Solution Manual for
Intermediate Accounting Volume 2 8 th Edition Thomas H. Beechy, Joan E.
Conrod, Elizabeth Farrell, Ingrid McLeod-Dick, Kayla Tomulka, Romi-Lee Sevel
Chapter 12-22
Chapter 12: Financial Liabilities and Provisions
Case 12-1 Winter Fun Incorporated
12-2 Prescriptions Depot Limited
12-3 Camani Corporation
Suggested Time
Technical Review
TR12-1 Financial liabilities and provisions (IFRS) ...... 10
TR12-2 Financial liabilities and provisions (ASPE) ..... 10
TR12-3 Provision, measurement ................................... 10
TR12-4 Guarantee ......................................................... 10
TR12-5 Provision, warranty .......................................... 5
TR12-6 Foreign currency .............................................. 5
TR12-7 Note payable .................................................... 5
TR12-8 Discounting, note payable ................................ 10
TR12-9 Discounting, provision ..................................... 10
TR12-10 Classification, liabilities................................... 10
Assignment A12-1 Financial versus non-financial liabilities……. 10
A12-2 Common financial liabilities………………… 10
A12-3 Common financial liabilities ............................ 10
A12-4 Common financial liabilities: taxes ................. 20
A12-5 Common financial liabilities: taxes ................ 20
A12-6 Foreign currency payables……………………. 10
A12-7 Foreign currency payables ............................... 10
A12-8 Common financial liabilities and foreign currency 25
A12-9 Provisions......................................................... 20
A12-10 Provisions ........................................................ 20
A12-11 Provisions......................................................... 20
A12-12 Provision measurement .................................... 15
A12-13 Provision measurement .................................... 15
A12-14 Provisions; compensated absences…………... 15
A12-15 Provisions; compensated absences .................. 15
A12-16 Provisions; warranty ........................................ 15
A12-17 Provisions; warranty ....................................... 20
A12-18 Provisions; warranty ....................................... 25
A12-19 Discounting; no-interest note ........................... 15
A12-20 Discounting; low-interest note ........................ 20
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, A12-21 Discounting; low-interest note ......................... 20
A12-22 Discounting; provision ..................................... 15
A12-23 Discounting; provision ..................................... 25
A12-24 Discounting; provision ..................................... 25
A12-25 Classification and SCF..................................... 20
A12-26 SCF .................................................................. 20
A12-27 Liabilities – IFRS and ASPE .......................... 10
A12-28 Liabilities - ASPE ........................................... 20
A12-29 Liabilities - ASPE ............................................ 20
A12-30 Provisions/Contingencies – IFRS and ASPE…. 20
A12-31 DAIS – warranty provision trend……………... 15
A12-32 DAIS – provision for coupon refund………… 15
Cases
Case 12-1 (LO12.3, LO12.5, LO12.6)
Winter Fun Incorporated
To: Members of Board of Directors
From: Accounting Consultant
RE: Winter Fun Incorporated
Overview
Winter Fun Incorporated (WFI) uses IFRS for financial reporting. The bank loan has a
minimum current ratio so you will need to be careful and watch for any impacts on the
ratio. You have had a tough year this year and faced a loss so the bank financing is critical
to your operations.
Issues
1. Revenue recognition memberships
2. Revenue recognition guests
3. Special promotions
4. Coupons
5. Manufacturer Loan
6. Lawsuit
7. Warranty
8. Gasoline storage tanks
9. Foreign currency payables
10. Compensated absences
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,Analysis and Recommendations
1. Revenue recognition memberships
Following the 5 step IFRS model:
Initiation fee
Step 1: The contract with the customer is for the membership in the club. This would be a
written agreement between the member and WFI.
Step 2: There is one performance obligation, the promised service is membership in the
ski club. There is no transfer of the service until the membership is provided.
Step 3: The contract price is $10,000. The non-refundable deposit is an advance payment
towards this initiation fee and is part of the overall transaction price.
Step 4: No allocation since there is only one performance obligation.
Step 5: The performance obligation for the initiation fee is satisfied over the period of
time that the member belongs to the club. The $10,000 would be recognized over the
average period a member belongs. There should be enough historical data available to
come up with a reasonable estimate. There would be no cash collection risk since the
amount is paid upfront.
