Ch23 Other Measurement and Disclosure Issues Test Bank Docx - Test Bank Intermediate Accounting v2 13e | Canada by Donald E. Kieso. DOCX document preview.
CHAPTER 23
OTHER MEASUREMENT AND DISCLOSURE ISSUES
CHAPTER STUDY OBJECTIVES
1. Understand the importance of disclosure from a business perspective. Information disclosure is important to the proper functioning of capital markets and the allocation of capital. The information provided in financial statements helps investors compare the performance of companies and assess the relative risks and returns of different investments. Financial statement preparers must keep in mind both the costs and benefits of disclosure when making their disclosure decisions. Financial statements are just one of many sources of information for investors and creditors
2. Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes. The full disclosure principle calls for financial reporting of any financial facts that are significant enough to influence the judgement of an informed reader. Implementing the full disclosure principle is difficult because the cost of disclosure can be substantial and the benefits difficult to assess. Disclosure requirements for public entities have increased because of (1) the growing complexity of the business environment, (2) the necessity for timely information, and (3) sustainability and ESG reporting. For private entities, disclosure requirements are lower due to the lesser complexity of many private entities and the fact that many stakeholders of private entities have greater access to information.
Notes are the accountant’s means of amplifying or explaining the items presented in the main body of the statements. Information that is pertinent to specific financial statement items can be explained in qualitative terms, and supplementary quantitative data can be provided to expand the information in the financial statements. Accounting policy notes explain the accounting methods and policies chosen by the company, allowing greater comparability among companies.
3. Describe the disclosure requirements for major segments of a business. If only consolidated amounts are available to the analyst, much information regarding the composition of these figures is hidden in the aggregated figures. There is no way to tell from the consolidated data how much each product line contributes to the company’s profitability, risk, and growth potential. As a result, segment information is required by the profession for public entities, including general information about reportable segments; segment revenues, profit and loss, assets, liabilities, and related information; reconciliations; information about products and services; geographical area information; and information about revenues from major customers.
4. Describe the requirements and accounting problems associated with interim reporting. Interim reports cover periods of less than one year. There are two viewpoints regarding interim reports. The discrete view holds that each interim period should be treated as a separate accounting period. In contrast, the integral view holds that the interim report is an integral part of the annual report and that deferrals and accruals should consider what will happen for the entire year. IFRS encourages the discrete view approach. The same accounting principles that are used for annual reports should generally be used for interim reports; however, there are several unique reporting problems, such as seasonality and presentation of earnings per share.
5. Discuss the accounting issues for related-party transactions. Related-party transactions pose special accounting issues. Because the transactions are not at arm’s length, they may have to be remeasured under ASPE, as the exchange amount is not necessarily representative of the market or fair value. Without reliable information, the transaction may have to be remeasured to reflect historical values or carrying amounts. IFRS does not require remeasurement of related-party transactions, whereas ASPE does.
6. Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses. There are two types of subsequent everts. The first provides additional evidence about an event that existed at the statement of financial position date. These events should be reflected in the SFP and income statement. The second type of event provides evidence about events or transactions that did not exist at the SFP date. These events should be disclosed in notes if they will have a material impact on the company’s future.
The accounting issues faced by unincorporated businesses are similar to those that are incorporated, with a few exceptions such as (a) defining the economic entity (b) the need to clearly indicate salaries, interest, or similar items accruing to owners (c) the lack of a requirement for a provision for income taxes, and (d) the need detail the changes in owners’ equity during the period in the financial statements.
7. Identify the major considerations relating to bankruptcy and receivership. Bankruptcy is a legal process that occurs when a company (or individual) is unable to pay its debts. The Office of the Superintendent of Bankruptcy administers the bankruptcy process in Canada. Companies facing bankruptcy can make a proposal to pay their creditors a percentage of what was owed at the time of the proposal, or they could request an extension to the time available to pay off their debts (or both). A receivership process is typically started by a secured creditor, or a group of secured creditors, if a company defaults on a loan. A receiver is appointed by the bankruptcy court. A receivership and a bankruptcy could occur at the same time, and two different companies could be appointed for the roles of receiver and trustee in bankruptcy.
8. Identify the major disclosures found in the auditor’s report. If the auditor is satisfied that the financial statements present fairly, in all material respects, the financial position, its financial performance and its cash flows in accordance with GAAP, the auditor expresses an unmodified opinion. A qualified opinion contains an exception to the standard opinion; however, the exception would not be significant enough to invalidate the statements as a whole. An adverse opinion is required in any report in which the exceptions to fair presentation are so pervasive that a qualified opinion is not justified. A disclaimer of an opinion is appropriate when the auditor has gathered insufficient information on the financial statements so that no opinion can be expressed
9. Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis. Various techniques are used in the analysis of financial statement data. These include ratio analysis, common-size analysis, trend analysis, and examination of related data (in notes and other sources). No one technique is always more useful than another. Every situation faced by the analyst is different, and the answers needed are often obtained only on close examination of the interrelationships among all the data provided. Ratio analysis is a starting point in developing information desired by an analyst. While the basic concepts and tools for analysis are provided, keep in mind that there are limitations inherent in individual financial statement analysis techniques. For more complex techniques, you should refer to textbooks and courses that focus extensively on financial statement analysis.
10. Identify the major differences in accounting between IFRS and ASPE, and what changes are expected in the near future. Differences are noted in the chapter and the comparison chart in Illustration 23.12. No significant changes are expected in the near future. However, the OSC has released proposed amendments to its continuous disclosure requirements. In addition, IASB plans to update its Management Commentary Practice statement and issued a new Exposure Draft in 2021 to start the process.
