2019 Fall Final Detailed Solutions PDF

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Version 1 Last Name: _________________________ First Name: _________________________ STUDENT ID #: ___________________

Commerce 1AA3 – All Sections - SOLUTION Version 1 Duration of Examination: 2.5 hours

Dr. Emad Mohammad & AMJ

McMaster University Final Examination

December 9, 2019

INSTRUCTIONS: This examination paper comprises 14 pages (including cover page), and 20 True/False questions at 1.0 mark each, and 50 multiple-choice questions at 1.6 marks each. You are responsible for ensuring that your copy of the question paper is complete. Bring any discrepancy to the attention of the invigilator. Only the McMaster Standard Calculator (Casio FX-991 MS or MS Plus) may be used. NOTE: IT IS YOUR RESPONSIBILITY TO ENSURE THAT THE ANSWER SHEET IS PROPERLY COMPLETED: YOUR EXAMINATION RESULT DEPENDS UPON PROPER ATTENTION TO THESE INSTRUCTIONS. The scanner, which reads the sheets, senses the shaded areas by their non-reflection of light. A heavy mark must be made, completely filling the circular bubble, with an HB pencil. Marks made with a pen or felt-tip marker will NOT be sensed. Erasures must be thorough, or the scanner may still sense a mark. Do NOT use correction fluid on the sheets. Do NOT put any unnecessary marks or writing on the sheet. 1. Print your name, student number, course name, section number and the date in the space provided at the top of Side 1 (red side) of the form. Then the sheet MUST be signed in the space marked SIGNATURE. 2. Mark your student number in the space provided on the sheet on Side 1 and fill in the corresponding bubbles underneath. 3. Mark only ONE choice from the alternatives (1,2,3,4 or A,B,C,D) provided for each question. If there is a True/False question, enter response of 1 (or A) as True, and 2 (or B) as False. The question number is to the left of the bubbles. Make sure that the number of the question on the scan sheet is the same as the question number on the test paper. 4. Pay particular attention to the Marking Directions on the form. 5. Begin answering questions using the first set of bubbles, marked 1". For each of the following questions, choose the best answer then darken the identifying letter to the corresponding number in the answer sheet.

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Version 1 Part I: True or False (20 questions x 1 point each) 1. Freight Out costs for inventory are expensed immediately in the income statement while Freight In costs are capitalized in inventory. a. True b. False -

Freight out: Costs associated to the shipping of goods to a customer from the manufacturer/supplier. Freight out costs are considered an operating expense, and therefore expensed through the income statement immediately. Freight in: Costs associated to the purchase of inventory. These costs are considered part of the inventory and therefore included in inventory (i.e. capitalized in inventory). Therefore, the above is true.

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2. If ending inventory is overstated, the error will affect two income statement periods. a. True b. False -

If ending inventory is overstated, net income will also be overstated (as COGs is understated). If ending inventory is overstated, the beginning inventory (in the next period) will be overstated. If the beginning inventory is overstated, then COGs will also be overstated (as well goods available for sale). If COG’s is overstated, NI will also be understated. When NI is closed out to RE at the end of the 2nd period, the error will correct itself. I.e. the NI over both periods would be correct. Evidently, ending inventory being overstated will impact 2 income statements periods (period 1 NI is overstated, period 2 NI is understated), therefore the answer is true

3.

Inventory for a company that uses the perpetual system is destroyed in fire. That company would need to estimate its inventory using the gross profit percentage. a. True b. False

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False, the company would not have to estimate through gross profit percentage.

4.

The lower-of-cost-or-net-realizable-value rule applies only when a company uses the FIFO inventory valuation method. a. True b. False

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False, according to IFRS (International Financial Reporting Standards) and ASPE (Accounting Standards for Private Enterprises), inventory is to be measured at the lower of cost and net realizable value regardless of the valuation method used (FIFO, WA, etc.). (IAS 2 for IFRS and ASPE Section 3031).

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Version 1 5.

An error in the valuation of beginning inventory in the current period will affect the following year's net income. a. True b. False

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False, if there is an error in the current periods beginning inventory, there was also an error in the prior periods ending inventory. The net income is only affected for two periods, after which it corrects itself.

