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ACCT 3020 FINANCIAL ACCOUNTING II

SUMMER SEMESTER, 2012
EXAM ONE

Date: 16 July 2012

Time: 2pm – 3:30pm (90 minutes)

ANSWER ALL QUESTIONS.

PART A: 14 MULTIPLE CHOICE QUESTIONS (1.5 MARKS/MINUTE PER

QUESTION; 21 MARKS/MINUTE IN TOTAL)

1. What is the relationship between current liabilities and a company's

operating cycle?
a. Liquidation of current liabilities is reasonably expected within the
company's operating cycle (or one year if less).
b. Current liabilities are the result of operating transactions.
c. Current liabilities can't exceed the amount incurred in one operating
cycle.
d. There is no relationship between the two.

2. Dunn Trading Co. issued 2,500 ordinary shares, The shares have a ₤2
par value and sold for ₤12 per share. Dunn incurred ₤3,000 to sell the
shares related to underwriting costs and legal fees. Dunn Trading Co.
will record the ₤3,000 as
a. A debit to Share Premium—Ordinary.
b. A debit to Financing Expense.
c. A credit to Share Premium—Ordinary.
d. A credit to Share Capital—Ordinary.

3. When treasury shares are purchased for more than the par value of the
shares and the cost method is used to account for treasury shares,
what account(s) should be debited?
a. Treasury shares for the par value and share premium for the
excess of the purchase price over the par value.
b. have premium for the purchase price.
c. Treasury shares for the purchase price.
d. Treasury shares for the par value and retained earnings for the
excess of the purchase price over the par value.

4. How should a "gain" from the sale of treasury shares be reflected when
using the cost method of recording treasury shares transactions?
a. As other income shown on the income statement.
b. As share premium from treasury share transactions.
c. As an increase in the amount shown for share capital.
d. As an increase in the retained earnings amount.

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5. Porter Corp. purchased its own par value shares on January 1, 2010
for $20,000 and debited the treasury shares account for the purchase
price. The shares were subsequently sold for $12,000. The $8,000
difference between the cost and sales price should be recorded as a
deduction from
a. share premium—treasury to the extent that previous net "gains"
from sales of the same class of stock are included therein;
otherwise, from retained earnings.
b. share premium—treasury without regard as to whether or not there
have been previous net "gains" from sales of the same class of
shares included therein.
c. retained earnings.
d. net income.

6. The declaration and issuance of a share dividend larger than 25% of

the shares previously outstanding
a. increases ordinary shares outstanding and increases total equity.
b. decreases retained earnings but does not change total equity.
c. may increase or decrease share premium but does not change total
equity.
d. increases retained earnings and increases total equity.

7. The issuer of a 5% ordinary share dividend to ordinary shareholders

preferably should transfer from retained earnings to contributed capital
an amount equal to the
a. fair value of the shares issued.
b. book value of the shares issued.
c. minimum legal requirements.
d. par or stated value of the shares issued.

8. A feature common to both share splits and share dividends is

a. a transfer to earned capital of a corporation.
b. that there is no effect on total equity.
c. an increase in total liabilities of a corporation.
d. a reduction in the contributed capital of a corporation.

9. What effect does the issuance of a 2-for-1 share split have on each of
the following?
Par Value per Share Retained Earnings
a. No effect No effect
b. Increase No effect
c. Decrease No effect
d. Decrease Decrease

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10. Janae Corporation has outstanding 10,000 shares of £10 par value
ordinary shares and retained earnings of £500,000. If Janae declares a
10 percent share dividend when the fair value of the shares is £85 per
share, the entry includes:
a. A debit to Retained Earnings for £10,000.
b. A credit to Share Premium—Ordinary for £75,000.
c. A debit to cash for £85,000.
d. No entry is required for a share dividend.

11. Janae Corporation has outstanding 10,000 shares of £10 par value
ordinary shares and retained earnings of £500,000. If Janae declares a
2-for-1 share split when the fair value of the shares is £85 per share,
the entry includes:
a. A debit to Retained Earnings for £10,000.
b. A credit to Share Premium—Ordinary for £75,000.
c. A debit to cash for £85,000.
d. No entry is required for a share split.