Multiple Choice QUESTIONS
Answer No. Description
b 1. Components of annual report
a 2. Increased disclosure requirements
d 3. Disclosure of significant accounting policies
c 4. Definition of errors and irregularities
c 5. Criteria for reporting segmented information
d 6. Financial statement notes
b 7. Disclosure differences between IFRS and ASPE
d 8. Segment revenue test
b 9. Segment revenue test
c 10. IFRS disclosures for reportable segments
a 11. IFRS requirements for reporting segmented information
d 12. Operating segment characteristics
c 13. Identification of reportable segments
b 14. Identification of a reportable segment
a 15. Identification of a reportable segment
b 16. Identification of a reportable segment
b 17. Identification of a reportable segment
d 18. IFRS requirements for interim reporting
b 19. Discrete view for interim reporting
a 20. Discrete view for interim reporting
a 21. IFRS requirements for interim reporting
c 22. Problems with interim reporting
c 23. Bonus expense on quarterly income statement
b 24. Property taxes and repairs recognized in interim period
c 25. Annual expenses to be reported in interim statements
d 26. One time only and annual expense to be reported in interim statements
d 27. Related-party transactions
c 28. Related-party transactions
d 29 Related party transaction – ASPE
c 30. Related party transaction – IFRS
c 31. Subsequent events requiring adjustments
d 32. Subsequent events requiring disclosure only
a 33. Accounting for unincorporated businesses
d 34. Accounting for unincorporated businesses
a 35. Determine reportable segments
b 36. Auditor’s unmodified opinion
d 37. Auditor’s qualified opinion
c 38. Auditor’s adverse opinion
c 39. Auditor’s report
b 40. Limitations of financial statement analysis
a 41. Ratios reflecting financial strength
c 42. Ratios assessing management performance
c 43. Profitability ratios
d 44. Activity ratios
b 45. Calculate current ratio
c 46. Calculate inventory turnover
Answer No. Description
c 47. Calculate profit margin on sales
a 48. Calculate debt to asset ratio
d 49. Calculate debt to equity ratio
b 50. Calculate accounts receivable turnover
b 51. Guidance given by ASPE and IFRS
Exercises
Item Description
E23-52 Public company key disclosure requirements
E23-53 IFRS Practice Statement
E23-54 Notes to financial statements
E23-55 Segmented reporting and disclosure requirements
E23-56 Interim reporting
E23-57 Income taxes at interim dates
E23-58 Ratios for financial analysis
E23-59 Related Party disclosures
E23-60 Activity financial ratios
PROBLEMS
Item Description
P23-61 Segmented reporting (IFRS requirements)
P23-62 Segmented reporting and disclosure requirements
P23-63 Interim reporting
P23-64 Types of subsequent events
P23-65 Bankruptcy and types of creditors
P23-66 Auditor’s report
P23-67 Uncertainty and financial information
P23-68 Ratio analysis
P23-69 Ratio Analysis
MULTIPLE CHOICE QUESTIONS
1. Which of the following items found in an annual report is NOT subject to GAAP?
a) financial statements
b) management discussion and analysis
c) inventory methods
d) accounting policies
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
2. Reasons for increased disclosure requirements do NOT include
a) the current government trend toward reducing income taxes.
b) the necessity for timely information.
c) the complexity of the business environment.
d) accounting as a control and monitoring device.
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
3. Which of the following does NOT need be disclosed in a Summary of Significant Accounting Policies?
a) inventory valuation method(s)
b) revenue recognition method(s)
c) depreciation and amortization method(s)
d) claims of shareholders
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
4. Errors and irregularities are defined as intentional distortions of facts. Yes or No?
Errors Irregularities
a) yes yes
b) yes no
c) no yes
d) no no
Difficulty: Medium
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
5. Which of the following facts concerning property, plant and equipment should be included in the Summary of Significant Accounting Policies?
Depreciation Composition
Method of Assets
a) no yes
b) yes yes
c) yes no
d) no no
Difficulty: Medium
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
6. Which of the following is INCORRECT regarding the notes to the financial statements?
a) The notes are often overlooked because they are highly technical.
b) The notes are the accountant’s means of amplifying items presented in the statements.
c) The notes present information that is not included in the financial statements.
d) The notes often have limited value for users.
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
7. Which of the following statements best describes the difference in the disclosure requirements between IFRS and ASPE?
a) The disclosure requirements are generally the same under both IFRS and ASPE.
b) The disclosure requirements for publicly traded companies have increased substantially in the past two decades.
c) The disclosure requirements are more pervasive under ASPE.
d) Privately held companies using IFRS do not need to adhere to the same reporting disclosure requirements as publicly traded companies.
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
8. According to IFRS, an operating segment is a reportable segment if
a) its operating profit is 10% or more of the combined operating profit of profitable segments only.
b) its operating loss is 10% or more of the combined operating losses of segments that incurred an operating loss.
c) the absolute amount of its operating profit or loss is 10% or more of the greater, in absolute amount, of (a) the combined reported operating profit of all operating segments that incurred a loss, and (b) the combined reported profit of all operating segments that did report a profit.
d) the absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of (a) the combined reported operating profit of all operating segments that did not incur a loss, or (b) the combined reported loss of all operating segments that did report a loss.
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
9. According to IFRS, a segment of a business is to be reported separately when its reporting revenue (including both sales to external customers and intersegment sales or transfers) exceeds 10% of the
a) total domestic sales only.
b) combined revenues of all the enterprise's operating segments.
c) combined revenues of all the enterprise’s profitable operating segments.
d) combined net income of all the enterprise’s profitable operating segments.
Difficulty: Easy
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
10. IFRS requires that all of the following information about each reportable segment must be provided except
a) total liabilities.
b) interest revenue.
c) cost of goods sold.
d) income tax expense or benefit.
Difficulty: Easy
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
11. Although ASPE does NOT offer guidance for reporting segmented information, IFRS requires that
a) financial statements include selected information on a single basis of segmentation.
b) financial statements include selected information on multiple bases of segmentation.
c) financial statements disclose results for every segment, regardless of how many there are.
d) management segment the enterprise on a geographical basis only.
Difficulty: Easy
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
12. Which of the following is NOT a component or characteristic of operating segments?
a) The operating segment engages in business activities from which it earns revenues and incurs expenses.
b) The segments operating results are regularly reviewed by the company’s chief operating decision-maker to assess segment performance and allocate resources to the segment.
c) The operating segment(s) have discrete financial information available for it.
d) Operating segments must be aggregated together for reporting purposes.
Difficulty: Easy
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
13. Gooseberry Corp. is a multidivisional corporation that has both intersegment sales and sales to external customers. Gooseberry should report segmented financial information for each division meeting which of the following IFRS criteria?
a) segment profit or loss is 10% or more of consolidated profit or loss
b) segment profit or loss is 10% or more of combined profit or loss of all company segments
c) segment revenue is 10% or more of combined revenue of all the company segments
d) segment revenue is 10% or more of consolidated net income
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
14. Presented below are four segments that have been identified by Mango Corp.:
Operating
Segments Total Revenue Profit (Loss) Assets
A $300,000 $40,000 $1,200,000
B 800,000 (70,000) 1,200,000
C 300,000 6,000 600,000
D 120,000 8,000 300,000
According to IFRS, which segments would be considered reportable segments?
a) Segments A, B, and C
b) Segments A, B, C, and D
c) Segments A and B
d) Segments A and D
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Revenue test: Total revenue = $1,520,000 × 10% = $152,000
Operating profit test: $54,000 × 10% = $5,400
Asset test: Total assets = $3,300,000 × 10% = $330,000
15. Presented below are four segments that have been identified by Banana Corp.:
Operating
Segments Total Revenue Profit (Loss) Assets
A $300,000 $40,000 $1,200,000
B 100,000 (50,000) 300,000
C 30,000 6,000 100,000
D 12,000 2,000 30,000
According to IFRS, which segments would be considered reportable segments?
a) Segments A, B, and C
b) Segments A, B, C, and D
c) Segments A and B
d) Segments A and D
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Revenue test: Total revenue = $442,000 × 10% = $44,200
Operating profit test: $48,000 × 10% = $4,800
Asset test: Total assets = $1,630,000 × 10% = $163,000
16. Melon Corp. is engaged in manufacturing operations in various industries. The following data pertain to the industries in which operations were conducted for the year ended December 31, 2023.