6.

In line with the matching principle, the purpose of depreciation is to match the book value of the asset to the market value of the asset. a. True b. False

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Depreciation: allocation of an assets depreciable amount over its useful life. The purpose of depreciation, is to recognize the portion of an assets economic benefit, that was used up in the respective period. Therefore, the above statement is false.

7.

The total amount of depreciation recorded over the life of a long-term asset depends on the method used to depreciate that asset. a. True b. False

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Depreciation is the allocation of an assets depreciable amount over its useful life. There are three main depreciation methods: Straight line, units of production and diminishing balance. While the depreciation each period will vary depending on the method used, the total amount of depreciation (which is the depreciable cost) will be the same regardless. Therefore, the answer is false.

8. Capital Expenditures refers to recording a cost as an asset when incurred. a. True b. False -

Capital expenditures are expenses that increase an assets capacity/efficiency or extends its useful life. Consequently, when they are incurred they are debited to the asset account. Thus, true.

9.

An accelerated depreciation method refers to any method of depreciating a long-term asset that will result in greater amounts being expensed in the early years of an asset's life and comparatively smaller amounts being expensed in the latter years of the asset's life. a. True b. False

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Accelerated depreciation is any method of depreciation used for accounting for income tax purposes that allows greater deductions in the earlier years of the life of the asset. Consequently, the above statement is true.

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Version 1 10. If a bond’s interest expense is greater than its interest payment, then the market rate must be lower than the coupon rate. a. True b. False -

Market rate: rate investors demand Coupon rate: actual interest rate If the coupon rate is less than market, bond is at a discount If the coupon rate is greater than market, bond is at a premium When the interest expense is greater than the payment the bond is at a discount, meaning the coupon rate is less than the market rate. For this reason, the above statement is false. If the interest expense is greater than its payment, the market rate must be higher than the coupon rate (this is the correct statement)

11. A contingent liability that has a remote chance of occurrence should be disclosed in the financial statement footnotes. a. True b. False -

A contingent liability is a potential liability arising from a past event/transaction. The outcome is dependent on future decisions and events A contingent liability should only be disclosed in the FS notes if payment for damages is likely but the amount cannot be reasonably estimated The above statement notes that there is a remote chance of occurrence, therefore it should not be disclosed, meaning the answer is false.

12. Under straight-line method, both the carrying value and interest expense will increase over time when bonds are issued at discount. a. True b. False -

Under the straight line method, the amortization of the premiums or in this case the discount will result in the same interest expense for every period, Consequently, while the carrying amount will increase the interest expense will not. Therefore, the answer is false.

13. Investors will demand higher return for redeemable bonds than for non-redeemable bonds. a. True b. False -

A redeemable bond can be called by the investor before the bond reaches its maturity. Due to their callable nature, they can be more attractive to an investor as they can demand a high return through being able to call the bond earlier then maturity (i.e. when interest rates move), therefore the above statement is true.

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Version 1 14. The market or effective rate of interest is used to calculate the actual amount of interest bondholders will receive from a company issuing bonds. a. True b. False -

The market interest rate is the rate that investors demand for borrowing their money. The market rate changes throughout the duration of the bonds life. The stated interest rate or the coupon rate is the actual rate agreed upon for the bond payable. The coupon rate is used to determine the interest payment, and the market rate at the time of issuance is the interest expense Based on this, the statement is false.

15. Using the straight-line method of amortization, interest expense is based on the carrying amount of the bonds times the effective-interest rate for the interest period. a. True b. False -

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Under the straight line method, the entire premium or discount of the bond is divided into equal periodic amounts over the bond’s term (interest expense is the same each period). o i.e. divide discount/premium over periods/life of the bound Therefore, the above is false.

16. Declaration and payment of a stock dividend will have no effect on the Assets, Liabilities, or Equity of the company. a. True b. False -

The declaration date of payment, is simply the date on which the BOD declares the payment be paid to the shareholders. A stock dividend, is additional shares in the company paid to the shareholders (not cash, no impact to assets or liabilities). When a stock dividend is paid, the total equity as presented on the FS remains the same, however, there would be adjusted entries transferring the stock from RE to paid in capital. No effect on equity. Therefore, the above statement is true!

