Financial Accounting: Liabilities & Equities (FA3) Exam Review

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Financial Accounting: Liabilities & Equities (FA3) Exam
Review
Part 1: Module 1 – Accounting Polices and Analysis
NOTES: I do NOT know what is on your exam.
: Past exam questions are NOT updated to recent course material
: See Past Exam Questions after each online lecture for different questions.
3 hours = 1.8 minutes per mark Blueprint: 6-9%
Question 1 Multiple Choice (30 marks) 2 marks each
Select the best answer for each of the following unrelated items. Answer each of these
items in your examination booklet by giving the number of your choice. For example, if
(1) is the best answer for item (a), write (a)(1) in your examination booklet. If more than
one answer is given for an item, that item will not be marked. Incorrect answers will be
marked as zero. Marks will not be awarded for explanations.
a. A company reports a decrease of $50,000 in accounts receivable and a decrease of
$20,000 in unearned revenue. Sales reported on the income statement were $600,000.
What is the total cash collected from customers?
1) $530,000
2) $570,000
3) $630,000
4) $670,000
b. When vertical analysis is used to evaluate the balance sheet, what base amount is
usually selected?
1) Total assets
2) Total liabilities
3) Total shareholders’ equity
4) Total revenues
c. Sammy’s Sales Inc. has a current ratio of 2:1. This ratio will decrease if the company
does which of the following?
1) Borrows cash on a 6-month note
2) Sells merchandise for more than cost and records the sale using the perpetual inventory
method
3) Receives a 5% stock dividend on one of its marketable securities
4) Pays a large account payable that had been a current liability
Multiple Choice solutions:
a. 3 $600,000 + $50,000 – $20,000 = $630,000
b. 1
c. 1
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 2
Kerri Martinsky, CEO of Polly Inc., has asked you, assistant controller, to compare the
operations and financial position of Polly to those of its closest competitor, Plastic Ltd.
Polly and Plastic are similar in size and overall business operations. The following
information has been compiled for your review, based on the most recent financial
statements:
Common Size Income Statements
Polly Inc. Plastic Ltd.
2007 2006 2007 2006
Sales $100.0 100 % $ 100 100%
Cost of sales 72.0 70 68 70
Gross margin 28.0 30 32 30
Expenses 20.5 25 23 24
Net income $ 7.5 5 % $ 9 6 %
Increase in sales over 2006 30% 20%
Polly Inc. Plastic Ltd.
2007 2006 2007 2006
Current ratio 2.05 1.80 1.57 2.16
Quick ratio 0.87 0.53 0.42 0.66
Accounts receivable turnover 20.00 16.67 11.61 10.00
Inventory turnover 4.45 3.68 2.89 2.87
Long-term debt to equity 0.08 0.17 0.47 0.58
Return on total assets (ROA) 17.70 10.00 12.60 7.60
Return on equity 28.90 16.00 26.20 15.20
Investing activities
Purchase of capital assets $10,000 $40,000 $250,000 $400,000
You notice from the notes to the financial statements that both companies use similar
accounting policies.
Required
7 a. Write a memo to Kerri that compares and contrasts Polly to Plastic in terms of:
i) Liquidity, indicating which ratios you used in your analysis and which areas Kerri
should be concerned with
ii) Profitability, indicating which ratios you used in your analysis and which areas Kerri
should be concerned with
1 b. Indicate why Plastic’s long-term debt-to-equity ratio might be higher than Polly’s.
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Solution:
a. (7 marks)
To: Kerri Martinsky, CEO
From: Zhang Chen, Assistant Controller
Date: June 12, 2008
Re: Ratio comparison with Plastic Ltd.
(1) i) From a liquidity view, Polly appears to be quite liquid in 2007, compared with
Plastic (quick ratio).
(1) The receivables turnover and inventory turnover are significantly better than Plastic’s,
indicating good management over this area.
(1) This results in Polly having an overall better liquidity position than Plastic. There
appears to be no concerns in this area; however, this is not to say improvements could not
be made.
(1) ii) From a profitability view, the return on assets and equity is very good, indicating
that Polly is a well-managed and profitable business.
(1) However, it should also be noted that Plastic is increasing its fixed assets and longterm
debt, while Polly is not. Depending on the nature of these capital asset (for example,
improved efficiency), this could cause concern in the future.
(1) Also, Polly’s ROA is higher because it has a smaller asset base as a result of not
investing in capital assets as much as Plastic has in the past 2 years.
(1) We should investigate the decline of Polly’s gross margin, and attempt to reverse this
trend. We should also reconsider Polly’s capital asset financing policy. The company has
the capacity for additional long-term debt, which would provide leverage to further
improve return on equity, and potential strategic advantages if invested in the correct
assets.
Note:
3 marks for liquidity discussion; 3 marks for profitability discussion; 1 mark for areas of
concern (lack of capital asset investment or gross margin decline)
b. (1 mark)
Plastic’s long-term debt is higher than Polly’s because Plastic is likely financing the
purchase of capital assets with debt.
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 5 (9 marks)
Information for MTC Limited follows:
MTC LIMITED
Comparative Balance Sheet
2008 and 2007
2008 2007
Assets
Cash $ 200,000 $ 500,000
Accounts receivable 1,400,000 1,500,000
Inventory 600,000 400,000
Leased assets 3,250,000 3,250,000
Accumulated amortization, leased assets (1,950,000) (1,700,000)
Total $ 3,500,000 $ 3,950,000
Liabilities and shareholders’ equity
Accounts payable $ 320,000 $ 100,000
Lease liability 2,100,000 2,550,000
Bonds payable — 400,000
Discount on bonds payable — (20,000)
Preferred shares — 10,000
Common shares 600,000 500,000
Retained earnings 480,000 410,000
Total $ 3,500,000 $ 3,950,000
Additional information
1. Preferred shares were converted to common shares during the year at their book value.
2. Bonds payable were retired at the beginning of the year through an open market
purchase at 101. As a result, MTC reported a loss on retirement of $24,000.
