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BUS320

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Assignment #1

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QUESTION ONE
Downtown TV Repair Ltd.
(i) (1) Incorrect entry:

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1. Cash (B/S) ........................................................................ 5,700
Accounts Receivable (B/S) ........................................ 5,700

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2. Supplies (B/S) .................................................................. 9,000
Accounts Payable (B/S) .............................................. 9,000

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3. Utilities Expense (I/S) ...................................................... 300
Cash (B/S) .................................................................. 300

4. Salaries and Wages Expense (I/S)..................................... 18,000

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Cash (B/S) .................................................................. 18,000

5. Equipment (B/S) ............................................................... 900

Cash (B/S) .................................................................. 900
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(2) Correct entry:
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1. Cash (B/S) ................................................................................... 7,500

Accounts Receivable (B/S) ................................................ 7,500
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2. Equipment (B/S) ........................................................................ 9,000

Accounts Payable (B/S) ...................................................... 9,000
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3. Advertising Expense (I/S) ........................................................ 300

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Cash (B/S) ............................................................................ 300

4. Salaries and Wages Expense (I/S) ............................................. 12,000

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Salaries and Wages Payable (B/S) ............................................. 6,000

Cash (B/S) ............................................................................ 18,000
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5. Repairs and Maintenance Expense (I/S).................................. 900

Cash (B/S) ............................................................................. 900
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(3) Correcting entry:

1. Cash (B/S) ........................................................................ 1,800
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Accounts Receivable (B/S) ......................................... 1,800

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Adapted from material in the Kieso et al (2016) Intermediate Accounting textbook and
reproduced with permission of John Wiley & Sons Canada, Ltd. Do not distribute
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2. Equipment (B/S) ............................................................... 9,000

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Supplies (B/S) ............................................................ 9,000

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3. Advertising Expense (I/S) ................................................ 300
Utilities Expense (I/S) ................................................ 300

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4. Salaries and Wages Payable (B/S) .................................... 6,000
Salaries and Wages Expense (I/S) .............................. 6,000

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5. Repairs and Maintenance Expense (I/S) .......................... 900

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Equipment (B/S).......................................................... 900

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(ii) Corrected adjusted trial balance as at March 31, 20X2

DOWNTOWN TV REPAIR LTD.

Adjusted Trial Balance

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March 31, 20X2

Debit Credit
Cash ................................................................................. $ 73,800
Accounts receivable ........................................................ 33,200
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Supplies ........................................................................... 0
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Equipment ....................................................................... 158,100

Accumulated depreciation—equipment .......................... $ 30,000
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Accounts payable ............................................................ 59,500

Salaries and wages payable ............................................. 0
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Unearned revenue ............................................................ 15,000

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Common shares ............................................................... 100,000

Retained earnings ............................................................ 46,600
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Dividends declared .......................................................... 5,000

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Service revenue ............................................................... 80,000

Salaries and wages expense ............................................ 30,000
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Advertising expense ........................................................ 8,300

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Utilities expense .............................................................. 2,800

Depreciation expense ...................................................... 7,000
Repairs and maintenance expense ................................... 12,900 _______
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$331,100 $331,100
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Adapted from material in the Kieso et al (2016) Intermediate Accounting textbook and
reproduced with permission of John Wiley & Sons Canada, Ltd. Do not distribute
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(iii) DOWNTOWN TV REPAIR LTD.

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Income Statement
For the Year Ended March 31, 20X2

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Service Revenue .................................................................... $ 80,000
Expenses:
Salaries and wages expense ....................................... $ 30,000

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Advertising expense................................................... 8,300
Utilities expense......................................................... 2,800

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Depreciation expense ................................................. 7,000
Repairs and maintenance expense ............................. 12,900
Total expenses ................................................... 61,000

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Net income $ 19,000

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DOWNTOWN TV REPAIR LTD. Do
Statement of Retained Earnings
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For the Year Ended March 31, 20X2

Retained Earnings, April 1, 20X1 $ 46,600

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Add: Net income 19,000

65,600
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Less: Dividends 5,000

Retained Earnings, March 31, 20X2 $ 60,600
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Adapted from material in the Kieso et al (2016) Intermediate Accounting textbook and
reproduced with permission of John Wiley & Sons Canada, Ltd. Do not distribute
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DOWNTOWN TV REPAIR LTD.