Assets
Industry Revenue Profit 12/31/23
A $10,000,000 $1,650,000 $20,000,000
B 8,000,000 1,400,000 17,500,000
C 6,000,000 1,200,000 12,500,000
D 3,000,000 550,000 6,500,000
E 4,250,000 675,000 7,000,000
F 1,500,000 225,000 3,000,000
$32,750,000 $5,700,000 $66,500,000
According to IFRS, how many reportable segments does Melon have?
a) three
b) four
c) five
d) six
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Revenue test: $32,750,000 × 10% = $3,275,000
Profit test: $5,700,000 × 10% = $570,000
Asset test: $66,500,000 × 10% = $6,650,000
A, B, C, E
17. The following information pertains to Freeman Corp. and its various divisions for the year ended December 31, 2023:
Sales to external customers $2,250,000
Intersegment sales of products similar to those sold to
external customers 675,000
Interest earned on loans to other operating segments 45,000
According to IFRS, Freeman has a reportable segment if that segment's revenue equals or exceeds
a) $297,000.
b) $292,500.
c) $229,500.
d) $225,000.
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($2,250,000 + $675,000) × 10% = $292,500
18. For interim reporting, IFRS does NOT require a
a) comprehensive income statement.
b) statement of shareholders’ equity.
c) statement of cash flows.
d) detailed statement of financial position.
Difficulty: Easy
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
19. When using the discrete view to prepare interim statements, two exceptions that are permitted deal with the calculation of
a) depreciation and income tax expense.
b) income tax expense and employer’s payroll tax expense.
c) depreciation and unearned revenue.
d) unearned revenue and employer’s payroll tax expense.
Difficulty: Easy
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
20. Under the discrete view to interim financial reporting
a) each interim period should be treated as a separate accounting period.
b) each interim period should be treated as an integral part of the annual period.
c) the total estimated annual income tax expense is allocated to the interim period.
d) all of the above statements are consistent with the discrete view to interim financial reporting.
Difficulty: Easy
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
21. Which of the following statements is INCORRECT regarding IFRS requirements for interim reporting?
a) Only a statement of financial position and statement of comprehensive income are required.
b) The same accounting policies should be used as for the annual statements.
c) When an accounting change is applied retrospectively, the enterprise must present a statement of financial position for the beginning of the earliest comparative period.
d) Condensed financial statements are permitted.
Difficulty: Easy
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
22. Problems with interim reporting include
a) how to record depreciation.
b) inventory valuation.
c) how to present a change in accounting policy/principle.
d) revenue recognition.
Difficulty: Easy
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
23. In January 2023, Ricardo Ltd. estimated that its year-end bonuses to executives for calendar 2023 would be $960,000. In February 2023, $870,000 was paid in bonuses for the 2022 year end. The estimate for 2023 is subject to year-end adjustment. How much bonus expense should be reflected in Ricardo’s interim income statement for the three months ended March 31, 2023?
a) $960,000
b) $870,000
c) $240,000
d) $217,500
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $960,000 ÷ 4 = $240,000
24. On January 15, 2023, Link Corp. paid $480,000 in property taxes on its factory building for the calendar year 2023. In the first week of April 2023, the corporation made unanticipated repairs to its plant equipment at a cost of $1,200,000. How should these expenses be reflected in Link’s quarterly income statements?
Three Months Ended
3/31/23 6/30/23 9/30/23 12/31/23
a) $120,000 $520,000 $520,000 $520,000
b) $120,000 $1,320,000 $120,000 $120,000
c) $480,000 $1,200,000 $-0- $-0-
d) $420,000 $420,000 $420,000 $420,000
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $480,000 ÷ 4 = $120,000
25. Mason Corp. has estimated that total depreciation expense for the 2023 calendar year will be $240,000, and that 2023 year-end bonuses to employees will be $480,000. In Mason’s interim income statement for the six months ended June 30, 2023, what total expense relating to these two items should be reported?
a) $0
b) $120,000
c) $360,000
d) $720,000
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($240,000 + $480,000) ÷ 2 = $360,000
26. Blueberry Corp. had the following transactions during the quarter ended March 31, 2023:
Loss due to theft $189,000
Payment of fire insurance for calendar year 2023 270,000
What amount should be included in Blueberry’s income statement for the quarter ended March 31, 2023?
Loss from Theft Insurance Expense
a) $0 $270,000
b) $189,000 $270,000
c) $31,500 $67,500
d) $189,000 $67,500
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Loss from theft = $189,000
Insurance expense = $270,000 ÷ 4 = $67,500
27. Regarding related-party transactions,
a) transactions between related parties are usually presumed to take place at arms length.
b) related parties do not include members of the immediate family of company management.
c) both IFRS and ASPE deal only with disclosure requirements for such transactions.
d) ASPE requires that some related-party transactions be remeasured.
Difficulty: Easy
Learning Objective: Discuss the accounting issues for related-party transactions.
Section Reference: Related-Party Transactions
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
28. Grapes Ltd. has a 55% ownership interest in Merlot Corp. as of its December 31st year end. Grapes sells product to Merlot on a regular basis. Of the total $3,500,000 sales for the year, $700,000 of sales was to Merlot, which is used as an input in its production process. All inventory is sold by year end. How would Merlot report this disclosure in the notes of its financial statements?
a) Inter-Company Sales $700,000
b) Inter-Company Sales $3,500,000
c) Inter-Company Cost of Goods Sold $700,000
d) Inter-Company Cost of Goods Sold $3,500,000
Difficulty: Easy
Learning Objective: Discuss the accounting issues for related-party transactions.
Section Reference: Related-Party Transactions
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
29. Under ASPE, when related party transactions are remeasured to carrying value, the difference between the carrying amounts of the items exchanged is booked as
a) an adjustment to the related liability account.
b) an adjustment to the related asset account.
c) an adjustment to the related expense account.
d) a charge or credit to equity.
Difficulty: Easy
Learning Objective: Discuss the accounting issues for related-party transactions.
Section Reference: Related-Party Transactions
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
30. Under IFRS, related party transactions should be remeasured when
a) there is a lack of economic substance.
b) the transaction is not in the normal course of operations.
c) IFRS does not require the remeasurement of related party transactions.
d) the transaction does not result in a significant change in ownership.
Difficulty: Easy
Learning Objective: Discuss the accounting issues for related-party transactions.
Section Reference: Related-Party Transactions
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
31. Which of the following subsequent events (post-statement of financial position events) would require adjustment of the accounts before issuance of the financial statements?
a) major losses as a result of a fire in the company’s plant
b) decline in the fair value of investments
c) loss on an account receivable (on the books at statement of financial position date) resulting from a customer’s bankruptcy
d) lawsuit arising from a customer’s injury due to a defective product
Difficulty: Medium
Learning Objective: Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses.
