Chapter 10 Assigned Question SOLUTIONS

SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 10-1
(a)
Oct. 1 Cash ($6,000 + $780) ............................................ 6,780
Sales ............................................................. 6,000
Sales Tax Payable ($6,000 × 13%) .............. 780
(b)
Oct. 1 Cash ($6,000 + $899) ............................................ 6,899
Sales ............................................................. 6,000
Sales Tax Payable [($6,000 × 5%) +
($6,000 × 9.975%)] .................................... 899
LO 1 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-2
(a)
Apr. 30 Property Tax Expense ($36,000 ÷ 12 × 4)................. 12,000
Property Tax Payable ........................................ 12,000
(b)
July 15 Property Tax Payable ................................................ 12,000
Property Tax Expense ($36,000 ÷ 12 × 2.5).............. 7,500
Prepaid Property Tax ($36,000 ÷ 12 × 5.5) ............... 16,500
Cash .................................................................. 36,000
(c)
Dec. 31 Property Tax Expense ............................................... 16,500
Prepaid Property Tax ........................................ 16,500
LO 1 BT: AP Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-3
(a) Aug. 24 Salaries Expense ................................................... 15,000
Employee Income Tax Payable .................... 6,258
CPP Payable................................................. 743
EI Payable..................................................... 282
Cash ($15,000 – $6,258 – $743 – $282) ...... 7,717
(b) Aug. 24 Employee Benefits Expense .................................. 1,138

CPP Payable................................................. 743
EI Payable..................................................... 395
(c) Sept. 3 Employee Income Tax Payable ............................. 6,258

CPP Payable ($743 + $743) .................................. 1,486
EI Payable ($282 + $395) ...................................... 677
Cash ($6,258 + $1,486 + $677) .................... 8,421
BRIEF EXERCISE 10-4

(a) July 1 Cash ...................................................................... 60,000
Bank Loan Payable ....................................... 60,000
(b) (1) Aug. 1 Interest Expense ($60,000 × 5% × 1/12) ............... 250
Cash.............................................................. 250
(2) Aug. 31 Interest Expense .................................................... 250

Interest Payable ............................................ 250
(3) Sept. 1 Interest Payable ..................................................... 250
Cash.............................................................. 250
(4) Oct. 1 Interest Expense .................................................... 250
Cash.............................................................. 250
(c) Oct. 1 Bank Loan Payable ................................................ 60,000

Cash ............................................................. 60,000
BRIEF EXERCISE 10-5
IFRS ASPE
a) Record and disclose a provision Record and disclose a contingent
(likely is a higher level of probability than probable,
liability, which in turn, is more likely than not)
b) Not recorded, disclose only Not recorded, disclose only
c) Not recorded nor disclosed Not recorded nor disclosed
d) Not recorded, disclose only Not recorded, disclose only
e) Not recorded, disclose only Not recorded, disclose only
LO 1 BT: AN Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-6
a) The advantage of the fixed interest rate option is that the rate will not change
during the 10-year period, regardless of what happens to interest rates in the
future. One could view this feature as a disadvantage in that a decline in interest
rates will not result in a reduction of interest costs. In order to lock in the interest
rate for such a long period of time, the monthly instalment payment and the
amount of interest is higher.
The disadvantage of the fixed interest rate option becomes the advantage of the
floating interest rate option. When interest rates decline, the loan interest and the
monthly instalment payment are reduced. The disadvantage is that if interest
rates increase, the opposite will occur.
b) Students generally have limited income upon graduation and so the additional
risk of possible increases in instalment payments for student loans should be
avoided. The fixed interest rate is recommended. Alternately, choosing the
floating rate makes the initial monthly payments smaller, during the time when
earnings may be at their lowest. As long as rates do not increase too much, it
could be the less expensive alternative.
LO 2 BT: AN Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-7
(a) [1] $50,000 × 7% = $3,500

