ACT B861F – Tutorial questions and solution

Q.1
Listed below are several terms and phrases associated with current liabilities. Pair an item
from List B that you think is most appropriately associated with an item from List A.

List A Ans List B

1. Principal amount x Interest rate x ______ a. Informal agreement
Time
2. Payable with current assets ______ b. Secured loan
3. Short term debt to be rolled over ______ c. Refinancing prior to the
beyond 12 months financial year end
4. Present value of interest plus ______ d. Accounts payable
present value of principal
5. Noninterest bearing ______ e. Accrued liabilities
6. Non-committed line of credit ______ f. Commercial paper
7. Pledged accounts receivable ______ g. Current liabilities
8. Reclassification of debt ______ h. Long term liability
9. Purchased by other corporations ______ i. Usual valuation of liabilities
10. Expenses not yet paid ______ j. Interest on debt
11. Liability until refunded ______ k. Customer advances
12. Applied against purchase price ______ l. Customer deposits

Q.1 – Solution

List A Ans
1. Principal amount x Interest rate x ___j___
Time
2. Payable with current assets ___g__
3. Short term debt to be rolled over ___h___
beyond 12 months
4. Present value of interest plus ___i___
present value of principal
5. Noninterest bearing ___d___
6. Non-committed line of credit ___a___
7. Pledged accounts receivable ___b___
8. Reclassification of debt ___c___
9. Purchased by other corporations ___f___
10. Expenses not yet paid ___e___
11. Liability until refunded ___l___
12. Applied against purchase price ___k___

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 ACT B861F – Tutorial questions and solution

Q.2
You are an accountant working at BenQ LLP which is a mid-sized accounting firm. This
morning, your manager asked your opinion on the following transactions:

Client Amount Interest Loan taken out on: Financial year end
borrowed rate
W $100 million 9% 1st April, 20x0 31st July,20x0
X $200 million 8% 1st April, 20x0 30th June, 20x0
Y $300 million 7% 1st April, 20x0 31st October, 20x0
Z $400 million 6% 1st April, 20x0 31st December, 20x0

Specifically, each of the above 4 clients has taken out a loan from a bank on the date specified.

Required:

a) Determine the amount of interest expense that should be recorded by the respective
year end of the 4 clients above. Show your working.

In addition, your manager has given you an extra task which is relevant to Client Z above.
Client Z’s account for some reason does not seem to be in order; you are asked to suggest
the correct transactions for the following events:

Date Event
1st January HSBC agreed to lend Client Z a 3-month loan of $60 million at
an interest rate of 6% per year.
1st April The loan of $6 million was repaid to HSBC when it was due

Required:

b) Prepare the appropriate journal entries to record the 2 events above. Show your
working.

Q.2 – solution
a)
Client Working
W $100m x 9%
X 4/12
= $3 million
X $200m x 8%
X 3/12
= $4 million
Y $300m x 7%
X 7/12
= $12.25 million
Z $400m x 6%
X 9/12
= $18 million

b)

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 ACT B861F – Tutorial questions and solution

1st January

Dr Cr
Cash $60,000,000
Loan (3-month, 10%) $60,000,000

1st April

Dr Cr
Interest expense (Income statement account)
$60,000,000 x 6% x 3/12
900,000
Loan (repayment of principal) $60,000,000
Cash ($60,000,000 + $900,000) $60,900,000

Q.3
Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified
management in December 2022 of a circuit flaw in an amplifier that poses a potential fire
hazard. An investigation suggested that a product recall is virtually certain, estimated to cost
the company $2 million. The financial year ends on 31st December.
Required:
a) Should this loss be accrued, disclosed only, or neither? Explain.
b) What loss, if any, should Sound Audio report in its 2022 income statement?
c) What liability, if any, should Sound Audio report in its 2022 statement of financial
position?
d) Prepare any journal entry needed.

Q.3 – solution

a) This is a provision. A liability is accrued if it is both probable that the confirming event
will occur and the amount can be reliably estimated. If one or both of these criteria
are not met, but the loss is possible, a disclosure note should describe the contingent
liability. In this case, a provision is accrued since both of these criteria are met.

b) Loss: $2 million

c) Liability: $2 million

d)

Loss provision from product recall .............................2,000,000

Provision for product recall ................................................. 2,000,000

A disclosure note is also appropriate.