Section Reference: Other Accounting Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
32. Which of the following subsequent events (post-statement of financial position events) would generally require disclosure in the financial statement notes, but NOT adjustment of the accounts?
a) retirement of the company president
b) settlement of a lawsuit when the event that gave rise to the action occurred prior to the statement of financial position date
c) strike by the company’s unionized workers
d) issue of a significant number of common shares
Difficulty: Medium
Learning Objective: Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses.
Section Reference: Other Accounting Issues
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
33. Accounting issues involved for unincorporated businesses include
a) the definition of the economic entity.
b) who owns the issued shares.
c) segregating the salaries expense for the owner(s) from the salaries expense for the employees.
d) provision for income taxes.
Difficulty: Easy
Learning Objective: Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses.
Section Reference: Other Accounting Issues
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
34. Which of the following issues does NOT apply to unincorporated businesses?
a) whether of not the entity is a separate legal entity
b) salaries, interest, or similar items accruing to owners should be clearly indicated
c) No provision for income taxes should be made.
d) the share structure and ownership
Difficulty: Easy
Learning Objective: Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses.
Section Reference: Other Accounting Issues
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
35. In which order of preference are a company’s creditors paid in the event of bankruptcy?
a) Secured first, then preferred, then unsecured
b) Preferred first, then secured, then unsecured
c) Secured first, then unsecured, then preferred
d) Any may be applied, according to agreements among the creditors.
Difficulty: Easy
Learning Objective: Identify the major considerations relating to bankruptcy and receivership.
Section Reference: Bankruptcy and Receivership
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
36. When an auditor expresses an unmodified opinion about a company’s financial statements, it means that the financial statements
a) are free from error.
b) present fairly the financial position, results of operations, and cash flows in accordance with GAAP.
c) indicate that the company is doing well and would make a good investment.
d) contain exceptions due to a departure from GAAP.
Difficulty: Easy
Learning Objective: Identify the major disclosures found in the auditor’s report.
Section Reference: Auditor’s Reports
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
37. When an auditor expresses a qualified opinion about a company’s financial statements, it means that the financial statements
a) are free from error.
b) present fairly the financial position, results of operations, and cash flows in accordance with GAAP.
c) indicate that the company is doing well and would make a good investment.
d) contain exceptions due to a departure from GAAP.
Difficulty: Easy
Learning Objective: Identify the major disclosures found in the auditor’s report.
Section Reference: Auditor’s Reports
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
38. An auditor’s adverse opinion
a) although very rare in the past, is frequently seen nowadays.
b) means the financial statements are prepared in accordance with GAAP.
c) is given when the auditor deems a qualified opinion is not justified.
d) means there are some minor exceptions due to a departure from GAAP.
Difficulty: Easy
Learning Objective: Identify the major disclosures found in the auditor’s report.
Section Reference: Auditor’s Reports
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
39. Which of the following reporting standards is NOT required with the auditor's report?
a) The report must contain an expression of opinion regarding the compliance of the financial statements with GAAP.
b) The report must identify circumstances in which the auditor was unable to complete his or her work.
c) The report must clearly state whether the company has appropriate internal controls in place.
d) The report must contain all of the information listed here.
Difficulty: Easy
Learning Objective: Identify the major disclosures found in the auditor’s report.
Section Reference: Auditor’s Reports
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
40. Which of the following is NOT a limitation of financial statement analysis?
a) Financial statements report on the past.
b) Ratio and trend analyses will help identify strengths and weaknesses of a company.
c) A single ratio, by itself, is not likely to be very useful.
d) Financial statement analysis is not likely to reveal why things are as they are.
Difficulty: Easy
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
41. The ratios that reflect financial strength are
a) liquidity and coverage ratios.
b) liquidity and profitability ratios.
c) profitability and activity ratios.
d) activity and coverage ratios.
Difficulty: Easy
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
42. The ratios that assess management performance are
a) liquidity and coverage ratios.
b) liquidity and profitability ratios.
c) profitability and activity ratios.
d) activity and coverage ratios.
Difficulty: Easy
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
43. Profitability ratios
a) measure the enterprise’s long-term ability to pay its maturing obligations.
b) measure how effectively the enterprise is using its assets.
c) measure financial performance and shareholder value creation for a specific time period.
d) measure a company’s ability to meet its long-term obligations.
Difficulty: Easy
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
44. Activity ratios
a) measure the enterprise’s short-term ability to pay its maturing obligations.
b) measure financial performance and shareholder value creation for a specific time period.
c) measure a company’s ability to meet its long-term obligations.
d) measure how effectively the enterprise is using its assets.
Difficulty: Easy
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
45. Power Corp. reported the following data for calendar 2023:
Total assets $ 625,000
Current assets 325,000
Total liabilities 300,000
Long-term liabilities 145,000
Inventories, December 31/22 110,000
Inventories, December 31/23 100,000
Net sales 1,550,000
Gross profit 920,000
Net income 205,000
To two decimals, Power Corp.’s current ratio for 2023 is
a) 1.08.
b) 2.10.
c) 2.08.
d) 0.92.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $325,000 ÷ ($300,000 – $145,000) = 2.10
46. Power Corp. reported the following data for calendar 2023:
Total assets $ 625,000
Current assets 325,000
Total liabilities 300,000
Long-term liabilities 145,000
Inventories, December 31/22 110,000
Inventories, December 31/23 100,000
Net sales 1,550,000
Gross profit 920,000
Net income 205,000
To two decimals, Power Corp.’s inventory turnover for 2023 is
a) 14.76.
b) 12.81.
c) 6.00.
d) 3.00.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($1,550,000 – $920,000) ÷ [($100,000 + $110,000) ÷ 2] = 6.00
47. Power Corp. reported the following data for calendar 2023:
Total assets $ 625,000
Current assets 325,000
Total liabilities 300,000
Long-term liabilities 145,000
Inventories, December 31/22 110,000
Inventories, December 31/23 100,000
Net sales 1,550,000
Gross profit 920,000
Net income 205,000
Power Corp.’s profit margin on sales for 2023 is
a) 7.56%.
b) 168.48%.
c) 13.23%.
d) 59.35%.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $205,000 ÷ $1,550,000 x 100 = 13.23%
48. Power Corp. reported the following data for calendar 2023:
Total assets $ 625,000
Current assets 325,000
Total liabilities 300,000
Long-term liabilities 145,000
Inventories, December 31/22 110,000
Inventories, December 31/23 100,000
Net sales 1,550,000
Gross profit 920,000
Net income 205,000
Power Corp.’s debt to asset ratio for 2023 is
a) 48.0%.
b) 23.2%.
c) 208.3%.
d) 224.1%.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $300,000 ÷ $625,000 x 100 = 48.0%
49. Power Corp. reported the following data for calendar 2023:
Total assets $ 625,000
Current assets 325,000
Total liabilities 300,000
Long-term liabilities 145,000
Inventories, December 31/22 110,000
Inventories, December 31/23 100,000
Sales 1,550,000
Gross profit 920,000
Net income 205,000
Power Corp.’s debt to equity ratio for 2023 is
a) 44.6%.
b) 48.0%.
c) 23.2%.
d) 92.3%.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $300,000 ÷ ($625,000 – $300,000) x 100 = 92.31%.