12. Shipley Corporation had net income for the year of $480,000 and a
weighted average number of ordinary shares outstanding during the
period of 200,000 shares. The company has a convertible bond issue
outstanding. The bonds were issued four years ago at par
($2,000,000), carry a 7% interest rate, and are convertible into 40,000
shares. The company has a 40% tax rate. Diluted earnings per share
are
a. $1.65
b. $2.23.
c. $2.35.
d. $2.58.

13. In determining diluted earnings per share, dividends on nonconvertible

cumulative preference shares should be
a. disregarded.
b. added back to net income whether declared or not.
c. deducted from net income only if declared.
d. deducted from net income whether declared or not.

14. The if-converted method of computing earnings per share data

assumes conversion of convertible securities as of the
a. beginning of the earliest period reported (or at time of issuance, if
later).
b. beginning of the earliest period reported (regardless of time of
issuance).
c. middle of the earliest period reported (regardless of time of
issuance).
d. ending of the earliest period reported (regardless of time of
issuance).

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PART B: 5 PROBLEM QUESTIONS (69 MARKS/MINUTES IN TOTAL)

SHOW YOUR WORKINGS. OTHERWISE, YOU MAY NOT RECEIVE FULL

MARKS FOR A CORRECT ANSWER AND YOU WILL NOT RECEIVE
PARTIAL MARKS FOR AN INCORRECT ANSWER.

QUESTION ONE (14 MARKS/MINUTES)

(1) Mini Automobile Limited (MAL) signed a firm sales contract with Car
Trading Inc. (CTI) on 1 May 2012. The contract specifies that 300 units
of Mini Wagon II (MW II) have to be delivered before 28 February 2013
at a fixed price of $380,000. If the delivery is more than 1 month late,
MAL will grant CTI a discount of 30% on each delayed unit. The cost of
production is $288,000 per unit. Up to 31 December 2012, MAL was
able to deliver 260 units. MAL will be able to deliver only another 20
units before 28 February 2013. The unexpected delay is due to a strike
in one of the production plants.

(2) As at 31 December 2012, MAL was a defendant in a patent

infringement lawsuit of its driving control system (DCS) that has a high
probability of making a loss of $120 million. If MAL loses the case, the
management will take legal action to claim the loss from the DCS
Developer. The company’s lawyers advise that it is also highly
probable that MAL will be successful in the recovery of $100 million
from the DCS developer.

Required:

For each of the above situations, determine whether MAL should report
a provision or contingent liability/asset and if so, how much.

QUESTION TWO (13 MARKS/MINUTES)

On 1 January 2011, Promoil acquired a newly constructed oil platform at a
cost of $30 million together with the right to extract oil from an offshore oilfield
under a government licence. The terms of the licence are that Promoil will
have to remove the platform (which will then have no value) and restore the
seabed to an environmentally satisfactory condition in 10 years’ time when the
oil reserves have been exhausted. The estimated cost of this on 31 December
2020 will be $15 million. The present value of $1 receivable in 10 years at the
appropriate discount rate for Promoil of 8% is $0.46.

Required:

(1) Prepare all relevant journal entries for Promoil for the year ended
31 December 2011. Indicate the date next to your journal entries.
(9 marks/minutes)

(2) Describe how your answer to (1) would change if the government
licence did not require an environmental cleanup.
(4 marks/minutes)

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QUESTION THREE (10 MARKS/MINUTES)

On April 30, 2002, Company issued 8% bonds with a par value of $900,000
due in 20 years. They were issued at 82.8 to yield 10% and were callable at
102 at any date after April 30, 2010. Because of lower interest rates and a
significant change in the company's credit rating, it was decided to call the
entries issue on April 30, 2011, and to issue new bonds. New 6% bonds were
sold in the amount of $1,200,000 at 112.5 to yield 5%; they mature in 20
years. Interest payment dates are October 31 and April 30 for both and new
bonds.

Required:

(1) Prepare journal entries to record the retirement of the old issue
and the sale of the new issue on April 30, 2011. Unamortized
discount is $118,470.
(6.5 marks/minutes)

(2) Prepare the entry required on October 31, 2011, to record the
payment of the first 6 months' interest and the amortization of
premium on the bonds.
(3.5 marks/minutes)

QUESTION FOUR (12 MARKS/MINUTES)

On 1 January 1999, AJS Inc. issued a 10% convertible debenture with a face
value of $1 million maturing on 31 December 2008 at par. The debenture is
convertible into ordinary shares of AJS at a conversion price of $25 per share.
Interest is payable half-yearly in cash. At the date of issue, AJS could have
issued non-convertible debt with a 10-year term bearing a coupon interest
rate of 12% at par.