Q.4

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 ACT B861F – Tutorial questions and solution

Van Rushing Hunting Goods’ financial year ends on 31st December. At the end of 2022, the
company had notes payable of $12 million due on 8th February 2023. Rushing obtained the
agreement of its lenders on 3rd February 2023, to roll over $9 million of the notes to 8th
February 2025. Rushing paid off the remaining $3 million of its notes on 8 th February 2023,
through proceeds from the maturation of its three-month Certificates of Deposit.
Through his lawyers, one of Rushing’s construction workers notified management on 5 th
January 2023 that he planned to sue the company for $1 million related to a work-site injury
on 20th December 2022. As of 31 December 2022, management had been unaware of the
injury, but reached an agreement on 23rd February 2023 to settle the matter by paying the
employee’s medical bills of $75,000.
Rushing’s financial statements were authorised for issue on 3rd March 2023.
Required:
a) What amount(s), in any, related to the situations described should Rushing report
among current liabilities in its statement of financial position at 31st December 2022?
Why?
b) What amount(s), in any, related to the situations described should Rushing report
among long term liabilities in its statement of financial position at 31st December 2022?
Why?
c) How would your answers to 1) and 2) differ if the settlement agreement had occurred
on 15th March 2023 instead? Why?
d) How would your answers to 1) and 2) differ if the work site injury had occurred on 3rd
January 2023 instead? Why?
Q.4 – solution

a)
Portion of the notes payable not refinanced
on a long-term basis ................................................................... $3,000,000

Liability for the payment of employee’s medical bills ................... 75,000

Total ........................................................................................ $3,075,000

Normally, short-term debt (payable within a year) is classified as current liabilities.

However, when such debt is to be refinanced on a long-term basis, it may be included
with long-term liabilities. The narrative indicates that Rushing refinanced $9 million of the
notes payable on a long-term basis. Thus, Rushing should report that amount among
long-term liabilities. The remaining $3 million was a current liability at December 31.
The $75,000 payment of the employee’s medical bills is a provision as of December
31. Rushing can use the information occurring after the end of the year and before the
financial statements are issued (the settlement) to make the provision and to determine
appropriate disclosure. That payment is an adjusting event that confirms that a liability
exists at year-end.
A disclosure note is also appropriate.

b)

Portion of the notes payable refinanced

on a long-term basis ................................................................... $9,000,000

Normally, short-term debt (payable within a year) is classified as current liabilities.

However, when such debt is to be refinanced on a long-term basis with the same

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 ACT B861F – Tutorial questions and solution

counterparty, it may be included with long-term liabilities. The narrative indicates that
Rushing refinanced $9 million of the notes payable on a long-term basis. Thus, Rushing
should report that amount among long-term liabilities.

c)

If the settlement agreement had occurred on March 15, 2023, instead, the $75,000 payment
of the employee’s medical bills would not have been accrued as either a current or long-term
liability because that payment occurred after the date the financial statements were
authorized for issue.

d)
If the work-site injury had occurred on January 3, 2023, instead, the $75,000 payment of the
employee’s medical bills would not have been accrued as either a current or long-term
liability because the cause of the liability had not occurred as of December 31, 2022. The
payment would be a non-adjusting event. Thus, the liability did not exist as of that date.

Q.5
The financial year ends on 31st December for Lake Hamilton Development (LHD). To
provide funding for its Moonlight Bay project, LHD issued 5% bonds with a principal amount
of $500,000 on 1st November 2022. The bonds sold for $442,215, at a market rate of 6%.
The bonds mature on 31st October 2041 (40 years). Interest is paid semiannually on 30th
April and 31st October.
Required:
a) What amount of interest expense related to the bonds will LHD report in its income
statement for the year ending 31st December 2022?
b) What amount(s) related to the bonds will LHD report in its statement of financial
position at 31st December 2022?
c) What amount of interest expense related to the bonds will LHD report in its income
statement for the year ending 31st December 2023?

