERCISE 23-1
Full disclosure is essential to the proper functioning of capital
markets because the information provided in financial statements
and the accompanying notes to financial statements is used by
investors in making their investing decisions. Investors rely on this
information to compare the performance of similar companies and
to assess the relative risks and returns of different investments. Full
disclosure of all material information helps to ensure that investors
can make their investing decisions based on faithfully
representative information.
Private companies generally have fewer disclosure requirements
because many private entities have less complex business
transactions and stakeholders of private companies (such as
shareholders) tend to have greater access to information about the
entity. Overall, increased disclosure requirements for public
companies helps to ensure that economic resources are allocated
efficiently and helps to ensure the proper functioning of capital
markets.

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BRIEF EXERCISE 23-2


(a)

The increased likelihood that the company will suffer a costly


strike requires no disclosure in the financial statements. The
possibility of a strike is an inherent risk of many businesses.
It, along with the risks of war, recession, etc., is in the category
of general news and reporting on such a general contingency
is beyond the scope of financial reporting.

(b)

A note should provide a description of the discontinued


operation in order that the financial statement user has some
understanding of the nature of this item and its effect on
financial performance and position.

(c)

Gain contingencies and contingent assets are not recorded in


the accounts. However,
contingent assets which may
materially affect a companys financial position should be
disclosed where an inflow of economic benefits is probable. In
most situations, an asset would not be recognized until the
claim settlement occurs, at which time the related asset is no
longer a contingent asset, and its recognition is appropriate.

BRIEF EXERCISE 23-3


The reader should recognize that the firm has an obligation for
lease payments of approximately $5,711,000 for each of the next
three years. In certain situations, this information is very important
in determining: (1) the ability of the firm to use additional lease
financing, and (2) the nature of maturing commitments and the
amount of cash expenditure involved. Off-balance-sheet financing is
common and the investor should be cognizant that the company
has a commitment even though it is not reflected in the liability
section of the statement of financial position. The rental income
from the subleases also provides useful information concerning the
companys ability to generate revenues and to cover, in part, the
cash flow commitment, in the three year period.

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BRIEF EXERCISE 23-4


The reader should recognize that there are dilutive securities
outstanding but the overall impact on earnings per share must be
compared to recent and current EPS to be meaningful. In addition,
the purchase of shares enabled the company to increase its
earnings per share. The important point concerning this note is that,
apparently, no significant dilution of present shareholders interests
will occur if conversion occurs.
BRIEF EXERCISE 23-5
It should be emphasized that because a company discloses its
segmented results, this does not relieve the necessity for providing
consolidated results as well. Sometimes individuals become
confused because they believe that using segmented reporting
means that consolidated statements should not be presented. There
is a need to provide both types of information. The consolidated
results provide information on overall financial position and
profitability, while the segmented results provide information on the
specific details that comprise the overall results. Segmented
information is needed in part because (a) sales and earnings of
individual segments are needed to forecast consolidated profits
because of the differences among segments in growth rate, risk,
and profitability, and (b) segmented reports disclose the nature of a
companys businesses and the relative size of the components,
which aids in evaluating the companys investment worth.

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BRIEF EXERCISE 23-6


Total revenues:
$600 + $650 + $250 + $375 + $225 + $200 + $700 = $3,000
Revenue threshold:
$3,000 X 10% = $300
Therefore, Gamma, Kennedy, Red Moon, and Nuhn meet this test
and are reportable segments under IFRS.
Note that the revenue employed in this calculation includes both
sales to external customers and intersegment sales or transfers, not
consolidated revenue.
Segmented reporting is not required under ASPE.

BRIEF EXERCISE 23-7


Operating profits:
$90 + $25 + $50 + $34 + $100 = $299
Operating profits threshold:
$299 X 10% = $29.9
Therefore, Gamma, Kennedy (loss), Red Moon, Tsui, and Nuhn meet
this test and are reportable segments under IFRS.

BRIEF EXERCISE 23-8


Segment assets:
$500 + $550 + $400 + $400 + $200 + $150 + $475 = $2,675
Segment assets threshold:
$2,675 X 10% = $267.5
Therefore, Gamma, Kennedy, RGD, Red Moon, and Nuhn meet this
test and are reportable segments under IFRS.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-9


The accounting problems related to the presentation of interim data
include:
(a)Changes in accounting.
(b)The difficulty of allocating costs, such as income tax,
pensions, etc., to the proper quarter.
(c)Presentation of earnings per share (EPS) figures.
(d)Seasonality.
(e)Auditors involvement in interim reports.
BRIEF EXERCISE 23-10
Seasonality affects interim reports when wide fluctuations in profits
occur because off-season sales do not absorb the companys fixed
costs. These costs often tend to remain fairly constant regardless of
sales or production.
Revenues and expenses must be recognized and accrued when
they are earned or incurred according to IFRS. Companies can only
defer recognition of costs or revenues when it is appropriate to do
so. Deferral of costs is not appropriate unless the costs meet the
definition of an asset. (Note: ASPE does not contain any guidance
for reporting segmented information or interim reporting.)
It is difficult to completely overcome the problem of seasonality, but
disclosure as to the nature of the seasonality factors that face the
business and the pattern of revenues and expenses (including
comparative data) may help users of the financial statements to
understand whether seasonality is an adverse issue in any
particular case.
The effects of seasonality would be the same for companies
following IFRS and ASPE, except that the level of disclosure would
be enhanced in the case of those using IFRS.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-11


(a)
Land ......................................................................... 390,000
Cash..........................................................
390,000
This is a related party transaction. The transaction is considered not
to be in the normal course of operations of the company. Since the
land is acquired from the company president (assuming the
president is not a significant shareholder) there is a change in
ownership of the land. As well, the amount of the exchange is
supported by an independent appraisal. The transaction is therefore
measured at the exchange amount.
Disclosure of the transaction would include a description of the
relationship, a description of the transaction and amount,
measurement basis and any amounts due to the company
president.
However, if the president is a significant shareholder, and especially
if the president holds a controlling interest and this is a non-cash
transaction, a different conclusion may be reached as to how the
transaction should be valued as there is no beneficial change in
ownership in the assets.
(b)
The major difference between ASPE and IFRS is that IFRS does not
mandate remeasurement of a related party transaction.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-12


This is a related party transaction since the same individual owns
the two companies. Since the transaction is not in the normal
course of business, there is no commercial substance, and there is
no beneficial change in ownership in the assets, the transaction
would be recorded at the carrying amounts of the assets involved.
Fibreright Corp.
Computer Software Costs (new)............................ 15,100
Computer Software Costs (old).....................
11,000
Contributed Surplus.......................................
4,100
Frederick Corp.
Computer Software Costs (new)............................ 11,000
Retained Earnings................................................... 4,100
Computer Software Costs (old).....................
15,100
Under ASPE, certain related-party transactions must be remeasured
to the carrying amount of the underlying assets or services that
were exchanged. This is the case if the transaction is not in the
normal course of business, there is no substantive change in
ownership, and/or the exchange amount is not supported by
independent evidence. Transactions that are in the normal course of
business that have no commercial substance must also be
remeasured, and where the transaction is also a non-monetary
transaction, no gain or loss should be recognized. Note however,
that IFRS does not mandate remeasurement of related-party
transactions.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-13


This transaction is a non-monetary exchange. Since the software
packages perform different functions the transaction would be
considered to have commercial substance. The transaction would
therefore be measured at the exchange amount.
Fibreright Corp.
Computer Software Costs (new)............................ 20,800
Computer Software Costs (old).....................
11,000
Gain.................................................................
9,800
Frederick Corp.
Computer Software Costs (new)............................ 20,800
Computer Software Costs (old).....................
15,100
Gain.................................................................
5,700

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-14


If the shareholder owned only 40%, there is a presumption that
there has been a substantive change in ownership. A change in
ownership is considered substantive where an unrelated party has
gained or given up > 20% interest in the item exchanged. In the case
of a substantive change in ownership, the transaction would be
recorded in the same way as in BE23-13.
Fibreright Corp.
Computer Software Costs (new)............................ 20,800
Computer Software Costs (old).....................
11,000
Gain.................................................................
9,800
Frederick Corp.
Computer Software Costs (new)............................ 20,800
Computer Software Costs (old).....................
15,100
Gain.................................................................
5,700
BRIEF EXERCISE 23-15
Cruton and Bigelow are related parties. Transactions between
related parties are disclosed to insure that the users of the financial
statements understand the basic nature of some of the transactions.
Because it is often difficult to separate the economic substance
from the legal form in related party transactions, disclosure is used
extensively in this area. Purchase of a substantial block of the
companys common shares by Bigelow, coupled with the use of a
Bigelow affiliate to act as food broker, suggests that disclosure is
needed.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-16


(a) IFRS
(1) The flood loss ($80,000) is an event that provides information
about conditions that did not exist at the statement of financial
position date but are subsequent to that date. It does not
require adjustment of the financial statements.
(2) Under IFRS, the subsequent period ends when the financial
statements are authorized for issue. Because the liability was
settled before the financial statements are authorized for issue,
the financial statements should include adjustment of the
liability. As a result, net income will decrease by $50,000. The
settlement of the liability is the type of subsequent event that
provides additional evidence about conditions that existed at
the statement of financial position date, so the financial
statements should be adjusted accordingly.
(b) ASPE
(1) The flood loss would not require adjustment of the financial
statements, for the same reasons as stated above.
(2)

Under ASPE, the subsequent event period generally ends


when the financial statements are complete. The date is a matter
of judgement, taking into account management structure and
procedures followed in completing the statements. If it is judged
that the statements were complete on March 10, 2015, the
settlement of the liability would not require adjustment of the
financial statements. However, if it is judged that the statements
are complete on March 17, 2015 (the date the statements are
authorized for issue), net income will decrease by $50,000 as a
result of the adjustment of the liability.

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BRIEF EXERCISE 23-17


Subsequent events are of two types:
(1) Those that provide additional evidence about conditions
that existed at the statement of financial position date,
affect the estimates used in preparing financial statements,
and therefore, result in needed adjustments.
(2) Those that provide evidence about conditions that did not
exist at the statement of financial position date but arose
subsequent to that date and do not require adjustment of
the financial statements but whose effects may be
significant enough to be disclosed with appropriate figures
or estimates shown.
(a) Probably adjust the financial statements directly.
(b) Disclosure.
(c) Disclosure.
(d) Disclosure.
(e) Neither adjustment nor disclosure necessary.
(f) Neither adjustment nor disclosure necessary.
(g) Probably adjust the financial statements directly.
(h) Neither adjustment nor disclosure necessary.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-18


The auditor expresses a clean or unqualified opinion when the
clients financial statements present fairly the clients financial
position and results of operations on the basis of an examination
made in accordance with Canadian Auditing Standards (generally
accepted auditing standards), and the statements are in conformity
with generally accepted accounting principles (IFRS or ASPE) and
include all informative disclosures necessary to make the
statements not misleading. The auditor expresses a qualified
opinion when he/she must take exception to the presentation of one
or more components of the financial statements but the exception
or exceptions are not serious enough to negate his/her expression
of an opinion or to express an adverse opinion.
BRIEF EXERCISE 23-19
Percentage (common-size) vertical analysis is as follows:
Net sales
Cost of goods sold
Gross profit
Selling, general and
administrative expenses
Profit before tax

2014
2013
100% 100%
70%
70%
30%
30%
25%
5%

20%
10%

2012
100%
65%
35%
16%
19%

The companys profit before tax is declining in 2013 due to higher


cost of goods sold as a percentage of net sales (compared to 2012).
The profit before tax is also declining in 2013 and 2014 due to the
increasing selling, general, and administrative expenses as a
percentage of net sales. Although the companys gross profit
stabilized in 2014, the companys expenses relative to net sales are
increasing, resulting in declining profit before tax.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 23-20


Referring to the CICA Research Study discussed in chapter 23,
some limitations of the financial statement analysis done in BE 2319 are as follows:
1. Uncertainty about the nature and role of the financial
statements. For example, the composition of selling, general,
and administrative expenses is uncertain, and it is uncertain
whether the income statements have been audited. This may
lead users to misinterpret and/or place inappropriate reliance
on the information.
2. Uncertainty about the nature of business operations portrayed.
For example, the companys type of business activities and the
economic environment that the company operates in are
unknown.
3. Uncertainty due to limitations of financial statement
measurements and disclosures. The measurements in the
income statements are not well understood, because there are
no additional disclosures about the accounting policies and
practices followed.
4. Uncertainty about managements motives and intentions.
Managements choices in determining the accounting policies
and methods may be motivated by a need to maximize
bonuses over time, for example.
Other important limitations of financial statement analysis include
that estimated items (such as depreciation expense and bad debt
expense which may be included in selling, general, and
administrative expenses) are significant, and that achieving
comparability with other companies in the same industry may be
difficult.

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Intermediate Accounting, Tenth Canadian Edition

SOLUTIONS TO EXERCISES
EXERCISE 23-1 (15-20 minutes)
(a)

Some examples of illegal acts (the violation of laws and


regulations) may include:
paying bribes or kickbacks to secure business for the
entity
criminal activities committed by the company or its
employees on behalf of the company
violations of laws and regulations that enter into the
determination of financial statement amounts or
disclosures, such as the tax laws
violations of laws and regulations that have a fundamental
effect on the entitys industry and its operations, such as
violating pollution control and environmental laws for a
chemical company.

