B301 Specimen Examination August 200: suggested Solutions and Marking Guide
Part 1
Question 1 (8 marks)
(a) A finance lease is a lease that transfers substantially all the risks and rewards of ownership of an asset to the lessee. "Substantial" generally means if the present value of the minimum lease payments amounts to 90% or more of the fair value of the leased assets at the start of the lease. Another common feature of finance lease is that the lease term is for the major part of the useful life of the asset. Under an operating lease, assets are commonly rented out to a succession of different customers for short periods. (4)
(b) Under a finance lease, the lessor should record the amount due from a lessee as a debtor in the balance sheet. When the payment is received, it should be separated between finance charges and capital repayments. Finance charges should be credited to the profit and loss account, capital repayment to the debtor account. Under an operating lease, the lessor should record the asset as a fixed asset and depreciated over its useful life. Rental income should be recognized on a straight-line basis over the period of the lease. (4)
Question 2 (8 marks)
EPS is measured in response to investors' interest in using earnings rather than dividend yield to measure a company performance. In addition, relating earnings o the number of shares issues provide a more appropriate evaluation of the performance of companies who increase profits by acquiring other businesses through the issue of shares. (2 marks)
(a) When the company has a capital structure which contains any convertible securities, two EPS figures should be disclosed -- the basic EPS and the diluted EPS. TThe basic EPS will be calculated as follows: Earnings are divided by the number of equity shares in issue and ranking for dividend in respect of the period. The diluted EPS will include, in the denominator, the number of ordinary shares that may be converted. (2 marks)
(b) When the result is a loss, EPS should be calculated in the normal way with the result shown as a loss per share. (2 marks)
(c) When there is right issue during the period, the earnings should be apportioned over the number of shares ranking for dividend after the capitalization. The comparative figure for the corresponding previous period should be adjusted accordingly. (2 marks)
Question 3 (8 marks)
(a) A property held for own use is a fixed asset of the business. As the property is used to generate income on a continuing basis, it is necessary to charge a portion of the cost of the assets against income each year in respect of the use of the property over its useful life. Land held for own use is not depreciable because land has unlimited life. If the buildings are recorded in the balance sheet at a revalued amount, the revalued amount should be used in the calculation instead of historical cost. (3)
(b) A property which is held for its investment potential is not used to generate income as part of the trading operations of the business and so no depreciation charge is required. For investment property, the important issue is the current value of the the properties and the changes in their current value, rather than a calculation of systematic annual depreciation. (3)
(c) For land and buildings in the course of development ore redevelopment, they should be regarded as trading stocks of an enterprise and should be accounted for as such. (1)
(d) For land and buildings held for production, rental or administrative purposes or where no decision has yet been taken to resell the land and buildings, they should be included in the account as assets and be depreciated.(l)
Question 4 (8 marks)
(a) The direct write-off method is simpler but does not record bad debt expense until the account is confirmed to be uncollectible and is written off. This is usually in a different accounting period. As a result, the bad debt expense is not charged against the associated revenue. This violates the matching principle and therefore distorts the operational result of the company. (3) An alternative method is the allowance method which estimates and records uncollectible account expense in the same period when the associated revenue is earned based on a percentage of accounts receivable. This method is preferred because expenses are matched with revenues in the same period. (3).
(b) A debit balance in the Allowance for Uncillectible Account indicates that the actual write-off amount has exceeded the estimated uncollectible amount. An adjustment should be made to the estimated percentage of uncollectible accounts accordingly. (2)
Question 5 (8 marks)
(a) A hedge refers to the arrangement made to protect a contracting party against foreign currency losses. This is accomplished by creating an offsetting balance in the same foreign currency. Most companies hedge their monetary liabilities in foreign currency denominations. For example, if a Hong Kong company has to repay an outstanding loan obtained from Japan, it may enter into a forward exchange contract with a bank or a financing company for the amount in Hong Kong dollars. Then the loan amount will be exchange for Japanese yen at a specified rate at a specified time in the future. (4)
(b) Temporal method regards foreign currency translation as a measurement conversion process that only changes the unit of measurement not the attribute of the item being measured. Therefore under this method items are translated according to their basis of valuation. That is to say items measured at historical cost are translated at the historical rate; items measured at current basis are translated at the current rate. A shortcoming of the temporal method is that the process of translation changes the relationship between individual items in the financial statements because different rates are used for assets, liabilities, revenue, and expense. In some extreme cases, the profit of the foreign subsidiary may turn into loss after translation. This distorts the performance of the foreign subsidiary. (5)
Question 6 (24 marks)
(a)
Dr. Cash/Bank 1,320,000
Cr. Application and allotment account 1,320,000
( Cash received on application. )
(b)
Dr. Application and allotment account 340,000
Cr. Share premium account 200,000
Cr. Ordinary share capital account 140,000
(Amount due on allotment of 400,000 shares at $0.85.)
(c)
Dr. Application and allotment account 1,032,000
Cr. Cash/ Bank 1,032,000
(Return of application money oversubscribed.)