50. Prune Juice Corp. reported the following data on its 2023 financial statements:
Net sales $1,350,000
Net income $240,000
Average net receivables $185,000
To two decimals, the accounts receivable turnover for 2023 is
a) 5.63.
b) 7.30.
c) 8.59.
d) 0.14.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $1,350,000 ÷ $185,000 = 7.30
51. Which statement is INCORRECT regarding guidance given by IFRS and ASPE?
a) IFRS provides guidance for interim reporting, while ASPE does not.
b) ASPE provides guidance for segmented reporting, while IFRS does not.
c) IFRS provides guidance for segmented reporting, while ASPE does not.
d) IFRS does not provide guidance for reporting on unincorporated businesses.
Difficulty: Easy
Learning Objective: Identify the major differences in accounting between IFRS and ASPE, and what changes are expected in the near future.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Exercises
Ex. 23-52 Public company key disclosure requirements
The Ontario Securities Commission provides guidance on the key disclosure requirements for public companies.
Instructions
a) Identify the seven key disclosure documents required as per the OSC.
b) CRITICAL THINKING: Are the disclosure requirements different under ASPE? Explain why or why not?
Solution 23-52
a) The Ontario Securities Commission (OSC) lists the following key disclosure documents for public companies on its website:
• Annual information forms
• Financial statements
• Management information circulars
• Management’s discussion and analysis (MD&A)
• Material change reports
• News releases relating to material changes and earnings releases
• Prospectuses
b) CRITICAL THINKING: Generally, there are fewer disclosure requirements under ASPE because many private entities have less complex business transactions and stakeholders have greater access to information about the entity.
Difficulty: Medium
Learning Objective: Understand the importance of disclosure from a business perspective
Section Reference: The Importance of Disclosure from a Business Perspective
Learning Objective: Identify the major differences in accounting between IFRS and ASPE, and what changes are expected in the near future.
Section Reference: IFRS/ ASPE Comparison
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Communication
Ex. 23-53 IFRS Practice Statement
The IASB issued “Management Commentary: A Framework for Presentation” as an IFRS Practice Statement in December 2010 to help guide companies and regulators. What three things should a company provide as suggested by the Practice Statement?
Solution 23-53
The Practice Statement suggests that companies provide management’s perspective on the company’s performance, financial position, and progress (for example, how it has grown and is expected to change and grow in the future).
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes
Section Reference: Full Disclosure Principle
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication
Ex. 23-54 Notes to financial statements
An article in Dun's Review made the following comments: "At least every other year, businesses should print the notes in big type and the financial figures in smaller ones."
Instructions
a) Explain why you think that Dun’s Review made this comment. As part of your answer consider the role and basic purposes that the notes to the financial statements serve.
b) What are the general types of notes?
Solution 23-54
a) Notes are an integral part of the financial statements of a business enterprise. They are the accountant's method of more fully disclosing data relevant to the interpretation of the statements. Information pertinent to specific financial statement items can be explained in qualitative terms, and supplementary data of a quantitative nature can be provided to expand on the information in the financial statements. Restrictions imposed by financial arrangements or basic contractual agreements can also be explained in notes.
b) The more common types of notes disclose such items as the following: (1) accounting methods used for depreciation, amortization and inventory, (2) contingent assets or liabilities, (3) restrictions required by loan covenants, (4) revenue recognition methods, and (5) purchase commitments.
Difficulty: Easy
Learning Objective: Review the full disclosure principle and how it is implemented, and explain how companies use accounting policy notes.
Section Reference: Full Disclosure Principle
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Ex. 23-55 Segmented reporting and disclosure requirements
Laser Corporation is a publicly traded company. It's most recent (condensed) income statement is presented below:
Revenues $2,500,000
Expenses $1,600,000
Income before taxes 900,000
Income tax expense 270,000
Net income $ 630,000
The following data relates to Laser’s operating segments:
Percent Identified with Segment
Printing Digital Media
Revenues 60% 35% 5%
Expenses 63 35 2
Instructions
Based only on the above information, which segments must be reported and why? Show your work.
Solution 23-55
Operating Segment
Printing Digital Media Totals
Revenues $1,500,000 $875,000 $125,000 $2,500,000
Expenses 1,008,000 560,000 32,000 1,600,000
Operating profit $ 492,000 $315,000 $ 93,000 $ 900,000
Taxes 147,600 94,500 27,900 270000
Net Income $ 344,400 $220,500 $ 65,100 $ 630,000
Operating Segment Test
Revenue 10% Met Met Not met
Net Income 10% Met Met Met
All three segments are reportable. Printing and Digital satisfy the revenue test; while all three satisfy the Net Income test.
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 23-56 Interim reporting
Years ago, a publishing company reported a quarterly net profit figure that exceeded sales for that quarter. Such a situation suggests there are some difficult accounting issues involved in interim reporting.
a) What are the major accounting problems related to interim reports?
b) What problem exists with income taxes in interim reports and how does IFRS recommend that income taxes should be reported?
c) Many academics have attempted to predict the year's net income after the first quarter's income is reported. These attempts are generally unsuccessful, no matter how sophisticated the prediction model. What might be the reason for this inability to predict?
Solution 23-56
a) The major accounting issues related to interim reporting are the treatment of (1) annually determined items such as income taxes, pension costs, and executive compensation based on annual net income, (2) retrospective accounting changes, (3) earnings per share, and (3) the problem of seasonality.
b) The basic question with income taxes is whether, in the preparation of interim income statements, the provision for taxes should reflect the anticipated effective tax rate for the year or be calculated on the basis of actual results for that interim period. IFRS recommends that at the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. This rate should then be used in estimating income taxes on a current year-to-date basis.
c) The prediction models are probably unsuccessful because accountants have not treated the problem of seasonality correctly in their interim reports. One of the problems is that fixed nonmanufacturing costs are not charged in proportion to sales. Instead, these costs are charged as incurred, or spread evenly over each quarter. As a result, it is extremely difficult to make accurate predictions because some artificial concepts are used for matching purposes.
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 23-57 Income taxes at interim dates
The CEO of Umbrella Inc. wants an exact figure for the corporate taxes owing in F2023, the company year end is July 31. If is now January 15, 2023, and the CEO would like you to provide this information to him by January 31. The CEO is certain the net income before tax will be $10,000,000, this represents a 10% year over year increase, and that the income tax rate will remain steady at 25%.
Instructions
As the controller, how do you respond to the CEO’s request?
Solution 23-57
It is not feasible to prepare an accurate estimate of income taxes on interim statements as the tax rate is often dependent on the total taxable income for the year. As a result, interim income taxes are estimated using the annual estimated tax rate applied to the estimated interim taxable income and temporary differences.
