B301 Examination August 2000(Oct 1999)

Part 1. Answer four of the following six questions. (8 marks each. Total 32 marks)

1.Prudence and accrual are two of the fundamental accounting concepts stated in the HKSSAP 1.

a) Briefly explain the two concepts.

b) Give an example that you have learned in this course where the two concepts are in conflict, then explain the accounting treatment for such conflict according to HKSSAP 1

2. According to HKS SAP 8, contingent loss should be accrued when certain conditions are met while contingent gains should not be accrued unless they are likely to be realized. For each of the following situation with regard to Excellent Limited, briefly explain its accounting treatment and its presentation on the company92s financial statements, assuming the financial year for Excellent ended on March 31:

a. A customer is suing the company for $200,000 in damages because her child was injured when riding on the skateboard manufacturing by the company. Legal counsel feels that the child is partially at fault, but that it is probable the lawsuit will be settled for between $50,000 and $100,000, with $70,000 being the most likely amount.

b. The company is being sued for $10 million damages. The legal counsel of the company assessed the probability of losing the case to be 50:50.

c. On 20 February 1999, a major part of the office was destroyed by fire. The loss was estimated at $500,000, but only $300,000 of the loss was covered by insurance.

d. Notes receivables for $400,000 with a maturity date of 31 March 2000 was discounted on 6 December 2000. By 11 March 2000 it was clear that the debtor is experiencing financial difficulties.

3. With reference to HKSSAP2

(a) explain the factors to be considered when classifying an extraordinary item,

(b) provide two examples of extraordinary items,

4. You are recently appointed as the new assistant controller of a property development company. You discovered that your predecessor has been using the completion-of-contract method to account for construction project. What is your opinion about this method? Explain the accounting method required by the HKSSAP and the rationale behind such method.

5. Ming On Property Company owns the following properties:

- An office building for the company's operation

- An office building currently leased to another company

Explain to the CEO of the company how and why the accounting treatments for these two types of property are different according to HKSSAP 13 and 17.

6. Explain what causes accounting income to be different from taxable income. In addition, explain the appropriate accounting treatment for these differences according to HKSSAP 12.

Part 2 Complete all three problems. (Total 68 marks)

1. The financial statements for the Goodman Manufacturing Ltd, whose financial year end is at 31 December, are shown below:

1992 ($m) / 1991 ($m)

Current assets

Cash 15 / 20

Debtors 30 / 25

inventories 60 / 50

Prepaid Expenses 5 10

Sub-total 110 / 105

Property, plant and equipment (net) 330 295

Total current assets 440 / 400

Current liabilities

Creditors 20 / 25

Accrued expenses 15 / 10

Taxes payable 30 / 25

Total current liabilities 65 / 60

Share capital and reserves

Ordinary shares of $1 each 240 / 220

Profit and loss 135 / 120

Sub-total 375 / 340

Total Liabilities and Capital 440 / 400

Profit and loss account for the year ended 31 December 1992 ($m)

Net sales 480

Cost of sales 330

Gross profit 150

Operating expenses (including depreciation expense of $1 Om) 75

Profit from ordinary activities before taxation 75

Tax on profit from ordinary activities 35

Profit from ordinary activities after taxation 40

Required:

(a) Compute the amount of dividends declared and paid during 1992.

(b) Compute the value of equipment purchased during 1992, and the value at which share capital was issued during 1992.

(d) Prepare a cash flow statement of Goodman Manufacturing Ltd. for the year ended 31 December 1992.

2. .Hwanghai Hydralic Equipment Company sells and leases its equipment to its customers. Lowu Industries Ltd. leases one of the popular products from Hwanghai on January 2, 2000. The equipment costs $340,000 to make. The standard lease terms provide for 5 annual payments of $130,000 each (excluding executory costs), with the first payment due when the lease is signed and subsequent payments due on December 31 of each year. The implicit rate of interest in the contract is 10% per year. Initial direct costs of $17,000 are incurred by Hwanghai on January 2, 2000, to obtain the lease. Lowu 's incremental borrowing rate is determined to be 12%. The equipment is very specialized. It is assumed that the machine will have no salvage value after 5 years. Assume the lease qualifies as a capital lease and a sales-type lease for lessee and lessor, respectively. Also assume that both the lessee and the lessor are on a calendar-year basis and that the lessee is aware of the lessor92s implicit interest rate.

Required:

a. Calculate the present value of the minimum lease payment.

b. Prepare a table showing the reduction of liability by annual payment after considering the interest charge for Lowu Industries Ltd.

c. Prepare all entries required on the books of Lowu to record the lease for equipment from Hwanghai for the year 2000. The depreciation on owned equipment is computed once a year on the straight-line basis.

d. Prepare the balance sheet section involving lease balances for the Lowu's financial statements as of December 31, 2000. (23 marks)

3. Lok Shing Company92s capital structure is as follows:

As of 31/12/2000 and 31/12/2000

Outstanding shares of Ordinary shares 336,000 / 280,000

Nonconvertible, noncumulative Preference shares 10,000 / 10,000

10% convertible bonds 1,000,000 / 1,000,000

The following additional information is available:

(a) On September 1, 2000, Lok Shing sold 56,000 additional ordinary shares.

(b) Net income for the year ended December 31, 2000, was $860,000

(d) The 10% bonds are convertible into 40 ordinary shares for each $1,000 bond.

(e) Unexercised options to purchase 30,000 ordinary shares at $22.50 per share were outstanding at the beginning and end of 2000. The average market price of Lok Shing's ordinary shares during 2000 was $36 per share.

(f) Warrants to purchase 20,000 ordinary shares at $38 per share were attached to the preference shares at the time of issuance. The warrants, which expire on December 31, 2005, were outstanding at December 31, 2000.

(g) Lok Shing92s effective income tax rate was 30% for 1999 and 2000.

Required:

For the year ended December 31, 2000, compute the following:

a. Basic earnings per share

b. Diluted earnings per share figures based on what you have learned in this course.

c. Explain why it is important to show diluted EPS for companies with complex capital structure. (22 marks)