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Balance Sheet
March 31, 20X2

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Assets
Current assets
Cash ......................................................................... $ 73,800

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Accounts receivable ................................................ 33,200
Total current assets............................................ 107,000

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Equipment ............................................................... $ 158,100
Less: Accumulated depreciation ............................. (30,000) 128,100
Total assets $ 235,100

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Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable ................................................... $ 59,500
Unearned revenue .................................................. 15,000

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Total liabilities ............................................... 74,500
Shareholders’ equity
Common shares ............................................................. $ 100,000
Retained earnings .......................................................... 60,600
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Total shareholders’ equity 160,600
Total liabilities and shareholders’ equity $ 235,100
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Adapted from material in the Kieso et al (2016) Intermediate Accounting textbook and
reproduced with permission of John Wiley & Sons Canada, Ltd. Do not distribute
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QUESTION TWO

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ABT Security System Inc.
(i) Factors to consider in determining the appropriate basis of financial reporting management should

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use in the preparation of ABT’s financial statements

Consider the form of business organization of ABT. Is ABT a sole proprietorship, partnership

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or an incorporated business? From the name of the company, we can say with 100% confidence
that ABT is an incorporated business.

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Because ABT is an incorporated business, it has to be under the authority of a business
corporations act (e.g., the Business Corporations Act of British Columbia or the Canada

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Business Corporations Act). Factors to consider include any special and extra reporting

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requirements that the company has to follow in accordance with that particular business
corporations act.

ABT has to meet the financial reporting requirements stated in the applicable business
corporations act unless the company is a “reporting issuer”. If ABT has securities (i.e., shares or

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debts) already trading in a public market or has issued securities with filing documents (e.g., a
prospectus), then ABT is a “reporting issuer” as defined in the securities acts. ABT can also be
a “reporting issuer” if it has proposed to issue securities even though at the moment it has not yet
issued any securities. ABT can also be a “reporting issuer” if the company is designated as a
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“reporting issuer” in an order by the securities commission for the public interest in accordance
with provisions of the securities acts. These all are factors to consider in determining whether or
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not ABT is a “reporting issuer”. It is also important to know the jurisdictions and the applicable
securities acts that apply to ABT, especially if one of these jurisdictions is in a foreign country,
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because there can be special and extra listing and reporting requirements with which ABT has to
comply.
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If ABT is a “reporting issuer”, it is exempted from the financial reporting requirements of the
business corporations act. If this is the case, then ABT will have to meet the more stringent
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requirements of the applicable securities act(s). It is therefore important to know whether or not
ABT is a “reporting issuer”. We will come back to this possibility later.
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If ABT does not currently have securities trading in a public market and has no plan to issue
securities for public trading in the near future, then ABT is likely a “non-reporting issuer”. If
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ABT is a “non-reporting issuer”, the financial reporting requirements of the applicable business
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corporations act will apply unless there is a waiver obtained through unanimous resolution and
consent of all shareholders of the company removing the requirement of financial statements or
allowing the company to prepare financial statements on a basis other than GAAP as prescribed
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in the CPA Canada Handbook (formerly known as the CICA Handbook). Factors to consider
here include whether the shares of ABT are owned by a large number of shareholders or by a
group of very small number of shareholders, and how likely unanimous consent can be obtained
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from all shareholders to waive some or all of the requirements related to the financial statements
under the applicable business corporations act. If there is such a waiver, then ABT does not
have to meet the financial statement requirements of the applicable business corporation act. If
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there is no waiver, then the requirements of the act apply and the company has to have its

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financial statements prepared in accordance with GAAP as prescribed in the CPA Canada

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Handbook. Knowing whether such a wavier exists is therefore important because it can directly
affect the type of GAAP or the basis of financial reporting ABT should follow.

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If ABT is a “reporting issuer”, then it has to follow the requirements of the applicable securities
act(s). In terms of financial reporting, these requirements basically say that the reporting
issuer’s company financial statements have to be prepared in accordance with Canadian GAAP

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as a publicly accountable enterprise in accordance with the requirements of the CPA Canada
Handbook.

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The CPA Canada Handbook defines specifically the meaning of a “publicly accountable
enterprise” and a “private enterprise”. ABT would be considered a “publicly accountable

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enterprise” if its debts or shares are, or will be, traded in a public market (like a stock exchange).

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A “publicly accountable enterprise” can also be a company that has fiduciary responsibilities to
the general public (like banks and insurance companies), which in this case is likely not
applicable to ABT. These are all important factors to consider in determining whether ABT is a
“publicly accountable enterprise”. As a profit-oriented entity, ABT would be considered a

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“private enterprise” if it is not a “publicly accountable enterprise”.

