CONCORDIA

UNIVERSITY

COURSE Financial Reporting III

ACCOUNTANCY 420/2
EXAMINATION DATE
Mid term October 14, 2017
INSTRUCTOR
S. Audousset-Coulier, V. Campbell, G.
Fayerman
MATERIALS ALLOWED: No
CALCULATORS ALLOWED: Yes (non-
programmable)
SPECIAL INSTRUCTIONS:
SEE BELOW

1. This exam contains 4 questions, 6 pages (including the cover sheet).

2. Please ensure your exam is complete.

3. The exam must be returned in the examination booklet.

1
Question 1 (25 marks)

Razzle Designs Inc. (RDI) is a company following IFRS that owns and operates various retail store chains
across the world. RDI has a December 31st year-end. As the retail store industry has become increasingly
saturated and difficult to grow in, expansion occurs primarily through acquisitions of existing business
and with strategic partnerships. Bank assistance and financing is important to help RDI finance the
acquisitions and investments.

You, Controller, have been asked by the CFO of RDI to draft a memo outlining the accounting treatments
for the various transactions that RDI has undertaken during the current year in preparation for the
issuance of the year-end financial statements. The CFO would like you to explain your decision-making
process and ensure your discussions are fully supported. He would also like to know what the impact each
of the new transactions will have on net income for the year. Notes from your conversation with the CFO
are included below.

In order to invest excess cash and to earn a short-term return, RDI purchased 5% of the outstanding shares
of Trees R Us on January 1, a company operating in an unrelated industry as that of RDI, for $65,000.
RDI plans to keep the investment until the funds are needed for a new project in fifteen months. At year-
end the shares were worth $55,000. Trees R Us earned $80,000 during the year and paid dividends of
$30,000.

RDI has been interested in expanding into the growing Antarctica market, however they have had a lot of
difficulties to do so. Therefore, to help with this expansion, RDI partnered with an experienced company
based in Antarctica, Penguin Consulting Inc., to establish a separate entity. Polar Ice that will open retail
stores in Antarctica. Decision making of Polar Ice is shared between RDI and Penguin Consulting, with
all significant decisions requiring the consent of both parties and each party having a 50% ownership
interest. Polar Ice earned $50,000 this year.

Sourcing good quality shopping bags for their retail stores has always been difficult for RDI, so to secure
reliable and consistent access to shopping bags from their supplier, RDI purchased 25% of the ownership
interest in Fancy Bags Ltd on June 30th. RDI has always been one of the largest customers of Fancy
Bags and will continue to do so. They paid $100,000 for the 25% ownership interest and also received 1
of the 4 board of director’s seats and the ability to purchase the bags before other Fancy Bags customers.
For the current year, Fancy Bags net income was $65,000 and was earned evenly over the year. Fancy
Bags paid dividends of $10,000 each quarter.

RDI has always wanted to sell children’s clothes, but competition is very intense. So during the year
when an existing chain of children’s clothing stores, Kids Klothes Inc. was being sold by its owners, RDI
jumped at the opportunity to expand into this new line of business. RDI was able to obtain it at a very
good price. It will be operated as a separate division. RDI paid $500,000 and in return acquired the
tradename, right to operate the business, the existing store leases and the inventory. Since the acquisition,
Kids Klothes Inc. had a net loss of $200,000.

Required: Prepare the report requested by the CFO.

2
Question 2 (20 marks)

Pepper tentatively plans to issue 30,000 shares to the public, which have a current market value of $17 per
share net of commissions and other issue costs. Pepper then plans to acquire the assets and assume the
liabilities of Salt (excluding the cash that Salt has) for a cash payment of $800,000 and $300,000 in long-
term 4% notes payable. The current market rate of interest is 4%. In addition, Pepper has agreed to a
contingent consideration, based on future earnings, of $200,000. Pepper's receivables include $60,000
owed by Salt for goods received prior to the acquisition. Pepper is willing to pay more than the book
value of Salt assets because plant asset, are undervalued by $215,000 and Salt has some important
internally generated intellectual property and technical know-how valued at $300,000. The inventory has
been valued by an appraiser at $120,000. Pepper incurred legal and accounting fees of $50,000 to acquire
the assets and liabilities.

The Balance sheets for Salt and Pepper on December 3 l, 2016, follow:
Salt Pepper
ASSETS
Cash $ 95,000 $ 380,000
Receivables 117,000 230,000
Inventories 134,000 231,400
Plant assets 600,000 1,036,500
Goodwill 90,000
Total assets $1,036,000 $ l,877,900
LIABILITIES AND EQUITIES
Accounts payable $ 180,000 $ 255,900
Mortgage payable 152,500 180,000
Common stock, $20 per share 340,000 500,000
Other contributed capital 179,500 270,000
Retained earnings 184,000 672,000
Total $1,036,000 $1,877,900

Required:
1) Prepare a pro forma balance sheet showing the effects of the planned transactions on December 31,
2016.
2) Describe the implication of Pepper issuing the additional shares directly to the shareholders of Salt
rather than to the public.

