Prepare an income statement of mids co

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Reference no: EM131195767

Financial Accounting, Reporting and Disclosure

SECTION A: Answer this question.

QUESTION 1: On 1 April 2015, Ms. Velma Dinkley founded Mysteries Inc. Dog Snacks Company (MIDS Co.), a company with tax exempt status which sells specialty dog treats and toys. The following transactions occurred during the first month of operations:

(1) On 1 April, MIDS Co. was incorporated. Common stockholders invested $140,000 cash and received a total of 10,000 shares of $1 par value common stock.

(2) On 1 April, the company signed a rental agreement for retail space. The agreement calls for rent of $2,000 per month, payable quarterly in advance. Therefore, the company paid $6,000 cash on April 1.

(3) MIDS Co. purchased store fixtures and equipment on 1 April for $36,000. The company paid $12,000 cash and signed a note promising to pay the remainder in 9 months, on 31 December 2015. On 31 December, MIDS Co. will also have to pay interest on the borrowed amount based on an annual rate of 12%. The estimated useful economic life of the store fixtures and equipment is 6 years and their estimated salvage value was $0. The company uses straight-line depreciation.

(4) The company spent $10,500 cash for advertising which ran during April.

(5) During April, the company purchased $80,000 of inventory from various suppliers, paying $45,000 in cash and the remainder $35,000 on credit.

(6) During April, the company sold merchandise for cash of $25,000 and on account for $65,000. The merchandise cost the company $37,000.

(7) During April, wages of $34,000 to employees were paid in cash.

REQUIRED:

(a) Record in journal entries all transactions related to the events listed above and, if needed, include closing entries. For each journal entry, use the format we followed in lectures. Please number your journal entries as in the question above. For each journal entry, include the accounts affected, by how much, and whether debited (DR) or credited (CR). To simplify presentation of journal entries, use the following abbreviations:

Credits [CR]                        Debits [DR]

Revenues/Gains [R]       Expenses/Losses [E]

Assets [A]                           Liabilities [L]

Shareholders' Equity [SE]

(b) Prepare an income statement of MIDS Co. for the month ended 30 April 2015 and the statement of financial position (balance sheet) at that date. Describe the effect of change in depreciation estimates on the income statement and the balance sheet.

(c) Using the direct method, prepare a cash flow statement of MIDS Co. for the month ended 30 April 2015. Also present cash flows from operating activities for the month ended 30 April 2015 using the indirect method. Compare the effect of change in depreciation estimates on cash flows from operating activities under the direct method and the indirect method.

SECTION B: Answer TWO questions from this section.

QUESTION 2: The 2Faced Company Ltd made two small bond issuances on 1 January 2014 when its market determined yield was 10% and there were no issuance costs. Both bonds had a face value of £10,000, 2 years to maturity, and annual coupon payments payable on 31 December. While one bond had 14% nominal interest rate, the other bond had 6% nominal interest rate.

REQUIRED:

(a) Describe the accounting entries for 2014 related to these bonds, including amounts.

(b) Assume for this question that by 1 January 2015 the firm's market determined yield had changed to 14% and the company decided to buy back its outstanding debt associated with the 14% bond. What would be the accounting entry from this transaction, including amounts? Describe whether and how your answer would change if instead the other bond had been bought back.

(c) Assume for this question that by 1 January 2015 the firm's market determined yield had changed to 6% and the company decided to buy back its outstanding debt associated with the 6% bond. What would be the accounting entry from this transaction, including amounts? Describe whether and how your answer would have changed if instead the other bond had been bought back.

(d) The previous questions assumed historical cost based accounting for bonds. However, some regulators appear in favour of fair value based accounting for bonds to issuers. Discuss the effects and potential costs and benefits of fair value accounting for bonds relative to historical costs. Specifically, are there possible benefits from issuing two bonds each with face value of £10,000 instead of one bond with face value of £20,000 under fair value accounting and under historical costs?

QUESTION 3: On 1 April 2014 ElectroBikes Ltd purchased its initial inventory of 100 classical bikes. Each bike had specific characteristics and painting but cost an average of £500 per bike. During the remainder of 2014 the company recorded the following movements:

May                  Sold 80 bikes

July                   Purchased 200 bikes at an average price of £350 each

August               Sold 150 bikes

October              Purchased 130 bikes at an average price of £300 each

November          Sold 75 bikes

REQUIRED:

(a) Calculate the cost of sales and the value of the closing inventory of ElectroBikes Ltd for 2014, using (i) the perpetual FIFO and (ii) the perpetual LIFO methods of inventory valuation. Ignoring tax consequences, what is the effect of using different inventory valuation methods on the statement of cash flows?

(b) Show whether, why, and by how much, cost of sales and inventory under LIFO and FIFO vary under the periodic method compared to your answers in (a), and explain why this is the case. Ignoring tax consequences, what is the effect of using different methods on the statement of cash flows?