3. Net income was $80,000.
4. There was a common stock dividend valued at $4,000 and cash dividends were also
paid.
Required
3 a. Prepare the operating activities section of the cash flow statement for the year ended
December 31, 2008, using the indirect approach.
6 b. Prepare the financing activities section of the cash flow statement for the year ended
December 31, 2008.
3 a. Operating activities
Net income (given) $ 80,000
(1) Add Amortization (1,700,000 + ? - 0 = 1,950,000) 250,000
(1/2) Loss on bond repurchase (#2) 24,000
(1/2) Decrease in accounts receivable 100,000
(1/2) Increase in inventory (200,000)
(1/2) Increase in accounts payable 220,000
Cash provided by operating activities $ 474,000
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
6 b. Financing activities
(1) Bond repurchase (#2) $ (404,000)
(1) Lease payment (2,550,000 – 2,100,000) (450,000)
(2) Issuance of common shares (#4) 86,000
(2) Cash dividends* (410,000 + 80,000 - 4,000 - ? = 480,000) (6,000)
Cash used in financing activities $ (774,000)
*IFRS: Under operating or financing activities
First deal with Additional Information:
1. Preferred share 10,000 (change on balance sheet)
Common shares 10,000
Non cash thus not stated on cash flow statement
2. Bond payable 400,000
Loss (to balance) 24,000
Cash (101% x 400,000) 404,000
Discount on BP 20,000
3. Net income 80,000
4. Change in Common shares 500,000 bgn + 10,000 (#1) + 4,000 (#4) + ? = 600,000
end. Thus must have issued 86,000 of C/S in 2008 to have an ending balance of 600,000
Part 2: Module 2 - Liabilities
Blueprint: 10-13%
a. Suzette’s Saxophones Inc. (SS) borrowed US$200,000 on January 2, 2003, when the
exchange rate was US$1 = C$1.50. The exchange rate at December 31, 2003 was $1.48.
The average exchange rate during 2003 was $1.49. On December 31, 2003, which of the
following will be one of SS’s adjusting entries?
1) A foreign exchange loss of $2,000
2) A foreign exchange loss of $4,000
3) A foreign exchange gain of $2,000
4) A foreign exchange gain of $4,000
b. Which of the following lists indicates the proper order for reporting current liabilities?
1) Bank loan; accounts payable; warranty liability; unearned rent revenue
2) Bank loan; accounts payable, unearned rent revenue; warranty liability
3) Bank loan; unearned rent revenue; accounts payable; warranty liability
4) Bank loan; warranty liability; accounts payable; unearned rent revenue
Multiple Choice solutions:
a. 4) [$200,000 × ($1.50 – $1.48)] = $4,000
b. 1 (see text page 719)
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 1 (5 marks)
Zara’s Painting Supplies Ltd. entered into a non-cancellable contract with Paint Factory
Inc. to purchase 10,000 litres of paint at $20 per litre (total contract price $200,000). The
contract was signed on September 28, 2003. The paint was delivered on January 15,
2004. Paint Factory sells all of its product on 30-day terms.
At December 31, 2003, the market price of the paint was $18 per litre. When the paint
was delivered on January 15, 2004, the market price was still $18 per litre.
Required: Prepare all required journal entries for Zara’s Painting Supplies as at
September 28, 2003; December 31, 2003; and January 15, 2004. If a journal entry is not
required for a particular date, write ―No Entry Necessary‖ and briefly explain why.
September 28, 2003
1 No entry necessary. Commitments are not normally recorded in the accounting system.
December 31, 2003
1 Estimated loss on purchase commitment [10,000 litres ($18 – $20)] ...... 20,000
1 Estimated liability on non-cancellable purchase commitment ......................20,000
January 15, 2004
1 Inventory (paint)...................................................................... 180,000
1 Estimated liability on non-cancellable purchase commitment ........ 20,000
1 Accounts payable ........................................................................................200,000
Question 2 (13 marks)
On November 1, 2002, Zoë Ltd. issued $1,000,000 of 10% bonds payable to yield 8%.
Bond issue costs of $36,000 were paid and recorded in a separate ledger account. The
bonds were 10-year bonds dated May 1, 2002. Interest is payable semi-annually on April
30 and October 31. The bond issue costs are amortized on a straight-line basis. The bond
discount or premium is amortized using the effective rate method. Zoë, which has a
December 31 year end, does not make any adjusting entries throughout the year.
Required
3.5 a. Calculate the issue price of the bonds and record the required journal entry(ies) to
reflect the issuance of the bonds and payment of the bond issue costs.
2.5 b. Prepare the adjusting journal entry(ies) that would be required on December 31,
2002.
7 c. On February 28, 2003, $500,000 par value of the bonds were retired at 102 plus
accrued interest. Prepare the required journal entry(ies).
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
a. FV = $1,000,000, i = 8/2 = 4%, n = 19, PMT = 50,000, PV of bond $ 1,131,295 (1)
November 1, 2002
(1/2) Cash...................................................................................... 1,131,295
(1/2) Premium on bonds payable............................................................131,295
(1/2) Bonds payable ........................................................................... 1,000,000
(1/2) Bond issue costs ....................................................................... 36,000
(1/2) Cash..................................................................................................36,000
b. December 31, 2002
(1/2) Interest expense ($1,131,295 × 8% × 2/12)..................................... 15,084
(1/2) Premium on bonds payable ($16,667 – $15,084) ............................ 1,583
(1/2) Accrued interest payable ($1,000,000 × 10% × 2/12) ........................... 16,667
(1/2) Interest expense ..................................................................................... 632
(1/2) Bond issue costs ($36,000 × 2/114) 1 ..........................................................632
1 The 10-year bond will be outstanding for 114 months
(10 years × 12 months, less 6 months in 2002 unissued).
c. February 28, 2003
(1/2) Interest expense ($1,131,295 × 8% × 2/12) × 50% ................. 7,542
(1/2) Premium on bonds payable ($8,334 – $7,542).......................... 792
(1/2) Accrued interest payable ($1,000,000 × 10% × 2/12) × 50%.................8,334
(1/2) Interest expense ......................................................................................316
(1/2) Bond issue costs ($36,000 × 2/114) × 50% .............................................. 316
(1/2) Bonds payable ............................................................... 500,000
(1/2) Accrued interest payable (16,667 × 50% + 8,334) ......... 16,667
(1) Premium on bonds payable [($131,295 – $1,583) × 50% – $792].. 64,064
(1) Gain on bond retirement ........................................................................36,696
(1/2) Bond issue costs ($36,000 × 50% × 110 / 114) .....................................17,368*
(1) Cash [($500,000 × 102%) + ($500,000 × 10% × 4/12)]...................... 526,667
*(36,000 – 632) x 50% = 17,684 – 316 = 17,368
Note: For part c), the entries for interest expense, accrued interest payable, and premium
on bonds payable may be combined.