Q.5 – solution
a)
Interest expense (3% × $442,215 ×2/6) 4,422
Discount on bonds payable (difference) 255
Interest payable (2.5% x $500,000 x 2/6) 4,167

b)

Bonds payable (principal amount) ...................................... $500,000

Less: discount ($500,000 – 442,215) ................................ (57,785)
Initial balance, November 1, 2022 ...................................... $442,215
December 31, 2022 discount amortisation.......................... 255
Balance, December 31, 2022 ........................................... $442,470
Interest payable .................................................................. $4,167

c)

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 ACT B861F – Tutorial questions and solution

Partial amortisation schedule

Cash Increase in Outstanding
Interest Effective Interest Balance Balance
($500,000 x 5%/2) 442,215
1 12,500 .03 (442,215) = 13,266 766 442,981
2 12,500 .03 (442,981) = 13,289 789 443,770
3 12,500 .03 (443,770) = 13,313 813 444,583

$13,266 × 4/6 + 13,289 + 13,313 × 2/6 = $26,571

Q.6
At the beginning of 2022, VHF Industries bought a machine with a fair value of $6,074,700 by
issuing a 4 year, non-interest bearing note in the principal amount of $8 million. The note is
payable in four annual installments of $2 million at the end of each year.
Required:
a) What is the effective rate of interest implicit in the agreement?
b) Prepare the journal entry to record the purchase of the machine.
c) Prepare the journal entry to record the first installment payment at 31st December 2022.
d) Prepare the journal entry to record the second installment payment at 31st December
2023.
e) Suppose the fair value of the machine was unknown at the time of purchase, but the
market rate of interest for notes of similar risk was 11%. Prepare the journal entry to
record the purchase of the machine.

Q.6 – solution

a)
$6,074,700 ÷ $2,000,000 = 3.03735
Present value Installment Annuity factor
payment from annuity table

Using a present value table 3.03735 is matched to i = 12%. So, 12 percent is the
implicit interest rate.

b)
Machine (fair value) ................................................. 6,074,700
Notes payable (present value) ............................................ 6,074,700

c)
Interest expense (12% × $6,074,700) ......................... 728,964
Notes payable (difference) ....................................... 1,271,036
Cash (given) ....................................................................... 2,000,000

d)
Interest expense (12% × [$6,074,700—1,271,036]) .... 576,440
Note payable (difference) ........................................................ 1,423,560
Cash (given) ....................................................................... 2,000,000

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 ACT B861F – Tutorial questions and solution

e)
$2,000,000 × 3.10245 = $6,204,900
Installment Present
payment n = 4, i = 11% value

Machine ................................................................... 6,204,900

Notes payable .................................................................... 6,204,900

Q.7
Allied Paper Products offers a restricted share award plan to its vice presidents. On 1st
January 2021, the company granted 16 million of its $1 par ordinary shares, subject to
forfeiture if employment is terminated within two years. The ordinary shares have a market
price of $5 per share on the grant date.
Required:
a) Determine the total compensation cost pertaining to the restricted shares.
b) Prepare the appropriate journal entries related to the restricted shares through 31st
December 2022.

Q.7 – solution

a)

$5 fair value per share

× 16 million shares granted
= $80 million fair value of award

b)

31st December 2021 ($ in millions)

Compensation expense ($80 million ÷ 2 years) ......... 40
Issued capital—restricted shares .......................... 40

31st December 2022

Compensation expense ($80 million ÷ 2 years) ......... 40
Issued capital —restricted shares ......................... 40

Issued capital—restricted shares .............................. 80

Ordinary shares .................................................... 80

Q.8
a) On 1st October 2021, Farmer Fabrication issued share options for 100,000 shares to a
divisional manager. The options have an estimated fair value of $6 each. To provide
additional incentive for managerial achievement, the options are not exercisable unless
divisional revenue increases by 5% in three years. Farmer initially estimates that it is probably
the goal will be achieved. How much compensation will be recorded in each of the next 3
years?

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 ACT B861F – Tutorial questions and solution

Q.8a) – solution
The estimate of the total compensation would be:

100,000 X $6 = $600,000
Options expected to vest Fair value Estimated total compensation

One-third of that amount, or $200,000, will be recorded in each of the three years.

Q.8b) Suppose that after one year Farmer estimates that divisional revenue is not likely to
increase by 5% at all in the year and the next two years. How should the options be accounted
for in 2022?

Q.8b) – solution

The new estimate of the total compensation would change to:

0 X $6 = $0
Options expected to vest Fair value Estimated total compensation

In that case, Farmer would have to reverse the $200,000 expensed in 2021 because no
compensation can be recognised for options that do not vest due to performance targets not
being met which is the new expectation.

