Additional Questions

Question 1 – Bond payable

You issue a five-year bond with CU 1,000 face value and 5% coupon on January 1st X1. The
proceeds are CU 958. The coupon is paid on 31st December.
Required
Answer the following questions:
a. What is the interest expense you will record in X2?
b. What is the balance of this bond payable at the end of X3?
c. On 1.1.X5 you buy back the bond for 1,020. What is the gain, or loss, you will record
on this transaction?

Solution
Preliminaries: we need to find the effective interest rate by solving 958 = PV of five equal
payment of 50 and a final payment of 1,000. This can be done using the IRR function in
Excel. The result is 6%.
a. The ending balance on 31.12.X1 is 965.48 = 958 x 1.06 – 50. Hence the interest
expense in X2 is 57.92 (or, 6 rounded)
b. The balance at 31.12.X3 is the PV of one remaining payment of 50 and a final
payment of 1,050 at 6%. This is 981.66 = 50/1.06 + 1,050/1.062
c. The balance of the bond payable on 31.12.X4 is 1,050/1.06 = 990.57. Hence the
buyback will generate an accounting loss of 29.43

Question 2 – Repayment loan

You borrow 998.33 on 1.7.X1 at 6% to be repaid in five equal payments on 30.6 of each year
starting on 30.6.X2.
Required
Answer the following questions:
a. What is the annual payment?
b. What is the balance of the loan on 31.12.X2?
c. What is the balance of interest payable on 31.12.X2?
d. What is the split between current and non-current liabilities on 31.12.X2?

Solution

(1+0.06)5−1
a. Need to solve this equation: 998.33=PMT x .
0.06 x (1+ 0.06)5
The solution to this is PMT = 237.00.
b. The balance of the loan on 31.12.X4 is the PV of four payment of 237 at 6% = 998.33
x 1.06 – 237.00 = 821.23
c. Interest payable on 31.12.X2 is 821.33 x 6% x 0.5 = 24.64.

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 d. The balance of the loan on 31.12.X5 is 633.5 – this the non-current loan. The
difference between 633.5 and the balance of the loan on 31.12.X4 of 821.23 is the
current loan. This is equal to 187.73.
Another way to find the current element is to note that the payment of 237.00 on
30.6.X5 will be split between interest of 821.33 x 6% = 49.28 and the rest, 187.73
will reduce the principal.

Question 3 – Right-to-use asset and lease payable

You enter on 1.1.X1 to a six-year lease agreement that entails end-of-year payment of 600
and a final optional payment of 70.36 to assume the ownership right over the asset at the end
of X6. Since you estimate the useful life of the asset to be 10 years, you intend to exercise
this optional payment. The applicable discount rate is 6% and the estimated residual value at
the end of 10 years is zero. You use straight-line depreciation method for all your assets.
Required
a. What is the effect of this agreement on the balance sheet on 1.1.X1
b. What will be the balance of the right-to-use asset on 31.12.X2?
c. What will be the total balance of the lease payable on 31.12.X2?
d. What will be the effect on retained earnings over the first three operational years of
the asset?

Solution
a. At inception, a non-current asset similar to PPE is recognized and is called right-to-
use asset. At the same time, a liability, a lease payable liability is also recognised. The
initial amount at inception for both the asset and liability is the present value of all
future payment on the lease, including the purchase option at the end of the sixth year:

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70.36 (1+0.06) −1
3,000= 6
+600 x
(1+ 0.06) 0.06 x (1+0.06)6

b. At the end of X2 the balance is the undepreciated cost after two years: 3,000 x 4/6 =
4,000.

c. The balance of the lease payable is:

70.36 (1+0.06) 4−1

2,134.80= + 600 x
(1+ 0.06)4 0.06 x (1+0.06)4

d. The effect on retained earnings over three years is the sum of three years of
depreciation (3,000) and the cumulative interest expense is calculated using this
formula:

Ending balance on 31.12.X3 = Beginning balance on 1.1.X1 + interest (the unknown) –

payments

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 1,663 = 3,000 + interest? – 3 x 600
 Interest = 463.

The overall effect on retained earnings is total expense of 3,463.

Question 4 – Accounts receivable, bad debt expense and unearned revenues
Below you are provided selected information from the financial statements of a professional
service firm.
31/12/2019 31/12/2020
Gross accounts receivable 110,000 130,000
Allowance for bad debt 7,700 ?
Accounts written-off during 2020 5,600
Advances from customers 6,000 8,500
Fee revenues recognised during 2020 325,000

Required
a. Estimate the TOTAL amount of cash collected from clients during 2020.
b. Calculate 2020 fees received in cash.
c. Calculate the allowance for bad debt as at 31/12/2020 given the information below

Gross amount % of
31/12/20 doubtful debt
Specifically identified 6,000 100%
Overdue 12,000 50%
Due within the next three months 75,000 4%
Due between three and six months 23,000 2%
Due after six months 14,000 1%
Total 130,000

d. Calculate the bad debt expense for 2020.

Solution
Gross amount % of Allowance
31/12/20 doubtful for bad debt
debt 31/12/20
Specifically identified 6,000 100% 6,000
Overdue 12,000 60% 7,200
Due within the next three months 75,000 4% 3,000
Due between three and six months 23,000 2% 460
Due after six months 14,000 1% 140
Total 130,000 11,400

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 A/R - Allowance Cash Advances I/S
Gross for bad debt
Opening balance 110,000 (7,700) 6,000
Write-off (5,600) 5,600
Fee revenues 25,600 293,400 (6,000) 325,000
Advances received 8,500 8,500
Bad-debt expense (9,300) (9,300)
Ending balance 130,000 (11,400) 301,900 8,500 315,700

Total amount of cash collected from clients during 2020: 301,900.