(b)

Generally, illegal acts, if detected by authorities, are likely to


give rise to criminal penalties often including some form of
financial liability. As a result, when an illegal act occurs and an
accountant or auditor fails to detect it, a material liability may
be omitted from the financial statements (as, arguably, all
illegal acts are material). Another possibility is that the
potential liability fails to satisfy the requirements of accrual, in
which case note disclosure of the contingency will incorrectly
be omitted from the financial statements. In addition, revenues
and expenses derived from an illegal act, if material in relation
to the financial statements, should be disclosed.

(c)

Factors that could indicate that the inherent risk of violation of


laws and regulations is greater than normal include the
following:
violations of laws and regulations by the entity in the
current or previous years
recent, well-publicized violations of laws and regulations by
other companies in the industry
laws and regulations that are new or unusually complex
lack of experience on the part of management in
interpreting or applying specific laws and regulations

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Intermediate Accounting, Tenth Canadian Edition

active monitoring by regulators or other groups

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Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-2 (5-10 minutes)


(a) Revenue test: 10% X $398,000 = $39,800.
Segments A ($140,000), B ($40,000) and D ($190,000) meet this
test.
(b) Operating profit test:
10% X ($25,000 + $8,000 + $500) = $3,350.
Segments A ($25,000), B ($8,000), and C ($5,000 absolute
amount) meet this test.
(c) Identifiable assets test:10% X $351,000 = $35,100.
Segments A ($240,000), C ($36,000) and D ($49,000) meet this
test.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-3 (20-25 minutes)


(a)
Maffin Corp.:
Buildings (net)...................................................................
700
Retained Earnings............................................................
100
Contributed Surplus.........................................................
200
Cash..........................................................................

1,000

The transaction is not in the normal course of operations for the two
companies and there is arguably no material change in the
ownership interest in the building. The transaction would therefore
be measured at its carrying amount.
The adjustment to contributed surplus / retained earnings is
considered to be a capital payment by Maffin Corp. and a capital
receipt by Grey Inc.
Grey Inc.:
Cash ...................................................................................
1,000
Contributed Surplus................................................
Buildings (net).........................................................

300
700

(b)
Cash ...................................................................................
1,100
Gain on Sale of Buildings.......................................
Buildings (net).........................................................

400
700

A gain of $400 on sale of the building is recognized as income by


Maffin Corp. It is not appropriate to reverse the original debit of $300
made to equity and recognize a gain in Grey Inc. now that Maffin
Corp. has sold the building.
(c) If Maffin could purchase the building at an amount less than the
carrying amount on Greys financial statements, consideration
should be given to whether the value of the building is impaired and
should be written down in Greys books prior to transfer at the
reduced carrying amount.

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Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-3 (Continued)


(d)
Maffin Corp.:
Buildings (net)...................................................................
1,000
Cash..........................................................................

1,000

The transaction is in the normal course of operations for the two


companies and there is commercial substance. It is therefore
appropriate for Grey to recognize a gain of $300. Maffin would
record the building at the exchange amount.
Grey Inc.:
Cash ...................................................................................
1,000
Gain on Sale of Buildings.......................................
Buildings (net).........................................................

300
700

Maffin Corp. Sale of building in 2015


Cash ...................................................................................
1,100
Gain on Sale of Buildings.......................................
Buildings (net).........................................................

100
1,000

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Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-3 (Continued)


(e) Option 1: Transaction measured at carrying amount:
2014:
Maffin Corp. No impact on the income statement
Grey Inc. No impact on the income statement
2015:
Maffin Corp. Gain
Total income for 2014 and 2015

$0
0
400
$ 400

Option 2: Transaction measured at exchange amount:


2014:
Maffin Corp. No impact on the income statement
Grey Inc. Gain of $300
2015:
Maffin Corp. Gain of $100
Total income for 2014 and 2015

$0
300
100
$ 400

Regardless of the method used, the combined income for the


consolidated reporting unit will be the same. The purchase and sale
of the building between Maffin and Grey become cancelled in the
process of eliminating intercompany balances. The transaction with
the unrelated external party provides the objective measurement
of the gain to the reporting unit.
However, Grey and, to the lesser extent, Maffin, are required to
report to certain of their users as separate reporting units. In this
case, the measurement of intercompany transactions becomes
important in accurately reflecting economic substance. We can see
that under option two, a portion of the gain ($300) is earned by Grey
and the remainder is earned by Maffin, whereas under option one,
the entire amount of the gain is earned by Maffin. The method of
reporting will have significant impact on the income of each
company.

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Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-4 (20-25 minutes)


(a) The transaction is not in the normal course of operations and
the transaction has commercial substance:
Verez Limited:
Machinery (new)................................................................
700
Retained Earnings............................................................
200
Machinery (old)........................................................

900

Consior Inc.:
Machinery (new)................................................................
900
Contributed Surplus................................................
Machinery (old)........................................................

200
700

Since the transaction is not in the normal course of operations for


the two companies and there is no change in the ownership interest
in the machinery, the transaction is measured at its carrying
amount.
(b) The transaction is not in the normal course of operations and
the transaction does not have commercial substance:
The entries are the same as for part (a). Since the transaction is not
in the normal course of operations for the two companies and there
is no change in the ownership interest in the machinery, the
transaction is measured at its carrying amount regardless of
whether the transaction has commercial substance or not.
A related party transaction that is not in the normal course of
operations requires additional support for the substance of the
transaction in order for the exchange amount to be used for
financial reporting purposes. This is considered to occur when a
change in the ownership interests in the item transferred is
substantive and the exchange is supported by independent
evidence. In this case, the exchange amount is more representative
of the economic reality of the transaction than the carrying amount
and is sufficiently reliable to be used for financial reporting
purposes.

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Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-4 (Continued)


(c) The transaction is in the normal course of operations and the
transaction has commercial substance:
Verez Limited:
Machinery (new)................................................................
1,000
Gain on Sale of Machine.........................................
Machinery (old)........................................................

100
900

Consior Inc.:
Machinery (new)................................................................
1,000
Gain on Sale of Machine.........................................
Machinery (old)........................................................

300
700

As long as the amount of the exchange is supported by independent


evidence, the transaction is recorded at the exchange amount and a
gain or loss is recorded on each companys income statement.
(d) The transaction is in the normal course of operations and the
transaction does not have commercial substance:
The entries are the same as for part (a). A non-monetary transaction
that does not have commercial substance would be measured at the
carrying amount. In such a case, the adjustment to retained
earnings is considered a capital payment by Verez and a capital
receipt by Consior.
(e) Under ASPE, certain related-party transactions must be
remeasured to the carrying amount of the underlying assets or
services that were exchanged. This is the case if the transaction is
not in the normal course of business, there is no substantive
change in ownership, and/or the exchange amount is not supported
by independent evidence. Transactions that are in the normal
course of business that have no commercial substance must also
be remeasured, and where the transaction is also a non-monetary
transaction, no gain or loss should be recognized. However, note
that IFRS does not mandate re-measurement of related-party
transactions. Therefore, the transactions would be recorded as in
part (c) for all scenarios.
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23-23

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-5 (10-15 minutes)


(a)
(1) The issuance of common shares is an example of a subsequent
event which provides evidence about conditions that did not
exist at the statement of financial position date but arose
subsequent to that date. Therefore, no adjustment to the
financial statements is recorded. However, this event should be
disclosed in the notes, a supplemental schedule, or even
through pro-forma financial data.
(2) The changed estimate of tax payable is an example of a
subsequent event that provides additional evidence about
conditions that existed at the statement of financial position
date. The income tax liability existed at December 31, 2014, but
the amount was not certain. This event affects the estimate
previously made and should result in an adjustment of the
financial statements. The correct amount ($1,200,000) would
have been recorded at December 31 if it had been available.
Therefore, Jason should increase income tax expense in the
2014 income statement by $200,000. In the statement of
financial position, income tax payable should be increased and
retained earnings decreased by $200,000.

Solutions Manual

23-24

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-5 (10-15 minutes)


(b) The income tax payable as at December 31, 2014 should be
increased to $1.2 million because the information about the
increased estimate is available before the financial statements
are considered authorized for issue (March 10, 2015). In the
time between December 31, 2014 and March 10, 2015, the
company is preparing to issue its financial statements and
annual report, including preparing the necessary adjusting
journal entries to ensure that all material transactions are
reflected in the financial statements. Accordingly, an additional
accrual of $200,000 dated December 31, 2014 should be
recorded to reflect the additional income tax expense for 2014.
Investors would rely on the financial statements in assessing
the companys performance and making their investing
decisions. Therefore, investors would support increasing the
estimate of income tax payable as at December 31, 2014 so that
they may make their decisions based on financial statements
that are relevant, faithfully representative, complete, and free
from material error.

Solutions Manual

23-25

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-6 (15-20 minutes)


1.
2.
3.

(a)
(c)
(b)

Solutions Manual

4.
5.
6.

(b)
(c)
(c)

7.
8.
9.

23-26

(c)
(b)
(a)

10.
11.
12.

(c)
(a)
(b)

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-7 (20-30 minutes)


(a) Horizontal percentage analysis is as follows:
MACKAY CORPORATION
Statement of Financial Position
December 31, 2014
Assets
Cash
Accounts receivable
Investments-FV-NI
Inventory
Plant assets (net)
Intangible assets
Liabilities and Equity
Accounts payable
Long-term debt
Share capital
Retained earnings

2014

2013

Difference

% change

$285,000
142,000
133,000
355,000
442,000
113,000
$1,470,000

$292,000
181,000
132,000
401,000
465,000
143,000
$1,614,000

$(7,000)
(39,000)
1,000
(46,000)
(23,000)
(30,000)
(144,000)

(2.4%)
(21.5%)
0.8%
(11.5%
(4.9%)
(21.0%)
(8.9%)

$267,000
64,000
326,000
813,000
$1,470,000

$337,000
152,000
326,000
799,000
$1,614,000

$(70,000)
(88,000)
-014,000
$(144,000)

(20.8%)
(57.9%)
1.8%
(8.9%)

MACKAY CORPORATION
Income Statement
Year Ended December 31, 2014

Net sales
Cost of goods sold
Gross profit
Selling, general, and
administrative expenses
Other expenses, net
Income before income tax
Income tax
Net income

Solutions Manual

2014

2013

Difference

% change

$805,000
527,000
278,000

$781,000
530,000
251,000

$24,000
(3,000)
27,000

3.1%
(0.6%)
10.8%

140,000
118,000
20,000
6,000
$14,000

111,000
110,000
30,000
9,000
$21,000

29,000
8,000
(10,000)
(3,000)
$(7,000)

26.1%
7.3%
(33.3%)
(33.3%)
(33.3%)

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Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-7 (Continued)


The companys liquidity has improved as evidenced by the 21.5%
decrease in accounts receivable despite the 3.1% increase in net
sales (which signals improved cash collections), as well as the
20.8% decrease in accounts payable. The companys solvency has
improved significantly, as evidenced by the 57.9% decrease in longterm debt. However, the companys profitability has declined as
evidenced by the 33.3% decrease in net income. The decrease in net
income appears to be due to a significant 26.1% increase in selling,
general, and administrative expenses. Net sales and gross profit
increased only by 3.1% and 10.8% respectively, resulting in a
decrease in net income.
(b) Vertical percentage analysis is as follows:

Net sales
Cost of goods sold
Gross profit
Selling, general, and
administrative expenses
Other expenses, net
Income before income tax
Income tax
Net income

2014

2013

100.0%
65.5%
34.5%

100.0%
67.9%
32.1%

17.4%
14.7%
2.5%

14.2%
14.1%
3.8%

0.7%
1.7%

1.2%
2.7%

The companys cost of goods sold as a percentage of net sales


decreased, resulting in higher gross profit as a percentage of net
sales. However, the companys operating expenses including
selling, general, and administrative expenses, and other expenses
as a percentage of net sales increased. The company experienced
increased net sales, yet the companys operating expenses relative
to net sales increased significantly, resulting in decreased net
income.

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23-28

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-7 (Continued)


(c)
Referring to the CICA Research Study discussed in chapter 23,
some limitations of the financial statement analysis done in parts (a)
and (b) are as follows:
1. Uncertainty about the nature and role of the financial
statements. For example, the composition of selling, general,
and administrative expenses and other expenses is uncertain,
and it is uncertain whether the financial statements have been
audited. This may lead users to misinterpret and/or place
inappropriate reliance on the information.
2. Uncertainty about the nature of business operations portrayed.
For example, the companys type of business activities and the
economic environment that the company operates in are
unknown.
3. Uncertainty due to limitations of financial statement
measurements and disclosures. The measurements in the
income statements are not well understood, because there are
no additional disclosures about the accounting policies and
practices followed.
4. Uncertainty about managements motives and intentions.
Managements choices in determining the accounting policies
and methods may be motivated by a need to maximize
bonuses over time, for example.
Other important limitations of financial statement analysis include
that estimated items (such as depreciation expense and bad debt
expense which may be included in selling, general, and
administrative expenses) are significant, and that achieving
comparability with other companies in the same industry may be
difficult.