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 23-58 Ratios for financial analysis
Alberta Company is a privately held company that would like to provide more useful information to the users of its financial statements. Specifically, it would like to make the information easy to analyze and access. The CEO would like to move away from paper-based reporting and make all of Alberta Company’s information available on the internet. As the controller you have been asked to provide your recommendation on this.
Instructions
As part of your response please answer the following questions:
a) Identify the major categories of ratios that can be used for analysis. Describe how the ratios for each category would be used and provide examples of each.
b) Identify and discuss the advantages and disadvantages of internet versus paper-based reporting.
Solution 23-58
a) The four major types of ratios are:
1. Liquidity ratios, which measure the enterprise’s short-term ability to pay obligations as they become due. Examples are the current ratio and the acid-test ratio.
2. Activity ratios, which measure how effectively the enterprise is using its assets, as well as how quickly the asset’s value is realized. Examples are the inventory turnover and asset turnover ratios.
3. Profitability ratios, which measure financial performance and shareholder value creation for a specific time frame. Examples are profit margin on sales and rate of return on common shareholders’ equity.
4. Coverage (solvency) ratios, which measure the degree of protection for long-term creditors and investors, or the enterprise’s ability to meet long-term obligations. Examples are debt to total assets and times interest earned.
Liquidity and coverage ratios generally reflect financial strength, i.e., the ability to satisfy the financial requirements of non-ownership interests.
Activity and profitability ratios are generally used to assess management performance.
b) Advantages of internet reporting include the possibility of communicating with more users, lower costs of communication, the ability of users to use internet and computer tools to help in analysis of financial statements, more timely information, and the possibility of increased availability of information. Possible disadvantages are the differential access due to less than universal access to the internet and issues around reliability of the information, including the possibility of data corruption by hackers and the unaudited nature of much of the information.
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 23-59 Related Party disclosures
The CEO of Melet Plastics Inc. authorized an inter-company transfer from Reliable Resins to Melet. Melet is a major customer of Reliable Resins and the CEO of Melet Plastics is the sole shareholder of Melet and a 50% shareholder of Reliable Resins. The controller issues the transfer but recommends that the details of the transfer be disclosed in the financial statements. The CEO disagrees. He believes that only publicly traded companies require disclosures for related party transactions and since both companies are privately held and report under ASPE, no disclosures are required.
Instructions
As the controller provide a response to the CEO. As part of your explanation include a discussion regarding all the types of disclosures that are recommended under ASPE versus IFRS.
Solution 23-59
An accountant, in this case the controller, is expected to report the economic substance rather than the legal form of related party transactions under ASPE and to make adequate disclosures. The following disclosures are recommended:
1. The nature of the relationship(s) involved
2. A description of the transactions
3. The recorded amounts of transactions
4. The measurement basis that was used
5. Amounts due from or to related parties and the related terms and conditions
6. Contractual obligations with related parties
7. Contingencies involving related parties
8 Under IFRS, management compensation and the name of the entity’s parent company as well as its ultimate controlling entity or individual
Difficulty: Easy
Learning Objective: Discuss the accounting issues for related-party transactions
Section Reference: Related-Party Transactions
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication
Ex. 23-60 Activity financial ratios
The following select information is taken from Mercury Corp.’s statements of financial position at December 31, 2022 and 2023, and their income statement for calendar 2023:
2023 2022
Accounts receivable 570,000 480,000
Inventory 195,000 217,500
Total assets $2,700,000 $2,475,000
Net income $315,000
Net Sales (all on credit) 2,700,000
Cost of goods sold 1,050,000
Instructions
From the above information, to one decimal, calculate the following for 2023:
a) Inventory turnover
b) Receivables turnover
c) Asset turnover
Solution 23-60
a) Inventory turnover (cost of goods sold ÷ average INVT):
$1,050,000 ÷ [($195,000 + $217,500) ÷ 2] = 5.1 times
b) Receivables turnover (net sales ÷ average A/R):
$2,700,000 ÷ [$570,000 + $480,000 ÷ 2] = 5.1 times
c) Asset turnover (net sales ÷ average total assets):
$2,700,000 ÷ [$2,700,000 + $2,475,000 ÷ 2] = 1.04 times
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
PROBLEMS
Pr. 23-61 Segmented reporting (IFRS requirements)
A central issue in reporting on operating segments of a business enterprise is the determination of which segments are reportable under IFRS.
Instructions
a) According to IFRS, what are the tests to determine whether or not an operating segment is reportable?
b) What is the test to determine if enough operating segments have been separately reported upon, and what is the guideline on the maximum number of operating segments to be shown?
Solution 23-61
a) There are three basic tests to be applied to segments of an industry to see if they are significant enough to be separately reportable. If a segment meets any one of the tests, it is deemed significant and reportable.
The first test is based on revenue. If a segment's revenue from sales to external customers and intersegment sales and transfers is equal to 10% or more of the enterprise's combined revenues, the segment is reportable.
The second test is based on profits or losses. A segment is deemed reportable if the absolute amount of its profit or loss is 10% or more of the greater, in absolute amount, of:
The combined profits of all operating segments reporting profits.
The combined losses of all operating segments reporting losses.
Third, a segment is reportable if its assets equal or exceed 10% of the combined assets of all operating segments of the enterprise.
b) Enough operating segments must be separately reported so that the total of revenues from sales to external customers for the reportable segments equals or exceeds 75% of the combined sales to external customers for the entire enterprise. If applying the prescribed tests does not yield the required percentage of revenues described above, additional segments must be reported on until the 75% test is met.
The profession recognizes that if an enterprise has many reportable segments, the benefit to the reader may be lost if more than 10 segments are reported. Therefore, it has proposed ten segments as an upper limit for the number of reportable segments.
Note that ASPE does not provide guidance for reporting segmented information.
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Pr. 23-62 Segmented reporting and disclosure requirements
Tangerine Corporation is a publicly traded company. It's most recent (condensed) income statement is presented below:
Revenues $2,500,000
Expenses
Cost of goods sold $1,000,000
Operating and administrative expenses 500,000
Depreciation expense 100,000 1,600,000
Income before taxes 900,000
Income tax expense 270,000
Net income $ 630,000
Earnings per share (100,000 shares) $6.30
The following data relates to Tangerine's operating segments:
Percent Identified with Segment
Hotels Grains Candy
Revenues 42% 50% 8%
Cost of goods sold 48 49 3
Operating and administrative expenses 35 50 15
Depreciation expense 46 42 12
Included in the amounts allocated to each segment on the above percentages are the following expenses, which relate to general corporate activities:
Operating Segment
Hotels Grains Candy Totals
Operating and administrative expenses $30,000 $22,000 $8,000 $60,000
Depreciation expense 4,000 5,000 3,000 12,000
Instructions
a) Prepare a schedule showing the amounts distributed to each segment.
b) Based only on the above information, which segments must be reported and why?
c) CRITICAL THINKING: A junior accountant with Tangerine does not understand why all of this work related to Tangerine’s operating segments needs to be done. As the controller how do you explain this to the junior accountant?