3
 Question 3 (30 marks)

On January 1, 2014, Pruitt Company issued 30,000 shares for the shares of Shah. Pruitt's
common stock had a fair value of $28 per share at that time. A schedule of the Shah Company
assets acquired and liabilities assumed at book values and fair values follows:
Item Book Value Fair Value Excess

Receivables (net) $125,000 $ 125,000 $ --0-

Inventory 167,000 195,000 28,000
Land 86,500 120,000 33,500
Plant assets (net) 467,000 567,000 100,000
Patents 95,000 200,000 105,000
Total $940,500 $1,207,000 $266,500
Current liabilities $ 89,500 $ 89,500 $-0-
Bonds payable 300,000 360,000 60,000
Common stock 284,000
Retained earnings 267,000
Total $940,500

Additional Information:

 Pruitt's and Shah’s income tax rate is 35%.

 Shah's beginning inventory was all sold during 2014.
 Useful lives for depreciation and amortization purposes are:

Plant assets 10 years

Patents 5 years

Bond premium 10 years

 Pruitt follows ASPE and therefore uses the straight-line method for all depreciation and
amortization purposes. Pruitt follows the policy of recording future income taxes.
 The Goodwill from the acquisition was valued at $100,000 at December 31, 2016
 In 2016 Shah determined, as a result of an impairment test, that the Shah patents that
were there at the day of acquisition no longer had any value.

4
The December 31, 2016 Financial Statements follow:
Pruitt Shah
Income Statement
Sales 3,800,000 1,875,000
Cost of goods sold 2,657,000 1,050,000
Gross profit 1,143,000 825,000
Administrative expenses 189,000 106,000
Finance expenses 186,000 518,000
Tax expense 213,000 87,000
Net income 555,000 114,000
Beginning retained earnings 325,000 112,000
Dividends 200,000 0
Ending retained earnings 680,000 226,000

Balance sheet
Assets:
Receivables 180,000 95,000
Inventory 211,000 174,000
Land 125,000 86,500
Plant Assets 1,725,000 512,000
Patent 430,000 0
Investment in Shah 840,000 0
Total assets 3,511,000 867,500

Liabilities and Equity

Current liabilities 99,000 57,500
Bonds payable 732,000 300,000
Common shares 2,000,000 284,000
Retained earnings 680,000 226,000
Total Liabilities and equity 3,511,000 867,500

5
Required:
a) Prepare the acquisition analysis.
b) Prepare the fair value adjustments table for 2016.
c) Prepare the consolidated income statement and the consolidated statement of retained
earnings for the year ended December 31, 2016.
d) Calculate the following consolidated balance sheet accounts at December 31, 2016:
i) Inventory
ii) Plant assets
iii) Patents
iv) Bonds Payable

Question 4 (25 marks)

Pearson created Sedbrook in 2010 and owns 100% of the common stock of Sedbrook.

Pearson sells merchandise to Sedbrook a 25% gross profit. During 2016 and 2017 such sales amounted to
$300,000 and $487,500, respectively. The 2016 and 2017 ending inventories of Sedbrook included goods
purchased from Pearson for $150,000 and $195,000, respectively. There were no intra group sales prior
to 2016.

In 2013 Pearson sold land to Sedbrook for $130,000. At that date the land had a carrying value of
$90,000. In 2017 Sedbrook sold ¼ of the land for $87,000.

On January 1, 2017 Sedbrook sold equipment to Pearson for $84,000. The equipment had a carrying
value of $60,000 on the date of sale and a remaining useful life of 4 years.

Pearson reported net income from its independent operations (including sales to affiliates) of $480,000
in 2017 and its opening retained earnings were $380,000. Sedbrook reported net income of $275,000 in
2017 and had an opening retained earnings of $176,000.

The affiliated companies file separate income tax returns and have marginal income tax rates of 30%.

In 2017 Pearson declared and paid dividends of $50,000 and Sedbrook declared and paid dividends of
$40,000.

Required:
Answer the following questions below. Show your work.
1. Calculate the amount of unrealized profit/loss in the ending consolidated inventory account on the
consolidated Balance Sheet in 2017
2. Calculate the amount of realized intragroup profit, net of tax, reflected in net income on the sale
of land in 2017.
3. Calculate the amount of realized and unrealized profit on the equipment, net of tax, to be reflected
in net income in 2017.
4. Calculate consolidated FIT asset and FIT liability for 2017.
5. Calculate consolidated net income for 2017.
6. Calculate consolidated ending retained earnings for 2017.