[2] $13,500 – $3,500 = $10,000
[3] $12,800 – $2,800 = $10,000 or same as [2] as fixed principal reduction
[4] $40,000 – $10,000 = $30,000 (or $2,100 ÷ 7% = $30,000)
[5] $10,000 fixed principal reduction [6] + $2,100 = $12,100
[6] $10,000 fixed principal reduction
[7] $30,000 [4] – $10,000 [6] = $20,000
[8] $11,400 – $1,400 = $10,000 fixed principal reduction or $20,000 [7] – $10,000
[9] $10,700 – $700 = $10,000 fixed principal reduction
[10] $10,000 – $10,000 = $0
(b) The current portion of the note at the end of period 3 is the amount of principal
reduction in the next year (period 4), which is $10,000. This leaves $10,000
($20,000 less current portion of $10,000) as the non-current portion of the debt.
LO 2 BT: AP Difficulty: C Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
BRIEF EXERCISE 10-8
(a) [1] $50,000 × 7% = $3,500
[2] $12,195 fixed cash payment
[3] $12,195 [2] – $2,891 = $9,304 or $41,305 – $32,001
[5] $12,195 [4] – $9,955 = $2,240 or $32,001 × 7%
[6] $32,001 – $9,955 = $22,046
[8] $12,195 [7] – $1,543 = $10,652 or $22,046 [6] – $11,394 = $10,652
[10] $11,394 – $11,394 = $0
(b) The current portion of the note at the end of period 3 is the amount of principal
reduction in the next year (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.
BRIEF EXERCISE 10-9
(a) Fixed principal payment
(B) (C)
(A) Interest Reduction of (D)
Monthly Cash Expense Principal Principal
Interest Payment (D) × 4% ÷ ($300,000 ÷ Balance
Period (B) + (C) 12 months 120) (D) ̶ (C)
Nov. 30, 2017 $300,000
Dec. 31, 2017 $3,500 $1,000 $2,500 297,500
Jan. 31, 2018 3,492 992 2,500 295,000
2017
Nov. 30 Cash ......................................................................... 300,000
Mortgage Payable ............................................ 300,000
Dec. 31 Interest Expense ....................................................... 1,000

Mortgage Payable ..................................................... 2,500
Cash ................................................................. 3,500
2018
Jan. 31 Interest Expense ....................................................... 992
Mortgage Payable ..................................................... 2,500
Cash ................................................................. 3,492
BRIEF EXERCISE 10-9 (CONTINUED)
(b) Blended principal and interest payment
(B)
Interest (C) (D)
Monthly (A) Expense Reduction Principal
Interest Cash (D) × 4% ÷ of Principal Balance
Period Payment 12 mos. (A) – (B) (D) – (C)
Nov. 30, 2017 $300,000
Dec. 31, 2017 $3,037 $1,000 $2,037 297,963
Jan. 31, 2018 3,037 993 2,044 295,919
01476.73 22,000
2017
Nov. 30 Cash .................................................................. 300,000
Mortgage Payable ..................................... 300,000
Dec. 31 Interest Expense ................................................ 1,000

Mortgage Payable .............................................. 2,037
Cash .......................................................... 3,037
2018
Jan. 31 Interest Expense ................................................ 993
Mortgage Payable .............................................. 2,044
Cash .......................................................... 3,037
BRIEF EXERCISE 10-10
a. Non-current liability
b. Current liability
c. Current liability
d. Neither – any unused portion is not a liability and no balance is outstanding but
line of credit limits should be disclosed in the notes to the financial statements
e. Current liability
f. Neither – obligations are reported in the notes to the financial statements
g. Non-current liability
h. Current liability
i. Neither – current asset
j. Current liability for the $5,000 due next year. The remaining $70,000 balance is a
non-current liability.
k. Neither – because the outcome has a remote probability, it is neither recorded nor
disclosed
LO 3 BT: K Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting
(in $ millions)
(a) Current ratio

$443
= 1.0:1
$423
(b) Debt to total $1,014

= = 64.9%
assets $1,563
$76 + $19 + $28

(c) Times interest earned = = 6.5 times
$19
LO 3 BT: AP Difficulty: S Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005
CM: Reporting and Finance
(a) Debt to total assets Improvement