17. A stock split will have no effect on the company’s financial statements. a. True b. False -

A stock split, is when a company issues more shares to existing shareholder. As a result, the total dollar value of shares remains unchanged but the value of each share decreases. This has no impact on the FS, as the bottom line amount is still the same, its just spread across more shares. Therefore, the answer is true.

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Version 1 18. Dividends decrease net income, retained earnings, and equity. a. True b. False -

Consider, Beg RE + Profit/loss – Dividend = End RE. When dividends are paid out the ending RE balance will decrease. Given RE is an equity account, equity will also decrease. Dividends do not affect the net income/loss of company. Therefore, net income will not decrease with dividends. Therefore, the answer is false.

19. The TIE ratio (Times-interest-earned) measures the leverage of a business. a. True b. False -

The ratio of income from operations to interest expense. Ultimately, considers the number of times the entities operating income can cover the interest expense. This formula (as well as the debt ratio) assists in measuring leverage of a business. Therefore, the answer is true.

20. Income tax expense is calculated based on accounting income whereas income tax payable is calculated using taxable income. a. True b. False -

Income tax expense (income statement): income before income tax (accounting income from the income statement) x income tax rate Income tax payable (balance sheet): taxable income (from the income tax return, which is filed with the respective tax authorities) x income tax rate Some items are treated differently under accounting standards (IFRS and ASPE), as opposed to tax standards, consequently the above exists. Therefore, the above statement is true.

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Version 1 Part II: Multiple-Choice (50 questions x 1.6 points each) 21. Which statement below best describes how to account for the costs of inventory? a. The costs are initially recorded as expenses and depreciated over the estimated useful life b. Inventory costs are initially reported as assets and then maintained in the asset accounts for the life of the business c. The costs are initially recorded as assets and become expenses when the inventory has an increase in market value d. The costs are initially recorded as assets and become expenses when the inventory is sold -

Inventory affects both the balance sheet (assets) and income statement (cost of goods sold). When inventory is on-hand it sits as an asset on the balance sheet. When it shifts from the seller (on the balance sheet) to the buyer, the cost of the inventory that’s been sold to the buyer flows through cost of goods sold on the income statement.

22. Up-a-Creek Company had ending inventory of $60,000, purchases of $200,000, beginning accounts payable of $100,000, ending accounts payable of $80,000 and cost of goods sold of $150,000. What was the amount of beginning inventory? a. b. c. d. -

$90,000 $10,000 $30,000 $150,000 Ending inventory = Beginning inventory + purchases – COGS $60,000 = Beginning inventory + $200,000 - $150,000 Beginning inventory = $200,000 - $150,000 - $60,000 $60,000 - $200,000 + $150,000 = Beginning inventory $10,000 = Beginning inventory

23. A company with a perpetual inventory system purchases inventory on account. What is the effect of this transaction on the accounting equation? a. b. c. d.

Increase one asset and decrease another asset Increase an asset and decrease retained earnings Increase an asset and decrease a liability Increase an asset and increase a liability

Dr. Inventory XXX Cr. A/P XXX -

Assets = Liabilities + Equity Assets (Inventory is an asset) = Liabilities (Accounts Payable is a Liability) + Equity As shown in the equation above, when inventory is purchased on account both the asset (inventory) and liability (accounts payable), increase. Therefore, the correct answer is d.

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Version 1 24. Which of the following decreases the cost of inventory purchased? a. b. c. d. -

Sales tax Purchasing merchandise FOB shipping point Purchase allowances Payment of accounts payable By definition, a purchase allowance is when there is a decrease in the cost of purchase because the seller has provided the buyer with a discount for the amount owed (allowance), therefore the answer is c.

25. On May 27, Ace Electronics ordered merchandise from Elmo Company. Elmo shipped the merchandise to Ace on May 31, FOB destination. The merchandise arrived at Ace's warehouse on June 2. Ace paid for the merchandise on July 1. When should Ace record the purchase? a. b. c. d.