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Part 3: Module 3 – Shareholders’ Equity
Blueprint: 9-12%
a. JMN Company had opening retained earnings of $100,000. Net income for the year
was $23,000. During the current year, an error in the prior year was discovered resulting
in a credit to retained earnings for $5,000, and 1,000 shares were retired at $2 above their
book value. There was no contributed capital account prior to the retirement of the shares.
Ending retained earnings was $102,000. What was the amount of dividend declared for
the year?
1) $14,000
2) $24,000
3) $26,000
4) $28,000
b. When a property dividend is declared, the book value of the property and the market
value are not the same. How should the dividend be recorded?
1) It should be recorded at the book value of the property at the date of declaration.
2) It should be recorded at the market value of the property at the date of declaration.
3) It should be recorded at the market value of the property at the date of distribution.
4) It should be recorded at the book value or market value, whichever is higher at the date
of declaration.
c. What is a dividend called when a portion of the shareholders’ original investment is
returned?
1) Equity dividend
2) Special dividend
3) Liquidating dividend
4) Compensating dividend
d. Which of the following type of dividends does not reduce retained earnings?
1) Cash dividend
2) Stock dividend
3) Property dividend
4) Liquidating dividend
e. DKM Co. previously issued cumulative non-convertible preferred shares with an
annual dividend payable on December 31. Dividends were last paid on December 31,
2002, and no dividends were declared in 2005. In DKM’s December 31, 2005 financial
statements, how will DKM report these dividends in arrears?
1) Subtract 3 years of dividends on preferred shares from earnings when computing 2005
basic earnings per share
2) Report a liability equal to 2 years of dividends on the preferred shares
3) Disclose in a footnote that the dividends on preferred shares are 2 years in arrears
4) Disclose in a footnote that the dividends on preferred shares are 3 years in arrears
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
f. On July 1, 2006, XZC Co. issued (sold) 2,000 of its no-par-value common shares and
4,000 of its no-par-value convertible preferred shares for a lump sum of $60,000. At the
date of issue, XZC’s common shares were trading at $17 per share and the convertible
preferred shares at $7 per share. What should the amount of the proceeds allocated to
XZC’s common share account be?
1) $32,000
2) $32,903
3) $34,000
4) $35,133
Multiple Choice solutions:
a. 2 [100,000 + 23,000 + 5,000 – (1,000 × 2) – 102,000] = $24,000
b. 2
c. 3
d. 4)
e. 4)
f. 2) (2,000 × $17) = 34,000, (4,000 x $7) = 28,000. Total $62,000
(34,000/62,000) x $60,000 = $32,903
Part 4: Module 4 – Complex Debt and Equity Instruments
Blueprint: 11-18%
a. XQL Inc. sells $1,000,000 of 6%, 5-year bonds with detachable share purchase
warrants for $1,040,000. Each $1,000 bond carries a warrant that entitles the investor to
purchase 1 common share for $200. Shortly after the issuance, the warrants trade for $50
each and the bonds are quoted at 103 ex-warrants. Assuming that XQL used the
proportional method to record this transaction, what was the net amount allocated to the
bonds?
1) $ 950,000
2) $ 990,000
3) $ 991,850
4) $1,000,000
b. Zil Co. has $4,000,000 of 8% convertible bonds outstanding. Each $1,000 bond is
convertible into 30 no-par-value common shares. The bonds pay interest on January 31
and July 31. On July 31, 2006, the holders of $3,000,000 of the bonds exercised the
conversion privilege (converted their bonds into common shares). At the conversion date,
the market price of the bonds was $1,050 each, the market price of the common shares
was $36 each, and the balance in the contributed capital, common stock conversion rights
account was $120,000.
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
If Zil uses the book value method to record the conversion, what will the journal entry
include?
1) A $90,000 debit to contributed capital, common stock conversion rights
2) A $120,000 debit to contributed capital, common stock conversion rights
3) A loss on bond redemption of $150,000
4) A loss on bond redemption of $180,000
Multiple Choice solutions:
a. 3 [$1,030 / ($1,030 + $50)] $1,040 = $991,850
b. 1 120,000 x .75 = 90,000
Question 3 (18 marks)
Tom’s Tequila Inc. (TT) sold $1,000,000 of 9%, 10-year convertible bonds on January 1,
2002 for proceeds of $960,000. The market was demanding a 10% yield for similar bonds
that did not have a conversion privilege. At the investor’s option, each $1,000 bond is
convertible into 25 common shares until December 31, 2007, and into 30 common shares
from January 1, 2008, until maturity. The bonds are dated January 1, 2002, and pay
interest annually on December 31, maturing December 31, 2011. TT uses the effective
interest method to amortize discounts or premiums, and the book value method for
conversion.
On January 1, 2003, 70% of the bonds were converted. At that time, the common shares
were trading at $55. The rest of the bonds were never converted.
TT is a public company listed on the Toronto Stock Exchange.
Required: Note that the bonds are convertible at the investor’s option.
Prepare journal entries for January 1, 2002; December 31, 2002; January 1, 2003; and
December 31, 2011.