Times interest earned Deterioration
(b) Although Fromage’s debt to total assets ratio improved in 2018, its times interest
earned ratio deteriorated. Fromage’s overall solvency appears to have
deteriorated because even though liabilities relative to assets has fallen, the
company is generating less income before income tax and interest relative to its
interest expense than it did in the prior year.
LO 3 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005

*BRIEF EXERCISE 10-13

(a) The proceeds received from the issue of the bonds = face value of the bonds X
price.
$200,000 x 96 = $192,000
(b) Interest expense on the first semi-annual interest payment = bond carrying
amount x effective interest rate x 6/12
$192,000 x 7% x 6/12 = $6,720
(c) The semi-annual interest payment based on the coupon rate of 6% x face value
of the bonds x 6/12 = $200,000 x 6% x 6/12 = $6,000
The amortization of the bond discount is $6,720 less $6,000 or $720
The amortization of the bond discount is added to the bond carrying amount of
$192,000 making the carrying amount after the first interest payment $192,720.
(a) The proceeds received from the issue of the bonds = face value of the bonds X
price.
$100,000 x 109 = $109,000
(b) Interest expense on the first semi-annual interest payment = bond carrying
amount x effective interest rate x 6/12
$109,000 x 3% x 6/12 = $1,635
(c) The semi-annual interest payment based on the coupon rate of 5% x face value
of the bonds x 6/12 = $100,000 x 5% x 6/12 = $2,500
The amortization of the bond premium is $2,500 less $1,635 or $865
The amortization of the bond premium is deducted from the bond carrying
amount of $109,000 making the carrying amount after the first interest payment
$108,135.
(a) Key inputs: Future value (FV) = $500,000
Market interest rate (i) = 2.5% (5% × 6/12)
Interest payment (PMT) = $15,000 ($500,000 × 6% × 6/12)
Number of semi-annual periods (n) = 10 (5 years × 2)
Present value of $500,000 received in 10 periods

($500,000 × 0.78120) (n = 10, i = 2.5%) $390,600
Present value of $1 5,000 received each of 10 periods
($500,000 × 3% × 8.75206) (n = 10, i = 2.5%) 131,281
Present value (issue price) of the bonds $521,881
(b) Key inputs: Future value (FV) = $500,000

Market interest rate (i) = 3% (6% × 6/12)

($500,000 × 0.74409) (n = 10, i = 3%) $372,045
($500,000 × 3% × 8.53020) (n = 10, i = 3%) 127,953
Present value (issue price) of the bonds (rounded to $500,000) $500,000
This is rounded because we know that there would be no
discount or premium because the market and stated rate are equal
(c) Key inputs: Future value (FV) = $500,000

Market interest rate (i) = 3.5% (7% × 6/12)

($500,000 × 0. 70892) (n = 10, i = 3.5%) $354,460
($500,000 × 3% × 8.31661) (n = 10, i = 3.5%) 124,749
Present value (issue price) of the bonds $479,209
Note to the instructor: Rounding discrepancies may arise depending on whether present
value tables, calculators, or spreadsheet programs are used to determine the present
value.
(a) CARVEL CORP.
Bond Premium Amortization
(A) (B) (C) (D) (E)

Semi- Interest Interest Premium Unamor- Bond
annual Payment Expense Amor- tized Carrying
Interest (6% × (5% × 6/12 tization Premium Amount
Periods 6/12 = = 2.5%) (A) – (B) (D) – (C) ($500,000 + D)
3%)
Jan. 1/18 $21,881 $521,881

July 1/18 $15,000 $13,047 $1,953 19,928 519,928
Jan. 1/19 15,000 12,998 2,002 17,926 517,926
(b) CARVEL CORP.
Interest Interest Bond

Semi- Payment Expense Carrying
annual (6% × (6% × 6/12 Amount
Interest 6/12 = = 3%) ($500,000)
Periods 3%)
Jan. 1/18 $500,000

July 1/18 $15,000 $15,000 500,000
Jan. 1/19 15,000 15,000 500,000
BRIEF EXERCISE 10-16 (CONTINUED)
(c) CARVEL CORP.