2020 cash fees: 293,400.
Allowance for bad debt 31/12/20: 11,400.
Bad debt expense: 9,300.
Question 5 – Inventory
Your little convenience shop sells two types of beverages: Blue and Orange. You start the
year with 1,000 unit of Blue and 500 units of Orange. I also run a similar shop the opposite
corner and sell exactly the same beverages. Moreover, I also start the year with the same
number of units of each beverage type. Delivery takes place once a quarter. This year we
were supplied 12,000 units of Blue and 7,000 units of Orange each, as detailed in the table
below. As it turns out, we both sold 11,000 units of Blue and 4,500 of Orange. However, you
use FIFO as your periodic inventory method, while I use the weighted average (WA) method.
Your opening balance of Blue is valued at CU 3,000 while mine is valued at CU 3,300. Your
opening balance of Orange is valued at CU 2,000, while mine is valued at CU 1,900.

Beverage type Blue Orange

Quantity Price Quantity Price
st
1 quarter 2,000 3.5 2,500 4.25
2nd quarter 3,000 4.0 1,500 4.30
3rd quarter 4,500 4.5 2,000 4.40
4th quarter 2,500 4.0 1,000 4.50
Total 12,000 7,000

Required
a. Calculate the ending balance of inventory in each shop.
b. Calculate the cost of goods sold in each shop.
c. Now assume that the end-of-year NRV for Blue is 4.0 and for Orange is 4.4. You and
I classify impairment loss on inventory in cost of goods sold. Recalculate, if needed,
the cost of goods sold, to reflect this information.

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Solution
Total cost of purchases is as follows:
Blue – 49,250
Orange – 30,375
Total number of units available for sale
Blue – 13,000
Orange – 7,500
Ending inventory
Blue: 2,000 = 13,000 – 11,000
Orange: 3,000 = 7,500 – 4,500
Value of ending inventory using FIFO
Blue: 8,000 = 2,000 x 4
Orange: 13,300 = 1,000 x 4.5 + 2,000 x 4.4
Cost of sales for you: 63,325 = (3,000 + 2,000) + (49,250 + 30,375) – (8,000 + 13,300)
Calculation of WA unit cost for me:
Blue Orange
Beginning balance 3,300 1,900
Purchases 49,250 30,375
Total 52,550 32,275
Units available for sale 13,000 7,500
WA unit cost (rounded) 4.042 4.303

Value of ending inventory using WA

Blue: 8,084 = 2,000 x 4.042
Orange: 12,909 = 3,000 x 4.303
Cost of sales for me: 63,832 = (3300 + 1900) + (49250 + 30375) – (8084 + 12909)
NRV test:
You:
Blue Orange
Ending inventory at cost 8,000 13,300
Ending inventory at NRV 8,000 = 2,000 x 4.0 13,200 x 4.4
Impairment loss 0 100

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Me:
Blue Orange
Ending inventory at cost 8,084 12,909
Ending inventory at NRV 8,000 = 2,000 x 4.0 13,200 x 4.4
Impairment loss 84 0 since cost < NRV

Revised cost of sales:

You: 63,425 = 63,325 + 100
Me: 63,916 = 63,832 + 84
Question 6 - PPE
Below is the note on PPE in the balance sheet. You are required to complete it based on the
information provided below. You are also required to calculate the loss, or gain, on the
disposal of equipment.
Machinery IT Total
equipment
Cost
01/01/2019 20000 10000 30000
Additions 5000 5000
Disposals   ? ?
31/12/2019 25000 ? ?

Accumulated
depreciation
01/01/2019 9000 4000 13000
Charge for the year ? ? ?
Disposals  ? ? ?
31/12/2019 ? ? ?

Net book value

01/01/2019 11000 6000 17000
Net book value
31/12/2019 ? ? ?

Additional information:
1. The balances related to machinery as at 1/1/2019 represent assets that are three years
old and are depreciated on a straight-line basis with residual values equal to 20% of
original cost.
2. During 2019 the estimate of these residual values was revised to zero.
3. Additional machinery was purchased on 1/7/2019 at which point it came into
operations. Its useful life is five years with zero salvage value.
4. IT equipment is depreciated over four years, zero salvage value using the SYD
method. All equipment was purchased at the same time and comprises several
identical servers.

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 5. On 31/12/2019 the company sold 30% of its servers for 1,100.
Solution
Machinery IT Total
equipment
Cost
01/01/2019 20000 10000 30000
Additions 5000 5000
Disposals   (3000) (3000)
31/12/2019 25000 7000 32000

Accumulated
depreciation
01/01/2019 9000 4000 13000
Charge for the year 4167 3000 7167
Disposals   (2100) (2100)
31/12/2019 13167 4900 18067

Net book value

01/01/2019 11000 6000 17000
Net book value
31/12/2019 11833 2100 13933

Gain on disposal of 30% of IT equipment: 200 = 1,000 – (3,000 – 2,100)

Explanations
Depreciation of machinery with cots of 20,000. Revised depreciable amount is 11,000 and
remaining life is three years: 11,000/3 = 3,667 (rounded).
Depreciation of new machinery: 500 = (5,000/5)/2.
Depreciation of IT (full year): 3,000 = 10,000 x 3/10.