financial accounting tools for business decision making 6e solution manual chapter 10

Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition CHAPTER 10 Reporting and Analyzing Liabilities ASSIGNMENT CLASSIFICATION TABLE Questions Brief Exercises Account for current liabilities 1, 2, 3, 4, 5, 6, 7, 1, 2, 3, 4, 1, 2, 3, 1A, 2A, 6A 1B, 2B, 6B Account for instalment notes payable 8, 9, 10, 11, 12, 13 6, 7, 8, 5, 6, 3A, 4A, 5A 3B, 4B, 5B 1, 6, Identify the requirements for the financial statement presentation and analysis of liabilities 14, 15, 16, 17, 18 10, 11, 12, 8, 9, 10 1A, 2A, 4A, 5A, 6A, 7A, 8A, 10A 1B, 2B, 4B, 1, 2, 3, 5B, 6B, 7B, 4, 5, 8B, 10B Account for bonds payable *19, *20, *21 *13, *14, *15 *9A, *10A *9B, *10B Study Objectives Exercises *11, *12, *13, *14 A Problems B Problems BYP Solutions Manual 10-1 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Record and present current liabilities Moderate 25-30 2A Record and present short-term notes Moderate 30-40 3A Record instalment note Moderate 30-40 4A Prepare instalment payment schedule; record and present instalment note Moderate 30-40 5A Prepare instalment payment schedule; record and present instalment note Moderate 30-40 6A Classify liabilities Moderate 20-30 7A Analyze liquidity and solvency Moderate 30-40 8A Analyze liquidity and solvency Moderate 30-40 *9A Record bond transactions Moderate 30-40 *10A Calculate present value; prepare amortization schedule; record and present bond transactions Moderate 30-40 1B Record and present current liabilities Moderate 25-30 2B Record and present short-term notes Moderate 30-40 3B Record instalment note Moderate 30-40 4B Prepare instalment payment schedule; record and present instalment note Moderate 30-40 5B Prepare instalment payment schedule; record and present instalment note Moderate 30-40 6B Classify liabilities Moderate 20-30 Solutions Manual 10-2 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description Difficulty Level Time Allotted (min.) 7B Analyze liquidity and solvency Moderate 30-40 8B Analyze liquidity and solvency Moderate 30-40 *9B Record bond transactions Moderate 30-40 *10B Calculate present value; prepare amortization schedule; record and present bond transactions Moderate 30-40 Solutions Manual 10-3 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ANSWERS TO QUESTIONS Accounts payable and short-term notes payable are both forms of credit used by a business to acquire the items they need to operate Both represent obligations of the business to repay amounts in the future and are therefore considered to be liabilities However, an account payable is normally for a shorter period of time (e.g., 30, 60, 90 days) than a note payable A note payable usually provides for a longer period of time to settle the amount owing A note payable involves a more formal arrangement than an account payable A note payable is an obligation in written form and will provide documentation if legal action is required to collect the debt As well, a note payable often requires the payment of interest because it is generally used when credit is to be granted for a longer period of time than for an account payable An operating line of credit, or credit facility, is used by a business to overcome shortterm cash demands or temporary cash shortfalls that invariably happen during the operating cycle It is not usually intended to be a permanent type of financing and is generally used for operations When needed, the funds are used and then repaid as the liquidity improves and cash becomes available from operations Bank loans on the other hand are structured in such a way to deal with more short-term or long-term cash needs of the business Longer type loans are used to finance the purchase of property, plant, and equipment and short-term bank loans would be used to finance inventory Bank loans are for specific amounts that have structured terms for the repayment of the principal Disagree The company only serves as a collection agent for the taxing authority It does not keep and report sales tax as revenue; it merely forwards the amount paid by the customer to the government Therefore, until it is remitted to the government, sales tax is reported as a current liability on the statement of financial position A difference exists in the timing of the incurrence of the expense for property tax and the timing of the payment of the property tax bills Due to this difference, at any reporting period, the balance can shift from a liability when the property tax bill is received, to a prepayment when it is paid In addition, an expense must be recorded as the property tax prepayment is used up The difference between (a) gross pay (the total amount an employee earned in salary or wages) and net pay stems from the payroll deductions deducted from the gross pay of an employee Some of the deductions are mandatory, such as income tax, and some are optional