Bond Discount Amortization
(A) (B) (E)

Semi- (C) (D)
Interest to Be Interest Bond
annual Discount Unamortized
Paid Expense Carrying
Interest Amortization Discount
(6% × 6/12 = (7% × 6/12 Amount
Periods (A) – (B) (D) – (C)
3%) = 3.5%) ($500,000 – D)
Jan. 1/18 $20,791 $479,209

July 1/18 $15,000 $16,772 $1,772 19,019 480,981
Jan. 1/19 15,000 16,834 1,834 17,185 482,815
(a)
Jan. 1 Cash ............................................................ 521,881
Bonds Payable .................................... 521,881
July 1 Interest Expense .......................................... 13,047

Bonds Payable ............................................. 1,953
Cash.................................................... 15,000
Dec. 31 Interest Expense .......................................... 12,998

Bonds Payable ............................................. 2,002
Interest Payable .................................. 15,000
(b)
Jan. 1 Cash ............................................................ 500,000
Bonds Payable .................................... 500,000

Cash.................................................... 15,000

(c)
Jan. 1 Cash ............................................................ 479,209
Bonds Payable .................................... 479,209

Bonds Payable .................................... 1,772
Cash.................................................... 15,000

Bonds Payable .................................... 1,834
EXERCISE 10-2
(a)
Mar. 17 Cash ............................................................. 56,000
Sales .................................................... 50,000
Sales Tax Payable ($2,500 + $3,500) .. 6,000
May 1 Property Tax Expense ($52,800 ÷ 12 × 4) ... 17,600

Property Tax Payable ........................... 17,600
July 1 Property Tax Expense ($52,800 ÷ 12 × 2) ... 8,800

Prepaid Property Tax ($52,800 ÷ 12 × 6) ..... 26,400
Property Tax Payable ................................... 17,600
Cash ..................................................... 52,800
Aug. 15 Salaries Expense ......................................... 81,000

CPP Payable ........................................ 4,010
EI Payable ............................................ 1,523
Employee Income Tax Payable ........... 16,020
Pension Payable .................................. 6,400
Cash ..................................................... 53,047
15 Employee Benefits Expense ........................ 6,142

CPP Payable ........................................ 4,010
EI Payable ............................................ 2,132
22 CPP Payable ($4,010 + $4,010) .................. 8,020

EI Payable ($1,523 + $2,132) ...................... 3,655
Employee Income Tax Payable.................... 16,020
Cash ..................................................... 27,695
Oct. 1 Cash ............................................................. 100,000

Bank Loan Payable .............................. 100,000
EXERCISE 10-3 (CONTINUED)
(b)
Dec. 31 Property Tax Expense .................................. 26,400
Prepaid Property Tax ........................... 26,400
31 Interest Expense ($100,000 × 4% × 3/12).. 1,000

Interest Payable ................................. 1,000
(c)
April 1 Bank Loan Payable ........................................... 100,000
Interest Payable ................................................ 1,000
Interest Expense ............................................... 1,000
Cash ......................................................... 102,000
EXERCISE 10-5
(a) and (b)
(1) Fixed principal payment

(B) (C)
(A) Interest Reduction (D)
Semi-annual Cash Expense of Principal Principal
Interest Payment (D) × 5% × ($150,000 ÷ Balance
Period (B) + (C) 6/12 20) (D) – (C)
Dec. 31, 2017 $150,000
June 30, 2018 $11,250 $3,750 $7,500 142,500
Dec. 31, 2018 11,063 3,3,,53,563 7,500 135,000
01 01476.73 22,000
Issue of Mortgage
2017 Dec. 31 Cash .................................................... 150,000

Mortgage Payable ...................... 150,000
First Instalment Payment
2018 June 30 Interest Expense ($150,000 × 5% × 6/12) 3,750

Mortgage Payable ............................... 7,500
Cash ........................................... 11,250
Second Instalment Payment
Dec. 31 Interest Expense