Solutions Manual

23-29

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-8 (2030 minutes)


(a) The acid-test ratio is the current ratio with the subtraction of
inventory and prepaid expenses (generally insignificant relative
to inventory) from current assets. Any divergence in trend
between these two ratios would therefore be dependent upon the
inventory account. Inventory turnover has declined sharply in
the three-year period, from 4.91 to 3.72. During the same period,
sales to fixed assets have increased and total sales have
increased 5 percent. The decline in the inventory turnover is
therefore not due to a decline in sales. The apparent cause is that
investment in inventory has increased at a faster rate than
sales, and this has accounted for the divergence between the
acid-test and current ratios.
(b) Financial leverage is the use of borrowed funds (debt) to
increase the return earned by investors, such as the
shareholders of a business, and is measured by looking at the
relationship between the amount of debt and the amount of
shareholders equity. For example, if a company can borrow
$1,000 at an interest cost of 6% and put that $1,000 to work and
earn 10%, the excess 4% return goes to the shareholders
without their having to invest any additional funds of their own.
But consider the situation for the shareholders if the $1,000
borrowed and invested earns only 3%! Too much debt can be
injurious to a company. With increased debt come increased
requirements for regular interest and principal payments, and
bankruptcy risk increases.
In the Robbins situation, financial leverage has definitely
declined during the three-year period. This is shown by the
steady drop in the long-term debt-to-total-assets ratio, and the
total-debt-to-total-assets ratio. Apparently the decline of debt as
a percentage of this firms capital structure is accounted for by
a reduction in the long-term portion of the firms indebtedness.
This reduction of leverage accounts for the decrease in the
return on equity ratio. This conclusion is reinforced by the fact
that net income to sales and return on total assets have both
increased.

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23-30

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

EXERCISE 23-8 (Continued)


(c) The companys investment in plant and equipment has
decreased during the three-year period 20122014. This
conclusion is reached by using the sales to fixed assets (fixed
asset turnover) and sales as a percent of 2012 sales ratios.
Because sales have grown each year, the sales to fixed assets
could be expected to increase unless fixed assets grew at a
faster rate. The sales to fixed assets ratio increased at a faster
rate than the 3 percent annual growth in sales; therefore,
investment in plant and equipment must have declined.

Solutions Manual

23-31

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS


Problem 23-1(Time 25-30 minutes)
Purposeto provide the student with an understanding of rules for segment
reporting. The student must determine which of five segments are subject to segment
reporting rules and describe the required disclosures.

Problem 23-2(Time 30-40 minutes)


Purposeto provide the student with various disclosure issues from previous
chapters including subsequent events and changes in accounting policies and
estimates. The student must describe the appropriate disclosure for a variety of
situations.

Problem 23-3(Time 40-50 minutes)


Purposeto provide the student with statement of financial position reporting issues.
The student must prepare a corrected statement of financial position with proper
disclosure. The issues involve various errors and subsequent events. The student
must also describe any required note disclosure related to the items in the statement
of financial position. This problem provides a good overview of issues from previous
chapters.

Problem 23-4(Time 20-25 minutes)


Purposeto provide the student with an understanding of the necessary information
that should be disclosed in the financial statements and notes. The student is
required to evaluate the facts of four items concerning the companys operations and
to discuss any additional disclosures in the financial statements and notes that the
auditor should recommend with respect to these items.

Problem 23-5(Time 20-25 minutes)


Purposeto provide the student with an understanding of the conditions under which
note disclosures are necessary. The student is required to analyze three sets of
circumstances and to prepare the respective notes where deemed to be necessary
plus an explanation of the reasons for not making disclosures for those items in which
a note was not prepared.

Problem 23-6(Time 20-25 minutes)


Purposeto provide the student with an understanding of segment reporting. The
problem explores why a company did not have to prepare certain segment
information. In addition, the student is asked to determine why geographical area
information should be provided.

Solutions Manual

23-32

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 23-7(Time 25-30 minutes)
Purposeto provide the student with an understanding of the types of disclosures
that are necessitated under certain circumstances. This assignment involves three
independent situations dealing with such concepts as warranty claims, a selfinsurance contingency, and the discovery of a probable loss subsequent to the date
of the financial statements. The student is required to discuss the accrual treatment
and type of disclosure necessary and the reasons why such disclosure is appropriate
for each of the three situations.

Problem 23-8(Time 10-20 minutes)


Purposeto provide the student with an understanding of the necessary information
that must be disclosed in the financial statements with regard to certain asset
classifications. The student is required to discuss each of these respective
disclosures for Inventories and property, plant, and equipment in the audited financial
statements issued to the shareholders.

Problem 23-9(Time 30-35 minutes)


Purposeto provide the student with an understanding of segment reporting
requirements, including providing explanations as to which segments are reportable.

Problem 23-10(Time 20-25 minutes)


Purposeto provide the student with an understanding of the proper accounting for
subsequent event transactions. Bankruptcy, issue of debt, strikes, and other typical
subsequent event transactions are presented.

Problem 23-11 (Time 3545 minutes)


Purposeto provide the student with an understanding of certain key ratios. In
addition, the student is asked to identify and explain what other financial reports or
financial analysis might be employed. Also, the student is to determine whether the
company can finance the plant expansion internally and whether an extension on the
note should be made.

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23-33

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

SOLUTIONS TO PROBLEMS

PROBLEM 23-1

(a) Determination of reportable segments:


(1) Revenue test: 10% X $790,000* = $79,000.
Segments B ($80,000) and C ($580,000) both meet this test.
*$40,000 + $80,000 + $580,000 + $35,000 + $55,000
(2) Operating profit test:
10% X ($11,000 + $75,000 + $4,000 + $7,000) = $9,700.
Segments A ($11,000), B ($10,000 absolute value), and C
($75,000) all meet this test.
(3) Identifiable assets test: 10% X $710,000** = $71,000.
Only segment C ($500,000) meets this test.
**$35,000 + $60,000 + $500,000 + $65,000 + $50,000
(b) Disclosures required by IFRS 8:
A
External Revenues
$40,000
Intersegment Revenues
0
Total Revenues
40,000
Cost of Goods Sold
19,000
Operating Expenses
10,000
Total Expenses
29,000
Operating Profit (Loss)
11,000
Identifiable Assets
$35,000
Liabilities
$22,000

Solutions Manual

Other

Totals

$(60,000
20,000
(80,000
(50,000
(40,000
(90,000
(10,000 )
$(60,000
$ 31,000

$480,000
100,000
580,000
270,000
235,000
505,000
75,000
$500,000
$443,000

$90,000
0
90,000
49,000
30,000
79,000
11,000
$115,000
$ 41,000

$670,000
120,000
790,000

23-34

87,000
$710,000
$537,000

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-1 (Continued)


Reconciliation of revenues
Total segment revenues
Revenues of immaterial segments
Elimination of inter-segment revenues
Revenues from reportable segments

$790,000
(90,000)
(120,000)
$580,000

Reconciliation of profit or loss


Total segment operating profit
Profits of immaterial segments
Profits from reportable segments

$87,000
(11,000)
$76,000

Reconciliation of assets
Total segment assets
$710,000
Assets of immaterial segments ($65,000 + $50,000) (115,000)
Assets from reportable segments
$595,000
Reconciliation of liabilities
Total segment liabilities
Liab. of immaterial segments ($12,000 + $29,000)
Liabilities from reportable segments

$537,000
(41,000)
$496,000

(c) One of the major arguments against providing segment


information is that competitors will then be able to determine
the profitable segments and enter that product line themselves.
If this occurs and the other company is successful, then the
present shareholders of Franklin Corporation may suffer. This
question should illustrate to the student that the answers are
not always black and white. Disclosure of segments
undoubtedly provides some needed information, but some
disclosures desired by external parties may be confidential.

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23-35

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-2
1.

This is a change in estimate and should be applied to the


calculations for 2014 on a prospective basis. If the impact of the
change on depreciation expense is material, note disclosure
explaining the change in estimate and the effect on earnings is
required.

2.

Since income tax is self-assessed by companies, additional


assessments of prior years amounts occasionally happen. This
is considered a revision of an estimate and the additional
amount of income tax is expensed in 2014. If the additional
income tax stems from an error in the preparation of the tax
return, such as unreported revenues or over-estimation of
deductions, the assessment would be treated as an accounting
error. If the amounts are determined and adjusted prior to the
release of 2014 financial statements, no particular disclosure is
required. If not, such an accounting error is recorded as an
adjustment to opening retained earnings. Comparative financial
statement amounts are restated and note disclosure explaining
the nature of the error and the statement items adjusted would
be included.

3.

The overstatement of 2013 officers salaries is an accounting


error. Any impact on 2014 expenses would be corrected in the
current year and the opening balance of retained earnings
would be adjusted net of any related income tax effect.
Comparative financial statement amounts and earning per
share amounts are restated and note disclosure explaining the
nature of the error and the statement items adjusted would be
included.

4.

The stock dividend reduces retained earnings on the date of


declaration. It would therefore be shown on the 2014 statement
of retained earnings. Since the stock dividend is not issued
before year-end, there would also be a Stock Dividend
Distributable balance included in the Share Capital section of
Shareholders Equity.

Solutions Manual

23-36

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-2 (Continued)


4. (Continued)
Earnings per share would be adjusted as if the shares had been
outstanding throughout the year 2014 and any EPS figures
provided for earlier periods would also have to be restated for
comparative purposes. This is a requirement even if the stock
dividend was distributable in the new year. As long as it is
before the financial statements are issued, these adjustments
are required.
5.

This is a voluntary change in accounting policy as a result of


switching to a policy that provides reliable and more relevant
information. Daniel will need to record an adjustment to
opening retained earnings for the change in policy, net of any
related income tax effect and restate the comparative
statements. Note disclosure is required explaining the change
in policy and the reason for the change. The method of applying
the change (full or partial retrospective) must be disclosed as
well as the impact of the change on individual statement items.

6.

The guarantee should be (and should have been) disclosed in


the notes to the financial statements as a significant
commitment. Bonbee Inc. has defaulted on an interest payment
and Daniel has stated that it will pay the defaulted interest to
the bondholders on January 15, 2015. This is a subsequent
event that provides evidence of a condition that existed at year
end, and if Bonbee does not pay the interest by January 15,
2015, the interest should be shown as a current liability and an
expense or loss charged to income (with a receivable set up if it
is considered that an asset exists in terms of collectability from
Bonbee). If Daniel considers the possibility of having to honour
the principal amount of the bonds of Bonbee likely and
measurable, then a loss and liability should be accrued in the
2014 financial statements. If the probability of additional loss
is not determinable, Daniel may still have to disclose the risk of
additional loss. In either case, Daniel will have to examine the
underlying cause of Bonbees missed interest payment to

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Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

determine the likelihood of the guarantee being enforced


against Daniel.

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23-38

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-2 (Continued)


7.

The accounting treatment depends on Daniels legal counsels


evaluation of the likelihood of loss on appeal. If the companys
legal counsel estimates that it is not probable or
undeterminable that they will lose the appeal then no accrual is
required. This position would be doubtful however since the
company has already been found in breach of contract. The
company would have to accrue the loss and liability. Additional
note disclosure would be required to describe the liability and
whether any unaccrued additional exposure to loss exists.

Solutions Manual

23-39

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-3
(a)
SAMSON CORPORATION
Statement of Financial Position
As of December 31, 2014
Assets
Current assets
Cash ($571,000 $400,000)
$ 171,000
Accounts receivable
($480,000 + $30,000)
$ 510,000
Less allowance for
doubtful accounts
30,000 480,000
Notes receivable
162,300
Inventory (FIFO)
645,100
Prepaid expenses
47,400
Total current assets
$1,505,800
Long-term investments
Investments in land
Cash surrender value of
life insurance
Cash restricted for plant
expansion

185,000
84,000
400,000 669,000

Property, plant, and equipment


Plant and equipment
(pledged as collateral
for bonds)
($4,130,000 + $1,430,000) 5,560,000
Less accumulated
depreciation
1,430,000 4,130,000
Land
446,200 4,576,200
252,000
$7,003,000

Goodwill
Total assets
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23-40

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-3 (Continued)


Liabilities and Shareholders Equity
Current liabilities
Accounts payable
Income tax payable
Dividends payable
Salaries and wages payable
Unearned revenue
Interest payable
($750,000 X 8% X 8/12)
Total current liabilities

$ 510,000
145,000
200,000
275,000
489,500
40,000
$1,659,500

Long-term liabilities
Notes payable (due 2016)
157,400
8% bonds payable (due 2019; secured
by plant and equipment)*
705,939 863,339
2,522,839

Total liabilities
Shareholders equity
Common shares, authorized
200,000 shares; 184,000
shares issued and outstanding
Retained earnings
Total shareholders equity
Total liabilities and
shareholders equity

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23-41

1,990,000 **
2,490,161 ***
4,480,161
$7,003,000

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-3 (Continued)


** To find the effective interest rate on the note:
Using a financial calculator:
PV
$ 700,500
I
?
Yields 9.73%
N
5
PMT
$(60,000)
FV
$(750,000)
Type
0
Excel formula: =RATE(nper,pmt,pv,fv,type)
Interest expense = $700,500 X 9.73% X 8/12 = $45,439
Interest payable = $750,000 X 8% X 8/12 = $40,000
** $1,990,000 = $1,840,000 + $150,000
*** Retained earnings
$2,810,600
Salaries and wages omitted
(275,000)
Interest omitted
(40,000)
Bond discount amortization
(5,439)
$2,490,161
Additional comments:
1.