Annual fee
Step 1: The annual fee is a written agreement between the member and WFI.
Step 2: There is again one performance obligation, the service for this year.
Step 3: The fee of $2,000 is the total contract price and is received in 20X5 for the 20X6
ski season. This would be unearned revenue when received.
Step 4: There is no allocation since there is only one performance obligation.
Step 5: Assuming the ski season goes from Dec 1 until March 31 $500 would be
recognized in 20X5 and the remainder in 20X6 which would be the period in which the
service is performed. There would be no cash collection risk since the amount is paid
upfront.
2. Revenue recognition guests
Following the 5 step IFRS model:
Step 1: The contract with the guest is the written contract when they receive the ticket to
ski, not when the reservation is made since this reservation could be cancelled.
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,Step 2: The performance obligation is the right to ski that day.
Step 3: The overall contract price is the price of the ski ticket.
Step 4: There is no allocation since there is only one performance obligation.
Step 5: The performance would be the right to ski on that day. There is no cash collection
risk since the guest pays by credit card when they purchase the ticket.
3. Special promotions
Following the 5 step IFRS model:
Step 1: The contract with the customer is the written contract when they receive the ticket
and the right to a future lesson.
Step 2: There are two separate performance obligations the right to ski and the right to the
lesson.
Step 3: The total contract price is $100.
Step 4: This price would need to be allocated to the two separate performance obligations
based on their relative fair value.
Fair value ski pass 80 = 61.5% x 100 = $61.50
Fair value lesson 50 = 38.5% x 100 = $38.50
Total fair value 130
Step 5: The $61.50 allocated to the performance obligation for the ski pass would be
satisfied on the day that they ski. For the $38.50, the performance obligation would be
satisfied on the day they take the lesson. There would be no cash collection risk assuming
a credit card is used to purchase the special pass.
4. Coupons
It must be determined if an economic loss would occur for the coupons. The coupons are
for $5 and the price of a ski pass is $80. This is a minor amount compared to the price of
the ski pass so WFI would still be selling the ski pass at a profit. Therefore, the coupons
should only be recognized as a cost when they are redeemed.
5. Manufacturer Loan
The manufacturer of the ski lift has provided a 0% interest loan. This is often referred to
as a dealer loan. The loan is either measured in FVTPL or other liabilities. Most liabilities
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,are measured in other liabilities and since there is no mismatch I recommend this loan be
recorded in other liabilities and not to elect FVPL. WFI is required to record the loan at
fair value using the market rate of interest which would be their incremental borrowing
rate of 8%. Therefore, the loan would be recorded at $2.5 million (2 periods, 8%) =
$2,143,350. The loan would then be amortized using the effective interest method and
interest expense of $171,468 would be recorded in 20X5. This would not impact the
current ratio in 20X5 because the full amount would be presented as long term.
6. Lawsuit
It must be determined if the lawsuit is probable and if the amount can be measured. The
Board has decided to settle the lawsuit therefore it is probable there will be a payment.
The amount will be based on management‘s best estimate. Since there is a range, this
would be the midpoint of the range or $250,000 should be accrued as a provision,
assuming each point is equally likely. In addition, there would be note disclosure on the
details of the lawsuit. This liability would be current if the payment is expected to be
made next year, which would have a negative impact on the current ratio.
7. Warranty
The warranty is not a separate performance obligation – it is an assurance warranty (also
known as a standard warranty). In the period in which the skis are sold, a warranty
provision should be set up for the estimated costs to be incurred to service the skis as long
as the warranty costs are considered probable. If historically costs are low, the provision
may be small.
The provision is set up with a debit to warranty expense and credit to the provision for
warranty. Subsequently, when costs are incurred, the warranty provision is debited, and
cash, parts or other materials is credited.
Since the warranty provides a lifetime guarantee, at least a portion would likely be a non-
current liability. The portion that is expected to relate to the following year, would be
reported as a current liability at the reporting date. Any current portion would affect the
current ratio negatively.
8. Gasoline storage tanks
The gasoline storage tanks would be set up as an item of property, plant and equipment
and depreciated over the 15 years. The costs to remove the tanks would be a legal
obligation and would need to be set up as a decommissioning provision. The provision
would be set up at the present value of the $2.5 million. The PV would be $2.5 million
(15 periods, 8%) = $788,100. This amount would be debited to the gasoline storage tanks
and credited to the provision. Since the life of the storage tanks and the decommission
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,provision are the same, the $10,788,100 (the $788,100 is added to the $10M) would be
depreciated over the 15 years which would be $719,207 of depreciation expense in 20X5.