[($150,000 – $7,500) × 5% × 6/12] 3,563
Cash ........................................... 11,063
(a) and (b) (continued)
(2) Blended principal and interest payment

(B)
Interest (C) (D)
Semi-annual (A) Expense Reduction Principal
Interest Cash (D) × 5% × of Principal Balance
Period Payment 6/12 (A) – (B) (D) – (C)
Dec. 31, 2017 $150,000
June 30, 2018 $9,622 $3,750 $5,872 144,128
Dec. 31, 2018 9,622 3,603 6,019 138,109
01 0 01476.73 22,000
Issue of Mortgage
2017 Dec. 31 Cash .................................................... 150,000

Mortgage Payable ...................... 150,000
First Instalment Payment
2018 June 30 Interest Expense

($150,000 × 5% × 6/12) ................... 3,750
Cash ........................................... 9,622
Second Instalment Payment
Dec. 31 Interest Expense [($150,000

– $5,872) × 5% × 6/12] ................... 3,603
Mortgage Payable ............................. 6,019
Cash ......................................... 9,622
(c) Interest expense for the six-month period ended June 30, 2018 is the same
amount of $3,750 whether the payment is blended or based on fixed principal
payments because for this first period, the amount of the principal balance of the
loan is the same, at the initial amount of $150,000. Once the six-month period is
completed, the principal balance of the mortgage payable on which interest
charges are applied changes by a different amount based on whether the
principal payment is fixed or is blended with interest, based on the repayment
terms of the loan. Thereafter, the interest expense will differ under the two
approaches.
EXERCISE 10-7
(a) This is a blended principal and interest payment schedule, as the cash payment is
constant at $23,097.48 each year.
(b) The interest rate is 5% ($5,000 ÷ $100,000).
(c) Interest Expense ..................................................... 5,000.00

Bank Loan Payable ................................................. 18,097.48
Cash ............................................................. 23,097.48
(d) Current portion = $19,952.47

Non-current portion = $20,950.10 + $21,997.60 = $42,947.70
LO 2 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
EXERCISE 10-9
($ in thousands)
(a) Current ratio
2018: $4,744 = 1.6:1 2017: $4,298 = 1.4:1

$3,011 $2,989
(1) Based only on the current ratio, Fruition’s liquidity is improving in 2018.
There are proportionately more current assets to pay the current liabilities.
(2) To make a proper assessment, information concerning the due dates for the
liabilities and the type of current assets that make up the remaining assets
would need to be scrutinized. For example, if current assets consisted
mainly of cash rather than inventory, we would conclude that the company
had greater liquidity. Knowing the quality of receivables and the turnover of
the inventory would be useful.
(b) Current ratio for 2018:
Before:
$4,744
= 1.6:1
$3,011
After:
$4,744 - $1,000
= 1.9:1
$3,011 - $1,000
Paying off the $1 million improves Fruition’s current ratio from 1.6:1 to 1.9:1. This
is because $1 million represents a greater percentage of the denominator than it
does the numerator. The greater percentage decrease to the denominator makes
the ratio rise.
(c) Having access to an operating line of credit means that cash is available
on a short-term basis and therefore the assessment of the company’s short-term
liquidity is better than it first appeared. Although the ability to access cash
improves the liquidity position, it does not necessarily mean that drawing down
the operating line of credit will improve the current ratio. If the unused line of
credit were to be fully drawn down, Fruition’s current assets would increase by
the addition of $4 million of cash. At the same time, the current liabilities would
increase by the addition of a $4 million bank loan payable. As is demonstrated in
the calculation below, the current ratio would deteriorate to 1.2:1.
$4,744 + $4,000
= 1.2:1
$3,011 + $4,000
EXERCISE 10-10
($ in millions)
(a)
2014
$2,258
Debt to total assets = = 57.9%
$3,900
$218 + $58 + $28

Times interest earned = = 10.9 times
$28
2015
$2,559
Debt to total assets = = 58.3%
$4,388
$234 + $32 + $55

Times interest earned = = 5.8 times
$55
Open Text Corporation’s debt to total assets ratio deteriorated slightly in