such as donations to charities In turn, the difference between (b) deductions withheld from an employee (i.e., deducted from an employee’s pay), and employee benefits, is the employee benefits are paid by the employer only They are not part of the employee’s gross earnings These employer paid benefits include required payments for CPP and EI, for example Solutions Manual 10-4 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) When determining whether a contingent liability should be accrued as a provision, management must first assess the level of uncertainty concerning the outcome of a future event that will confirm either the existence or the amount payable or both Under IFRS, if the outcome of a future event is probable and a reasonable estimate can be made of the amount expected to be paid, the amount will appear as a current liability on the statement of financial position Probable, in this case means “more likely than not” which is normally interpreted to mean that there is more than a 50% probability of occurring The details of the reasons for the accrual will also be outlined in the financial statement notes If the outcome is not probable or if the amount cannot be reasonably estimated, the details of the contingent liability will be disclosed in the notes to the financial statements On the other hand, if the company is reporting under ASPE, the probability needs to be “likely.” This is a higher level of probability that the standard used in IFRS Shoppers must report details of any outstanding claims or possible claims even though the amount of any claim cannot be reasonably determined This disclosure helps the readers of the financial statements assess any future possible consequences that might come about concerning these potential claims Since they cannot be measured, the amounts cannot be recorded as provisions Unrecorded claims or possible claims are contingent liabilities Current liabilities include those payments that are going to be due for payment in one year from the financial statement date Non-current liabilities are to be paid beyond that period Included in current liabilities would be the principal portion of any loans or debt that will be paid in the next year Consequently, care must be taken to disaggregate balances of such non-current loans or mortgages to ensure that the current portion of the debt is properly classified as a current liability Long-term instalment notes are similar to short-term notes in that they both provide written documentation of a debtor’s obligation to the lender The main difference between the two types of notes is that long-term instalment notes have maturities that extend beyond one year and have principal repayments included in the periodic payments required by the note For both types of notes, interest expense is calculated by multiplying the outstanding principal balance by the interest rate However, because a portion of the principal balance is usually repaid periodically throughout the term of a long-term instalment note, the outstanding principal balance will change (decrease) In contrast, the principal balance does not change throughout the term of a short-term note Solutions Manual 10-5 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 10 Instalment notes usually require the borrower to pay down a portion of the principal through fixed periodic payments relating to the principal along with any interest that was due at that time Each time a payment is made, a constant amount of principal repayment is deducted from the note The total payment amount will decline over time as the interest expense portion decreases due to reductions in the principal amount of the note An instalment note with a blended principal and interest payment is repayable in equal periodic amounts and results in changing amounts of interest and principal being applied to the note The total payment remains the same over the life of the note but the portion applied to the principal increases over time as the interest portion decreases due to reductions in the principal amount of the note 11 It is a blended payment pattern Instalment notes with blended principal and interest payments are repayable in equal periodic amounts, including interest Instalment notes payable with fixed principal payments are repayable in equal principal periodic amounts, plus interest 12 (a) A student choosing the floating rate loan will initially pay less interest, but as the prime lending rate changes so does the amount of interest that is charged on the balance owed on the loan Since the loan repayment is typically several years in length, this changing of interest rate reduces the risk to the financial institution to get a proper return on their loan to the student With the fixed interest rate, the initial interest rate paid is higher, but the rate does not change over the term of the loan (b) If, in the view of the student, interest