COMM 217, Fall 2016

Solution to the Final Examination

Question 1: (30 marks)

1. b 6. c 11. d 16. c
2. d 7. c 12. b 17. d
3. b 8. c 13. a 18. c
4. c 9. a 14. a 19. a
5. d 10. a 15. a 20. b

Question 2: (16 marks)

1. (13.5 marks)
a) April 1, 2016

Cash Proceeds from bond issue:

Principal: $12,000,000 x 0.3118 = $3,741,600
Interest: ($12,000,000 x 0.11 x ½) x 11.4699 = 7,570,134
Cash proceeds $11,311,734

Cash 11,311,734
Discount on Bonds Payable 688,266
Bonds Payable 12,000,000

b) October 1, 2016
Interest Expense 678,704
Discount on Bonds Payable 18,704
Cash 660,000

Interest expense = $11,311,734 x 0.12 x 6/12 ;

Cash = $12,000,000 x 0.11 x 6/12

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c) December 31, 2017
Interest Expense 339,913
Discount on Bonds Payable 9,913
Interest Payable 330,000

Interest expense = $11,330,438* x 0.12 x 3/12

Interest payable = $12,000,000 x 0.11 x 3/12
* $11,330,438 = ($11,311,734 + $18,704)

d) January 31, 2017

To update accounts before redemption of bonds:

Interest Expense 113,304
Discount on Bonds Payable 3,304
Interest Payable 110,000

Interest expense = $11,330,438* x 0.12 /12

*$11,330,438 = $11,311,734 + $18,704

To record the bond redemption

Bond Payable 12,000,000
Loss on Bond Redemption 776,345
Discount on Bonds Payable 656,345
Cash 12,120,000

Cash = $12,000,000 x 1.01 = 12,120,000

Discount on bond payable = $688,266 – 18,704 – 9,913 – 3,304 = $656,345
Loss on bond redemption = $12,120,000 – (12,000,000 – 656,345) = $776,345

2. (2.5 marks)

The reason TR Corp. may decide to call the bonds early and face a loss of $776,245 in the process if
the market interest rate decreased significantly. By calling the bonds, TR can issue new ones at a
lower coupon rate.

TR might also pay it back to decrease the liabilities in its statements of financial position, thus
improving its financial strength and ratios.

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 Question 3: (19 marks)
(a) (12.5 marks)
NR INC.
Statement of Cash Flows
For the year ended December 31, 2015
Operating Activities
Net earnings $91,480
Add (deduct) effects of non-cash items:
Depreciation expense $58,700
Gain on sale of equipment (8,750)
Increase in accounts receivable (53,800)
Increase in inventory (19,250)
Increase in accounts payable 4,420
Decrease in accrued liabilities (6,730) (25,410)
Net cash flow from operating activities 66,070
Investing Activities
Sale of land 22,500
Sale of equipment 15,550
Purchase of equipment (91,000) See note 1
Net cash flows from investing activities (52,950)
Financing Activities
Issuance of notes payable 70,000
Payment of cash dividends (37,670)
Net cash flows from financing activities 32,330
Net cash flow for the year 2015 45,450
Add: Cash balance, January 1, 2015 47,250
Cash balance, December 31, 2015 $92,700

Additional disclosure:
Equipment with a cost of $50,000 was exchanged for common shares.
Interest paid, $2,940.
Income taxes paid, $39,000.

Note 1: Transactions affecting Building and Equipment:

Purchase of equipment for cash = Ending balance at December 31, 2015 – (Beginning balance at
January 1, 2015 + Equipment purchases for non-cash consideration – Equipment sold)
Purchase for cash = [$290,000 – ($205,000 + $50,000 – $56,000)] = $91,000

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b) (1.5 mark)

Cash collected from customers = Net sales – Increase in accounts receivable

= $297,500 – ($90,800 – 37,000) = $243,700

c) (2 marks)

Yes. Under IFRS, NR Inc. may classify dividends received as either an operating or an investing
activity. Similarly, interest paid can be classified as either a financing or an operating activity.

d) (3 marks)

Quality of earnings ratio = Cash flows from operations / Net earnings

= $66,070 / $91,480 = 0.72

This ratio implies that cash flows from operations are not moving in line with net earnings
which could mean that accruals are heavily used to boost net earnings, resulting in poor
earnings quality.

Capital expenditures ratio = Cash flows from operations / Capital expenditures

= $66,070 / $91,000 = 0.73

This ratio implies that NR Inc. financed 73% of its capital expenditures through operating
activities. This means NR Inc. needs to resort to external financing (debt or equity) in order to
pay for asset purchases.