Using factor tables: $ 938,514
Value of conversion rights ($960,000 – $938,514) = $21,486 (Incremental method)
Note: A financial calculator may also be used. Answers determined with the calculator
may vary slightly due to rounding. FV = 1,000,000, n = 10, i = 10, PMT = 90,000, PV =
938,554
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
January 1, 2002
(1) Cash............................................................................................. 960,000
(1) Discount on bonds payable ($1,000,000 – $938,514) .................. 61,486
(1) Contributed capital - conversion rights ............................ 21,486
(1) Bonds payable ........................................................................................... 1,000,000
December 31, 2002
(1) Interest expense ($938,514 x 0.10) ................................................ 93,851
(1) Discount on bonds payable............................................................................ 3,851
(1) Cash ($1,000,000 × 0.09) .............................................................................. 90,000
January 1, 2003
(1) Contributed capital - conversion rights ($21,486x0.70) .... 15,040
(1) Bonds payable ($1,000,000x 0.70)................................................... 700,000
(1) Discount on bonds payable [($61,486 – $3,851) 0.70]............................... 40,345
(1) Common shares ($700,000 – $40,345 + $15,040)....................................... 674,695
December 31, 2011
(1) Interest expense ($297,276x 0.10) ........................................... 29,728 1
(1) Discount on bonds payable............................................................................ 2,728
(1) Cash ($300,000x 0.09) ................................................................................. 27,000 2
(1) Cont. capital - conversion rights (21,486–15,040) ..... 6,446
(1) Contributed capital, lapse of conversion rights............................................. 6,446
(1) Bonds payable .......................................................................................300,000
(1) Cash..............................................................................................................300,000 2
1 PV of the bond ($300,000) and interest ($27,000) = $327,000
$327,000 xP/F, 10%, 1 = $327,000x 0.9091 = $297,276
2 May be combined
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Part 5: Module 4 continued
Question 5 (11 marks)
On January 1, 2000, SVO Ltd. granted stock options to its chief executive officer (CEO).
This is the only stock option plan that SVO offers. The details of the stock options are set
out below:
Option to purchase 5,000 no-par-value common shares
Option price per share $62.00
Market price per share at grant date $57.00
Stock options expire The earlier of 8 years after issuance or the
employee’s cessation of employment with the
company for any reason other than retirement.
The options are first exercisable The earlier of 4 years after issuance or the date on
which an employee reaches the retirement age of
65.
Fair value at grant date is$10.00. On January 1, 2005, 4,000 of the options were exercised
when the market price of the common shares was $78.00. The rest of the options were
allowed to expire.
Required
8 a. Record the required journal entries for the following dates:
(1) i) January 1, 2000 (issue date)
(2) ii) December 31, 2000 (year-end)
(3) iii) January 1, 2005 (exercise date)
(2) iv) December 31, 2007 (the expiry date of the options)
3 b. Record the required note disclosure on financial reporting for the stock option plan at
December 31, 2000.
Extra: Assuming SVO uses the indirect method for preparing the statement of cash
flows, state the required disclosure in this statement.
8 a.
(1) i) Jan. 1, 2000 (the grant date): Memo entry, describing the options and their terms
(2) ii) December 31, 2000
(1) Compensation expense (5,000 × $10 / 4 years) ................................12,500
(1) Contributed capital — common share options.................................12,500
(To record the grant of stock options to the CEO)
(3) iii) January 1, 2005
(1) Cash (4,000 × $62) ................................................................ 248,000
(1) Contributed capital — common share options
(4,000 / 5,000 × $50,000 1 )............................................................ 40,000
(1) Common shares ............................................................................ 288,000
(To record the exercise of stock options to the CEO)
1 (5,000 × $10.00 or $12,500 per year × 4 years = $50,000)
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
(2) iv) December 31, 2007
(1) Contributed capital — common share options.......................... 10,000
(1) Contributed capital — lapse of common share options ................. 10,000
(To record the expiration of stock options granted to the CEO)
3 b. On January 1, 2000, SVO granted stock options to the CEO for the purchase of 5,000
of the company’s no-par-value common shares at $62 each.
The options expire on December 31, 2007.
Options are exercisable the earlier of 4 years after issuance (January 1, 2004) or the date
on which the employee reaches the retirement age of 65.
The value of each option at grant date, as determined by using a binomial pricing model,
was $10.00.
$12,500 was charged to compensation expense for the year ended December 31, 2000.
No options are currently exercisable under this plan, which is the only one that SVO
offers.
No options were exercised or lapsed during the year.
Note: 1 mark each to a maximum of 3 marks
Extra:
Indirect method of presentation: 2000-2003
i) Cash flows from operating activities
Net income $ xxx
Add: Compensation expense — stock options 12,500 (non-cash)
In 2005: Cash flows from financing activities
Add: Issuance of common shares for cash $ 248,000
Part 6: Module 5 – Leases
Blueprint: 8-12%
a. What is the difference between a direct financing lease and a sales-type lease for
lessors?
1) For a direct financing lease, collection is not reasonably assured.
2) For a direct financing lease, there are significant costs that are difficult to estimate.
3) For a direct financing lease, the lease does not meet any of the capitalization criteria
for a capital lease.
4) For a direct financing lease, the lessor earns only interest revenue on the lease
arrangement.
NOTE: IFRS terminology is different: direct financing = financing company; salestype
= manufacturer/dealer
Multiple Choice solution: a. 4
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 4 (13 marks)
Fred’s Fabricating Ltd., which has a December 31 year end, offers lease financing to
customers who want to buy its prefabricated buildings. Fred’s Fabricating has just
completed a building at a cost of $3,000,000 and will lease it on July 1, 2003, to Bill’s
Building Corp., a manufacturing company. Fred’s Fabricating’s mark up on the building
is 30% of cost.
• The lease term is 15 years; the building’s estimated useful life is 22 years.
• The building’s residual value at the end of the lease term is estimated to be $500,000.
This value is not guaranteed. The salvage value is estimated to be $100,000. Terms of
the lease allow Bill’s Building the option of purchasing the building at the end of the
lease term for $200,000.
• Bill’s Building’s incremental borrowing rate is 9%.
• Bill’s Building knows that the interest rate implicit in the lease is 8%.
