You are working for an elite accounting consulting firm and have been hired by

You are working for an elite accounting consulting firm and have been hired by

One-two-three Incorporated (“123 Inc.”) to assist them with a number of

questions which have arisen while preparing their October 31, 2016 financial

statements. 123 Inc. is a Canadian public manufacturer of high-end paper coffee

cups on the cutting edge of ‘rim rolling prize’ technology.

For each of the situations presented on the attached page please present the

following:

1. The appropriate journal entry (or entries) which should have been

entered to account for the situation described. Indicate which reporting

period your entries need to be recorded in (i.e. fiscal 2016 or fiscal 2017).

Part marks available for incorrect answers but only if you show your work.

(80% of available marks)

1. A short description of why the entry is necessary in plain language that

the CEO of 123 Inc. will understand (she has an engineering background

not an accounting one). (15% of available marks)

 

1. Describe (UP or DOWN) the impact your proposed entries (on a combined

basis) will have on the following metrics for fiscal 2016 (5% of available

marks).

• EBITDA (earnings before interest taxes depreciation and amortization)

• Current ratio

• Interest coverage ratio

Please format your answers as follows:

1.

A.

B.

C.

NOT

A.

1.

2.

3.

Question 1 (10 marks):

During October 2016 a number defects were being reported by customers for

cups produced during one particular manufacturing run which occurred during

September 2016. On October 26, 2016 it was decided to issue a recall.

• In October 2016 $50,000 of refunds were issued to the customers who had

already complained.

• The sale price of the entire production run for which refunds will be

provided was $700,000 (including refunds which have already been issued).

• It is unknown what additional costs relating to the recall will be but it is

likely that there will be at least an additional $100,000. It is not

determinable what further costs there will be but they may be up to a

further $200,000.

 

Question 2 (10 marks):

On June 1, 2016 a 3-year bond was issued to a private investor to fund an

international expansion. The bond had a face value of $800,000 and makes

quarterly interest payments of $24,000 (the first payment was made on time on

September 1, 2016). The bond was sold for $841,031. Also – 123 Inc.’s CEO just

attended a corporate finance seminar and learned about bond yields, she would

like you to calculate the yield that her company’s bonds’ offer. (Note: this may

require you to reach beyond the material covered in class.)

Hint: you need to show the journal entries required for the 2016 and 2017 fiscal

year ends, and for each interest payment paid in 2016 and 2017.

 

Question 3 (10 marks):

In order to take advantage of a tax incentive 123 Inc. decided to buy new

machinery on August 1, 2016 which had a cost of $300,000. For income tax

purposes this machinery has a special CCA rate of 45% (the ½ year rule applies).

123 Inc.’s corporate tax rate is 20%. The deprecation for accounting purposes is

going to be based on usage. The machinery is expected to have a useful life of

1.3 billion coffee cups produced, and has an expected net salvage value of

$25,000. The expected usage is as follows:

Fiscal year: 2016 2017 2018 2019 2020

# of units: 0.1B 0.2B 0.4B 0.4B 0.2B

On August 1, 2016 the following entry was made:

Dr. Capital assets $300,000

Cr. Accounts payable $300,000

Hint: You will need to calculate depreciation and future taxes. Remember you

need to present both fiscal 2016 and fiscal 2017 calculations.

 

Question 4 (10 marks):

On May 1, 2016 123 Inc. issued 600, ten-year 8% bonds for $1,000 each. The

bonds pay interest annually on April 30. These bonds can be converted by the

bondholders into common shares at a rate of 25 common shares for each bond

converted (so far no bonds have been converted).

Required:

You have been asked to calculate what impact these bonds had on the earnings

per share. Net income for 2016 was $2 million and there are 500,000 common

shares (and no preference shares) outstanding. Assume a tax rate of 20%.

Question 5 (10 marks):

123 acquired 25% of the outstanding common shares of another public

company, Alphabet Soup Inc. on November 1, 2015. The purchase price was

$2.5M for 125,000 shares. Alphabet declared and paid a $1.50 per share cash

dividend on January 15, and again on August 15, 2016. Alphabet reported net

income of $1,040,000 on its October 31, 2016 financial statement. The fair

market value of Alphabet’s shares was $20.25 per share at October 31, 2016.

Required

Given the complex circumstances of this acquisition it is unclear whether 123

can exercise significant influence over Alphabet. Accordingly you have been

asked to prepare two sets of journal entries depending on whether 123 must

use the equity method of accounting or FV-OCI.

Indicate which method of accounting will result in a higher level of net income

and explain why that occurred.