The information related to the competitor should be disclosed


because this innovation may have a significant effect on the
company. The value of the inventory is overstated because of
the need to reduce selling prices. This factor along with the net
realizable value of the inventory and the specially designed new
plant should be disclosed. Consideration should be given as to
whether or not Samson is a going concern under these
circumstances or whether any of Samsons product lines and
the associated plant assets (where the fixed costs may only be
partially recovered) have suffered impairment.

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Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-3 (Continued)


2.

The pledged assets should be described in the statement of


financial position as indicated or in a footnote.

3.

The error in calculating inventory will have been offset, so no


adjustment is needed in the statement of financial position. The
comparative income statement and statement of retained
earnings for 2013 will need to be restated to reflect the
correction of this error.

4.

Salaries and wages payable is included as a liability and


retained earnings are reduced.

5.

The fact that the gain on sale of plant assets was credited
directly to retained earnings has no effect on the statement of
financial position presentation; the income statement and
statement of retained earnings will need to be corrected.

6.

The plant and equipment account should be separately


disclosed and depreciation calculated on each item
individually; accumulated depreciation should be also split out
on the statement of financial position. However, the information
to divide the accounts was not given in this problem.

7.

Accrued interest on the bonds ($750,000 X 8% X 8/12 = $40,000)


was not recorded. This amount will also reduce retained
earnings. The related discount amortization [($700,500 X 9.73%
X 8/12) $40,000 = $5,439] will reduce retained earnings and
increase the carrying amount of the bond.

8.

The premium on common shares is combined with common


shares since shares are recorded at the fair market value of the
consideration received. A premium is recorded when shares
are par value shares; there is no indication in the problem that
this is the case.

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23-43

Chapter 23

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-3 (Continued)


9.

The company needs to include a summary of accounting


policies in its notes, detailing its accounting policies for
inventory (FIFO), depreciation method for plant and equipment
(straight-line), revenue recognition policy and any other
policies used.

(b) Management has the primary responsibility for the preparation,


integrity, and objectivity of the companys financial statements.
If management wishes to present information in a certain way, it
may do so. If the auditor objects because GAAP is violated,
some type of audit exception is called for.

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PROBLEM 23-4
Item 1
The staff auditor reviewing the loan agreement misinterpreted its
requirements. Retained earnings are restricted in the amount of
$420,000, which was the balance of retained earnings at the date of
the agreement. The nature and amount of the restriction should be
disclosed in the statement of financial position or a note to the
financial statements.

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Item 2
Unless cumulative preferred dividends are involved, no
recommendation by the auditor is required. Dividend policy is
understood by readers of financial statements to be discretionary
on the part of the Board of Directors. The company need not commit
itself to a prospective dividend policy or explain its historical policy
in the financial statements, particularly since dividend policy is to
be discussed in the presidents letter. If cumulative preferred
dividends are omitted, this should be disclosed in the notes to the
financial statements.
Item 3
A competitive development of this nature normally is considered to
be the second type of subsequent event, one that provides evidence
with respect to a condition that did not exist at the date of the
statement of financial position, but in some circumstances the
auditor might conclude that Radioheads poor competitive situation
was evident at year-end. In any event, the development should be
disclosed to users of the financial statements because the
economic recoverability of the new plant is in doubt and Radiohead
may incur substantial expenditures to modify its facilities. Because
the economic effects probably cannot be determined, the usual
disclosure will be in a note to the financial statements. (Only if
circumstances were such that it was concluded that this condition
did exist at year-end should the financial statements for the year
ended December 31, 2014, be adjusted for the ascertainable
economic effects of this development). Consideration should be
given whether the going concern assumption is appropriate in these
circumstances.

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PROBLEM 23-4 (Continued)


Item 4
The lease agreement with Armadillo National Bank meets the criteria
for a capital lease because it contains a bargain purchase option (a
25-year-life building can be purchased at the end of 10 years for $1).
Additionally, unless the fair value of the building is considerably
greater than its $2,400,000 cost, the present value of the lease
payments probably exceeds 90% of the fair value of the building.
IFRS does not use quantitative factors to establish whether or not
the risks and rewards of ownership are transferred to the lessee.
Nonetheless the calculations supports the classification as a
finance lease. The lessee, therefore, must capitalize the leased
asset and the related obligation in the statement of financial
position at the appropriate discounted amount of the future rental
payments under the lease agreement. The lessee must disclose: (1)
the gross amount of the leased asset and the accumulated
depreciation thereon, (2) the future minimum lease payments as of
the latest statement of financial position date, in the aggregate and
for each five succeeding fiscal years and the amount of imputed
interest necessary to reduce the lease payments to present value,
(3) a general description of the lease arrangement, and (4) the
existence of and the terms of the purchase option. The income
statement should contain a charge for depreciation of the leased
asset plus the interest charge.

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PROBLEM 23-5
(a) The auditor might recommend the following notes be appended
to the financial statements in regard to item 2 and item 3.
Note A.In 2014 depreciation of plant assets is calculated by the
straight-line method. In prior years depreciation was calculated
using an accelerated method. The new method of depreciation
was adopted in recognition of . . . (state justification for the
change of depreciation method) . . . and has been applied
prospectively effective January 1, 2014. The change in
accounting estimate has not affected prior year comparative
amounts.
1

Other Observations
The change in method of calculating depreciation for all
capital assets represents a change in accounting estimate
and as such is accounted for on a prospective basis.

2. Accordingly, the new method should be reflected in the


current-year financial statements, and the financial
statements included for comparative purposes should not
be restated.
Note B.The Canada Revenue Agency (CRA) is examining the
federal income tax return, filed by the Corporations domestic
subsidiary for the year 2012. The CRA has questioned the
amount of a deduction claimed for a loss sustained by the
subsidiary in 2012. The examination by the CRA has not
progressed to the point that would indicate the extent of the
subsidiarys liability. The Company believes that they will not
be subject to any substantial consolidated income tax liability
with respect to this matter.

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PROBLEM 23-5 (Continued)


(b) Item 1.Non-accounting matters such as management changes
and pending proxy fights are not disclosed unless such
information is needed for the proper interpretation of the
financial statements. The president should be informed that
notes are an integral part of the financial statements and as
such should be limited to information that relates to the
financial statements. Furthermore, there is no certainty that a
proxy fight will materialize and, hence, in view of the
uncertainty no reason for note disclosure. Disclosure of events
that have no relevance to those matters essential to proper
interpretation of the financial statements frequently creates
doubt as to the reasons for disclosure and inferences drawn
could be misleading. Information about the pending proxy fight
might be included in the presidents letter to the shareholders,
which is usually an integral part of a companys annual report.

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PROBLEM 23-6
(a) Some companies such as H. J. Heinz have only one dominant
product or service and therefore it is impossible to provide
segmented data in a meaningful fashion. Dominant means that
a given segment has 90% of all the sales, profit and identifiable
assets of the company. In this case, segmented data are not
provided, but the industry in which the dominant segment
operates must be identified.
(b) Reporting sales by geographical area is extremely important.
Countries have widely differing political and economic risk
profiles, which may affect earnings prospects. Less stable
geographic areas should be evaluated carefully, whereas more
stable areas may require less analysis and attention.
Note to Instructor: The IASB requires that financial statements
include selected information on a single basis of segmentation. The
method chosen is sometimes referred to as the management
approach. The management approach is based on the way that
management segments the company for making operating
decisions, which is made evident by the companys organization
structure. As this approach focuses on information about the
components of the business that management looks at in making its
decisions about operating matters, the components are referred to
as operating segments rather than geographic or industry
segments.

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PROBLEM 23-7
(a)
Situation 1
When a company sells a product subject to a warranty, it is probable
that there will be expenses incurred in future accounting periods
relating to revenues recognized in the current period. As such, a
liability has been incurred to honour the warranty at the same date
as the recognition of the revenue. Based on prior experience or
technical analysis, the occurrence of warranty claims can be
reasonably estimated and a probable dollar estimate of the liability
can be made, and the estimated amount of the expense and related
liability should be reflected in the financial statements.
Situation 2
Even though: (1) there is a probable loss on the contract, (2) the
amount of the loss can be reasonably estimated and (3) the
likelihood of the loss was discovered prior to the date of
authorization of the financial statements, the fact that the contract
was entered into subsequent to the date of the financial statements
precludes accrual of the loss contingency in financial statements
for periods prior to the incurrence of the loss. However, the fact that
a material loss has been incurred subsequent to the date of the
financial statements but prior to their authorization should be
disclosed by means of a note in the financial statements. The
disclosure should contain the nature of the contingency and an
estimate of the amount of the probable loss or a range into which
the loss will probably fall.

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PROBLEM 23-7 (Continued)


Situation 3
The fact that a company chooses to self-insure the contingency of
injury to others caused by its vehicles is not enough of a basis to
accrue a loss contingency that has not occurred at the date of the
financial statements. An accrual or reserve cannot be made for
the amount of insurance premium that would have been paid had a
policy been obtained to insure the company against this particular
risk. A loss contingency may only be accrued if prior to the date of
the financial statements a specific event has occurred that will
impair an asset or create a liability and an amount related to that
specific occurrence can be reasonably estimated. The fact that the
company is self-insuring this risk should be disclosed by means of
a note to alert the financial statement reader to the exposure
created by the lack of insurance.
(b)
If the contract is a non-cancellable purchase contract that will
probably result in a significant loss to the company, the unavoidable
costs of completing the contract are higher than the benefits
expected from receiving the contracted goods or services. This is
known as an onerous contract. ASPE does not require a loss and a
liability to be recognized if the company has entered into an
onerous contract, although Canadian practice has been to
recognize the loss and the liability. Before a contract takes effect, no
asset or liability is recognized because it is an executory contract
(meaning that neither party has fulfilled its part of the contract).
However, if the contract is non-cancellable and a probable loss
related to the contract would be unavoidable, the loss and the
liability should be recognized. A user of the financial statements
would support recognizing the loss and the liability in the period
that a probable loss becomes evident, so that they may make their
decisions based on financial statements that are relevant, faithfully
representative, and complete.

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PROBLEM 23-8
(a)
Leopard Corporation, must disclose the following information
regarding inventory under IFRS:
1.
2.
3.

4.
5.
6.

The dollar amount assigned to inventory.


The method of inventory costing; e.g., FIFO, weighted
average or specific identification.
The basis of valuation: i.e., cost or lower of cost or net
realizable value; if an amount other than cost is presented,
then cost should still be presented by stating the amount of
cost or by stating the amount of the valuation allowance.
The composition of the inventory, identifying the value of raw
materials,
work-in-process,
finished
goods
and
manufacturing supplies.
Inventory pledged as collateral for loans.
The amount of inventory recognised as expense during the
accounting period.

The following information must be disclosed for property, plant, and


equipment:
1. The measurement bases used for determining the gross
carrying amount.
2. The balance of major classes of depreciable assets (assets
classified by nature or function) and their cost.
3. Accumulated depreciation, either by major classes of
depreciable assets or in total including any write-downs.
4. A general description of the methods used in computing
depreciation on major classes of depreciable assets and the
depreciation rate or period of useful life.
5. A reconciliation of the carrying amount at the beginning and
end of the accounting period, including the amount of the
depreciation recorded.
6. Any impairment losses, and reversals reversed.
7. Liens, restrictions, pledges and commitments.
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PROBLEM 23-8 (Continued)


(a) (Continued)
The information regarding inventory and property, plant, and
equipment will be disclosed in the body of the financial statements
and in the notes, which are an integral part of the statements.
(b)
The full disclosure principle calls for reporting of any financial facts
that are significant enough to influence the judgement of an
informed user of the financial statements. While providing
information that is not detailed enough is problematic, providing too
much information, including information that would not make a
difference in a users decision, is equally problematic. A user of the
financial statements would want the company to provide relevant
information that is detailed enough to disclose matters that would
make a difference in their decisions, and condensed enough to
make the information understandable. The name of the supplier that
each asset was purchased from and the current location of each
asset would not normally make a difference in a users decision.
Providing this information may result in information overload,
where the user may be unable to digest or process the relevant
information effectively.

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PROBLEM 23-9
To:

Timothy Chow, Accountant

From:

Student

Date:

Current date

Subject: Determination of reportable segments for Vu


Corporation
International
The following comments assume that the information provided to
me represents the companys operating segments defined
according to IFRS 8.5. Please note that Corporate cannot be
defined as an operating or reportable segment because it does not
generate revenues, but only serves to incur common costs that are
not allocated out to each segment. I also assume that you have
applied the qualitative tests to these segments and determined that
none of them has the same basic economic characteristics that
would suggest combining some of them into reportable segments.
The next step, then, is to apply the quantitative threshold
requirements.
I have analyzed the information and determined that the funeral, the
cemetery, and the limousine segments should
be reported
separately. The remaining twothe floral, and catering segments
can be combined under the category of other with the corporate
data indicated as unallocated.
To make this determination, I applied three criteria put forth by the
IFRS 8 to the information provided from 2014. Meeting any one of
the three criteria makes the segment reportable. First, a segment
must be reported separately if its revenue is greater than or equal to
10 percent of the enterprises combined revenue. This is the case
with both the funeral and the cemetery segments, as revenue for
both is greater than $41,600 (10 percent of combined revenue).