• The first annual lease payment is due July 1, 2003.
Required
2 a. Calculate the required annual lease payments.
8 b. Prepare all required journal entries for the lessee, Bill’s Building Corp., for the year
2003.
3 c. Accounting standards sets out the classification criteria that the lessee must use to
determine if a lease qualifies as a capital lease for financial reporting purposes.
Essentially, the 4 criteria are
• a transfer of ownership at the end of the lease term or a bargain purchase
option;
• the lease term major/ ≥ 75% of economic life; or
• the present value of the minimum lease payments substantially all/ ≥ 90% of
fair market value.
• IFRS: specialized nature of asset
In addition to the foregoing, the lessor is required to use supplemental criteria. Identify
the supplemental criteria used by the lessor and explain briefly (in one or two sentences)
why these additional requirements are necessary.
Solution: There is a bargain purchase option (option to purchase at $200,000 versus an
estimated value at the end of the lease term of $500,000). Accordingly, this is a
capital/financing lease as there is reasonable assurance that the lessee will obtain
ownership of the leased property by the end of the lease.
a. Selling price ($3,000,000 × 1.30) $3,900,000
BGN, PV = 3,900,000, n = 15, i = 8, FV = 200,000, PMT = ? = 415,064 (tables 415,067)
b. July 1, 2003
(1) Asset under capital/financing lease ................................3,900,000
(1) Lease liability ............................................................ 3,900,000
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
(1) Lease liability ........................................................ 415,067
(1) Cash.................................................................................................... 415,067
December 31, 2003
(1) Interest expense [($3,900,000 – $415,067) × 0.08 × 6/12] ............ 139,397
(1) Accrued interest payable .................................................................... 139,397
(1) Amortization expense {[($3,900,000 – $100,000) / 22] × 6/12}.. 86,364
(1) Accumulated amortization.................................................................. 86,364
c.
(1) • The credit risk associated with the lease is normal when compared with the risk of
collection of similar receivables.
(1) • The amounts of any non-reimbursable costs that are likely to be incurred by the
lessor under the lease can be reasonably estimated.
(1) • The profession wants to make sure that the lessor has really transferred the risks and
rewards of ownership.
Part 7: Module 6 – Accounting for Income Tax
Blueprint: 11-15%
a. Which of the following is true about intraperiod tax allocation?
1) It involves the allocation of income taxes between current and future periods.
2) It arises because items included in the determination of taxable income may be
presented in different parts of the financial statements.
3) It arises because certain revenues and expenses appear in the financial statements
either before or after they are included in the income tax return.
4) It is more directly related to the full disclosure principle than the matching principle.
b. In 2006, DTY Inc. made an investment of $200,000 that qualifies for a 7% investment
tax credit. How should DTY record the benefit of the investment tax credit?
1) As a decrease in tax expense for 2006
2) As a direct increase to retained earnings
3) As an increase in a deferred charge
4) As a reduction in the cost of the investment
Multiple Choice solutions:
a. 2
b. 4
15

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 4 (13 marks)
Lion Ltd. is about to prepare its financial statements for the year ended December 31,
2004. Pertinent information follows:
• In 2004, amortization was $270,000 and CCA was $135,000. At the beginning
of the year, the net book value of capital assets was $2,000,000, while the UCC
was $1,500,000.
• Accounting income before income taxes was $1,000,000.
• The company had $50,000 in entertainment expenses, which were included in
the income statement. Only 50% of this amount is deductible for tax purposes.
• The company received rent in advance of $75,000. This amount is taxable but
has not been included in its income statement.
• In March 2004, the income tax rate for 2004 and later years increased to 35%.
This was not expected since the income tax rate had been 30% since 2000. The intended
change was enacted into law in November 2004.
Required
11 a. Assume that Lion is a public company. Reconcile ―Accounting income before
income taxes‖ to ―Taxable income,‖ and prepare the required income tax related journal
entries for 2004.
2 b. Prepare the bottom section of the income statement, beginning with income before
income taxes.
11 a. Income taxes payable
(1/2) Accounting income before income taxes $ 1,000,000
Permanent differences
(1/2) 50% entertainment expenses 25,000
Temporary differences
(1/2) Rent received in advance 75,000
(1/2) CCA (135,000)
(1/2) Amortization/depreciation 270,000
(1/2) Taxable income $ 1,235,000
Income tax payable @ 35% $ 432,250
Journal entry:
(2) Income tax expense (432,250 – 26,250 – 22,250) ....................... 383,750
(2) Deferred/Future income tax asset - rent revenue ......................... 26,250
(2) Deferred/Future income tax liability - capital assets ... 22,250
(2) Income taxes payable....................................................................... 432,250
2 b. Income statement
(1/2) Income before income taxes $ 1,000,000
(1/2) Income tax expense — current $ 432,250
(1/2) — Deferred/future (48,500) 383,750
(1/2) Net income $ 616,250
Effective tax rate: 383,750/1,000,000 = 38.375%
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
The following table and reconciliation are not required for marks.
B/S I/S
2004 Tax Basis Accounting Temporary Defer/Future Opening Adjustment
dr (cr) Basis Difference Tax Asset Balance for Current
dr (cr) deductible (liability) dr (cr) Year
(taxable) @ 35% dr (cr)
Rent
Revenue 75,000 0 75,000 26,250 0 26,250
Capital
Assets 1,365,000 1 1,730,000 2
(365,000) (127,750) (150,000) 3
1
$1,500,000 – $135,000 = $1,365,000
2
$2,000,000 – $270,000 = $1,730,000
3
($1,500,000 – $2,000,000) x 0.30 = $150,000 beginning balance already on BS
Part 8: Module 7 – Pension Costs and Obligations
Blueprint: 8-14%
22,250
a. A company’s pension plan assets equal its accrued benefit obligation. If the company’s
balance sheet indicates a pension liability, which of the following must be true about the
company’s pension plan?
1) There are unrecognized past services costs.
2) There are unamortized actuarial losses.
3) There are unamortized actuarial gains.