(d)
Dr. Cash/Bank (1) 51,975
Cr. Application and allotment account 51,975
(Balance of money received on allotment. )
(e)
Dr. Call account 60,000
Cr. Ordinary share capital account 60,000
(Amount due on first and final call. )
(f)
Dr. Cash/ Bank 59,910
Cr. Call account 59,910
(Amount received on first and final call. )
(g)
Dr. Investment - own shares 115
Cr. Applicaton and allotment account 25
Cr. Call account 90
(Forfeiture of shares. )
(h)
Dr. Cash/ Bank 500
Cr. Investment- own shares 115
Cr. Share premium 385
(Re-issue of forfeited shares. )
(i)
Dr. Cash/ Bank 800,000
Cr. Application and allotment account (redeemable shares) 800,000
(Amount received on issue of 500,000 redeemable shares.
(j)
Dr. Application and allotment account (redeemable shares) 800,000
Cr. Redeemable shares account 500,000
Cr. Share premium account 300,000
(Amount due on issue of 500,000 redeemable shares.)
(k)
Dr. Redeemable shares account 500,000
Dr. Share premium account 100,000
Dr. Profit and loss account 100,000
Cr. Redemption of shares account 700,000
(Amount due on shares to be redeemed. )
(l)
Dr. Redemption of shares account 700,000
Cr. Cash/Bank 700,000
(Amount paid on redemption of shares. )
(m)
Dr. Investments account 100,000
Cr. Ordinary share capital account 100,000
(Purchase of 400,000 $0.25 ordinary shares in Mayfair Ltd. in exchange for 200,000 of own ordinary shares. )
(n)
Dr. 8% debentures account 400,000
Dr. Share premium account 40,000
Cr. Debenture redemption account 440,000
(Amount due on redemption of 8% debentures. )
(o)
Dr. Debenture redemption account 440,000
Cr. Cash/ Bank 440,000
(8% debentures redeemed for cash.)
(p)
Dr. Cash/Bank 475,000
Dr. Share premium account 25,000
Cr. 7% debentures account 500,000
(Issue of 7% debentures at a 5% discount. )
(1/2 mark for each of the above 40 entries, total of 20 marks)
Workings:
1.
Amount received on allotment
Total due on application and allotment 340,000
Received on application 1,320,000
Less: Returned to applicants 1,032,000
Sub-total 288,000
Amount due on allotment 52,000
Less:
Unpaid amount (100 x $0.25) 25
Total 51,975
(3 marks for the above workings; if the candidate did not show the workings, but got the $51,975 entries correct, then give him/her 3 additional marks)
Question 7 (22 marks)
1. Dec.31
Dr. Kao, Capital 38,000
Cr. Au, Capital 38,000
To record transfer of Kao equity in the partnership to Au.
2.
Dec.31
Dr. Kao, Capital 38,000
Cr. Bains, Capital 19,000
Cr. Johnson, Capital 19,000
To record transfer of Kao equity in the partnership to Bains and Johnson.
3.
Dec.31
Dr. Kao, Capital 38,000
Cr. Cash 5,000
Cr. Note payable to Kao 33,000
To record withdrawal of Kao from the partnership.
4.
Dec.31
Dr. Kao, Capital 38,000
Dr. Lam, Capital ($2,000 x 4/7) 1,143
Dr. Ma, Capital ($2,000 x 3/7) 857
Cr. Cash 20,000
Cr. Note Payable to Kao 20,000
To record withdrawal of Kao from the partnership.
5.
Dec.31
Dr. Equipment ($150,000 - $130,000) 20,000
Cr. Kao, Capital ($20,000 x .30) 6,000
Cr. Lam, Capital ($20,000 x .40) 8,000
Cr. Ma, Capital ($20,000 x .30) 6,000
To revalue the equipment and allocate the gain in value to the partners.
Dec. 31
Dr. Kao, Capital ($38,000 + $6,000) 44,000
Cr. Cash 10,000
Cr. Inventory 34,000
To record withdrawal of Kao from the partnership.
(1 mark for each of the above 20 entries, 1/2 mark for each of the above 6 explanations, total 23 marks)
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Question 8 (22 marks)
Overmeyer Corporation
Statement of Cash Flows
For 1991
Cash flows from operating activities
Sales $8,000,000 (1 marks)
Increase in accounts receivable (250,000) (2 marks)
Cash collections from customers $7,750,000
Cost of sales $4,800,000 (1 marks)
Increase in inventory 400,000 (2 marks)
Increase in accounts payable (300,000) (2 marks)
Cash payments for merchandise (4,900,000)
Other operating expenses (2,300,000) (2 marks)
Net cash flow from operating activities $ 550,000
Cash flows from financing activities
Proceeds from sale of capital stock $1,000,000 (2 marks)
Retirement of bonds (500,000) (2 marks)
Dividends paid (200,000) (2 marks)
Net cash flow from financing activities 300,000
Cash flows from investing activities
Purchase of land ($250,000) (2 marks)
Purchase of building and equipment (500,000) (2 marks)
Net cash flow from investing activities (750,000)
Net increase in cash $100,000
It is assumed that there were no sales of land, buildings and equipment, or bonds. (2 marks)
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