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PROBLEM 23-9 (Continued)


Second, a segment is considered significant enough to be reported
separately if its absolute operating profit or operating loss is greater
than or equal to: (a) the combined operating profit of all segments
without an operating loss or (b) the combined operating loss of all
segments that incurred a loss. Combined operating profit for all
profitable segments totals $ 65,000 + $36,000 = $101,000. The
funeral, cemetery, and limousine segments all meet this
requirement. Thus, all three must be separately reported.
Third, a segment must be reported separately if its identifiable
assets are greater than or equal to 10 percent of the combined
identifiable assets for all operating segments. Again, the funeral and
the cemetery segments meet this test. Note that the floral and
catering segments meet none of the above criteria, so they are not
reported separately, yet are combined to enable a reconciliation of
segment data to consolidated amounts. The unallocated Corporate
data will also be needed to complete the reconciliation.
When reporting segment information, you must include the profit as
well as the total assets and liabilities for each. Additional
information by segment is required only if the amounts are regularly
reviewed by the chief decision-maker/management in their review
and assessment of the segments. These include revenues from
external customers, inter-segment revenues, interest revenue and
expense, depreciation, amortization, unusual items, equity method
investment income, income tax expense or benefit revenues,
operating profit (loss), identifiable assets, liabilities, depreciation
and amortization expense and other significant non-cash items, and
amount of capital expenditures.
Reconciliations of segment revenues, operating profits and losses
and assets and liabilities to the totals reported on the consolidated
financial statements must be provided.

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PROBLEM 23-9 (Continued)


Please also note that other entity-wide disclosures are also
required, even if a company determines that it operates in only one
segment: how the segments were determined, the amount of
revenue from external customers (not applicable in your case),
Canadian and foreign revenues, capital assets and goodwill. I do not
expect that you have any major customers that account for more
than 10% of your total revenue, as that would also be a required
disclosure.
I hope that this information helps you in determining future
reportable segments. If you have any other questions, please
contact me.

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PROBLEM 23-10
1.

The financial statements should be adjusted for the expected


loss pertaining to the remaining receivable of $260,000. Such
adjustment should reduce accounts receivable to its realizable
value as of December 31, 2014.

2.

Report the fire loss in a note to the statement of financial


position and refer to it in connection with the income statement,
since earnings power is presumably affected.

3.

Strikes are considered general knowledge and therefore


disclosure is not required. Many auditors, however, would
encourage disclosure in all cases.

4.

This case is a difficult problem. If this event is of the second


type that provides evidence with respect to conditions that did
not exist at December 31, 2014, then appropriate disclosures
should indicate that:
(a) Recovery of costs invested in plant and inventory is in
doubt.
(b) The company may incur additional costs to modify the
existing facility.
(c) Due to this situation, future economic events cannot be
determined.
If it is the first type of subsequent event and the condition
existed at December 31, 2014, then the financial statements
must be adjusted. The provisions of accounting for
contingencies would govern if amounts could not be estimated.
It should be emphasized in class that no right answer exists for
this problem. Judgement must play a major role in determining
the adjustment or disclosure necessary for this transaction.
Consideration should be given whether the going concern
assumption is appropriate under the circumstances.

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PROBLEM 23-10 (Continued)


5.

Adjust the inventory figure as of December 31, 2014 as required


by a market price of $2.00 instead of $1.40, applying the lower
of cost and net realizable value principle. The actual quotation
was a transitory error and no purchases had been made at this
quotation.

6.

Report the action of the new share issue in a note to the


financial statements, as this has relevance to the users,
particularly existing shareholders.

7.

This is a subsequent event that provides evidence about


conditions that did not exist at the statement of financial
position date. The decline in value, if material in effect on
Bouviers statements, would be disclosed in the notes to the
financial statements. The loss would not be recorded in the
December 31, 2014 financial statements.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-11
(a)
1.

BRADBURN CORPORATION
Financial Statistics
Current ratio =

Current assets
Current liabilities

2013: $320,000 = 2.02 to 1


$158,500

2014: $403,000 = 2.46 to 1


$164,000

Current assets:
2013: $12,500 + $132,000 + $125,500 + $50,000 = $320,000
2014: $18,200 + $148,000 + $131,800 + $105,000 = 403,000
Current liabilities:
2013: $6,000 + $61,500 + $90,000 = $158,500
2014: $9,000 + $76,000 + $79,000 = $164,000
2.

Quick ratio =
2013:

3.

Current assets Inventories


Current liabilities

$270,000 = 1.70 to 1
$158,500

Inventory turnover =

2014:

$298,000 = 1.82 to 1
$164,000

Cost of goods sold


Average inventory

$1,530,000
2014: $50,000 + $105,000 = 19.7 times (every 18.5 days)
2

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PROBLEM 23-11 (Continued)


4.

Return on assets =

Net income
Average total assets

2013:

$346,500
$1,688,500 + $1,740,500 = 20.2%
2

2014:

$427,000
$1,740,500 + $1,852,000 = 23.8%
2

5. Percent Changes

Sales
Cost of goods sold
Gross margin
Net income

Amounts
Percent Increase
(000s omitted)
2014
2013
$300
$3,000
$2,700
= 11.11%
$2,700
$105
1,530
1,425
= 7.37%
$1,425
$195
1,470
1,275
= 15.29%
$1,275
$80.5
427
346
= 23.23%
$346.5

(b) Other financial reports and financial analyses which might be


helpful to the commercial loan officer of Hibernia Bank include:
1. The Statement of Cash Flows would highlight the amount of
cash provided by operating activities, the other sources of
cash, and the uses of cash for the acquisition of noncurrent assets and long-term debt requirement.
2. Projected financial statements for 2015 including a projected
Statement of Cash Flows. In addition, a review of Bradburns
comprehensive budgets might be useful. These items would
present managements estimates of operations for the
coming year.
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PROBLEM 23-11 (Continued)


(b) (Continued)
3. A closer examination of Bradburns liquidity by calculating
some additional ratios, such as days sales in receivables,
accounts receivable turnover, and days sales in inventory.
4. An examination as to the extent that leverage is being used
by Bradburn.
5. Details concerning the due dates of the notes receivable on
account of their large size in both fiscal years.
(c) If the percentage changes experienced in fiscal year for sales
and cost of goods sold and operating expenses continue for
each of the next 2 years, assuming depreciation expense
remains constant to that of 2014, Bradburn Corporation should
be able to finance the plant expansion from internally generated
funds as shown in the calculations presented below.
2014
Sales
Cost of goods sold
Gross margin
Operating expenses
Income before tax
Income tax (30%)
Net income

$3,000.0
1,530.0
1,470.0
860.0
610.0
183.0
$ 427.0

Add: Depreciation
Deduct: Dividends
Note repayment
Funds available for plant
expansion
Plant expansion
Excess funds

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(000 omitted)
2015

2016

$3,333.3
1,642.7
1,690.6
948.2
742.4
222.7
$ 519.7

$3,703.7
1,763.7
1,940.0
1,045.5
894.5
268.4
$ 626.1

102.5
(260.0)
(6.0)
356.2

102.5
(260.0)

(150.0)
$ 206.2

(150.0)
$ 318.6

468.6

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 23-11 (Continued)


Assumptions: for 2015

For 2016

Sales increase at a rate of 11.11%.


Cost of goods sold increases at rate
of 7.37%, despite depreciation
remaining constant.
Other operating expenses increase
at the same rate experienced
from 2013 to 2014; i.e., at 10.26%
($80,000 $780,000).

There are no other significant


non-cash expenses.
Dividends remain at $2.00 per
share.
Plant expansion is financed
equally over the two years
($150,000 each year).
Loan extension is granted.

(c) Hibernia Bank should probably grant the extension of the


loan, if it is really required, because the projected cash flows
for 2015 and 2016 indicate that an adequate amount of cash
will be generated from operations to finance the plant
expansion and repay the loan. In actuality, there is some
question whether Bradburn needs the extension because the
excess funds generated from 2015 operations might cover the
$70,000 loan repayment. However, Bradburn may want the
loan extension to provide a cushion because its cash balance
is low. The financial ratios indicate that Bradburn has a solid
financial structure. If the bank wanted some extra protection,
it could require Bradburn to restrict cash dividends for the
next two years to the 2014 amount of $2.00 per share.

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CASES
Note: See the Case Primer on the Student website, as well as the
Summary of the Case Primer in the front of the text. Note that the
first few chapters in volume 1 lay the foundation for financial
reporting decision making.
CA 23-1 HOLTZMAN ENTERPRISES
Overview
-

Company has authorized the issue of bonds which will affect financial
statement ratios once the bonds are issued.
Treasurer concerned about the ratios which might negatively affect the share
price.
Users of financial statements will want transparency.
Since the shares trade on the local exchange, IFRS is a constraint.

Analysis and recommendations


-

The issue is whether to delay the issuance of the bonds until the following
year.
Should a company delay transactions just because they do not like the impact
on the financial statements?
Technically no. If the company has done an analysis from an economic or
strategic perspective and has decided that they need the money now, the
financial reporting should not be a factor.
Accounting should be neutral.
On the other hand, if they do not really need the money, then there is no real
loss to the company to defer the issue.
In summary, must look at the cost to the company of deferral of the issue
(economic costs and other costs).
If there are real costs, then must not delay.
Must weigh the costs of deferral with the costs of showing more debt on the
balance sheet.

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IC 23-1 PENRON
Overview
-

PL is in the business of selling oil and gas and derivatives. Even though they are
expanding, they appear to be spinning off non-essential assets. Due to the growth,
there may be pressure to manipulate the financial statements to continue this trend.
In addition, the company has signaled to the marketplace that they will meet their
growth targets, adding further pressure.
The bank would be a key user since the company has guaranteed the LPL debt and
LPL otherwise does not seem to have any cash flows.
The analysts will also be key users and will be looking for information to support
whether they should tell their clients to buy or sell. They will be looking for signals
such as declines in revenues or profits.
The pension plan would also be a key stakeholder since it is investing significant
amounts of money onto the company stock. The plan would be looking at the stability
and solvency of the company.
There is additional potential bias for management to overstate earnings since they
have stock options. It appears as though many of the executive may leave next year
and so they may be interested in producing short- term profits (versus longer term).
Finally, the Class A shares are mandatorily redeemable if management resigns and so
they stand to gain if the share price is higher or the company looks good in the
financial statements.
The auditor must be very conservative since there appears to be multiple
opportunities for biased information.
IFRS is a constraint since this is a public company.

Analysis and Recommendations


Issue how to account for the pipeline sales.
This is related party since LPL is owned by the President of the company. Additional
disclosures are required. IFRS does not require remeasurement of related party
transactions however, this information is relevant to the users especially given the
magnitude of the transactions and significance to the bottom line.
Issue how to account for the Class A share issue

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IC 23-1 (CONTINUED)
Liability
- The shares are liabilities in substance
since they have a mandatory
redemption feature. In this case, the
shares must be redeemed if the
executives/shareholders resign. At this
point, the company will have to pay
the shares out and this creates a
liability or obligation to pay cash.
- The probability of the triggering event
must be assessed. At year end, it
appears likely that many of the
executives will leave since their
benefits vest and there is a concern
that they will resign.
- Thus the obligation to pay cash is
likely.
- Other.

Equity or part debt/part equity


- The shares are equity-like since they
represent residual ownership interests
in terms of asset and dividend
distribution.
- They have no preferential rights and do
not obligate the company to pay cash.
- The legal form is equity and more
importantly, the shares are equity in
substance since absent the triggering
event, they are residual in nature.
- Other.

Recommendation: More conservative to treat at least part of the instrument as liability since
the entity stands ready to pay of the triggering event occurs.
Issue how to account for the website costs?
Capitalize costs
- Once in development stage, costs
should be capitalized if related to
hardware and software as they have
future benefit.
- Development of graphics would be
seen as an integral part of the
software and thus capitalized.
- Costs incurred to develop content
should be capitalized since they will
have future benefit lasting beyond
the next year.
- Other.

Expense costs
- All costs in the planning stages should
be expensed due to the uncertainty
attached to possible future revenues.
In this case, the company had not even
decided whether to go ahead with this
new business model.
- The benefit of any content is uncertain
and should therefore be expensed.
- Content will likely change every year
and thus is an ongoing cost of doing
business.
- Other.