2015, with the increase from 57.9% to 58.3%. The company’s times interest
earned ratio decreased significantly from 10.9 times in 2014 to 5.8 times in 2015.
This reveals a deterioration in Open Text’s solvency.
(b) Having access to an operating line of credit means that cash is available
on a short-term basis. None of the total line of credit available in the amount of
$300 million has been drawn down at the date of the financial statements. Since
no liability exists at the end of the year, only a note disclosure of the available
operating line of credit will be needed.
LO 3 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
SOLUTIONS TO PROBLEMS
PROBLEM 10-1A
(a) Mar. 2 Accounts Payable ..................................... 10,000

Notes Payable .................................. 10,000
5 Cash ......................................................... 45,200

Sales................................................. 40,000
Sales Tax Payable ($40,000 × 13%) 5,200
Cost of Goods Sold .................................. 24,000

Inventory ........................................... 24,000
9 Property Tax Expense ($18,000 × 3/12) .. 4,500

Property Tax Payable ....................... 4,500
As we are now in the third month, expense 3 months of property taxes.
12 Unearned Revenue .................................. 11,300

Service Revenue .............................. 10,000
Sales Tax Payable ($11,300 ÷ 1.13 × 13%) . 1,300
13 Sales Tax Payable.................................... 5,800

Cash ................................................. 5,800
16 CPP Payable ($1,340 + $1,340) ............... 2,680

EI Payable ($468 + $655) ......................... 1,123
Employee Income Tax Payable ................ 5,515
Cash ................................................. 9,318
27 Accounts Payable ..................................... 30,000

Cash ................................................. 30,000
PROBLEM 10-1A (CONTINUED)
(a) (continued)
Mar. 30 Salaries Expense ....................................... 16,000

CPP Payable ..................................... 792
EI Payable ......................................... 301
Employee Income Tax Payable ......... 5,870
Cash .................................................. 9,037
30 Employee Benefits Expense...................... 1,213

CPP Payable ..................................... 792
EI Payable ......................................... 421
(b) Mar. 31 Interest Expense........................................ 50

Interest Payable .................................... 50
($10,000 × 6% × 1/12)
(c)
MOLEGA LTD.
Statement of Financial Position (partial)
March 31, 2018
Current liabilities
Accounts payable ($42,500 – $10,000 – $30,000).................. $ 2,500
Notes payable ......................................................................... 10,000
Unearned revenue ($15,000 – $11,300) ................................. 3,700
Employee income tax payable ($5,515 – $5,515 + $5,870) .... 5,870
Property tax payable ............................................................... 4,500
Sales tax payable ($5,800 + $5,200 + $1,300 - $5,800) ......... 6,500
CPP payable ($2,680 – $2,680 + $792 + $792) ...................... 1,584
EI payable ($1,123 – $1,123 + $301 + $421) .......................... 722
Interest payable ....................................................................... 50
Total current liabilities .................................................. $35,426
LO 1,3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
PROBLEM 10-4A
(a)
Interest
Semi-annual Cash Expense Reduction of Principal
Interest Period Payment 6.5% × 6/12 Principal Balance
June 30, 2017 $700,000

Dec. 31, 2017 $48,145 $22,750 $25,395 0674,605
June 30, 2018 48,145 021,925 26,220 0648,385
Dec. 31, 2018 48,145 021,073 27,072 621,313
June 30, 2019 48,145 020,193 27,952 0593,361
(b) 2017
June 30 Cash ......................................................... 700,000
Mortgage Payable ........................... 700,000
(c) 2017;
Dec. 31 Interest Expense....................................... 22,750
Mortgage Payable .................................... 25,395
Cash ................................................ 48,145
2018
June 30 Interest Expense....................................... 021,925
Mortgage Payable .................................... 26,220
Cash ................................................ 48,145
(d)
STARLIGHT GRAPHICS LTD.
Statement of Financial Position (Partial)
June 30, 2018
Current liabilities
Current portion of mortgage payable ............................... $ 55,024*
Non-current liabilities
Mortgage payable ............................................................ 0593,361
*($27,072 + $27,952) = $55,024
LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
PROBLEM 10-7A
(a)
2015 2014
(in millions)
1. Current ratio $1,962 $1,896