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 Question 4: (35 marks)

PART A (16 marks)

1. (11 marks)

Ratio 2015 2014

Total Asset = Revenue $2,031,718 = 1.29 $2,008,480 = 1.24

Turnover Average Total Assets $1,573,4701 $1,622,8253

Net earnings +
Interest expense $76,629 + [17,627 x $75,524 + [16,759 x
Return on = (net of tax) (1–(24,790/101,419))] = 0.06 (1–(27,610/103,134))] = 0.05
Assets Average Total Assets $1,573,4701 $1,622,8253

Return on = Net earnings $76,629 = 0.13 $75,524 = 0.14

Equity Average $574,7542 $522,8304
Shareholders’ Equity
Price = Price $14.10 = 13.06 $17.90 = 16.73
Earnings Net earnings $1.08 $1.07

Financial ROE – ROA 0.13 – 0.057 = 0.07 0.14 – 0.054 = 0.09

Leverage %

1 3
($1,563,476 + $1,583,463) ÷ 2 ($1,682,174 + $1,563,476) ÷ 2
2 4
($549,105 + $600,402) ÷ 2 ($496,555 + $549,105) ÷ 2

2. (3 marks)

The return on assets had a slight increase from 2014 to 2015 due to the decrease in average assets
and increase in net earnings from 2014 to 2015.
The return on equity decreased slightly from 14% to 13%, caused primarily by an increase in
retained earnings (from net earnings).
Leon’s has a positive financial leverage percentage in both years (although it decreased from 2014
to 2015).
Total Asset Turnover increased from 2014 to 2015 due to an increase in revenue and a decrease in
average assets.
In addition to comparing the ratios over the two-year period, it would be useful to compare Leon’s
profitability to that of other companies in the same industry.

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3. (2 marks)
The financial statements are highly relevant to my decision since they provide useful information
about the company’s profitability (operations and performance), cash flows, assets and
obligation (financial strength). Provided the future for the industry is relatively stable, this
information allows the forecast and prediction of the company’s future earnings, obligations
and survivability (going concern).

Additional information: an investor should examine the industry opportunities as well as specific
strengths and weaknesses of the company’s operations including the quality of its management
team. Such assessments are made by financial analysts on a periodic basis to advise their clients
whether they should buy shares in Leon’s or sell the shares they already own, and I may want to
seek the advice of a financial analyst before making my final decision.

PART B (19 marks):

1. (3 marks)
The three elements of the statement of financial position that had the largest changes in their
carrying amounts, and the typical reasons for these changes are summarized below:
Statement of financial position
element Change Reasons for change

Cash and cash equivalents –$38,311 The account decreased because cash outflows
exceeded cash inflows during the year,
particularly after repaying loans and
borrowings.

Loans and borrowings –48,006 This decrease reflects payment of loans and
other borrowings during the year. And transfer
from long-term to short-term liabilities

Retained earnings +48,128 This increase reflects essentially the difference

between net earnings reported for 2015 and
dividends declared to shareholders.

2. (6 marks)

Cash 98,000
Accumulated depreciation - Trucks 159,680
Trucks 200,000
Gain on sale of trucks 57,680

Depreciation, 2013 = $200,000 x [2/5 x ½] = $ 40,000

Depreciation, 2014 = ($200,000 – 40,000) x 2/5 = 64,000

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 Depreciation, 2015 = ($160,000 – 64,000) x 2/5 = 38,400
Depreciation, 2016 = ($96,000 – 38,400) x [2/5 x 9/12] = 17,280 – 9,680 = 6800*
Accumulated depreciation, September 30, 2016 $150,000
* Depreciation for 2016 is reduced to $6,800 to ensure that the carrying value of the
two trucks does not fall below their residual value of $50,000.
Gain on sale of trucks = $98,000 – ($200,000 – 150,000) = $48,000
Alternatively, the depreciation may be calculated for all 5 trucks and then take 2/5 of these
amounts. In this case, the depreciation amounts would be: $100,000 + 160,000 + 96,000 +
19,000 = $375,000 ==> 2/5 of this amount = $150,000.

3. (4 marks)
Common shares (100,000 x $0.47) 47,000
Retained earnings 1,363,000
Cash (100,000 x $14.10) 1,410,000

Average issue price per share = $34,389,000 / 73,168,000 = $0.47

4. (3 marks)
Retained earnings, beginning + Net earnings – Dividends declared = Retained earnings, end
$510,398 + 76,629 – Dividends declared = $558,526 ==> Dividends declared = $28,501
Dividends paid = Dividends declared – Increase in Dividends payable
= $28,501 – (7,141 – 7,105) = $28,465
5. (3 marks)
Deferred warranty plan revenue is reported twice in the statement of financial position because
the liability to be settled within one year as Current liability, and the amount to be settled after
one year from the date of the statement as Non-current liability.

Deferred warranty plan revenue, beginning $143,365 ($51,111 + 92,254)

+ Sale of new deferred warranty plans 63,785
– Warranty plan revenue X X = $61,995
Deferred warranty plan revenue, beginning $145,155 ($49,380 + 95,775)

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