Interest expense of $63,048 ($788,100 * 8%) would also be recognized in 20X5 which
would increase the decommissioning provision. The asset would be a long term asset and
the decommissioning provisions would be a long term liability so this would not impact
the current ratio.
9. Foreign currency payables
The following entries are required for the foreign currency inventory purchase:
Inventory (150,000 x $1.11)…………………………………………… 166,500
Accounts payable………………………………………………………… 166,500
Accounts payable……………………………………………………….. 166,500
Foreign exchange loss…………………………………………………… 12,000
Cash (150,000 x 1.19)…………………………………………………… 178,500
The payable has been settled by year-end, therefore there is no impact on the current ratio.
10. Compensated absences
WFI must record a provision for compensated absences at the December 31, 20X5 year-
end through an adjusting entry.
The calculation is as follows:
7 employees x $22 x 7.5 hours x 11 days = $12,705
14 employees x $22 x 7.5 hours x 9 days = $20,790
Total: $33,495
Salary expense……………………………………………….. 33,495
Provision for compensated absences………………………… 33,495
Since the carried forward vacation must be used the following year, the provision for
compensated absences is a current liability. Recording the provision therefore negatively
impacts the current ratio.
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,Case 12-2 (LO12.2, LO12.5)
Prescriptions Depot Limited
Overview
Prescriptions Depot Limited (PDL) is a large private company with revenues of $5.4
billion and earnings of $295 million. The company complies with IFRS, and is
contemplating a public offering in the medium term. GAAP compliance is therefore
important. Reporting objectives are to report growth in sales, especially year-over-year
same-store sales growth, and stable earnings. Because of possible analyst interest, sales
measurement is of critical importance. Ethical reporting choices are critical, given the
possibility for increased scrutiny in the future; sudden changes in accounting policy at a
later date may not be viewed with favor by analysts. Reporting objectives are meant to
support a public offering.
Issues
1. Loyalty points program
2. Decommissioning obligations
3. Cash refund program
4. Coupon program
Analysis and recommendations
1. Loyalty points program
PDL operates a loyalty points program, which will impact on the measurement of
sales revenue, a measure important for analysts.
Currently, a sales transaction with point value attached is recognized as a sale entirely
in the current period. An expense and liability for the cost – not sales value – of goods
to be redeemed in the future is recognized in the same time period as the sale.
This policy maximizes the sales value recorded with the initial transaction. It does not
reflect the substance of the transaction, though, which is that PDL has rendered
multiple deliverables in sale: both the initial sale, and the subsequent sale based on
points value are being sold.
Accordingly, PDL must consider an alternate approach to its loyalty point program:
1. The sale in the store is a contract with the customer but there are two separate
performance obligations. There is the sale of the goods now and the future
redemption of points. This loyalty program provides the customer with a
material right. On a sale that involves issuance of points, the consideration
received must be allocated between the sale of the product and the points on a
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, relative stand alone basis. The value of points to be redeemed in the future is
recorded as unearned revenue.
2. As is now the case, careful measurement of the amount - unearned revenue,
now - includes analysis of redemption, bonus offers, breakage, expiry, and
the like.
3. When points are redeemed, the sales value of the redemption transaction is
recorded as sales revenue and cost of goods sold reflects the merchandise
purchased.
This approach defers sales revenue and gross profit to later periods.
As a result, current earnings (and sales) are lower, but future periods show higher
sales and earnings. Trends may be affected. Analysts will react better to accurate
information, and there is time for this to be assessed since plans to offer shares to
the public are described as ―medium term‖.
2. Decommissioning obligation
PDL has an obligation to remove its customized, specialized pharmacy installations in
leased premises. This is a future obligation based on a past action, and represents a
provision in the financial statements. It is not currently recorded. This is essentially a
decommissioning obligation, and standards require recognition.
Accordingly, PDL must estimate the cost to restore premises, removing the custom
set-up. PDL must also estimate when restoration is likely to happen; lease renewal
must be assessed. Finally, a borrowing rate for the appropriate term and amount must
be estimated, and a discounted liability calculated.