Q.8c)

Suppose that Farmer initially estimated that it is not likely that the goal will be achieved, but
then after one year, Farmer estimates that divisional revenue will increase by 5% by the end
of 2023. How should the options be accounted for in 2022 and thereafter?

Q.8c) – solution
In that case, in 2022, the revised estimate of the total compensation would change to $600,000:

100,000 X $6 = $600,000
Options expected to vest Fair value Estimated total compensation

Farmer would reflect the cumulative effect on compensation in 2022 earnings and record
compensation thereafter:

2022
Compensation expense ([$600,000 x 2/3] – $0) 400,000
Issued capital – share options 400,000

2023
Compensation expense ([$600,000 x 3/3] – $400,000) 200,000
Issued capital – share options 200,000

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 ACT B861F – Tutorial questions and solution

Q.9

Tung Chung Ltd has 1 million issued ordinary shares and 100,000 rights entitling holders to
subscribe to the company’s ordinary shares at $5 each. At the end of the year, the market
price of shares is $8 each, and all rights are exercised.

Required:

a) Show the journal entries for the exercise of the rights.

b) Explain why a company would make a rights issue.
c) Distinguish between a bonus issue and a rights issue.

Q.9 – solution

a)

The journal entries for the exercise of rights are:

Dr Cr
$000 $000
Bank (100,000 x $5) 500
Ordinary share capital 500
To record exercise of rights

b) Rights are issued to existing shareholders in proportion to their shareholding if the company
wants to raise funds through the issue of shares, and to maintain proportionate ownership
interest of the existing shareholders.

c) A rights issue is an issue of a right that entitles holders to subscribe to shares at a fixed
price at a specified time. Bonus shares are issued to existing shareholders in proportion to
their shareholding without consideration.

Q.10
R Ltd issued 300 shares of $10 par value ordinary shares and 100 shares of $50 par value
preference shares for a lump sum of $13,500. The ordinary shares have a market price of
$20 per share, and the preference shares have a market price of $90 per share.
a. What is the fair value of each type of the shares?
b. What is the amount of proceeds that should be allocated to each type of shares

Q.10 – Solution
a. Ordinary: ($20 x 300) = $6,000
Preference: ($90 x 100) = $9,000
Total: $15,000
b.
Allocated to ordinary: ($6000/ $15000) × $13,500 = $5,400

Allocated to preference: ($9000/ $15000) × $13,500 = 8,100

$13,500

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 ACT B861F – Tutorial questions and solution

Q.11
W Ltd declared a cash dividend of $1 per share on its 2 million outstanding shares. The
dividend was declared on 1st August, payable on 9th September to all shareholders of record
on 15th August.
Required: prepare the relevant journal entries regarding the above.

Q.11 – Solution

Dr Cr
1st August Retained earnings (2,000,000 x $1) $2,000,000
Dividends payable $2,000,000

15th August No need for any journal entry

9th September Dividends payable $2,000,000

Cash $2,000,000

Q.12
GD Ltd has outstanding 400,000 shares of $10 par value ordinary shares. The company
declares a 5% share dividend.
Required: prepare the relevant journal entries regarding the above.

Q.12 – solution
Declaration date Dr Cr
Retained earnings $200,000
Ordinary share dividend distributable $200,000
([400,000 x 0.05] x $10)
Distribution date
Ordinary share dividend distributable $200,000
Share capital – ordinary $200,000

Q.13
NB Ltd has outstanding 10,000 shares of $100 par value, 6% preference shares and 60,000
shares of $10 par value ordinary shares. The preference shares were issued in January 2019,
and no dividends were declared in 2019 or 2020. In 2021, NB declares a cash dividend of
$300,000. How will the dividend be shared by ordinary and preference shareholders if the
preference shares are a) non-cumulative, and b) cumulative?

Q.13 – solution

a) Preference shareholders would receive $60,000 (0.06 × $1,000,000) and the

remainder of $240,000 ($300,000 – $60,000) would be distributed to ordinary
shareholders.

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 ACT B861F – Tutorial questions and solution

b) Preference shareholders would receive $180,000 (0.06 × $1,000,000 × 3) and the

remainder of $120,000 ($300,000 – $180,000) would be distributed to the ordinary
shareholders.