rates are expected to rise, the fixed rate of interest is the better choice On the other hand, if interest rates are expected to remain steady or fall, the variable rate loan would be the better choice 13 Doug is incorrect because the amount of interest paid each month will decrease as payments are made and the outstanding (remaining) principal balance decreases The amount of interest is calculated as a percentage of the outstanding principal amount Because the monthly cash payment remains constant, over time, greater portions of the payment will be applied to the principal thereby more rapidly reducing the balance of the mortgage Solutions Manual 10-6 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 14 (a) Current liabilities should be presented in the statement of financial position with each major type shown separately They are normally listed in order of maturity, although other listing orders are also possible The notes to the financial statements should indicate the terms, including interest rates, maturity dates, and other pertinent information such as assets pledged as collateral (b) The nature and the amount of each non-current liability should be presented in the statement of financial position or in schedules included in the accompanying notes to the statements The notes should also indicate the interest rates, maturity dates, conversion privileges, and assets pledged as collateral 15 Liquidity ratios measure the short-term ability of a company to repay its maturing obligations Ratios such as the current ratio, receivables turnover, and inventory turnover can be used to assess liquidity Solvency ratios measure the ability of a company to repay its total debt and survive over a long period of time Ratios that are commonly used to measure solvency include debt to total assets and times interest earned ratios 16 An operating line of credit, or credit facility, is used by a business to overcome shortterm cash demands that invariably happen during the operating cycle It is not usually intended to be a permanent type of financing and is generally used for operations When needed, the funds are used and then repaid as the liquidity improves and cash becomes available from operations As a consequence, the business does not incur the constant charge for interest on a long-term debt loan and can save on interest costs The liquidity issues of a business can therefore be effectively dealt with using an operating line of credit 17 A company’s debt to total asset ratio should be measured in terms of its ability to manage its debt A company may have a high debt to total asset ratio but still be able to meet its interest payments because of high profits Alternatively, a company with a low debt to total assets may find itself in financial difficulty if it does not have sufficient profit to cover required interest payments Therefore, it is important to interpret these two ratios in conjunction with one another 18 A company with significant operating leases has obligations that are reported in the notes to the financial statements rather than on the statement of financial position This is referred to as off-balance sheet financing The existence of these off-balance sheet forms of financing highlights the importance of including the information contained in the notes in any analysis of a company’s solvency These notes also help the financial statement user forecast the amount of the future cash outflows that will occur to satisfy these lease commitments Solutions Manual 10-7 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 19 (a) A bond is a form of a long-term note payable They are similar in that both have fixed maturity dates and pay interest The most significant difference between a note payable and a bond is that bonds are often traded on the stock exchange, whereas few notes are In addition, bonds tend to be issued for much larger amounts than notes Because of these differences, generally only large companies use bonds as a form of debt financing (b) When it comes to large sums of money, a business would consider the issue of shares or bonds for obtaining the necessary cash Both would be traded on the stock exchange Bonds are classified as debt on the statement of financial position and common shares are classified as equity Bonds require principal and interest payments; common shares not have to be repaid The board of directors may choose to pay dividends to the common shareholders, however 20 Investors paid more than the face value of the bond; therefore, the market interest rate must have been less than the coupon interest rate Investors are willing to pay more for a bond that offers a coupon rate of return greater than the rate offered in the market The demand for this bond then causes the price to increase above its face value 21 (a) When a bond is sold at a discount, the proceeds received are less than the face value of the