Recommendation: More conservative to expense due to the uncertainty of future


revenues.
Other: Disclosure of guarantee and/or going concern.
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IC 23-2 FRANGIPANI LTD. (FL)


Overview
-

New company privately owned tight cash situation


Users include government who has sponsored a bank loan and will be
interested in long term viability and cash flows must report annually and
maintain debt to equity of 1:1 therefore key ratio
Family members own preferred shares and will be interested in return on
investment and management stewardship note that shares are redeemable if
no profit therefore pressure to show a profit
Scientists are taking share appreciation rights in lieu of salary will be
interested in performance of company and net value
As accountant will want to be transparent but put best foot forward and show
company in a favourable light
No legal GAAP constraint but users may find most useful. The company has
decided to use ASPE (although company has the option to follow IFRS as an
accounting policy choice)

Analysis and recommendations


SARs settleable in cash or a variable number of shares at the option of the
company
Debt
- Whether settle in cash or variable
number of shares still an
obligation to give the same amount
of value.
- Under ASPE may argue debt
since it will be settled with cash or
a variable number of shares (see
accounting for financial
instruments).

Part debt/part equity or all equity


- No obligation to deliver cash since
may settle in shares. Under ASPE
may argue all equity since
settlement method at the option of
the company.

Recommendation: There is significant judgement here and therefore, whichever


presentation is chosen (debt, equity or part debt/part equity), the company should
provide ample note disclosures.
Government loan forgivable (will take back preferred shares)

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IC 23-2 (CONTINUED)
Grant/equity
- Normally, would treat as grant and
recognize as offset to costs
incurred. However, this is not
completely forgivable as the
government would take back
preferred shares in the company.
Therefore the transaction would be
credited to equity.
- The company needs to meet
certain conditions for it to be
forgivable including completing the
project within three years. They are
very close to patenting the process

Loan
- The loan is with the bank even
though the government is
sponsoring it. Therefore it is a
liability to the bank.
- Certain conditions must be met for
the loan to be forgivable and those
have not yet been met. There are
complications as someone else
may patent the process first
(technology stolen?).
- In addition, the company must
maintain a debt to equity ratio of 1:1
otherwise the debt is repayable.

Recommendation: Probably more reasonable to represent as debt due to the


significant uncertainty surrounding the patenting of the new technology.
Preferred shares
Debt
- Redeemable at the option of the
holder if no profit. Under ASPE
would assess probability of this
happening. The issues discussed
here will have a significant impact
on the amount of profit recognized
so care must be taken to ensure
unbiased reporting.

Equity
- No obligation to pay cash since
may redeem for common shares.
- The shares are only redeemable at
the option of the holder if a profit is
made. This may not be the case
this year.

Recommendation: Under ASPE would assess likelihood of profits. If not likely, then
recognize as equity.
Advertising revenues (significant amount received just before year end)

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IC 23-2 (CONTINUED)
Recognize revenues upfront
Recognize over time
- Advertising is for the month and
- Advertising services are provided
non-refundable therefore earned by
over time therefore recognize over
the end of the month at latest
time
- Commonly display advertising for
the entire year
- Ensure that the entity does not
succumb to pressure to recognize
these early due to the preferred
shares becoming payable in cash if
the company does not make a
profit.
Recommendation: Recognize over time as earned over time.
Going concern issue
- Ensure full disclosure since idea stolen and may not be able to bring to market.
- If this is the case, the government loan is not forgiven and preferred shares
may be redeemable (if no profit).
R&D
Capitalize
Expense/write-off/down
- Technology is feasible since appear
- Have not quite reached the stage
close to submitting for
where technical feasibility is
patent/similarly costs known or close
established
to being known
- Technology has been stolen before
- Intent is there to produce since that is
patent and therefore may have no
the main goal of the company
future value
- No info but appears to be a market
- Under ASPE may choose to
for solar powered vehicles in general
expense development costs even if
- Resources available through
criteria are met
- This will reduce costs and be less
government loan and investors
- Presenting as an asset shows that
complex
the company is investing in its future
- Lawyer confident that he can prove
theft of ideas so value not
compromised
- Other

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Recommendation: It is likely okay to recognize as asset as long as conditions met for


capitalization. The company is confident that they can prove theft of the ideas. They
should check with lawyers for their views.

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SOLUTIONS TO WRITING ASSIGNMENTS


WA 23-1
(a) Financial reporting for segments of a business enterprise involves
reporting financial information on a less-than-total enterprise basis.
These segments may be defined along organizational lines, such as
divisions, branches, or subsidiaries. Segmentation could be based
on areas of economic activity, such as industries in which the
enterprise operates, product lines, types of services rendered,
markets, types of customers, or geographical areas. In addition to
these possible individual definitions of an enterprises segments, a
company may use more than one of the above-cited bases of
segmentation.
(b) The reasons for requiring financial data to be reported by segments
include the following:
1. They would provide more detailed disclosure of information
needed by investors, creditors, and other users of financial
statements.
2. Appraisers can evaluate major segments of a business
enterprise before considering the business in its entirety.
3. In addition to being useful and desirable, such information is
practical to compute.
4. The growth potential of an enterprise can be evaluated by
reviewing the growth potential of its major segments.
5. Users can better assess managements decisions to drop or
add a segment.
6. Projection of future earnings power is made more effective
when approached on a segment basis because different
segments may have differing rates of growth, profitability, and
degrees of risk.
7. Managerial ability is better assessed with segment data
because managerial responsibility within the enterprise is
frequently decentralized.

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WA 23-1 (CONTINUED)
(c) The possible disadvantages of requiring financial data to be reported
by segments include the following:
1. They could be misinterpreted due to the publics general lack of
appreciation of the limitations of the somewhat arbitrary bases
for most allocations of common costs.
2. They may disguise the interdependence of all the segments.
3. They might result in misleading comparisons of segments of
different enterprises.
4. Confidential information would be revealed to competitors about
profitable or unprofitable products, plans for new products or
entries into new markets, apparent weaknesses that might
induce competitors to increase their own efforts to take
advantage of the weakness, and the existence of advantages
not otherwise indicated.
5. Information thus made available might cause customers to
challenge prices, to the disadvantage of the company.
6. Operating data reported by segments might be misleading to
those who read them. Segment data prepared for internal
management purposes often include arbitrary judgments that
are known to those using the data and taken into account in
making evaluations. The difficulty of making such background
information available and understandable to outside users is
considered by many to be insurmountable.
7. Uniform reporting categories would be established that might
call for additional expense in recording and reporting, and that,
because arbitrarily defined, might not fairly represent the
operations of the enterprise as a going concern. Some fear that
establishment of arbitrary reporting requirements might in turn
lead to arbitrary rules for business activities in order to make the
required reporting possible.

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WA 23-1 (CONTINUED)
(d) The accounting difficulties inherent in segment reporting include the
following:
1. The basis of segmentation must be established. [The various
possible bases were cited in answer (a), above.]
2. The transfer prices must be determined. Transfer prices are
those charged when one segment deals with another segment
of the same enterprise. Various possible transfer prices exist,
and the company must select one.
3. The method of reporting segment sales must be defined. A
company may or may not include inter-company transactions
with other segments within the enterprise in its sales.
4. The computation of segment net income must be defined. The
net income may be merely a contribution margin; that is, sales
less variable costs or a more conventional measure of net
income. If a contribution-margin approach is used, the variable
costs must be identified. If a more conventional measure of net
income is used, the treatment of various items for each
segments net income must be established. Such items include
the following:
a. Determining whether common costs should be allocated to
segments.
b. Selecting allocation bases if common costs are to be
allocated.
c. Determining which costs of capital (interest, preferred
dividends, etc.) should be attributed to segments.
d. Determining whether extraordinary items should be
attributed to segments.
e. Determining how income tax should be allocated to
segments.
f. Determining how a minority interests share of income, and
income from investee companies, should be attributed to
segments.
5. The segment information to be reported, relating to a balance
sheet and statement of cash flows, must be established. This
includes allocation of assets to various segments.
6. The treatment of segment information in interim financial reports
must be established.
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WA 23-1 (CONTINUED)
7.
8.
9.

The method of presenting segment information in financial


statements must be established. Such presentation may be by
notes or by separate financial statements.
The additional disclosures required, such as accounting policies
used, must be established.
The effect of annual comparisons must be considered. This
would entail retroactive restatement of previously reported
segment information presented currently for comparative
purposes.

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WA 23-2
(a) 1.

IFRS favours the discrete view for interim reporting. This


means that Kersee should report its operating results for the
quarter as if the quarter were an entirely separate reporting
period.

2.

The companys revenue and expenses would be reported as


follows on its quarterly report prepared for the first quarter of the
2014 fiscal year:
Sales
Cost of goods sold ($36,000,000 + $245,000)
Variable selling expenses
Fixed selling expenses
Advertising
Other ($1,500,000 $500,000)

$60,000,000
36,245,000
2,000,000
2,000,000
1,000,000

Sales and cost of goods sold receive the same treatment as if


this were an annual report. Under IFRS the inventory variance
cannot be deferred even though the company believes it will
reverse before the third quarter. Consequently, the inventory
must be reduced and cost of goods sold increased by the
amount of the price variance of $245,000. Costs and expenses
other than product costs should be charged to expense in
interim periods as incurred or allocated among interim periods.
Consequently, the variable selling expense and the portion of
fixed selling expenses not related to the television advertising
should be reported in full. With respect to the advertising costs,
if the costs cannot be recognized as an asset and deferred at
the year end, then this treatment is not be allowed for the
interim period. Consequently, the full advertising expense must
be expensed.

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WA 23-2 (CONTINUED)
(b) The financial information to be disclosed to its shareholders in its
quarterly reports, as a minimum, includes:
1. a condensed balance sheet showing comparative information
for the immediately preceding fiscal year (December 31, 2013);
2. a statement of comprehensive income showing the current
interim period and year-to-date and comparable information for
the preceding year ;
3. a statement of changes in equity showing cumulative totals to
date and comparable information for the previous year;
4. a statement of cash flows showing cumulative year to date
information and comparable information for the preceding year.
5.
basic and fully diluted earnings per share;
6. nature and amount of any unusual items;
7. nature and amount of any changes in estimates;
8. disclosure that the statements comply with IFRS;
9. a statement that the company follows the same accounting
policies as at the previous fiscal year end
10. a description of any changes in accounting principles;
11. any subsequent events to the interim period;
12. issuances, repurchases or repayments of debt or equity;
13. dividends paid;
14. information about the reportable segments;
15. information about any changes in composition of the entity;
16. information about any contingencies;
17. a description of any seasonality or cyclicality of interim period
operations and
18. other material matters not previously reported.

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WA 23-3
(a) Acceptable. The use of estimated gross profit rates to determine the
cost of goods sold is acceptable for interim reporting purposes as
long as the method and rates utilized are reasonable. The company
should disclose the method employed and any significant
adjustments that result from reconciliations with annual physical
inventory.
(b) Not acceptable. Even though pension costs are identifiable with a
time period rather than with the sale of a product or service, the
pension expense for the interim period is to be calculated using
actuarial estimates of costs. In addition, any one-time adjustments
for significant market fluctuations, curtailments, settlements and any
other events must be included in the interim period. Consequently,
the full gain or loss on settlement should be recognized in the
quarter in which the settlement occurred (IAS 19.110).
(c) Acceptable. Any loss in inventory value should be reported when the
decline occurs. Any recoveries of the losses on the same inventory
in later periods should be recognized as gains (recovery of loss) in
the later interim periods of the same fiscal year. However, the gains
should not exceed the previously recorded losses.
(d) Not acceptable. Gains on the sale of investments would not be
deferred if they occurred at year-end. Consequently, they should not
be deferred to future interim periods but should be reported in the
quarter the gain was realized.
(e) Acceptable. The annual audit fee is an expense that benefits the
companys entire year. Companies are encouraged to make
quarterly estimates of these items that usually result in year-end
adjustments. Therefore, this expense can be prorated over the four
quarters.

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WA 23-3 (Continued)
(f)

Not acceptable. Revenue from products sold should be recognized


as earned during the interim period on the same basis as followed
for the full year. Because the company normally recognizes a sale
when shipment occurs, it should recognize the revenue in the
second quarter and not defer the revenue recognition. To do
otherwise would be an inconsistent application of company
accounting policy and violate general accounting rules for revenue
recognition.

(g) Not acceptable. Goodwill impairment losses cannot be reversed in


the interim period, which is consistent with yearend treatment.
(h) Not acceptable. A bonus that is anticipated can only be accrued in
the interim period if the bonus is a legal obligation or a constructive
obligation, the company is required to pay it, and a reasonable
estimate can be made. In this case, the company will only be legally
required to pay the bonus only if the share price at December 31,
2014 is still above the target price. Since this is not known at the
end of June 30, 2014, the bonus should not be accrued.