Q.14
30 June 20X1: Solar Ltd began operations and issued 50,000 shares of ordinary shares on
that date.
31 December 20X1: Solar declared and paid $20,000 in dividends.
1 January 20X3: After a vote of the board of directors, Solar issued 30,000 shares of
cumulative preference shares. These preference shares pay dividends of $0.60 per share.
31 December 20X3: Solar declared and paid $16,800 in dividends
31 December 20X4: Solar declared and paid $32,400 in dividends.
Required: Determine the amount of dividends to be distributed to each class of shares for
each of Solar’s dividend payments.

Q.14 – Solution
31.12.20X3: $16,800 – ($0.60 x 30,000) = ($1,200): the entire amount would go to preference
shareholders, with an amount of $1,200 being outstanding or accrued, i.e. to be paid off in the
next round
31.12.20X4: $32,400 – 1,200 = 31,200; $31,200 - ($0.60 x 30,000) = $13,200
$18,000 would go to preference shareholders
$13,200 that remains would go to ordinary shareholders

Q.15
Edward Ltd paid dividends at the end of each year as follows:
20X1: $150,000;
20X2: $260,000;
20X3: $390,000.

Required: Determine the amount of dividends and the dividends per share paid on ordinary
and preference shares each year, assuming independent capital structures as follows:
a. 20X1: 300,000 ordinary shares; 10,000 shares of non-cumulative preference shares.
The preference shares pay a dividend of $9 per share.
b. 20X2: 200,000 ordinary shares; 20,000 non-cumulative preference shares. The
preference shares pay a dividend of $9 per share.
c. 20X3: 200,000 ordinary shares; 20,000 cumulative preference shares. The preference
shares pay a dividend of $9 per share.

Q.15 – Solution:

a. Preference shareholders: $150,000 – ($9 x 10,000) = $60,000; $90,000 goes to

preference shareholders; $60,000 goes to ordinary shareholders

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 ACT B861F – Tutorial questions and solution

b. Preference shareholders: $260,000 – ($9 x 20,000) = $80,000; $180,000 goes to

preference shareholders; $80,000 goes to ordinary shareholders
c. Preference shareholders: $390,000 – ($9 x 20,000) = $210,000; $180,000 goes to
preference shareholders; $210,000 goes to ordinary shareholders

Q.16

On January 1, 2020, DSA Ltd issued $300,000 of 9%, 10-year bonds at par. Interest is
payable quarterly on April 1, July 1, October 1, and January 1.

Required:

Prepare journal entries to record the following:

a) The issuance of the bonds.
b) The payment of interest on July 1.
c) The accrual of interest on December 31.

Q.16 – Solution (DSA Ltd)

a) Bond issuance Dr Cr
01.01.2020 Cash $300,000
Bonds payable $300,000

b) Interest payment on 01.07.2020 Dr Cr

01.07.2020 Interest expense ($300,000 x 0.09 x 3/12) $6,750
Cash $6,750

c) Interest expense/ accrual Dr Cr

31.12.2020 Interest expense ($300,000 x 0.09 x 3/12) $6,750
Interest payable $6,750

Q.17
On 1st January 2021 a company issued some 12% bonds to the amount of $700,000 (face
value) which matures in 3 years’ time, with coupons or interest payable twice a year on June
30 and December 31. The current market interest rate is 14%. Prepare an amortisation
schedule.
Note: Adjustment to the cost is recorded as bond interest expense over the life of the bonds
through a process called amortisation.

Q.17 – Solution

Step 1: compute the PV of the bonds

$700,000 x 12% x ½ = $42,000; $42,000 x 4.76654 = $200,195

$700,000 x 0.66634 = $466,438

$200,195 + $466,438 = $666,633

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 ACT B861F – Tutorial questions and solution

(Make sure you know where to find the two factors that are highlighted in yellow)

Date Cash paid Interest expense Discount Outstanding balanced (Carrying

(interest) (effective interest) amortised amount of the bonds)
Principal x Outstanding
6% amount x 7%
01.01.2021 666,633
30.06.2021 42,000 0.07 (666,633) = 4,664 671,297
46,664
31.12.2021 42,000 0.07 (671,297) = 4,991 676,288
46,991
30.06.2022 42,000 0.07 (676,288) = 5,340 681,628
47,340
31.12.2022 42,000 0.07 (681,628) = 5,714 687,342
47,714
30.06.2023 42,000 0.07 (687,342) = 6,114 693,456
48,114
31.12.2023 42,000 0.07 (693,456) = 6,544 700,000
48,544*
* rounded 33,367

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