bond because the stated rate of interest that the bond offers is lower than the market interest rate This has made the bond less attractive to investors who will increase the return they get from the bond buy paying less than its face value The bond discount is considered to be an additional cost of borrowing This additional cost of borrowing should be recorded as additional interest expense over the term of the bond through a process called amortization Initially, the discount is recorded by showing the Bond Payable at an amount lower than its face value but over time, this account is increased (credited) so that it will be equal to its face value by the time it matures The offsetting debit is made to interest expense This is the additional interest expense incurred by the company for selling a bond at a discount When interest is actually paid, this amount is added to interest expense So interest expense will consist of a portion that is paid and a portion relating to the amortization of the discount thereby making it greater than the interest paid Solutions Manual 10-8 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) (b) When a bond is sold at a premium, the proceeds received are greater than the face value of the bond because the stated rate of interest that the bond offers is higher than the market interest rate This has made the bond very attractive to investors who will be prepared to pay a higher price for the bond than its face value The bond premium is considered to be a reduction in interest This benefit should be recorded through reductions to interest expense over the term of the bond through a process called amortization Initially, the premium is recorded by showing the Bond Payable at an amount higher than its face value but over time, this account is decreased (debited) so that it will be equal to its face value by the time it matures The offsetting credit is made to interest expense This lowers interest expense to reflect the benefit of the premium When interest is actually paid, this amount is added to interest expense So interest expense will consist of a portion that is paid and a portion relating to the amortization of the premium thereby marking it lower than the interest paid Solutions Manual 10-9 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) Oct Cash ($6,000 + $780) Sales Sales Tax Payable ($6,000 × 13%) 6,780 Cash ($6,000 + $899) Sales Sales Tax Payable [($6,000 × 5%) + ($6,000 × 9.975%)] 6,899 6,000 780 (b) Oct 6,000 899 BRIEF EXERCISE 10-2 (a) Apr 30 Property Tax Expense ($36,000 ữ 12 ì 4) Property Tax Payable 12,000 Property Tax Payable Property Tax Expense ($36,000 ữ 12 ì 2.5) Prepaid Property Tax ($36,000 ữ 12 ì 5.5) Cash 12,000 7,500 16,500 Property Tax Expense Prepaid Property Tax 16,500 12,000 (b) July 15 36,000 (c) Dec 31 16,500 Solutions Manual 10-10 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition *PROBLEM 10-10B (Continued) (c) July 2014 Cash Bonds Payable 928,942 928,942 Note: Interest would also be recorded January 1, 2014 and July 1, 2014 (not illustrated here) (d) Dec 31 2015 Interest Expense Bonds Payable Interest Payable 32,692 2,692 30,000 (e) PONASIS CORPORATION Statement of Financial Position (Partial) December 31, 2015 Liabilities (f) Current Liabilities Interest payable $ 30,000 Non-current liabilities Bonds payable, due 2024 Total liabilities 936,748 $966,748 Jan 2016 Interest Payable Cash 30,000 30,000 Solutions Manual 10-69 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-1 FINANCIAL REPORTING (a) Shoppers Drug Mart shows the following current and non-current liabilities on its consolidated balance sheet at December 29, 2012: Current liabilities: Bank indebtedness Commercial paper Accounts payable and accrued liabilities Income taxes payable Dividends payable Current portion of long-term debt Provisions Associate interest Non-current liabilities Long-term debt Other long-term liabilities Provisions Deferred tax liabilities (b) The bank indebtedness that appears on Shopper’s balance sheet does not necessarily represent a bank account with a negative balance that can be offset or paid off with a bank account balance with a positive balance at the same financial institution The bank indebtedness in this case consists primarily of lines of credit drawn on by various stores Although the cash balance appearing on the balance sheet seems available immediately for paying off the bank indebtedness, it is very likely that immediate cash demands require that a substantial balance of cash be in place to make quick payments, for example to take advantage of a purchase discount (c) Commercial paper is a very liquid means of obtaining financing for Shoppers when cash is needed The use of this type of debt is very flexible and for very short periods of time (90 days) allowing Shoppers to find more permanent sources of financing if it is deemed necessary and appropriate Because