May 27 May 31 June 2 July 1 As noted above, the arrangement is FOB destination. This means, that the buyer (Ace) takes ownership of the merchandise from the supplier (Elmo), when the merchandise arrives at ACE’s warehouse. Thus, the purchase should be recorded on June 2nd, the date at which the inventory arrives at the buyers (Ace).

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26. Jambo Inc. sells inventory for $4,000 that it had purchased for $3,200, under the periodic inventory system. Which of the following is true on the sale date for Jambo Inc.? a. b. c. d. -

Equity will increase by $800; Assets will increase by $800 Equity will increase by $4,000; Assets will increase by $4,000 Equity will decrease by $3,200; Assets will decrease by $3,200 Equity will decrease by $4,000; Assets will decrease by $4,000 Under the periodic inventory system there is no running record of merchandise. Dr. Cash/A/R for $4,000 (increase to assets by $4,000), as that is the actual amount that was received for the inventory. There will be an increase to equity by $4,000 (remember, at the end of a period NI is closed out through RE, which is an equity account). Therefore the answer is b.

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Version 1 27. Which method results in the cost of goods sold equaling the exact cost of the actual goods that have been sold? a. b. c. d. -

FIFO LIFO Weighted average method Specific identification FIFO (First in, First out): expenses the oldest costs firsts LIFO (Last in, First out): expenses the most recent costs first Weighted average: uses the weighted average cost, i.e. cost of goods available for sale divided by the number of units available Specific identification: Distinguishes each piece of inventory from the time it enters to leaves (different then FIFO, LIFO, Weighted average, which group pieces together). The question states that the COGs equals the exact cost of the goods, which specific identification does as it distinguishes each piece of inventory. Therefore the answer is specific identification, d.

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28. Newcastle Company has the following inventory data for the current period: Beginning inventory + Purchases Cost of goods available for sale - Ending inventory Cost of goods sold

$ 10,000 130,000 140,000 20,000 $120,000

Assume that the ending inventory is understated by $5,000. What is the effect on the current period’s net income? a. b. c. d. -

It will be overstated by $5,000 It will be understated by $5,000 It will be understated by $20,000 The inventory error will have no effect on net income

If ending inventory is understated by $5000, then the COGs is overstated by $5000. If COGs is overstated by $5000, then NI will be understated by $5000, b.

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Version 1 29. A flood destroyed the inventory of Kara Inc. on May 18, 2018. Kara Inc. uses the periodic method of inventory recording. The information below was available from the cloud servers: Beginning inventory Sales Purchases Gross profit percentage

$10,000 $100,000 $80,000 40%

What is the balance in the inventory account on May 18, 2018? a. b. c. d.

$30,000 $40,000 $20,000 $10,000

This is a PERIODIC system. The inventory is NOT updated as the year progresses. The question is NOT asking for destroyed inventory estimation. It is asking for the BALANCE in the inventory account on the date. And the BALANCE on the account would be the last updated balance at end of last year which is beginning balance of this year. Use the following information to answer the next 2 questions: Basil Company had the following activity in its inventory account during March 2018: Cost per Total Unit unit Costs Date Activity Units Mar-01 Beginning Inventory 100 $ 4.00 $ 400.00 Mar-03 Purchase 1 45 $ 4.05 $ 182.25 Mar-05 Sale 1 50 Mar-09 Purchase 2 60 $ 4.75 $ 285.00 Mar-12 Sale 2 70 Mar-14 Purchase 3 10 $ 5.00 $ 50.00 Mar-15 Sale 3 30 Mar-30 Purchase 4 35 $ 5.05 $ 176.75

30. What is the cost of ending inventory if the company uses periodic FIFO? a. b. c. d.

$904 $488 $606 $322

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Version 1

Beginning (100 units) Purchase (45 units) Sales (50 units) Purchase (60 units) Sales (70 units) Purchase (10 units) Sales (30 units) Purchase (35 units) Ending

400 182.25 -(4*50) = - 200 285 -(4*50) = - 200 -(4.05*20) = - 81 50 -(4.05...