Solution 23-62
a) Operating Segment
Hotels Grains Candy Totals
Revenues (1) $1,050,000 $1,250,000 $200,000 $2,500,000
Expenses
Cost of goods sold (1) 480,000 490,000 30,000 1,000,000
Operating and admin. expense (2) 145,000 228,000 67,000 440,000
Depreciation expense (3) 42,000 37,000 9,000 88,000
Total expenses 667,000 755,000 106,000 1,528,000
Operating profit $ 383,000 $ 495,000 $ 94,000 $ 972,000
(1) Total times segment percentage.
(2) Hotels = ($500,000 × 35%) – $30,000 = $145,000
Grains = ($500,000 × 50%) – $22,000 = $228,000
Candy = ($500,000 × 15%) – $8,000 = $67,000
(3) Hotels = ($100,000 × 46%) – $4,000 = $42,000
Grains = ($100,000 × 42%) – $5,000 = $37,000
Candy = ($100,000 × 12%) – $3,000 = $9,000
b) Two segments, Hotels and Grains, must be reported because they satisfy the revenue test; that is, the segment's revenues are 10% or more of the combined revenues of all operating segments. In addition, both the Hotels and the Grains segments meet the 10% of the operating profit test.
c) CRITICAL THINKING:
Tangerine is a publicly traded company and must follow IFRS. IFRS requires that an enterprise report the following segmented information:
1. General information about its reportable segments.
2. Segment revenues, profit and loss, assets, liabilities, and related information.
3. Reconciliation of the total of the segments’ revenues to total revenues, a reconciliation of the total of operating segments’ profits and losses to its income before income taxes and discontinued operations, and a reconciliation of the total of the operating segments’ assets and liabilities to total assets and liabilities. Reconciliations for other significant items that are disclosed should also be presented.
4. Information about products and services (revenue from external customers).
5. Revenues from external customers (domestic vs foreign) and capital assets and goodwill (domestic vs. foreign). If the amounts are material, foreign information must be disclosed by country.
6. If 10% or more of the revenues are derived from a single customer, the enterprise must disclose the total amount of revenues from each of these customers by segment.
Note that ASPE does not provide guidance for reporting segmented information.
Difficulty: Medium
Learning Objective: Describe the disclosure requirements for major segments of a business.
Section Reference: Segmented Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 23-63 Interim reporting
There is ongoing discussion as to the proper method of reflecting results of operations at interim dates. Accordingly, IFRS has made recommendations regarding interim financial reporting.
Instructions
a) Discuss generally how revenue should be recognized at interim dates and specifically how revenue should be recognized for industries subject to large seasonal fluctuations in revenue and for long-term contracts using the percentage-of-completion method.
b) Discuss generally how product and period costs should be recognized at interim dates. Also discuss how inventory values should be treated at interim dates.
c) Discuss how the provision for income taxes is calculated and reported in interim financial statements.
Solution 23-63
a) Sales and other revenues should be recognized for interim financial statement purposes in the same manner as for annual reporting purposes. This means normally at the point of sale or, in the case of services, at completion of the earnings process.
In the case of industries whose sales vary greatly due to the seasonality, revenues should still be recognized as earned, but a disclosure should be made of the seasonal nature of the business.
In the case of long-term contracts recognizing earnings on the percentage-of-completion basis, the current state of completion of the contract should be estimated and revenue recognized at interim dates in the same manner as at the normal year-end.
b) For interim reporting purposes, product costs (costs directly attributable to the production of goods or services) should be matched with the product and associated revenues in the same manner as for annual reporting purposes.
Period costs (costs not directly associated with the production of a particular good or service) should be charged to earnings as incurred or allocated among interim periods based on an estimate of time expired, benefit received, or other activity associated with the particular interim period(s). Also, if a gain or loss occurs during an interim period and is a type that would not be deferred at year end, the gain or loss should be recognized in full in the interim period in which it occurs. Finally, in allocating period costs among interim periods, the basis for allocation must be supportable and may not be based on merely an arbitrary assignment of costs between interim periods.
Inventory losses from a decline in market value at interim dates should be recognized in the appropriate period unless they are temporary and no loss is expected for the fiscal year.
c) A corporation would prepare its tax return at year end and assess taxes payable and related tax balances. It is normally neither cost effective nor feasible (since tax rates are often graduated) to do this for each interim period. Therefore, an annual estimated tax rate is calculated, then an estimate is made of interim taxable income and temporary differences and then the annual estimated tax rate is applied.
Difficulty: Medium
Learning Objective: Describe the requirements and accounting problems associated with interim reporting.
Section Reference: Interim Reporting
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 23-64 Types of subsequent events
Identify and describe the difference between the two types of subsequent events.
Solution 23-64
Type 1 events provide additional evidence about situations that existed at the statement of financial position date, affecting the estimates used in preparing the financial statements and, therefore, will result in required adjustments. These items should be reflected in the final financial statements. To ignore these subsequent transactions is to miss an opportunity to improve the accuracy of the financial statements.
Type 2 events provide evidence about situations that did not exist at the statement of financial position date. They arise subsequent to the statement of financial position date, and no adjustments are made to the accounts. However, they should be afforded note disclosure if they will have a material impact on the future of the enterprise.
Difficulty: Easy
Learning Objective: Identify the accounting issues relating to subsequent events and those faced by unincorporated businesses.
Section Reference: Other Accounting Issues
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Pr. 23-65 Bankruptcy and types of creditors
Brylan Enterprises Inc. has recently run into financial difficulty and is having difficulty meeting its financial obligations. The company is publicly traded and has the following liabilities:
Current Liabilities
Bank Indebtedness $500,000
Accounts Payable 150,000
Wages Payable 75,000
GST Payable 50,000
Deferred Revenues 112,500
Total Current Liabilities $887,500
Non-Current Liabilities
Bank Loan Payable $ 850,000
Mortgage Payable 4,500,000
Bonds Payable 1,750,000
Total Non-Current Liabilities $7,100,000
The CEO has asked you, as the controller for your advice.
Instructions
Prepare a response for the CEO outlining the options available to the company. Include an explanation of the different types of creditors and how they are affected under these options. Identify what types of creditors Brylan has.
Solution 23-65
Companies facing bankruptcy can make a proposal to either pay their creditors a percentage of what was owed at the time of the proposal, or they could request an extension to the amount of time available to pay their debts (or both). The main categories of creditors affected are:
• Secured creditors. These creditors may have a lien (a legal claim on assets to secure the payment of a debt) against all or part of a debtor’s property (such as a bank with a lien on the company’s inventory that acts as security or collateral for a loan). This may include bank indebtedness, the mortgage payable and possibly the bank loan payable and bonds payable if assets have been pledged against the loans. Otherwise, the bank loan payable and bonds payable may be unsecured.
• Preferred creditors. These creditors have the first priority when claiming any funds that are available (after, for example, secured creditors take possession and dispose of their collateral). Preferred creditors typically include employee claims for unpaid wages and GST payable.