On 1 January 2001, the convertible debenture has a fair value of $1,200,000.

AJS makes a tender offer to the holder of the debenture to repurchase the
debenture for $1,700,000, which the holder accepts. At the date of
repurchase, AJS could have issued non-convertible debt with a 8-year term
bearing a coupon interest rate of 8% at par.

Required:

Prepare the journal entries for the transactions. Indicate the date next to
your journal entries.

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QUESTION FIVE (20 MARKS/MINUTES)

The issued share capital of X Ltd, a listed company, as at 31 March 20X3
comprised 20,000,000 fully paid ordinary shares with par value of $1 each.

During the year ended 31 March 20X4, the following events took place in
respect of the company’s capital structure.

1. On 1 October 20X3, the company issued 2,000,000 shares with a par

value of $1 each at $4 each.
2. On 1 November 20X3, the company approved a capital structure
change, which involved a stock split of every 1 share as at 1 October
20X3 into 2 shares.
3. On 1 December 20X3, the company issued 3,000,000 shares with a
par value of $1 each at $5 each.
4. On 1 February 20X4, the company issued 5,000,000 8% convertible
cumulative preference shares of $1 each, which convert at a rate of
one ordinary share for ten preference shares outstanding.
5. As at 31 March 20X4, the company has certain stock options granted
to its employees with details as follows:

Number of share options granted and outstanding Exercise price

900,000 $ 8
630,000 $ 7
700,000 $10
400,000 $11

The average share price of the company was $9 for the year ended 31 March
20X4. All the options were granted on 1 April 20X3.

Extracts from the income statements for the years ended 31 March 20X3 and
20X4 are as follows:

20X3 20X4

Profit for the year $37,125,000 41,250,000

The rate of profits tax is 17.5%.

Required:

Based on the above information, compute the basic and diluted

earnings per share (if any) of X Ltd for the years ended 31 March 20X3
and 31 March 20X4, assuming you are reporting the financials for both
years in the same annual report.

***END OF EXAM***

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SUGGESTED SOLUTION

PART A (1.5 MARKS/MINUTE PER QUESTION; 21 MARKS/MINUTE IN

TOTAL)

1. A
2. A
3. C
4. B
5. A
6. B
7. A
8. B
9. C
10. B
11. D
12. C
13. D
14. A

PART B (69 MARKS/MINUTE IN TOTAL)

QUESTION ONE (14 MARKS/MINUTES)

(HKICPA QP, Module A, September 2006, amended)

Part (1)
According to the contract, the amount of the revenue from the remaining 40
units would be HK$12,920,000 (HK$380,000x20+380,000x70%x20).

The total cost of the 40 units would be HK$11,520,000 (HK$288,000x40).

Therefore, a gross profit of HK$1,400,000 would be resulted when MAL
completes the remaining obligations under the contract.

Since the contract is not an onerous contract, no provision at 31 December

2006 should be made for the future completion of the contract according to
IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

It is NOT appropriate to make a provision of HK$440,000 [(HK$380,000x70%

- HK$288,000)x 20] for the loss related to the delayed delivery of the 20 units,
since the unfinished part of the contract should be considered as a whole.

Part (2)
The past event leading to the highly probable loss of HK$120,000,000 was
the alleged infringement of DCS.

The obligation was a present obligation at 31 December 2012 since MAL had
already committed the alleged infringement.

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There were material uncertainties as to the timing and the amount of the
obligation until the settlement of the legal case, although MAL’s lawyers were
of the view that the loss of HK$120,000,000 was highly probable.

Therefore, MAL should recognize a provision of HK$120,000,000 at 31

December 2006, which represents the best estimate of the uncertain amount
of the loss.

The potential recovery from the DCS developer is a contingent asset, which is
a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of MAL.

Although it is highly probable that MAL will succeed in recovery of

HK$100,000,000 from the DCS developer, according to IAS 37, MAL should
not recognize any asset until the realization of the recovery is virtually certain.