the interest rate on commercial paper is floating, the risk to Shoppers is reduced as it is not committed to any particular interest rate for a long period of time Solutions Manual 10-70 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-2 COMPARATIVE ANALYSIS (a) in millions Current ratio Receivables turnover Inventory turnover Debt to total assets Times interest earned Shoppers $2,765.0 $2,334.9 = 1.2:1 = 22.4 times $10,781.8 $469.7 + $493.3 $6,609.2 = 3.2 times $2,148.5 + 2,042.3 $3,150.4 $7,473.7 = 42.2% $608.5 + $214.8 + $57.6 = 15.3 times $57.6 Jean Coutu $421.9 $265.3 $2,468.0 $199.6 + $206.5 $2,169.0 $190.1 + $166.2 $281.9 $1,392.7 = 1.6:1 = 12.2 times = 12.2 times = 20.2% $558.4 + $78.9 + $2.0 = 320 times $2.0 (b) Liquidity: Comparing the ratios related to liquidity, Jean Coutu on an overall basis is more liquid than Shoppers and their industry with the exception of receivables turnover Its current ratio is excellent While its receivables turnover ratio is not as strong as either that of Shoppers or the industry, its inventory turnover ratio is far superior, at 12.2 times (30 days) Solutions Manual 10-71 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP10-2 (Continued) (b) (Continued) Solvency: The higher a company’s percentage of debt to total assets is, the greater the risk that this company may be unable to meet its maturing obligations Shoppers’ debt to total assets ratio of 42.2% is higher (worse) than that of the industry average of 30.6% and more than double that of Jean Coutu However, it is well able to handle this level of debt, as evidenced by its high times interest earned ratio of 15.3 which is well in excess of the industry average of 6.5 times The times interest earned ratio provides an indication of a company’s ability to meet interest payments Jean Coutu’s debt to total assets is low at 20.2% which means that it is primarily financed by equity Its times interest earned ratio is consequently extremely high Solutions Manual 10-72 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-3 COMPARING IFRS AND ASPE (a) Two key ratios that Matthew could use to assess Fly Fast’s solvency in comparison to that of East Jet are the debt to total asset ratios and the times interest earned ratio The following is a summary of the results of these two ratios for each of the two companies ($ in thousands) Total debt to assets Times interest earned East Jet Fly Fast ($832,172 + $1,222,993) ÷ ($1,268,710 + $ 2,294,134) = 57.7% ($120,000 + $270,000) ÷ ($317,178 + $573,533) = 43.8% ($136,720 + $59,947 + $60,164) ÷ $60,164 = 4.3 times ($34,180 + $14,986 + $9,876) ÷ $9,876 = 6.0 times Fly Fast appears to be less burdened with debt as compared to East Jet Only 43.8% of its assets are leveraged compared to 57.7% for East Jet The times interest earned ratio is also better, at 6.0 times compared to 4.3 for East Jet This implies that Fly Fast is the more solvent of the two companies and in a better position to pay its interest payments (b) The main difference between IFRS and ASPE is that with IFRS there is increased likelihood that a liability will be recognized on the statement of financial position The requirement for recognition of a provision is “more likely than not” for IFRS rather than “likely” under ASPE Specifically, ASPE indicates that a contingent liability should be recognized when the chance of occurrence is higher than under IFRS, where a provision should be recognized when the chance of occurrence is greater than 50% This difference could cause East Jet to recognize liabilities that Fast Fly did not recognize Matthew could also review the notes to the financial statements to identify any contingencies that did not meet recognition criteria but only the disclosure criteria under ASPE Solutions Manual 10-73 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-4 CRITICAL THINKING CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS Current Assets: Cash Accounts receivable Merchandise inventory 2015 2,000 20,000 30,000 52,000 2014 $10,000 5,000 7,500 22,500 Property, plant and equipment, net Total assets 60,000 $112,000 50,000 $72,500 Current liabilities: Accounts payable Non-current liabilities Total liabilities $ 30,930 40,000 $ 70,930 $16,550 30,000 $46,550 $24,000 (1) $20,000 (2) Profit before taxes and interest (1) $100,000 – $50,000 – $26,000 (2) $50,000 – $20,000 – $10,000 $ Average $6,000 12,500 18,750 37,250 Solutions Manual 10-74 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP10-4 (Continued) Please note that when calculating turnover ratios, amounts from the current and prior year statement of financial position are averaged However, if the prior year amount is not available, we use the current year amount only 2015 in thousands 2014 Current ratio $52,000 $30,930 Receivables turnover $100,000 $12,500 Inventory turnover $50,000 $18,750 = 2.7 times Debt to total assets $70,930 $112,000 = 63.3% Times interest