(c) Assuming that sales remain as above and that management purchased an additional 100 bikes on 1 December for £600 each. What would be the effect on reported income under (i) perpetual FIFO, (ii) perpetual LIFO, (iii) periodic FIFO, and (iv) periodic LIFO?

(d) Discuss which method FIFO or LIFO 'more appropriately' (as you choose to define it) represents inventory values and cost of goods sold. You may also discuss the potential benefits of alternative inventory valuation methods, if appropriate.

QUESTION 4: On 15 December 2010, Zoogle, Ltd purchased a machine for £800. During the remaining weeks of December 2010, the company incurred an additional cash outlay of £300 to make the machine ready for its intended use. The company started using the machine on 1 January 2011. Initially, the machine was depreciated using straight-line depreciation method and had an estimated economic life of 5 years and an estimated salvage value of £200.

REQUIRED:

(a) What were depreciation expense and accumulated depreciation on this machine for calendar years 2011, 2012 and 2013?

(b) Assume that on 1 January 2014, Zoogle, Ltd decided to change the estimated salvage value from £200 to £250. What would be the effect on reported income before tax expense and total assets for calendar year 2014?

(c) Ignoring your answer to question (b), assume instead that on 1 January 2014, Zoogle, Ltd decided to change the estimated useful economic life from 5 years to 10 years. What would be the effect on reported income before tax expense and total assets for calendar year 2014?

(d) Ignoring your answer to questions (b) and (c), assume instead that on 1 January 2014, Zoogle, Ltd decided to change the depreciation method from straight-line to sum-of-the-years digits. What would be the effect on reported income before tax expense and total assets for calendar year 2014?

(e) Based on the Harnischfeger case in the course package, recall that accounting standards may treat changes in accounting methods or estimates either prospectively or using prior year cumulative effect. Discuss the trade-off in permitting or requiring the prospective approach. You may illustrate your argument by referring to other accounting changes implemented in the Harnischfeger case.

QUESTION 5: On 1 August 2014, Akwi Ltd acquired 100% of the ordinary share capital of Tahge Ltd for a cash consideration of £13,400. Tahge Ltd's retained earnings at the date of acquisition were £5,750. The statements of financial position (balance sheets) of the two companies as at 31 December 2014 are as follows:


Akwi Ltd £

Tahge Ltd £

Non-current assets



Property, plant and equipment

100,000

11,000

 Investment in Tahge Ltd

13,400

-


113,400

11,000

Current assets

24,900

4,800

Current and non-current liabilities 

(45,600)

(4,150)

Net assets

92,700

11,650

Equity and reserves



Ordinary shares of £1 each 

40,000

4,800

Revaluation reserve

0

1,500

Retained earnings

52,700

5,350

Total equity 

92,700

11,650

Additional information:

(1) Tahge Ltd's property, plant and equipment were valued at £9,500 at the date of acquisition, and included equipment which was revalued upwards from £5,500 to £7,000 on November 1, 2014. This revaluation is reflected in Tahge's year-end accounts.

(2) The inventory of Tahge Ltd at 31 December 2014, includes goods which cost £2,000 that were purchased from Akwi Ltd on 1 December 2014. The cost of the goods to Akwi Ltd was £600. £1,050 from this transaction was still unpaid at the end of the year, and is reflected in the working capital of both companies.

(3) At the end of the year, Akwi Ltd decided that goodwill had been impaired by £135.

REQUIRED:

(a) Calculate the goodwill arising on acquisition and prepare the consolidated statement of financial position (balance sheet) of Akwi Group as at 31 December 2014.

(b) In this case Akwi Ltd's ownership stake in Tahge Ltd was 100%. Discuss how your answer to (a) would change if Akwi's ownership stake in Tahge Ltd were 97%. No further calculations are required.

(c) In part (a), it is assumed that Akwi Ltd paid £13,400 in cash for its 100% ownership stake in Tahge Ltd. Assume instead that Akwi Ltd paid £4,000 in cash for its 100% ownership stake in Tahge Ltd. Discuss whether upwards revaluation of net assets at the time of acquisition is an appropriate accounting treatment. Further, assuming Tahge Ltd could choose between two inventory accounting methods, FIFO or LIFO, prior the acquisition, how would this choice affect the revaluation reserve and goodwill?

SECTION C: Answer ONE question from this section.

QUESTION 6: The International Accounting Standards Board (IASB) is considering requiring that all leases be treated as capital leases (finance leases). Please describe current accounting rules under U.S. Generally Accepted Accounting Principles (US GAAP), the pros and cons of the IASB proposal, and possible economic consequences of both rules.

QUESTION 7: Discuss conditions under which managers likely have incentives to report lower earnings, i.e., engage in income-decreasing earnings management. You may compare and contrast these to conditions under which managers likely have incentives to report higher earnings. Please refer to the relevant course materials as appropriate.

Reference no: EM131195767

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