4) The company’s balance sheet is incorrect; there should be no asset or liability reported
for pensions.
b. MJU’s pension plan had the following balances at the beginning of 2006:
Plan assets $ 800,000
Projected benefit obligation 940,000
Unamortized past service costs 80,000
Unamortized actuarial gain 120,000
Assume MJU uses the corridor method for calculating pension expense. The average
remaining service period (ARSP) is 10 years and the period of vesting* is 8 years. What
amount of the actuarial gain should be included in the calculation of pension expense for
2006?
1) $2,600
2) $3,250
3) $4,000
4) $5,000
* PEQs may state expected period to full eligibility
Multiple Choice solutions:
a. 3
b. 1 940,000 x .10 = 94,000 – 120,000 = 26,000/10 = 2,600
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 4 (16 marks)
On January 1, 2003, Rhonda’s Roofing Inc. (RR), improved the non-contributory defined
benefit pension plan for its employees. An actuary has indicated that the amendment
resulted in past service costs (PSC) of $1,200,000. The employees’ period to vesting and
expected average remaining service life is both 8 years.
On July 1, 2003, the actuary advised you that the projected benefit obligation increased
$75,000 as a result of a change in the assumptions used.
Other details of note in 2003 are as follows:
• Employer’s contribution (paid to the pension trustee) at the end of the year $400,000
• Current service cost $150,000
• Deferred pension liability as at January 1, 2003 $300,000
• Accrued benefit obligation at the beginning of the year (excluding the PSC) $800,000
• Plan assets at the beginning of the year $500,000
• Benefits paid out during 2003 $100,000
• Expected return on plan assets 11%
• Actual return on plan assets $60,000
• The actuarial interest rate 10%
Required
4 a. Calculate the pension expense recognized in 2003.
2 b. Calculate the accrued benefit obligation as at December 31, 2003.
4 c. Prepare the journal entries to reflect RR’s accounting for the pension plan for 2003.
6 d. Pension legislation currently permits three different methods of funding defined
benefit pension plans. Identify the three methods and briefly describe each.
Note: the table is not required for marks.
Deferred Accrued Unamortized
Date and Pension Pension Benefit Plan Unamortized Actuarial
Details exp. Cash Asset/Liab Obligation Asset PSC Loss
12/31/02 $ $ $300,000C $800,000C $500,000D $ $
01/01/03 1,200,000C 1,200,000D
01/01/03 300,000C 2,000,000C 500,000D 1,200,000D
Actuarial loss 75,000C 75,000D
Service cost 150,000D 150,000C
Interest 200,000D 200,000C
Exp Return 55,000C 55,000D
Actual ret. 60,000D 60,000C
Amortize PSC 150,000D 150,000C
Pension payments 100,000D 100,000C
12/31/03 400,000C 400,000D
445,000D 400,000C 45,000C
$345,000C $2,325,000C $860,000D $1,050,000D $70,000D
Next year amortization of net actuarial gain/loss? $70,000 < ($2,325,000 x 10%) thus no
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
4 a.
(1) Current service cost $ 150,000
(1) Interest on accrued benefit obligation [(800,000 + 1,200,000) × 10%] 200,000
(1) Expected return on plan assets ($500,000 × 0.11) (55,000)
(1) Amortization of past service cost ($1,200,000 / 8) 150,000
Pension expense $ 445,000
2 b. Accrued benefit obligation as at December 31, 2002 (as per above) $ 2,325,000
4 c. December 31, 2003
(1) Pension expense ........................................................ 445,000
(1) Deferred pension asset.................................................. 445,000 1
(1) Deferred pension asset ............................................ 400,000 1
(1) Cash..... ........................................................................................... 400,000
1 May be combined into one entry
6 d.
(2) The accumulated benefit method calculates the contribution that an employer must
make in order to fund the pension to which the employee is currently entitled, based on
the years of service to date and on their current salary.
(2) The projected benefit/unit credit method calculates the required funding based on the
years of service to date but on a projected estimate of the employee’s salary at the
retirement date.
(2) The level contribution method projects both the final salary and the total years of
service and then allocates the cost evenly over the years of service.
Part 9: Module 8 – Accounting Changes
Blueprint: 6-10%
NOTE: Assume IFRS
a. Frank Inc. purchased equipment on January 1, 2000 for $100,000. The company
estimated that the equipment had a 5-year useful life and no salvage value. Frank
amortized the equipment using the straight-line method for 4 years. During 2004, Frank
re-estimated the total useful life of the equipment to be 8 years. What is the amount of the
amortization expense in 2004?
1) $ 2,500
2) $ 5,000
3) $ 8,000
4) $ 12,500
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
b. Based on an annual review, CDF Company changed its amortization policy from
straight line to declining balance. How should this change in policy be applied, assuming
that CDF has all of the information required to make the change?
1) Prospectively
2) Retrospectively without restatement
3) Retrospectively with restatement
4) This change should not be allowed
c. Maluk Mining Ltd. spent $3,000,000 developing a silver mine. The $3,000,000 in
development costs was debited to an asset account ―Natural resources — Silver Mine‖.
Maluk estimated that the mine would yield 10,000,000 ounces of silver. Maluk
commenced operations in 2002. During 2002, 2,000,000 ounces of silver were mined.
Early in 2003, a new vein of ore was discovered that contained an estimated additional
4,000,000 ounces of silver. During 2003, 3,000,000 ounces of silver were mined. What is
the amount of depletion expense in 2003?
1) $471,429
2) $600,000
3) $642,857
4) $900,000
j. KYM Corporation discovered an error in its record keeping from the previous year.
Utilities for the month of December were recorded as $2,600 instead of the correct
amount of $6,200. Which of the following journal entries would be made to correct the
error in the current year? Ignore taxes.