= 1.7:1 = 1.1:1
$1,179 $1,725
2. Receivables $10,658 $9,223

= 13.4 times = 12.9 times
turnover $785 + $807 $807 + $625
2 2
3. Inventory $7,688 $6,518

= 7.9 times = 7.7 times
turnover $1,006 + $933 $933 + $770
2 2
4. Debt to $3,172 $3,518

= 46.6% = 55.3%
total assets $6,800 $6,357
5. Times
interest earned $613+$237+$73 = 12.6 times $534+$225+$69 = 12.0 times
$73 $69
(b) Saputo’s current ratio has improved significantly and is more in line with industry
averages in 2015. The receivables turnover ratio also improved from 12.9 times
in 2014 to 13.4 times in 2015 and now matches the industry average. The
inventory turnover improved as well from 7.7 times in 2014 to 7.9 times in 2015.
In this respect, Saputo is well ahead of industry averages. This means that
Saputo is collecting its receivables and moving its inventory more quickly in 2015
than in 2014. Improvements in the receivable and inventory turnover ratios likely
lead to the improvement in the current ratio in 2015 because as the turnovers
improved, cash was collected faster and used to pay down current liabilities. It is
the reduction in the denominator of this ratio that caused the most significant
change in the current ratio increase in 2015. . Overall, Saputo’s 2015 liquidity
ratios are quite healthy.
During 2015, Saputo’s debt to total assets ratio improved from 55.3% in 2014 to
46.6% in 2015. The company’s times interest earned ratio also improved. In
comparison to the industry average, Saputo is carrying less debt compared to
total assets (partly due to the lower current liabilities mentioned in the previous
paragraph), and its times interest earned ratio is significantly higher. This
indicates that the company appears to be earning more than enough net income
to make the required debt interest payments or the majority of the debt is non-
interest bearing. Therefore, there do not appear to be any significant concerns
regarding Saputo’s solvency in 2015.
(c) Saputo has secured a line of credit that helps it through short-term liquidity
problems during its operating cycle. The fact that it has used only 15% of the
$1.1 billion line of credit as of the end of 2015 demonstrates that it is not in great
need of cash to meet its obligations. Saputo is ready to take advantage of
opportunities that may come up in the future that would require significant
amounts of cash. As for the rise in the U.S. dollar relative to the Canadian dollar
in 2015, this has a detrimental effect on Saputo as the business must purchase
U.S. dollars to repay the debt. In addition, balances for any U.S. dollar debt
would be reported at higher exchange rates as of the date on the statement of
financial position.
(d) When assessing Saputo’s liquidity and solvency it is necessary to look at

operating lease commitments that will require cash payments in the same way as
all liabilities in the coming years. The fact that the amounts do not appear as
liabilities on the statement of financial position does not erase the commitment to
pay the amounts under those contracts in the future. The absence of these
commitments on the statement of financial position artificially improves the
company’s solvency. Upon further analysis, and with the inclusion of these
amounts, one can better assess the company’s liquidity and solvency.