If ABT is a “publicly accountable enterprise”, then it has to use Part I in the Accounting section
of the CPA Canada Handbook (Part I is IFRS) as the appropriate basis of financial reporting in
the preparation of the company’s financial statements.
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If ABT is a “private enterprise”, then it can choose between Part I of the CPA Canada handbook
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(i.e., IFRS), and Part II of the CPA Canada Handbook (which is often referred to as ASPE or in
the past as PE-GAAP), in determining the appropriate basis of financial reporting for the
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company’s financial statements.

It is possible that ABT has already made a choice and decided some time ago to use IFRS even
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though it is not required to do so under the CPA Canada Handbook. An important factor to
consider is therefore whether or not such a choice has already been made by ABT.
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It is also possible that, due to contractual requirements, ABT uses IFRS even though it is a
“private enterprise” as defined in the CPA Canada Handbook. For example, as one of the
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conditions of a contractual lending agreement, a bank or creditor may require ABT to submit
financial statements that are prepared in accordance with IFRS. Therefore, an important factor
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to consider is whether or not ABT is subject to such conditions and contractual requirements.
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(ii) Accounting for the $3,400,000

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Applicable GAAP is IFRS in this case (given in the question). Under IFRS, we need to consider
the applicable conceptual framework concepts
- Assumptions described in the conceptual framework, e.g., the going-concern assumption.

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Is ABT’s business viable? Is the company in financial difficulties and likely unable to
continue operating as a going-concern business?
- Fundamental and enhancing qualitative characteristics in the conceptual framework, e.g.

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relevance, faithful representation, comparability, timeliness. The $3.4 million should be
accounted for in such a way that the information conveyed in ABT’s financial statements

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is relevant, representationally faithful, etc.
- Materiality – Is $3.4 million a material amount for this company? GAAP need not be
applied to immaterial items.
We are using

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the conceptual - Professional judgement is required in applying conceptual framework concepts and

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framework deciding on the appropriate accounting treatment.
concepts here,
see Textbook,
pp. 2-6 to 2-12 Are there possible alternative treatments for the $3.4 million (e.g., expensing the amount versus
recognizing the amount as asset) under IFRS? Are there special interests or motivation ABT

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management may have that can affect management’s choice of the accounting treatment?
- Is there evidence suggesting that ABT management is trying to recognize the $3.4 million
as asset in order to increase reported income and total assets of the company and make the
financial statements look better?
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Before recognizing the $3.4 million (or a portion thereof) as assets, we need to make sure that
the recognition criteria are met. Specifically, we need to ensure that
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- The item meets the definition of an element, i.e. an asset in this case.
 Is the item a present economic resource? Does having spent the amount represent a
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right that has the potential to produce economic benefits? What exactly can ABT
expect from having spent the amount and visiting the prospective customers? Is it
likely that these visits will result in new customer contracts which in turn will lead
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We are using the

to future cash flows to the company?
definition of asset  Is the economic resource controlled by ABT? Are the economic benefits, in the
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here, see Textbook, form of future cash flows, expected to go to ABT?

pp. 2-12 to 2-13
 Has the event that gives rise to ABT’s control over the economic resource
occurred? Can the visits to the prospective customers be considered the past event?
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- Would recognizing the $3.4 million (or a portion thereof) as an asset provide users of
financial statements with information that is useful (i.e., relevant and a faithful
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representation of the asset)?

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 For those new customers who sign up, how much and at which point in time are
We are using the
recognition criteria they supposed to pay? Will they be able to pay? Has ABT carried out credit
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here, see Textbook, checks on these customers and obtained reasonable assurance that these customers
pp. 2-17 to 2-18 have the ability to pay? How likely is ABT going to be receiving the future cash
flows?
 Is it reasonable to expect that all 8,500 prospective customers will sign up? Or is it
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more reasonable to expect only a certain percentage of these 8,500 visits will result
in new customer contracts?
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 Out of the amount that each new customer will be paying (we are not given the

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amount in this case), can ABT recover the $400 cost? If not, what are the

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implications? Is there concern about an overstated asset?

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QUESTION THREE

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Red Tree Limited, Blue Tree Limited, and Green Tree Limited

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(i) Between “historical cost accounting” and “market value accounting”, which set of the
corresponding company ROAs and ROEs do you think gives us results that are more meaningful

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and useful for evaluating managerial performance?