QUESTION TWO (13 MARKS/MINUTES)

(ACCA, F7, December 2008, amended)

Part (1)
1 January 2011 Oil Platform 30,000,000
Cash 30,000,000

Oil Platform 6,900,000

Environmental Provision 6,900,000

31 December 2011 Depreciation Expense 3,690,000

Accumulated Depreciation 3,690,000
(36,900,000 / 10)

Interest Expense 552,000

Environmental Provision 552,000
(6,900,000 x 8%)

Part (2)
If there was no legal requirement to incur the environmental costs, then
Promoil should not provide for them as they do not meet the definition of a
liability. Thus the oil platform would be recorded at $30 million with $3 million
depreciation and there would be no finance costs.

However, if Promoil has a published policy that it will voluntarily incur

environmental clean up costs of this type (or if this may be implied by its past
practice), then this would be evidence of a ‘constructive’ obligation under IAS
37 and the required treatment of the costs would be the same as in part (1)
above.

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QUESTION THREE (10 MARKS/MINUTES)

(Part 1) April 30, 2011
Bonds payable ($900,000 – $118,470) ...................... 781,530
Loss on Extinguishment of Bonds .............................. 136,470
Cash ............................................................................. 918,000

Working:
Reacquisition price ($900,000 × 102%) .................................. $918,000
Net carrying amount of bonds redeemed: ..............................
($900,000 – $118,470) ................................................. 781,530
Loss on extinguishment ........................................................... $136,470

Cash ($1,200,000 × 112.5%) .................................. 1,350,000

Bonds Payable ............................................................. 1,350,000

(Part 2) October 31, 2011

Interest Expense ................................................. 33,750*
Bonds Payable ..................................................... 2,250
Cash .......................................................................... 36,000**
*($1,350,000 × 5% × 6/12)
**(.03 × 1,200,000 = $36,000)

QUESTION FOUR (10 MARKS/MINUTES)

1 January 1999 Cash 1,000,000

Bonds Payable 885,296
Share Premium – Conversion Equity 114,704
(F.V. of “pure” bond = 1,000,000 x 0.31180 + 50,000 x 11.46992 = 885,296)

1 January 2001 Bonds Payable 898,935

Share Premium – Conversion Equity 83,475
Loss on Repurchase 217,590
Conversion Expense (“Sweetener”) 700,000
Cash 1,700,000
(F.V. of “pure” bond = 1,000,000 x 0.53391 + 50,000 x 11.65230 = 1,116,525)
(Amount allocated to equity = 1,200,000 – 1,116,525 = 83,475)
(Loss on repurchase = 1,116,525 – 898,935 = 217,590)

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QUESTION FIVE (20 MARKS/MINUTES)

(HKICPA QP, Module A, June 2003, amended)

Year ended 31 March 20X4

Preference dividend = 5,000,000 x 8% x 2/12 = 66,667

1/4-30/9 20,000,000 x 2 x 6/12 = 20,000,000

1/10-30/11 22,000,000 x 2 x 2/12 = 7,333,333
1/12-31/3 47,000,000 x 4/12 = 15,666,667

Weighted-average number of shares

outstanding 43,000,000

Basic EPS = (41,250,000 – 66,667) / 43,000,000 = $0.9578 per share

Computation of incremental EPS of potentially dilutive securities:

Profitable
Potential attributable No. of Incre-
ordinary to ordinary ordinary mental
shares shareholders shares EPS Rank
Options (exercise
Nil 100,000 Nil 1
price = $8)
Options (exercise
Nil 140,000 Nil 1
price = $7)
Preference
66,667 83,333 0.8000 2
Shares
Note: Options with exercise prices of $10 and $11 are anti-dilutive.

Computation of diluted EPS:

Profitable
attributable to No. of
ordinary ordinary
shareholders shares EPS
Basic EPS 41,183,333 43,000,000 $0.9578
Add: Options Nil 240,000
41,183,333 43,240,000 $0.9524
Add: Convertible 66,667 83,333
preference shares
41,250,000 43,323,333 $0.9521

Diluted EPS = $0.9521 per share

Year ended 31 March 20X3

Basic EPS = 37,125,000 / 40,000,000 = $0.9281 per share

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