PROBLEM 10-8A
(a) When reviewing the liquidity ratios for the two companies, it would appear that
Sun-Oil is less liquid than Petro-Zoom. Sun-Oil has a lower current ratio than
Petro-Zoom. Although it is turning its receivables over faster than Petro-Zoom,
Petro-Zoom is able to move its inventory much more quickly than Sun-Oil.
Furthermore, neither Petro-Zoom’s nor Sun-Oil’s receivables turnover ratios are
of particular concern. Both are collecting their receivables within an average 30-
day collection period (365 days divided by either 12 or 13 is approximately 30
days).
What is of concern is Sun-Oil’s inventory turnover of 10 times which is well below
Petro-Zoom’s of 16 times and the industry average of 19 times. This may be of
concern to a lender or other creditor as a company will not be able to generate
cash in the short-term if it cannot sell its inventory.
Based on the concerns over Sun-Oil’s inventory turnover, I would think that
Petro-Zoom is the more liquid of the two companies. I would be more inclined to
lend money to Petro-Zoom.
(b) In reviewing the solvency of these two companies we see that Petro-Zoom’s debt
to total assets ratio is marginally higher (worse) than Sun-Oil’s ratio, indicating
that Petro-Zoom has a higher percent of its assets financed by debt. Sun-Oil also
appears to be in a better position to make its interest payments, as indicated by
the higher times interest earned ratio (24 times for Sun-Oil compared to 21 times
for Petro-Zoom).
When compared to the industry, we can see that both companies have debt to
total assets ratios higher than the industry average. On the other hand, these
ratios are not far off the industry average and their high times interest earned
ratios leave little doubt that both companies are able to make their respective
interest payments on the debt.
(b) (Continued)
Based on the debt to total assets ratio and times interest earned ratio, Sun-Oil
seems to be the more solvent of the two. However, both companies appear to be
generating sufficient income to cover interest payments so I would not be
significantly concerned about the solvency of either company.


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SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 10-1

BRIEF EXERCISE 10-2

(b) Aug. 24 Employee Benefits Expense .................................. 1,138

(c) Sept. 3 Employee Income Tax Payable ............................. 6,258

BRIEF EXERCISE 10-4

(2) Aug. 31 Interest Expense .................................................... 250

(c) Oct. 1 Bank Loan Payable ................................................ 60,000

BRIEF EXERCISE 10-6

(a) [1] $50,000 × 7% = $3,500

Dec. 31 Interest Expense ....................................................... 1,000

Dec. 31 Interest Expense ................................................ 1,000

BRIEF EXERCISE 10-11

(a) Current ratio

(b) Debt to total $1,014

$76 + $19 + $28

(a) Debt to total assets Improvement

LO 3 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005

*BRIEF EXERCISE 10-13

Present value of $500,000 received in 10 periods

(b) Key inputs: Future value (FV) = $500,000

Present value of $500,000 received in 10 periods

(c) Key inputs: Future value (FV) = $500,000

Present value of $500,000 received in 10 periods

(A) (B) (C) (D) (E)

Jan. 1/18 $21,881 $521,881

(b) CARVEL CORP.

Interest Interest Bond

Jan. 1/18 $500,000

(c) CARVEL CORP.

(A) (B) (E)

Jan. 1/18 $20,791 $479,209

July 1 Interest Expense .......................................... 13,047

Dec. 31 Interest Expense .......................................... 12,998

July 1 Interest Expense .......................................... 15,000

Dec. 31 Interest Expense .......................................... 15,000

July 1 Interest Expense .......................................... 16,772

Dec. 31 Interest Expense .......................................... 16,834

May 1 Property Tax Expense ($52,800 ÷ 12 × 4) ... 17,600

July 1 Property Tax Expense ($52,800 ÷ 12 × 2) ... 8,800

Aug. 15 Salaries Expense ......................................... 81,000

15 Employee Benefits Expense ........................ 6,142

22 CPP Payable ($4,010 + $4,010) .................. 8,020

Oct. 1 Cash ............................................................. 100,000

31 Interest Expense ($100,000 × 4% × 3/12).. 1,000

(1) Fixed principal payment

2017 Dec. 31 Cash .................................................... 150,000

First Instalment Payment

2018 June 30 Interest Expense ($150,000 × 5% × 6/12) 3,750

Second Instalment Payment

Dec. 31 Interest Expense

(2) Blended principal and interest payment

2017 Dec. 31 Cash .................................................... 150,000

First Instalment Payment

2018 June 30 Interest Expense

Second Instalment Payment

Dec. 31 Interest Expense [($150,000

(b) The interest rate is 5% ($5,000 ÷ $100,000).

(c) Interest Expense ..................................................... 5,000.00

(d) Current portion = $19,952.47

(a) Current ratio

2018: $4,744 = 1.6:1 2017: $4,298 = 1.4:1

(b) Current ratio for 2018:

$218 + $58 + $28