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WA 23-4
There are some major differences between IFRS and ASPE with respect
to the items discussed in the chapter. The differences arise due to the
fact that ASPE is used by private companies with less complex business
structures and fewer users. In addition, the standards for ASPE have
been designed to keep costs in line with benefits by reducing disclosure
and allowing more choices in standards. The following highlights the
differences between IFRS and ASPE:
Disclosure is greatly reduced for private enterprises as their
business structures are less complex and the main users usually
have access to management and rely less on the notes for
information.
Due to the large range of sizes and complexity of private
enterprises, ASPE has a greater number of accounting policy
choices for reporting and measuring items such as income taxes,
controlled or significantly influenced investments, defined benefit
pension plans, to name a few. Additionally, when a choice is made,
it does not need to be shown to be reliable and more relevant. In
contrast, IFRS is trying to reduce the number of choices so that
comparisons across peer groups are easier, and any change in an
accounting policy must be shown to be reliable and more relevant
than the previous one.
IFRS requires segment reporting and provides detailed guidance
on the definition of a reportable segment and the information that
must be disclosed. ASPE does not require segment reporting due
to private enterprises being less complex, and to reduce the note
disclosure required.
ASPE does not require interim reports. Due to the fact that shares
of a private enterprise are not easily liquidated, shareholders and
creditors are long term investors in private enterprises.
Consequently, interim reporting would not be relevant for their
needs. In addition, these stakeholders have access to
management to request information as required. For publicly
traded enterprises that have shareholders who might be invested
for very short periods of time, interim reports are vital for their
needs. Although IFRS does not mandate who will issue interim
reports and how often, guidance is provided on measurement and
reporting interim financial information.
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WA 23-4 (Continued)
ASPE has detailed standards on how to measure, report and
disclose related party transactions. This results from past Canadian
practices and also the fact that related party transactions may be
more prevalent in private enterprises.
IFRS only provides
guidance on disclosure requirements for related party transactions.
IFRS also requires disclosure on key management compensation,
whereas ASPE does not. (It is interesting to note that the first draft
of ASPE did include similar compensation disclosure, but the
feedback was so negative that the requirement was eliminated on
the final version.)
For ASPE, subsequent events arise between the report date and
the completion date, which has been past practice in Canada.
IFRS defines subsequent events to be events arising between the
report date and the date of authorization.
ASPE has standards for unincorporated business requiring the
statements to define the entity and disclose salaries and other
items accrued to the owners. ASPE has this standard since there
may be private enterprises that are not incorporated. As all
publicly traded entities are incorporated, there are no similar
standards under IFRS.

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WA 23-5
(a)
1. Current ratio = $905,000 ($420,000 + $52,000) = 1.92:1
2. Acid-test ratio = ($60,000 + $198,000 + $120,000) $472,000 = .8:1
3. Accounts receivable turnover =
$1,640,000 $80,000+$198,000 = 11.8 times
2
4. Inventory turnover =
$800,000 $640,000 + $520,000 = 1.4 times
2
5. Days payables outstanding =
$420,000 + $345,000 ($800,000 + 440,000) = 113 days
2
365
6. Rate of return on assets =
$360,000 $1,732,000+ $1,762,000 = 20.6%
2
7. Profit margin on sales =
$360,000 $1,640,000 = 21.95%
(b)

Financial ratios should be evaluated in terms of industry peculiarities


and prevailing business conditions. Although industry and general
business conditions are unknown in this case, the company appears
to have a relatively strong current position. The main concern from a
short-term perspective is the apparently low inventory turnover ratio.
This ratio may be low because the business buys in bulk and does
not purchase frequently. The rate of return on assets and profit
margin on sales are extremely good and indicate that the company
is employing its assets advantageously. The days payables
outstanding seems high, but should be evaluated in terms of the
credit terms provided by Maudes suppliers.

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WA 23-5 (Continued)
(c) Unearned revenue is a liability that arises from current sales but for
which some future services or products are owed to customers in
the future. At the time of sale, customers pay not only for the
delivered product, but they also pay for future products or services.
In this case, the company recognizes revenue from the current
product and part of the sale proceeds is recorded as a liability
(unearned revenue) for the value of future products or services that
are owed to customers. An increase in the unearned revenue
liability, rather than raising a red flag, often provides a positive signal
about sales and profitability. When the sales are growing, the
unearned revenue account should grow. Thus, an increase in a
liability may be good news about company performance. In contrast,
when unearned revenues decline as they did for Maude, the
company owes fewer services and products, but this also means
that sales of new products may have slowed.
(d) Discounting the price of some of their goods to move sales and
profits from 2015 into 2014 would be misleading for investors by
overstating sales in 2014. This would subsequently lead to an
understatement of sales in 2015. Furthermore it is not considered to
be normal business activity, therefore the managers would be
unethically increasing bottom line profits. The normal/expected
amount of sales will not occur in the next period, so it also adversely
affects the quality of earnings the firm produces.

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RESEARCH AND FINANCIAL ANALYSIS


RA23-1

AIR CANADA INC. VERSUS BRITISH AIRWAYS PLC

(a) (1) Air Canada commented on the following list of items in its Note
3 on accounting policies:
Basis of Measurement
Principles of consolidation
Passenger and cargo revenues
Capacity purchase agreements
Aeroplan loyalty program
Other revenues
Employee future benefits
Employee profit sharing plan
Stock-based compensation plan
Maintenance and repairs
Other operating expenses
Financial instruments
Foreign currency translation
Income taxes
Earning Per Share
Cash and cash equivalents

Solutions Manual

Short-term investments
Restricted cash
Aircraft fuel inventory and spare parts
inventory
Property and equipment
Interest capitalized
Leases
Intangible assets
Goodwill
Impairment of long-lived assets
Non-current assets held for sale
Provisions
Aircraft lease payments in excess of or
less than rent expense
Exceptional items
Segment reporting
Accounting standards and amendments
issued but not yet adopted

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RA23-1 AIR CANADA INC. VERSUS BRITISH AIRWAYS PLC


(Continued)
(2) British Airways commented on the following list of items in its
Note 2 on accounting policies (*):
Basis of Preparation
Basis of consolidation
Revenue
Revenue recognition: customer loyalty
programmes
Segmental reporting
Intangible fixed assets
Property, plant, and equipment
Non-current assets held for sale
Inventories
Interests in associates
Cash and cash equivalents
Other current interest bearing deposits
Trade and other receivables
Available-for-sale financial assets
Employee benefits
Share-based payment

Taxation
Provisions
Foreign currency translation
Derivatives and financial instruments
Cash flow hedges
Impairment of financial assets
Investment in own shares
Derecognition of financial assets and
liabilities
Exceptional items
Key accounting estimates and
judgements
Impact of new International Financial
Reporting Standards
New standards, amendments and
interpretations not yet effective

(*) Shares of British Airways trade on both the London Stock Exchange
(LSE) and the New York Stock Exchange (NYSE). The information in this
sample solution is contained in the 2011 annual report on the companys
website.

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RA23-1 AIR CANADA INC. VERSUS BRITISH AIRWAYS PLC


(Continued)
(b) There are several of the items discussed in their notes on
accounting policies that are similar. Both companies are in the airline
industry. Their policies that are similar and that relate to this industry
include revenue recognition for loyalty program, foreign currency
translation, and property and equipment. Some policies would be
common to all businesses such as cash and cash equivalents, shortterm investments, share based payments, financial assets, financial
instruments and hedging and taxation. Other policies relate more to
the size of the businesses, such as principles of consolidation.
Notable differences in the accounting policies deal with restricted
cash, aircraft lease payments in excess of or less than rent expense,
in Air Canadas notes. British Airways notes deal with interests in
associates.
(c) Under Note 3, Summary of Accounting Policies, Air Canada states
that it operates as only one reportable segment based on how
financial information is produded internally for the purposes of
making operating decisions. In Note 21, Air Canada Inc. provides
information on passenger revenues and cargo revenues. In addition,
geographic segment revenues are provided for Canada, US
transborder, Atlantic, Pacific and Other.

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RA23-1 AIR CANADA INC. VERSUS BRITISH AIRWAYS PLC


(Continued)
(c) (Continued)
British Airways, in Note 3, also states that its cargo and passenger
operations are managed as single business unit as management
makes resource allocations based on route economics and with little
reference to cargo operations. It also states that although the
operations of OpenSkies and CityFlyer are considered separate
operating segments, they are similar enough to be grouped in with
passenger and cargo operations. As a result, the company only has
one reportable segment for its airline business. Other segments
include Air Miles Travel Promotions Limited, British Airways Holidays
Limited, Speedbird Insurance Company Limited.
Information
provided by segments include: sales to external customers; intersegment sales; segment results; other non-operating expenses;
profit before finance and taxes; net finance costs; loss on sale of
assets; share or associate profits; revaluation of convertible bond
derivative liability; taxes; profit after tax; assets; investment in
associates; segment liabilities; unallocated liabilities; property, plant
and equipment additions; intangible asset additions, purchase of
subsidiary; depreciation, amortization; non-current assets held for
sale-transfers in and impairment; impairment of available-for-sale
investments; exceptional items including restructuring, and net
impairment reversal.
British Airways also provides geographic segment revenue
information for: UK and Continental Europe; The Americas; Africa,
Middle East and India subcontinents; Far East and Australasia.
Since both companies really only have one significant reportable
segment, the information has limited use. The note disclosure for
British Airways appears to be more useful since disclosure is made
as to why the company believes it has only one reportable unit for its
airline operations. In addition, because it does have more than one
reportable segment, a lot of individual segment information is
provided which would be difficult to find in the other notes.

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RA23-1 AIR CANADA INC. VERSUS BRITISH AIRWAYS PLC


(Continued)
(d) Air Canadas independent auditors are PricewaterhouseCoopers
LLP, which conducted the audit in accordance with Canadian
generally accepted auditing standards. Air Canadas auditors did not
reference certain regulations but did make note of management and
auditors responsibility.
British Airways independent auditors are Ernst & Young LLP, which
conducted the audit in accordance with International Financial
Reporting Standards. It provided the details of responsibilities of
management (directors) and auditors and made more references to
the regulations (IFRS requirements) related to the company.

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RA 23-2 Thomson Reuters Corporation


(a) As described in Note 29, the company had the following related party
transactions:
The company is owned 55% by Woodbridge.
- During the year, Woodbridge and some of its affiliates purchased
some of the companys wholly owned subsidiaries for
approximately $49 million. A gain of $49 million was recorded within
Other operating gains (losses).
- During the year, the company paid administration service fees of
$69,000 to Woodbridge. There is no indication whether these
reflected fair value for the services or not or if there any outstanding
balances still owing at the year end.
- Thomson Reuters buys insurance coverage for which Woodbridge
is also covered. During the year, Woodbridge paid $58,000 to
Thomson Reuters which would approximate what a third party
insurer would charge for similar coverage.
- The company has negligible amounts in receivables from
Woodbridge. Again, the amount is not provided as the company
indicates that it is not significant at the report date.
- Until April 2008, the company paid Woodbridge an annual fee of
$750,000 to indemnify up to $100 million in liabilities for directors
and officers. This amount was less than normal market prices
would have been (although we are not told by how much). In 2008,
this was replaced with conventional insurance coverage. The
coverage with Woodbridge is in place for any claims arising before
April 2014, which relate to events occurring prior to April 2008.
The company also had the following transactions with affiliates and
joint venturers which occurred as part of normal business and at arms
length:
- The company and The Depository Trust and Clearing Corporation
each have a 50% ownership in Omega. During the year, Omega
paid fees for facility, technology and other services totalling $10
million and the outstanding receivable is $1 million. There is no
information as to whether or not this represents fair market value
and whether terms of payments are normal business terms.

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RA 23-2 Thomson Reuters Corporation (Continued)


-

The Company and Shin Nippon Hoki Shuppan K.K. each own 50%
of Westlaw Japan K.K., a joint venture. During the year, the
company provided technology and other services valued at $1
million. The receivable at the yearend was negligible. There is no
information as to whether or not this represents fair market value
and whether terms of payments are normal business terms.
The company owns 3XSQ Associates from which it leases office
space. The companys investment in 3XSQ Associates is reported
using the equity method, although the percentage of ownership is
not disclosed in this note. The lease is for 690,000 square feet and
expires in 2021, and includes provisions for portions to terminate
early and various renewal options. The company incurred $37
million for rental costs, taxes and other related expenses to this
lease agreement. The amount payable at the yearend was
negligible. The company did not disclose if the lease was at fair
market rates or not.