• Unsecured creditors. These creditors do not have any security or collateral for the debts owed to them. This would include accounts payable, deferred revenues, and possible the bank and bonds payable as identified above.
Difficulty: Easy
Learning Objective: Identify the major considerations relating to bankruptcy and receivership.
Section Reference: Bankruptcy and Receivership
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication
Pr. 23-66 Auditor’s report
Identify and describe the major disclosures found in the auditor’s report.
Solution 23-66
If the auditor is satisfied that the financial statements fairly present the financial position, results of operations, and cash flows, in all material respects, in accordance with generally accepted accounting principles, an unmodified opinion is expressed.
A qualified opinion contains an exception to the standard opinion; ordinarily the exception is not of sufficient magnitude to invalidate the statements as a whole. A qualified opinion may also be given if there is a scope limitation where the auditor has not been able to obtain sufficient and appropriate evidence.
An adverse opinion is required in any report in which the exceptions to fair presentation are so material that a qualified opinion is not justified. A disclaimer of an opinion is appropriate when the auditor has gathered so little information on the financial statements that no opinion can be expressed. In such a case, the financial statements taken as a whole are not presented in accordance with generally accepted accounting principles.
Difficulty: Easy
Learning Objective: Identify the major disclosures found in the auditor’s report.
Section Reference: Auditor’s Reports
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Pr. 23-67 Uncertainty and financial information
Harmat Inc. is currently assessing an opportunity to invest in Max Systems, a relatively new financial technology start-up. Max Systems has been in operations for 18 months and has made its most recent set of accountant prepared financial statements available to Harmat to assist it with making the investment decision. Harmat approaches you as a CPA to ask for advice. It specifically wants to know how reliable the financial statements are
Instructions
Provide Harmat with a report explaining all of the sources of uncertainty when considering the usefulness of financial statement information to a decision-maker.
Solution 23-67
A research study identified the following four sources of uncertainty as being important when considering the usefulness of financial statement information to a decision-maker.
1. Uncertainty about the nature and role of financial statements. Misunderstanding the nature, purpose, terminology used, and method of preparation of financial statements can lead users to misinterpret and/or place inappropriate reliance on the information.
2. Uncertainty about the nature of business operations portrayed in the financial statements. The unpredictability of business activities due to factors such as economic environment, technology, and competitors’ actions causes uncertainty. Knowledge of the type of business activities carried out is important in determining the extent of the uncertainties that characterize these activities.
3. Uncertainty due to limitations of financial statement measurements and disclosures. The conceptual framework, CPA Canada Handbook recommendations, and accounting practices provide various principles to be followed and methods used. Uncertainty occurs when the resulting measurements and disclosures are not well understood, are thought to be incomplete or lack relevance in a particular decision context.
4. Uncertainty about management’s motives and intentions. Management is responsible for determining the accounting policies and methods used to prepare the financial statements. Choice of a policy or method should be based on reflecting underlying economic reality. This source of uncertainty suggests, however, that users may suspect that management’s choices are more motivated by a need to “manage earnings” to maximize bonuses over time, or to avoid debt covenant violations.
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
Pr. 23-68 Ratio analysis
The following select information is taken from Blueberry Pie Corp.’s statements of financial position at December 31, 2022 and 2023, and their income statement for calendar 2023:
2023 2022
Assets:
Cash $ 18,000 $ 22,000
FV–NI investments 25,000 -0-
Accounts receivable 38,000 42,000
Inventory 61,000 52,000
Prepaid insurance 6,000 9,000
Long-term investments 49,000 20,000
Equipment (net) 130,000 130,000
Land 33,000 33,000
Goodwill 55,000 55,000
Total assets $415,000 $363,000
Net income $ 62,250
Sales (all on credit) 305,000
Cost of goods sold 123,000
Interest expense 15,600
Income tax expense 17,450
Instructions
From the above information, to one decimal, calculate the following for 2023:
a) Inventory turnover
b) Receivables turnover
c) Rate of return on assets
d) Times interest earned.
Solution Pr. 23-68
a) Inventory turnover (cost of goods sold ÷ average INVT):
$123,000 ÷ [($61,000 + $52,000) ÷ 2] = 2.2 times
b) Receivables turnover (net sales ÷ average A/R):
$305,000 ÷ [($38,000 + $42,000) ÷ 2] = 7.6 times
c) Rate of return on assets (net income ÷ average total assets):
$62,250 ÷ [($415,000 + $363,000) ÷ 2] x 100 = 16%
d) Times interest earned (income before interest and taxes ÷ interest exp):
($62,250 + $15,600 + $17,450) ÷ $15,600 = 6.1 times
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 23-69 Ratio analysis
The following select information is taken from Mulberry Corp.’s statements of financial position at December 31, 2022 and 2023, and their income statement for calendar 2023:
2023 2022
Assets:
Cash $ 18,000 $22,000
FV–NI investments 25,000 -0-
Accounts receivable 38,000 42,000
Inventory 61,000 B
Prepaid insurance 6,000 9,000
Long-term investments 49,000 20,000
Equipment (net) 130,000 130,000
Land 33,000 33,000
Goodwill 55,000 55,000
Total assets $415,000 C
Net income D
Sales (all on credit) A
Gross Profit 181,000
Operating expenses…………………………. F
Interest expense 15,600
Income tax expense E
Mulberry has calculated the following ratios for 2023 (all rounded to one decimal place):
Inventory Turnover 2.2 times
Receivables Turnover 7.6 times
Rate of Return on Assets 16%
Times Interest earned 6.1 times
Instructions
Solve for the missing variables in the financial statements above. Round to the nearest whole number. (Hint: solve for the variables in alphabetical order)
Solution Pr. 23-69
A: Receivables turnover (net sales ÷ average A/R):
A ÷ [($38,000 + $42,000) ÷ 2] = 7.6 times
A= 7.6 times x [($38,000 + $42,000) ÷ 2] = $304,000
B: Inventory turnover (cost of goods sold ÷ average inventory):
COGS = $304,000 – 181,000 = $123,000
$123,000 ÷ [($61,000 + B) ÷ 2] = 2.2 times
$123,000 ÷ 2.2 = [($61,000 + B) ÷ 2]
B= $50,818
C: $22,000 + 0 + $42,000 + $50,818 + $9,000 + $20,000 + $130,000 +$33,000 + $55,000 = $361,818
D: Rate of return on assets (net income ÷ average total assets):
D ÷ [($415,000 + $361,818) ÷ 2] x 100 = 16%
D = 16% x [($415,000 + $361,818) ÷ 2] = $62,145
E: Times interest earned (income before interest and taxes ÷ interest exp):
($62,145 + $15,600 + E) ÷ $15,600 = 6.1 times
E = 6.1 times x $15,600 – ($62,145 – $15,600) = $17,415
F: $181,000 – $15,600 – $62,145 – $17,145 = $86,110
Difficulty: Medium
Learning Objective: Describe methods used for basic financial statement analysis and summarize the limitations of ratio analysis.
Section Reference: Financial Statement Analysis
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
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