1) Utilities expense .................................................................................3,600
Utilities payable .................................................................................. 3,600
2) Retained earnings .............................................................................. 3,600
Utilities payable .................................................................................. 3,600
3) Utilities payable ..................................................................................3,600
Retained earnings ................................................................................ 3,600
4) Utilities payable ..................................................................................3,600
Utilities expense .................................................................................. 3,600
Multiple Choice solutions:
a. 2 $100,000 – $100,000 (4/5) = $20,000; $20,000 / 4 = $5,000
b. 1
c. 2
3,000,000 × $0.20 1 = $600,000
1 Depletion rate in 2002 $3,000,000/10,000,000 ounces = $0.30 per ounce
Depletion base in 2003 $3,000,000 – $600,000 2 = $2,400,000
10,000,000 ounces – 2,000,000 ounces + 4,000,000 ounces = 12,000,000 ounces
Depletion rate in 2003 $2,400,000/12,000,000 ounces = $0.20 per ounce
2 2,000,000 × $0.30
j. 2
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 6 (6 marks)
JD Limited has used the average cost (AC) method to determine inventory values since
its inception. In 2008, the company decided to switch to the first-in, first-out (FIFO)
method to conform to industry practice. The income tax rate is 40%. Assume any tax
difference due to change in inventory valuation policy is a temporary difference. The
following information is available:
2006 2007 2008
Ending inventory, AC method $ 15,000 $ 24,000 $ 23,000
Ending inventory, FIFO method 26,000 30,000 28,000
Net income, AC method 60,000 62,000 55,000
Opening RE, AC method 170,000 180,000 230,000
JD has a December 31 year end.
Required
2 a. Briefly explain how the change in inventory policy should be reported for the 2008
financial statements.
6 b. Calculate net income, using the FIFO method, for 2007 and 2008
2 a.
Retrospective application with restatement of prior periods is required since information
is available to recalculate comparative figures for the 2008 financial statements.
6 b.
2007 net income
Original $ 62,000
(2) Change in beg. inventory, net of tax (26,000 – 15,000) (1 – 0.40) (6,600)
(1) Change in end. inventory, net of tax (30,000 – 24,000) (1 – 0.40) 3,600
2007 net income (FIFO) $ 59,000
2008 net income
Original $ 55,000
(1) Change in beg. inventory, net of tax (30,000 – 24,000) (1 – 0.40) (3,600)
(2) Change in ending inventory, net of tax (28,000 – 23,000) (1 – 0.40) 3,000
2008 net income (FIFO) $ 54,400
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Part 10: Module 9 –Earnings per share
Blueprint: 6-9%
a. At December 31, 2003, Bob Co. has share options outstanding that permit the holders
to acquire a total of 100,000 common shares at a price of $20 per share. The options can
be exercised at any time between January 1, 2005 and December 31, 2008, at which latter
time they expire. The average common share price during 2003 was $30, and the yearend
price was $25. Because of the options, how would the denominator of the diluted
EPS change in the December 31, 2003 financial statements?
1) No change as the options are not yet exercisable
2) Increase by 20,000 shares
3) Increase by 33,333 shares
4) Increase by 100,000 shares
a. 3 100,000 x $20 = $2,000,000; $2,000,000 / $30 = 66,667; 100,000 issue – 66,667
retired = 33,333 net increase
Question 4 (13 marks)
Below is information from the December 31, 2006 balance sheet for NG Co.
Bonds payable — $500,000 par value, 7%, maturing December 31,
2015, each $1,000 bond is convertible into 30 common shares at the
holder’s option (net) $ 450,000
Preferred shares — $2, no par value, cumulative, convertible
at 1 preferred share for 2 common shares - 14,000 shares outstanding 210,000
Contributed capital — common share options outstanding 70,000
Common stock conversion rights — 7% bonds 30,000
Common shares — no-par value, 320,000 shares outstanding 800,000
Additional information
1. There are no dividends in arrears at the beginning of the year. No dividends have been
declared for 2006.
2. Net income for 2006 is $1,263,000; includes $38,000 interest expense for the 7%
bonds.
3. Income tax rate is 40%.
4. Bonds, options, and preferred shares were outstanding for the entire year.
5. The stock options are noncompensatory and are convertible into a total of 80,000
common shares at an exercise price of $32.30. The average share price during the year
was $34.
6. No other common share transactions occurred during the year.
Required
10 a. Calculate basic and diluted earnings per share (EPS) for the year ended December
31, 2006.
3 b. Assume that one-half of the stock options were exercised on January 1, 2007.
Prepare the journal entry(ies) to record the exercise of stock options.
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
10 a.
Basic EPS Basic EPS
Net income $ 1,263,000
(1) Preferred dividends (14,000 × 2) (28,000)
Net income available to common shareholders $ 1,235,000
(1) Weighted average common shares outstanding 320,000 $3.86
(3) Individual calculations:
Net Income Shares EPS
7% Bonds
[38,000 × (1 – 0.4)] $ 22,800
(500,000 / 1,000 × 30) 15,000 1.52
Preferred shares 28,000
(14,000 × 2) 28,000 1.00
Options: Cash = (80,000 × $32.30) = $2,584,000/$34 = 76,000 buy back.
80,000 issue – 76,000 retired = 4,000 net increase in new shares.
Diluted EPS
Basic $ 1,235,000 320,000 $ 3.86
Options
(1.5) Shares issued 4,000
(1/2) 1,235,000 324,000 3.81
(1) Preferred shares 28,000 28,000
(1/2) 1,263,000 352,000 3.59
(1) Bonds 22,800 15,000
(1/2) Diluted EPS $ 1,285,800 367,000 $ 3.50
Note: 1.5 marks for determining order of dilution
3 b.
(1) Cash (80,000 × 1/2 × 32.30)..................................................1,292,000
(1) Contributed capital — Options (70,000 × 1/2)...........................35,000
(1) Common shares ..................................................................... 1,327,000
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Part 11: Module 10 – Partnership Equity Accounting
Blueprint: 5-8%
a. Bob and Zarai invited Helen, a CGA, to join their partnership. Helen will be required
to invest $120,000 in the partnership. This contribution will entitle her to a 25%
ownership interest. Assuming that Bob’s capital balance is $80,000 and that Zarai’s
balance is $100,000, what will Helen’s opening balance in her capital account be?