The discounted liability is recognized as an asset and a liability. The asset is
depreciated over the life of the leased premises. Interest is accrued annually on the
liability. These two charges will decrease earnings, but represent appropriate
accounting measurement.
Note also that estimates must be revised, and any changes in estimate are reflected in
a revised present value and asset balance.
3. Cash refund program
The cash refund program is now accounted for when the refund takes place, recording
a reduction to cash and a reduction to sales.
Since the promotion involves a cash refund, an obligation exists to pay cash in the
future, based on a past transaction.
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, If there was a refund period open over the end of a reporting period, this accounting
policy would not capture the obligation to provide refunds. That is, if the six-week
documentation window were open, after a given promotion, there would be refunds to
be made based on recorded sales of the period. This obligation to provide refunds
would not be reflected in the financial statements.
Therefore, PDL must estimate the extent of cash refunds waiting to be filled and
record them as a liability when the promotion weekend ends. Estimates can be based
on past practice.
The amount refunded to customers should be reported as a sales discount (a contra-
sales account), not as a direct decrease to sales. It should also not be recorded as a
promotion expense, as it is a reduction in sales value. Recording the amounts as a
sales discount is preferable to directly reducing sales, because it may help preserve
information about the extent of program use for internal tracking. Analyses of sales
trends may focus on net sales, so this accounting treatment may not improve sales
trends, a corporate reporting objective.
The policy will record refunds earlier, and may decrease earnings in the short term.
Over time, there will be no cumulative difference to earnings.
4. Coupon program
The coupon program is now accounted for by recording sales at the amount of cash
received from customers. PDL then reduces inventory – and thus cost of goods sold -
for manufacturer rebates given for coupons redeemed. (i.e., debit accounts payable,
and credit inventory which becomes cost of goods sold). This has the correct impact
on gross profit (give or take some timing issues of inventory sale), but understates
sales.
Since PDL is increasingly concerned with correct measurement of sales, the
accounting policy for coupons must be revisited. The correct treatment:
1. Sales is measured at the retail price, regardless of whether the value is received
from customers ($20,000, in the case example) or from the manufacturer in the
form of coupons ($5,000). The coupons are in essence an account receivable, used
to reduce an account payable.
2. Merchandise is recorded at the invoice cost ($98,000) not the amount of cash paid
($93,000).
Using the existing accounting policy, sales are recorded at $20,000, and cost of goods
sold (for many products, one assumes) at $93,000. With the revised system, sales are
$25,000 and cost of goods sold is $98,000.
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, There is no overall change to earnings, but sales are more accurately stated, which is
preferable for PDL.
Conclusion
Any company with an eye on public markets must carefully assess its reporting
practices and ensure appropriate accounting is followed. PDL has several policies,
for loyalty points, cash refunds and coupon transactions that impact on reporting
of sales and timing of earnings. In addition, they have unrecorded
decommissioning obligations. Appropriate accounting demonstrates the ethical
commitment of management.
Case 12-3 (LO12.5, LO12.10)
Camani Corporation
Overview
Camani Corporation has been negatively affected by economic conditions, and the 20X3
financial results are under particular scrutiny to determine the viability of the existing
strategic model. The executive team will receive a ―return to profitability‖ bonus if 20X3
earnings are positive. Under these circumstances, there is obvious pressure to select
reporting policies and estimates to support higher earnings. There are significant ethical
pressures on all stakeholders in the company, but especially management.
Issues
1. Calculate cash from operating activities, based on current draft financial
statements.
2. Analyse reporting implications of identified estimated financial statements
elements: legal issues, depreciation policy, technology contract, inventory
valuation, restructuring and environmental liability.
3. Re-calculate cash from operating activities, based on revised financial statements
Analysis and conclusions
1. Cash flow from operating activities, existing draft financial statements
Based on the information provided in the question, a statement of cash flows may be
prepared to determine cash flow from operations (Refer to Exhibit I in the solution).
Exhibit 1 shows that cash flow from operating activities is a negative, at ($1,721).
Earnings of $1,535 reflect cash flows of ($800), and dividends on common shares are
another ($921). The negative operating cash flows are caused by large build-ups in
account receivable and inventory. The increase in accounts payable and accrued
liabilities works to mitigate this, but is not as large as the inventory build-up.
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