The three companies in this question are identical in all respects and the only difference is that

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the economic performance of each company depends solely on the abilities of the company
manager. The example is set up in such a way that, for the current year, Mr. Diligent has the

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strongest abilities reporting a $30,000 net income for Green Tree Limited, Mr. Good ranks the
second with a $25,000 net income for Blue Tree Limited, and Mr. Slack has the weakest abilities
reporting a $20,000 net income for Red Tree Limited.

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The set of ROAs and ROEs calculated based on “market value accounting” gives us results that are
consistent with the ranking of Mr. Diligent being the highest (10.0%), Mr. Good being the second
(8.3%), and Mr. Slack being the lowest (6.7%). However, the set of ROAs and ROEs calculated on
the basis of “historical cost accounting” gives us the opposite results ranking Mr. Good lowest
(10%) and Mr. Slack highest (20%), and this ranking of relative performance is incorrect and

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inconsistent with what we expect. The reason for this incorrect ranking is that the ROAs and ROEs
are calculated using historical costs that do not reflect the economic value of the resources
necessary to generate the income of the respective companies. Under “historical cost accounting”,
the costs of land reported by Red Tree Limited are costs incurred 40 years ago. The high ROAs
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and ROEs are the direct results of the low historical costs of the company’s land and the smaller
dollar amount of the denominator used in the calculation of the ratio. This distortion in the relative
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performance of the managers is avoided under “market value accounting” as we use the market
value of land to measure the economic value of the resources necessary to generate the income of
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the respective companies.

In this example, it is clear that the set of ROAs and ROEs calculated on the basis of “market value
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accounting” would give us results that are more meaningful and useful for evaluating managerial
performance.
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Notice that you can change the setting of this example yourself and confirm that you would
arrive at the same conclusion even if the three managers have identical abilities and
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performance. You can easily change the income statements in the example and use the same
dollar amount net income across the three companies. The old historical costs used in the
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denominator of the ROA and ROE calculations will lead to distorted results that are similar to
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what we have shown in this question.

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(ii) Assume that, next year in 20X2, Blue Tree Limited is going to sell one parcel of land and Mr.
Good, the company manager, can choose which one of the 5 parcels of land to sell. Between
“historical cost accounting” and “market value accounting”, which system do you think will
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generate a more “reliable” measure of the net income of the company?

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Mr. Good can choose a particular parcel of land to sell and under “historical cost accounting”

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create a bigger or smaller gain (or a bigger or smaller loss) depending on the level of net income

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Mr. Good likes to report. For example, let us assume that the parcel of land is sold for $45,000
in 20X2. If Mr. Good wants to report the highest possible net income for 20X2, then all he
needs to do is to choose to sell the particular parcel of land that was purchased 40 years ago

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(with a historical cost of 10,000). With this sale, the company will report a gain of $35,000 on
the disposal of land. If Mr. Good prefers to report a lower net income or even a loss in 20X2,
then he can choose to sell one of the other parcels of land that has a higher historical cost

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attached to it. If Mr. Good sells the parcel of land that was purchased 20 years ago (with a
historical cost of $30,000), then the company will report a smaller gain of $15,000 in 20X2 and

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Mr. Good will be able to save the remaining potential gain for use in future years. If Mr. Good
sells the parcel of land that was purchased 5 years ago (with a historical cost of $50,000), then
the company will report a loss of $5,000. If Mr. Good wants to report a bigger loss, he can sell

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the parcel of land that was purchased 10 years ago with a historical cost of $60,000. This type

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of income manipulation is possible under “historical cost accounting”. Mr. Good can pick and
choose (or cherry-pick) which piece of land to sell.1 The amount of realized gain or loss
reported on the disposal of the land will depend on the choice made by Mr. Good, and the net
income of the company will be affected by this choice. A high net income of the company does