earned $24,000 $2,400 = 1.7:1 = 8.0 times = 10.0 times $22,500 $16,550 $50,000 $5,000 $20,000 $7,500 $46,550 $72,500 $20,000 $1,500 = 1.4:1 = 10.0 times = 2.7 times = 64.2% = 13.3 times Although Jim might conclude that profitability and liquidity has improved, a closer scrutiny of all ratios reveals issues with the liquidity and solvency of Atlas Limited The current ratio has increased from 1.4:1 to 1.7:1 in 2015 but this was due to the high levels of accounts receivable and inventory The receivable turnover has deteriorated substantially from 10 times in 2014 to only times in 2015 Fortunately, the inventory turnover has remained unchanged at 2.7 times for both years Atlas needs to improve its collection of receivables Furthermore, Jim needs to keep in mind that some cash has been retained by negotiating an interest only loan that will end in 2017 This advantage will not continue forever From a solvency point of view, Atlas has a very similar debt to total assets ratio in both years but the ratio remains rather high given that more than 60% of the company’s assets have been purchased with debt financing In addition, Atlas’ times interest earned ratio had diminished from 13.3 times in 2014 to 10 times in 2015 indicating less capability to pay the interest on the loan Furthermore, it is likely that the existing loan is secured by the plant and equipment The loan now represents 67% of the plant and equipment balance, up from 60% of the year before This increase arises because the carrying value of plant and equipment is declining Solutions Manual 10-75 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP10-4 (Continued) Some of the underlying causes for the slowdown in the turnover of accounts receivable might be that Atlas has given its customers too generous terms for payment, possibly to improve sales or there has been a lack of attention paid to delinquent accounts In looking at the income statement, the banker will notice that gross profit did not rise as much as sales This is due in part to the fact that cost of goods sold is now 50% of sales in 2015 compared to 40% of sales in 2014 Also although sales have doubled, operating expenses more than doubled and lastly it appears that the interest rate on the loan has risen to 6% from 5% These factors which have decreased profitability will concern the banker A final area of concern from the point of view of the banker will be the future settlement of the contingent liability stemming from the lawsuit launched against Atlas Although no amount could be accrued for this contingency as no reasonable estimate could be arrived at, the mere mention of this looming potential obligation will rightly bring doubt as to Atlas’ ability to deal with any related payments in the near future Solutions Manual 10-76 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-5 ETHICS CASE (a) The stakeholders in this situation include: Shareholders Lenders and other creditors Employees Management (b) Currently, operating lease payments are treated as rent expense The details of the amount of the future payments under the lease contract are reported in the notes to the financial statements On the other hand, a finance lease is treated as a means of financing the acquisition of the asset and so the asset being leased is added to the assets and the total obligations under the lease appear in the liabilities section of the statement of financial position Payments on finance lease obligations are treated as part interest expense and part debt repayment A finance lease causes increased interest expense and debt on the financial statements and so the debt to total assets ratio and the times interest earned ratio are adversely affected (c) While management does have a choice of structuring a lease agreement as an operating or finance lease, it is unethical on the part of management to deliberately structure a transaction for the sole purpose of keeping debt off the financial statements This behaviour could be construed as a type of financial engineering which is designed to deceive others and remove obligations that occur as a result of a transaction In this case, management must meet some specific financial conditions with respect to its debt covenants with the bank Following through with the plan might put the bank at a disadvantage in obtaining recourse under its loan agreement with Crown Point Inc (d) Analysts are not fooled by financial engineering involving leases Notwithstanding the application of the current rules surrounding the capitalization of leases, analysts will make the necessary adjustments to the financial results to interpret the impact of the treatment of operating versus finance leases Solutions Manual 10-77 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-6 “ALL ABOUT YOU” ACTIVITY (a) Most student loan programs require repayment and begin charging interest as soon as the student has finished school