1) $ 45,000
2) $ 75,000
3) $100,000
4) $120,000
b. DEF partnership is formed on January 1, 2004. Partners D, E, and F contribute cash of
$20,000, $30,000, and $150,000 respectively. The partners agree on a profit and loss
sharing ratio of 1:1.5:7.5.
During the first year, net income is $180,000 and the partners’ drawings are D: $20,000,
E: $20,000, and F: $70,000. What is partner E’s capital balance as at December 31, 2004?
1) $ 18,000
2) $ 37,000
3) $ 70,000
4) $ 215,000
c. Which of the following views best describes the nature of ownership in a partnership?
1) The normative theory view
2) The proprietary view
3) The entity view
4) The residual equity view
d. If one partner in a partnership acts negligently causing losses, under which form(s) of
partnership are the other partners not held liable for these losses?
Limited Partnership General Partnership
1) Not liable Not liable
2) Liable Liable
3) Not liable Liable
4) Liable Not liable
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Multiple Choice solutions:
a. 2) (120,000 + 80,000 + 100,000) x .25 = 75,000 (Bonus Method)
Bonus: 80,000 + 100,000 + new cash 120,000 = 300,000 new book value
Cash 120,000
Helen, capital 75,000
Bob, capital 22,500
Zarai, capital 22,500
If asset revaluation: MV = 120,000/.25 = 480,000 - 300,000 NBV = 180,000 increase
Goodwill 180,000
Bob, capital 90,000
Zarai, capital 90,000
Cash 120,000
Helen, capital 120,000
b. 2) $30,000 + (15% x $180,000) – $20,000 = $37,000
c. 2) Assets – liabilities = Equity
d. 3)
Question 4 (6 marks)
Elmer, John, and Gill are partners in EJG Company. Their capital balances and profit and
loss ratios are as follows:
Capital Ratios
Elmer $ 60,000 0.35
John 58,000 0.35
Gill 40,000 0.30
Required
Assume that Gill will retire from the partnership and that he will be paid $100,000.
Prepare the 2 alternative journal entries to record Gill’s retirement.
2.5 Bonus method
Gill, capital ........................................................................... 40,000
Elmer, capital ....................................................................... 30,000
John, capital.......................................................................... 30,000
Cash........................................................................................100,000
3.5 Asset revaluation method
Unrecorded goodwill $100,000 – 40,000 = 60,000 / 0.30 = 200,000
Goodwill....................................................................... 200,000
Elmer, capital (.35 x 200,000) ................................................70,000
John, capital (.35 x 200,000) ................................................ 70,000
Gill, capital (.30 x 200,000).................................................... 60,000
Gill, capital............................................................................ 100,000
Cash................................................................................................. 100,000
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FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 5 (6 marks)
On May 1, 2006, Nancy and Drew formed a partnership by investing $96,000 and
$64,000 respectively. On May 1, 2007, the opening balances of the partner’s capital
accounts were $118,000 for Nancy and $68,000 for Drew. For the fiscal year ended April
30, 2008, net income of the partnership was $50,000.
During the 2008 fiscal year, Nancy withdrew $2,000 per month and Drew withdrew
$1,500 per month. Profits of the partnership are to be allocated based on a 2008 salary of
$40,000 for Nancy and $20,000 for Drew, with the remaining profit or loss split based on
original investment proportions.
Required
3 a. Determine the allocation of net income for the year ended April 30, 2008.
3 b. Prepare a statement of partners’ capital for the year ended April 30, 2008.
3 a.
Nancy Drew Total
Salaries $ 40,000 $ 20,000 $ 60,000
Remainder 2008
96,000 / (96,000 + 64,000) × (10,000) (6,000) (6,000)
64,000 / (96,000 + 64,000) × (10,000) (4,000) (4,000)
Total 2008 net income $ 34,000 $ 16,000 $ 50,000
Notes:
50,000 N.I. – 60,000 salary = (10,000) to allocate
1.5 marks for each of Nancy’s and Drew’s calculations
3 b.
Statement of Partners’ Capital
For the year ended April 30, 2008
Nancy Drew Total
Opening balance $ 118,000 $ 68,000 $ 186,000
Share of net income 34,000 16,000 50,000
Total 152,000 84,000 236,000
Drawings (24,000) (18,000) (42,000)
Ending balance $ 128,000 $ 66,000 $ 194,000
Note: 1 mark for format; 1 mark for drawings; 1 mark for net income carry-forward from
part (a)
26

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 1 (10 marks)
Allan, Betty, and Carl, the partners in ABC Catering, have agreed to liquidate the
partnership because of declining profitability. The balance sheet on December 31, 2002,
just prior to liquidation, is as follows:
ABC CATERING
Balance Sheet
December 31, 2002
Cash $ 20,000 Accounts payable $ 175,000
Non-cash assets 330,000 Allan, capital 16,000
Betty, capital 35,000
Carl, capital 124,000
$ 350,000 $ 350,000
The partners split profits and losses 50% to Allan, 20% to Betty, and 30% to Carl. Allan
has had personal financial setbacks and has only $44,000 in personal assets. The other
partners have significant personal assets. During January 2003, the non-cash assets were
sold for a total of $200,000 and the accounts payable were paid in full.
Required: Prepare journal entries to record the liquidation, including any entries to
adjust and liquidate the partners’ capital balances.
2 Cash.....................................................................................200,000
Allan, capital (50%)................................................................65,000
Betty, capital (20%)................................................................26,000
Carl, capital (30%)..................................................................39,000
Non-cash assets ............................................................................. 330,000
1 Accounts payable ............................................................... 175,000
Cash................................................................................................175,000
1 Cash.......................................................................................44,000
Allan, capital .................................................................................44,000
3 Betty, capital .......................................................................... 2,000
Carl, capital .............................................................................3,000
Allan, capital ........................................................................ 5,000
3 Betty, capital ...........................................................................7,000
Carl, capital ............................................................................82,000
Cash.................................................................................................89,000
NOTE: Use T-accounts to keep track of account balances
GOOD LUCK ON YOUE EXAM!!
� Barbara
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