The company also purchased SuperLawyers, a company controlled by


one of the directors for $15 million. The directors father is CEO of this
company and has agreed to stay on until later in 2010. The director,
Vance Opperman abstained from voting on the transaction which was
reviewed and approved by the Board. There is no indication if this
represents fair value for the acquisition.
In October 2010, the Company acquired Serengeti, a provider of
electronic billing and matter management systems for corporate legal
departments. As a result of a prior investment in a venture lending
firm, Peter Thomson, one of the Companys directors, may have the
right to the acquisition of Serengeit and refrained from deliberating and
voting on the acquisition.
Finally the last disclosure for related parties relates to the key
management compensation. During 2011 and 2010, the company paid
the following total amounts to its directors and executive officers:

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RA 23-2 Thomson Reuters Corporation (Continued)


US$ millions
Salaries and benefits
Share-based payments
Total

2011
27
25
52

2010
23
28
51

(b) In general the information was useful and mostly adequate. In all
cases, the nature of the relationship was provided, along with
disclosure of the specific related party. The amount of the
transactions and the reasons for the transactions were also
provided. Even though this is not required by IFRS, users would
appreciate knowing the amounts reflect fair values. In some areas
the company did not disclose if the transactions were at fair value
and consistent with market conditions. In addition, the company did
not disclose if payment terms and conditions were consistent with
normal business practices. Finally, for some of the transactions, if
the amounts were insignificant, the amounts were not disclosed.
From a user perspective, even these minor details would have
been helpful since by their nature related party transactions may not
occur under normal market and business conditions.
(c) Note 30 provides details of the subsequent events, which are
summarized below:
In January 2012, the sale of the Trade and Risk Management
business was completed. The Company expects to record a gain
on this transaction in the first quarter of 2012.
In February 2012, the Company reached agreement to sell it Portia
business. The Company expects to record a gain on this
transaction, which is expected to close in the second quarter of
2012.
In February 2012, the Companys board of directors approved a
$0.04 share increase in the annualized dividend to $1.28 per
common share. A quarterly dividend of $0.32 was paid on March
15, 2012 to shareholders of record as of February 22, 2012.
As disclosed under Note 1, under general business description, the
directors approved the statements on March 7, 2012.
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NESTL GROUP

(a) The statement of comprehensive income has been presented for the
six month periods ended June 30, 2012 and June 30, 2011. The
statement of financial position has been presented as at June 30,
2012, December 31, 2011 and June 30, 2011. The statement of
changes in equity has been presented showing the changes during
the periods January 1 to June 30, 2012 and January 1 to June 30,
2011. The statement of cash flows has been presented for the period
January 1 to June 30, 2012 and January 1 to June 30, 2011.
(b) Note 1 on accounting policies, basis of preparation, indicates that the
company has followed IAS 34 in preparing the interim financial
statements. The company has used the same accounting policies and
conventions as it did for its 2011 fiscal yearend report, except for the
additional disclosures provided. These changes in the accounting
policies are the following:
IFRS 9 Financial Instruments: The standard addresses the
classification, measurement and derecognition of financial
assets and financial liabilities.
IFRS 10 Consolidated Financial Statements: This standard
introduces a new single control model as the basis for
consolidation applicable to all investors;
IFRS 11 Joint Arrangements: This standard establishes
principles from the financial reporting by parties by a joint
agreement. IFRS 12 Disclosure of Interests in Other Entities:
This standard combines, enhances and replaces disclosure
requirements for subsidiaries, joint arrangements, associates
and unconsolidated structured entities;
IFRS 13 Fair Value Measurement: This standard applies when
other IFRS require or permit fair value measurements. IAS 19
Revised 2011 Employee Benefits: These changes will affect
profit for the period and the earnings per share by increasing
employee benefit costs of the Group.
Improvements and other amendments to IFRS have no material
impact on the financial reports of the company;
IAS 1 Presentation of Financial Statements Requires entities
to separate items presented in other comprehensive income into

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two groups, based on whether or not they may be recycled to


the income statement in the future.

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NESTL GROUP (Continued)

(c) The other notes include information on the following:


Note 2 - Modification in the scope of consolidations indicates that
there were no acquisitions or disposals during the period.
Note 3 Provides segmented information for the periods January 1
to June 30, 2012 and comparative information for the period
January 1, to June 30, 2011.
Note 4 discusses seasonality and indicates that the results for the
group do not show seasonal variations or cyclical patterns.
Note 5 Provides a detailed breakdown of Net other income
(expenses) which provides further information on profit and losses
on sales of assets and divisions, restructuring costs and impairment
losses reported during the interim period.
Note 6 Provides information on the share of associates profits
and indicates that this relates to the groups ownership of LOreal.
Note 7 on cash flow before changes in operating assets and
liabilities. Shows the operating profits and changes in non-cash
items included in profit for the year, and which are part of the
reconciliation of net income to operating cash flow in the statement
of cash flows. Note 8 on equity provides disclosure on share
repurchases and issuances during the interim period and the total
number of shares outstanding as of June 30, 2012. In addition, the
note provides information on dividends paid and declared during
the interim period.
Note 9 Provides the details of specific bonds issued and repaid
during the year.
Note 10 Subsequent events that warrant a modification of the
value of the assets and liabilities or an additional disclosure.
(d)

No, this information is not audited.

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RA23-4 ADOPTION OF IFRS IN THE UNITED STATES


(a) The article states that in November, 2008, the SEC published a
roadmap regarding adoption of IFRS in the United States. At the
time feedback comments were requested, but the SEC only received
about 200 comment letters in total, which seems insignificant given
the number of organizations that would be impacted with this move.
Since that time, there has been virtual silence on this issue. The
article suggests that this lack of progress has cost companies in the
way of operational efficiencies and credibility in crunching the
numbers. One example was provided of a company that had hired
IFRS expertise to use 40% of their time to look at strategies to
implementing the IFRS standards. This IFRS transition was now on
hold until notice from the SEC. A second company that will go public
in the near future and wants to use IFRS in its reports, has hired the
expertise required and is now waiting for approval from the SEC to
go forward.
(b) Some argue that the US will never adopt IFRS for the following
reasons:
There is no compelling reason for public companies or private
companies to adopt IFRS (as stated by Bruce Pounder, president to
an accounting education firm).
A professor (and a former academic fellow in the SECs office)
conducted an informal survey and found that most respondents felt
that IFRS was not perceived to be better than US GAAP and that
efforts to try to make IFRS and US GAAP consistent was not
worthwhile.
A Grant Thornton study found that only 23% of (800) respondents
felt that the IASB should be setting accounting standards for the
United States.
A partner in a US CPA firm stated that stakeholders are not asking
for IFRS so there is no sense of urgency. In addition, there seem to
be other more important things going on there is just little interest
on conversion to IFRS right now.
Microsoft has studied the conversion to IFRS for a while and has
concluded that savings will not likely be achieved.
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RA23-5 ADOPTION OF IFRS IN UNITED STATES (Continued)


CFOs in the past 24 months have had larger issues to deal with
including the impact of the recession and the financial crisis, the
mandate to move XBRL, along with uncertain public policies related
to health care, employee benefits, and taxation.
In a survey of Financial Executives International, IFRS has moved
from the No 2 challenge facing these respondents to No.5.
Some believe that trial lawyers will have more to argue under IFRS
since IFRS is a principles-based system and allows more choices
than under the rules- based US GAAP. Historically, US GAAP was
once a principles-based approach and moved to rules-based
primarily due to litigation and perceived lower liability risk.
In the rush to converge IFRS and FASB, many suggest that
compromises will be made, which might be detrimental to
companies in the long run.
Estimates of costs to convert to IFRS vary between 0.1% and 0.5%
of revenues, again making companies wary of the transition.
Others argue that the US should proceed to IFRS conversion and this is
supported by the following comments:
Many US multinationals are already moving towards adopting
IFRS.
A 2008 survey of 200 CFOs of firms with more than $1 billion in
revenues found that 83% of respondents felt that one standard
would produce business benefits and help with comparisons across
international peers.
By streamlining the back office and having only one accounting
standard across all geographic locations for multi-national firms,
significant cost savings could be achieved.
Small and medium sized private companies that are involved in
international operations and raise debt internationally are moving to
adopt IFRS for SMEs since it is less complex that US GAAP.
The AICPA supports the move to IFRS and states that IFRS is
credible and authoritative.

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RA23-5 ADOPTION OF IFRS IN UNITED STATES (Continued)


In February, 2010, the SEC issued a notice indicating that it still
believes that a single set of high quality accounting standards will
benefit US preparers. It is working on a plan to evaluate US
conversion to IFRS and will make a statement in 2011 as to
whether or not it will proceed with incorporating IFRS into the US
reporting system.
(c) The answer is dependent on decisions made by SEC which is still
ongoing.

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CUMULATIVE COVERAGE (Chapters 19-23)


Land .....................................................................
Building.......................................................
15,000,000

15,000,000

To correctly allocate land, recorded in building account in error.


This entry affects both the 2013 and 2014 balance sheet numbers.

Accumulated Depreciation - Building...............


Depreciation Expense...............................

750,000
750,000

To reverse the entry of 2014 depreciation recorded in error


($15,000, 000 20 = $750,000)

Income Tax Expense...........................................


Income Tax Payable...................................

225,000
225,000

($750, 000 X 30% = $225,000) Addition income tax expense


for the current year based on the second entry above

Accumulated Depreciation - Building...............


Income Tax Payable...................................
Retained Earnings.....................................

1,500,000
450,000
1,050,000

Correction of prior years error for the depreciation recorded


$750,000 X 2 = $1,050,000
It is assumed that there were no prior years errors in the calculation
of future income tax.

Land .....................................................................
Common Shares........................................
10,000,000

10,000,000

This related party transaction between a majority shareholder and


the company is recorded at the shareholders carrying amount. It
is assumed that there is no substantive change in ownership
since the same individual effectively owns the land before and
after the transaction.
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Note that none of these entries affects the statement of cash flows.

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CUMULATIVE COVERAGE (Chapters 19-23) [Continued]


MC Travel Inc.
Balance Sheet
December 31, 2014
2014
ASSETS
Current assets
Cash
Fair value-net income investments
Accounts receivable
Allowance for doubtful accounts
Total current assets
Capital assets
Land
Building and equipment
Accumulated depreciation
Total capital assets
Total assets

$7,600,000
2,006,000
5,000,000
(200,000)
14,406,000

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$5,040,000
1,900,000
3,700,000
(100,500)
10,539,500

25,250,000 15,250,000
40,270,000 40,072,000
(5,175,000) (3,450,000)
60,345,000 51,872,000
$74,751,000 $62,411,500

LIABILITIES AND SHAREHOLDERS EQUITY


Current liabilities
Accounts payable
$3,800,800
Interest payable
30,000
Income tax payable
1,025,000
Dividends payable
-04,855,800

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2013 Restated

$4,100,750
15,000
700,000
100,000
4,915,750

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CUMULATIVE COVERAGE (Chapters 19-23) [Continued]


Long term liabilities
Long term bank loan
1,145,000
807,000
5% Bond payable
Miami property, due 2022
40,000,000 40,000,000
Future income tax liability
175,000
150,000
Total long-term liabilities
41,320,000 40,957,000
Total liabilities
46,175,800 45,872,750
Shareholders equity
Common shares
11,000,000
1,000,000
Retained earnings
17,575,200 15,538,750
Total shareholders equity
28,575,200 16,538,750
Total liabilities and
shareholders equity
$74,751,000 $62,411,500
MC Travel Inc.
Income Statement
Year Ended December 31, 2014
Sales revenue
$37,500,000
Expenses:
Salaries and wages
5,000,000
Purchases from tour operators
22,500,000
Depreciation expense
1,750,000
Office, general and selling expense
3,489,800
Bad debt expense
150,000
Interest on long term debt
30,000
Bond interest expense
2,000,000
Total expenses
34,919,800
Income from operations
2,580,200
Investment income
256,000
Gain on sale of equipment
73,000
Income before income tax
2,909,200
Income tax expense
872,750
Net income
$2,036,450
CUMULATIVE COVERAGE (Chapters 19-23) [Continued]

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The adjustment to reverse the depreciation charged in error in 2014


on the land is taken into account in this income statement. As a
result, depreciation expense has decreased by $750,000, income tax
expense has increased by $225,000 and net income has increased
by $525,000.
MC Travel Inc.
Statement of Cash Flows
Year Ended December 31, 2014
Cash flows from operating activities
Received from customers
Dividend received on fair value-net income
investment
Paid to suppliers and employees
Payments for interest
Income tax paid
Net cash provided by operating activities
Cash flows from investing activities
Proceeds on sale of equipment
Purchase of equipment
Net cash used by investing activities
Cash flows from financing activities
Increase in long term loan
Dividend paid on common shares
Net cash used by financing activities
Increase in cash

150,000
(31,289,750)
(2,015,000)
(522,750)
2,472,000
100,000
(250,000)
(150,000)
338,000
(100,000)
238,000
2,560,000
5,040,000
$7,600,000

Cash, January 1
Cash, December 31

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$36,149,500

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CUMULATIVE COVERAGE (Chapters 19-23) [Continued]


Note 1: Common shares were issued during the year in exchange
for land valued at $10,000,000.
Note 2: Interest income of $106,000 was reinvested in fair value-net
income investments.
Calculations:
Received from customers:
Sales revenue
$37,500,000
Change in accounts receivable
(1,300,000)
Accounts written off
(50,500)
$36,149,500
Accounts written off:
Allowance for doubtful accounts, opening balance
$100,500
Bad debt expense
150,000
250,500
Ending balance for the allowance account
200,000
Accounts written off during year
$50,500
Paid to suppliers and employees
Office, general and selling expense
Tour operators
Salaries and wages
Decrease in accounts payable
Payments for interest
Interest expense ($2,000,000 + $30,000)
Increase in interest payable
Income tax paid
Income tax expense
Increase in income tax payable
Increase in future tax liability

$3,489,800
22,500,000
5,000,000
299,950
$31,289,750
$2,030,000
(15,000)
$2,015,000
$872,750
(325,000)
(25,000)
$522,750

CUMULATIVE COVERAGE (Chapters 19-23) [Continued]


Buildings and equipment:
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Opening balance
Cost of equipment purchased in year
Ending balance
Cost of equipment disposed of during year
Accumulated depreciation on asset disposal:
Opening balance
Depreciation expense
Ending balance
Accumulated depreciation on asset disposal
Proceeds on sale of equipment:
Net carrying amount of equipment ($52,000 $25,000)
Gain on sale of equipment
Proceeds on sale of equipment

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$40,072,000
250,000
40,322,000
40,270,000
$52,000

$3,450,000
1,750,000
5,200,000
5,175,000
$25,000
$27,000
73,000
$100,000

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Chapter 23