The options offered by the Canada Student Loan Program are: • Start making interest payments as soon as the student finishes school • Add the amount of interest for the first six month grace period to the loan principal and make regular loan payments • Pay six months of interest as a lump sum before making regular loan payments The length of time to repay the loan can vary up to 114 months (if you take advantage of the grace period) or up to 120 months if you don’t You can also choose a shorter repayment period One can also request an extension to 174 months (with grace period) or 180 months (without grace period) (b) The answer will depend on the prime rate This solution uses a prime rate of 3% With a fixed rate the monthly loan payments are: Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum (c) Monthly Payment $303.32 # of Months 120 Note $326.33 114 $313.78 114 Interest of $1,000 added to loan Lump sum of $1,000 to be paid The answer will depend on the prime rate This solution uses a prime rate of 3% With a floating rate the monthly loan payments are: Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum Monthly Payment $271.32 # of Months 120 $289.80 114 $282.05 114 Note Interest of $687.50 added to loan Lump sum of $687.50 to be paid Solutions Manual 10-78 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP10-6 (Continued) (d) For a loan to be repaid in five years (60 months) the monthly repayment options are: (1) Fixed Rate: Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum Monthly Payment $506.91 # of Months 60 Note $574.92 54 $552.81 54 Interest of $1,000 added to loan Lump sum of $1,000 to be paid (2) Floating Rate: Option Start interest payments when school finishes Add grace period interest to loan Pay six months interest as a lump sum Monthly Payment $477.53 # of Months 60 $538.07 54 $523.67 54 Note Interest of $687.50 added to loan Lump sum of $687.50 to be paid Solutions Manual 10-79 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 10-7 SERIAL CASE (a) The balance of the mortgage payable at November 25, 2015 is $46,718 as calculated below Monthly Interest Period June July Aug Sept Oct Nov (b) 25, 25, 25, 25, 25, 25, 2015 2015 2015 2015 2015 2015 (A) (B) Interest Expense Cash Payment (D) × 5% × 1/12 Balance $667 667 667 667 667 $204 202 201 199 197 (C) Reduction of Principal (A) – (B) $463 465 466 468 470 (D) Principal Balance (D) – (C) $49,050 48,587 48,122 47,656 47,188 46,718 The balance of the mortgage payable at November 25, 2015 of $46,718 will increase by $25,000 to a total of $71,718 after the mortgage is renegotiated Nov 26, 2015 Bank Indebtedness Mortgage Payable 25,000 25,000 Solutions Manual 10-80 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP10-7 (Continued) (c) Monthly Interest Period (A) (B) Interest Expense Cash Payment (D) × 4% × 1/12 (C) Reduction of Principal (A) – (B) (D) Principal Balance (D) – (C) Nov Dec 25, 2015 25, 2015 Balance $1,320 $239 $1,081 $71,718 70,637 Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan Feb 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2016 25, 2017 25, 2017 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 1,320 235 232 228 225 221 217 214 210 206 202 199 195 191 188 1,085 1,088 1,092 1,095 1,099 1,103 1,106 1,110 1,114 1,118 1,121 1,125 1,129 1,132 69,552 68,464 67,372 66,277 65,178 64,075 62,969 61,859 60,745 59,627 58,506 57,381 56,252 55,120 Mar Apr May June 25, 2017 25, 2017 25, 2017 25, 2017 1,320 1,320 1,320 1,320 184 180 176 172 1,136 1,140 1,144 1,148 53,984 52,844 51,700 50,552 Solutions Manual 10-81 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP10-7 (Continued) (d) First Instalment Payment 2015 Dec 25 Interest Expense Mortgage Payable Cash 239 1,081 1,320 Second Instalment Payment 2016 Jan 25 Interest Expense Mortgage Payable Cash 235 1,085 1,320 (e) KOEBEL’S FAMILY BAKERY Statement of Financial Position (Partial) June 30, 2016 Liabilities Current liabilities Current portion of 4% mortgage payable ($64,075 – $50,552) Non-current liabilities Mortgage payable, 4%, due in 2020 $13,523 $50,552 Solutions Manual 10-82 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Legal Notice Copyright Copyright © 2014 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd (MMXIV xii F3) Solutions Manual 10-83 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... Bank Loan Payable Cash 18,333 83,333 100 ,000 1,000,000 13,333 103 ,333 101 ,666 Solutions Manual 10- 37 Chapter 10 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized... Non-current debt ($250,000 – $30,000) 10, 000 594 257 1,300 5,000 30,000 220,000 10 Not on the financial statements as not drawn on Solutions Manual 10- 43 Chapter 10 Copyright © 2014 John Wiley & Sons... (period 4), which is $10, 652 [8] This leaves $11,394 ($22,046 [6] less current portion of $10, 652) as the non-current portion of the debt Solutions Manual 10- 13 Chapter 10 Copyright © 2014 John