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not necessarily mean strong performance by the manager. Conversely, a low net income or a
reported loss for the company does not necessarily mean that the performance of the manager is
poor. In contrast, with “market value accounting”, each parcel of land is carried at the same
$50,000 on the company’s books at the end of 20X1. When the land is sold for $45,000, the
company will report a loss of $5,000 in 20X2 and it is the same amount of loss regardless of
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which parcel of land is sold.
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If “market value accounting” is used, then all assets are carried at market value on the
company’s books and company income would not be affected by the manager’s choice in the
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disposal of selected assets. Such “cherry picking” behaviour and the resulting income
manipulation would be avoided under “market value accounting”.
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With “historical cost accounting”, the manager can essentially pick and choose the specific asset
to sell and change the level of company income the manager wishes to report. This “cherry
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picking” behaviour is possible under “historical cost accounting”, with income manipulation
being an undesirable effect. Because different amounts of net income would be reported
depending on which piece of asset the manager decides to sell, it can be argued that net income
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reported under “historical cost accounting” is less representationally faithful (i.e., less “reliable”)
compared to the net income reported under “market value accounting”.
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NOTE: Prior to 2011, the IFRS Conceptual Framework listed “reliability” as one of the
principal qualitative characteristics of financial statements. Starting 2011, the reference to
“reliability” is replaced by “faithful representation”.2 This change was explained by the standard
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“Gains trading” is another term used in the accounting literature to describe such “cherry-picking” behaviour.
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In the IFRS Conceptual Framework before 2011, the four principal qualitative characteristics are understandability,
relevance, reliability and comparability. Starting 2011, the IFRS Conceptual Framework categorizes the qualitative
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setting bodies at that time as just a change of wordings. The intent and effects of this change,

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however, have been debated and challenged in the accounting literature.

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(iii) “Comparability of financial information will be enhanced if all companies use historical cost

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accounting”. Do you agree with this statement? Briefly explain your answer.

You can agree or disagree with this statement and provide a sensible response to this question as

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long as your explanation is properly justified.

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The Red Tree/Blue Tree/Green Tree example in part (i) shows us that the use of historical costs can
lead to distortions when we use certain popular ratios, like ROA and ROE, to compare different
companies. The example in part (ii) also shows us that the reported net income can be manipulated

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under historical cost accounting through the choices involved in asset disposal. The discussions we

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have in parts (i) and (ii) would provide a strong basis for you to explain your position if you
disagree with the statement.

Our results in part (i) indicate that, if all 3 companies use “historical cost accounting”, the ROA and

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ROE rankings would give us incorrect conclusions in all pairwise comparisons when we compare
the managers’ performance. In terms of comparability, this setting gives us the worst outcome.
Correct conclusion about the managers’ Incorrect conclusion about the managers’
performance performance
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None Mr. Slack (20.0%) > Mr. Good (11.4%)
Mr. Slack (20.0%) > Mr. Diligent (10.0%)
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Mr. Good (11.4%) > Mr. Diligent (10.0%)

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If all 3 companies use “market value accounting”, the ROA and ROE rankings would give us
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correct conclusions in the three comparisons. In terms of comparability, this gives us the best
outcome.
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Correct conclusion about the managers’ Incorrect conclusion about the managers’
performance performance
Mr. Diligent (10.0%) > Mr. Good (8.3%) None
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Mr. Diligent (10.0%) > Mr. Slack (8.3%)

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Mr. Good (8.3%) > Mr. Slack (6.7%)

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characteristics into two groups: (1) fundamental qualitative characteristics for relevance and faithful representation, and
(2) enhancing qualitative characteristics for comparability, verifiability, timeliness and understandability.
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Interestingly, if one of the 3 companies (say, Red Tree) uses “market value accounting” while the

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other two companies use “historical cost accounting”, we will see an improvement in the outcome
compared to the worst scenario case when all 3 companies use “historical cost accounting”.

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Correct conclusion about the managers’ Incorrect conclusion about the managers’
performance performance
Mr. Diligent (10.0%) > Mr. Slack (6.7%) Mr. Good (11.4%) > Mr. Diligent (10.0%)

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Mr. Good (11.4%) > Mr. Slack (6.7%)

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If Blue Tree uses “market value accounting” while the other two companies use “historical cost

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accounting”, we still see an improvement compared to the worst outcome under the all-3-

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companies-using-“historical cost accounting” scenario.
Correct conclusion about the managers’ Incorrect conclusion about the managers’
performance performance

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Mr. Diligent (11.0%) > Mr. Slack (8.3%) Mr. Slack (20.0%) > Mr. Good (8.3%)
Mr. Slack (20.0%) > Mr. Diligent (10.0%)
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If any two of the 3 companies use “market value accounting” while the third companies use
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“historical cost accounting”, we should see further improvement in the outcome.3

Our example here demonstrates that having all companies use “historical cost accounting” in this
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case does not improve the outcome in terms of enhancing comparability when we use the financial
statement information.
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In our example, because the ROA (and ROE) for Green Tree Limited are the same between “historical cost accounting”
and “market value accounting”, we would not be able to see any difference in the outcome between the use of the two
measurement systems by Green Tree Limited.
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