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									UNIVERSITY OF WATERLOO School of Accountancy
AFM 101 Professor Duane Kennedy Mid-Term Examination Fall 2007 Date and Time: October 19, 2007, 4:45 – 6:15pm Pages: 16, including cover Tutorial Number and Time: Instructions: 1) 2) Cordless calculators may be used. The calculator must be standalone with no other communication or data storage features. Answers for the multiple-choice questions must be recorded on the UW answer card. All other questions must be answered in the space provided on the examination paper. Answers written outside of the provided space will not be graded. You must submit both this examination paper and the UW answer card. Show details of all calculations. The final page of the examination contains a list of ratios. For your convenience, this page may be detached from the examination paper. Please verify that this examination paper has the appropriate number of pages. Question 1 2 3 4 5 6 Total Maximum Marks 14 20 12 10 8 21 85 Mark Awarded


3) 4) 5)

Question 1 (14 marks) Hawthorn Landscaping Corporation is a small company which specializes in the design and construction of unique lawns and gardens for businesses and individuals. At the end of June 2007, the company had $250,000 of net assets and $121,000 of liabilities. Required: Provide the journal entries required to record the following transactions that occurred in July 2007. You do not need to include explanations. Answers must appear in the space provided. A) The company received a deposit of $1,500 from a customer, J. Thomson, for work to be done in August. Cash Unearned Revenue $1,500 $1,500

B) The company sold an old dump truck for $4,250, received in cash. The truck had an original cost of $35,500 and accumulated amortization of 24,800. Cash Accumulated Amortization Loss on Sale of Truck Truck $4,250 24,800 6,450 $35,500

C) The company received an electric and gas utility bill of $575 for the month of July which is due to be paid in August. Utility Expense Utilities Payable $575 $575


D) Salaries of $8,750 for the month of July were paid. Salaries Expense Cash $8,750 $8,750

E) Paid $5,800 on account for landscaping supplies which were delivered in June. Accounts Payable Cash $5,800 $5,800

F) Completed a landscaping project for R. Brown. The invoice price was $11,300. The customer had paid a deposit of $2,000 in June and the remainder of the invoice will be billed on account for collection in August. Unearned Revenue Accounts Receivable Revenue $2,000 9,300 $11,300

G) The company purchased a new tractor for use in the business. The cost was $22,400. The company paid $5,000 in cash and signed a short-term note for the remainder. Equipment Cash Short-term Note Payable $22,400 $5,000 17,400


Question 2 (20 Marks) The following information relates to activities for Houston Limited for 2007. a) Net income for the year ended December 31, 2007, was $22,500. b) The company borrowed $23,000 on a long-term note from the bank. Interest is payable annually and the interest expense is included in net income. c) An additional piece of land was purchased on November 30, 2007. The seller of the land accepted a mortgage as full payment. d) During the year, a piece of equipment was sold for $15,000, paid in cash. Any gain or loss on the sale was included in net income. A new piece of equipment costing $28,000 was purchased in June. The purchase price was paid in cash. e) Dividends of $9,000 were paid in cash. f) Capital stock was issued in exchange for the retirement of $10,000 of long-term notes payable. g) A portion of the bonds matured during 2007 and the company paid cash to redeem these bonds. Selected account balances at December 31, 2006 and 2007 are shown in the following table. All account balances have the usual sign. 2006 $15,000 17,000 14,000 3,500 50,000 19,000 11,000 80,000 13,000 550 31,000 50,000 210,000 2007 $25,200 21,000 18,400 1,000 65,000 27,000 14,000 125,000 19,000 1,150 44,000 30,000 220,000

Cash Accounts receivable Inventories Prepaid expenses Equipment Accumulated amortization, equipment Amortization expense, equipment Land Accounts payable Interest payable Notes payable Bonds payable Capital stock

Required: Prepare the statement of cash flows for Houston Limited for 2007 using the indirect method. Please use the table on the following page to complete this question. Be sure to prepare a schedule for any non-cash items for disclosure, if appropriate.


Houston Limited Statement of Cash Flows For the Year Ended December 31, 2007 Operating Activities: Net Income________________ Add (deduct) items not effecting cash Gain on Sale of Equipment Amortization Expense Increase in Accounts Receivable Increase in Inventories__ Decrease in Prepaid Expenses Increase in Accounts Payable Increase in Interest Payable _________________________ Net cash flow from operating activities Investing Activities: Sale of Equipment_______ Purchase of Equipment _________________________ _________________________ Net cash flow from investing activities Financing Activities Long-term Note Payable From Bank Dividends________________ Redeem Bonds Payable_____ _________________________ Net cash flow from financing activities Net Increase in Cash_____ Cash balance on January 1, 2007 Cash balance on December 31, 2007 Non-cash Investing and Financing Activities Purchase of Land in Exchange for Mortgage Capital Stock Exchanged for Long-term Note _________________________

___$22,500 __________ _____(8,000) _____14,000 _____(4,000) _____(4,400) ______2,500 ______6,000 _______600 __________ ____29,200

____$15,000 __($28,000) __________ __________ __($13,000)

____$23,000 ____(9,000) ___(20,000) __________ ___($6,000) ____10,200 ____15,000 ___$25,200

$45,000 $10,000


Question 3 (12 marks) The following alphabetical listing shows all of the account balances taken from the unadjusted trial balance at December 31, 2007, for Vance Management Limited. All account balances have the usual sign. Vance Management Limited Unadjusted Trial Balance December 31, 2007 Accounts Payable Accounts Receivable Accumulated Amortization, Equipment Advertising Expense Capital Stock Cash Equipment Land Note Payable Office Supplies Inventory Prepaid Insurance Retained Earnings (as at Dec 31, 2006) Revenue Salaries Expense Utilities Expense $ 13,500 17,400 21,000 23,800 145,000 21,900 82,000 215,000 60,000 3,600 4,000 71,100 127,700 63,400 7,200

Required: Provide the adjusting entries required at December 31, 2007. You do not need to include explanations. Answers must appear in the space provided. A) The equipment was purchased in a previous year. It has an estimated life of 6 years with an expected salvage value of $10,000. The company uses straight-line amortization. Amortization Expense Accumulated Amortization ($82,000 – 10,000) = $12,000 6 years $12,000 $12,000


B) The office manager counted the office supplies inventory on December 31, 2007 and found that supplies costing $350 remained on hand. Office Supplies Expense Office Supplies Inventory $3,250 $3,250

C) The note payable was borrowed on September 1, 2007. The note and interest at 12% are to be repaid on August 31, 2008. Interest Expense Interest Payable $60,000 * 12% * 4/12 = $2,400 $2,400 $2,400

D) The prepaid insurance was purchased on April 1, 2007, and provides insurance coverage for twelve months.

Insurance Expense Prepaid Insurance $4,000 * 9/12 = $3,000

$3,000 $3,000

E) The company ran an advertising campaign in the local newspaper in December. The bill has not been received or recorded yet. The cost of the campaign was $1,200.

Advertising Expense Accounts Payable

$1,200 $1,200

F) Vance Management Limited pays salaries every second Friday. On December 31, salaries of $1,500 were owed to employees. Salaries Expense Salaries Payable $1,500 $1,500


Question 4 (10 marks) Sproule Limited reported the following December 31 amounts in its financial statements (in millions): 2007 $475.0 197.9 277.1 66.1 33.8 311.0 52.7 191.9 22.0 2006 $448.2 171.3 276.9 71.1 29.6 293.3 39.8 177.4 20.0 2005 $433.6 159.9 273.7 73.3 27.8 272.0 35.5 146.0 16.0

Sales revenue Cost of goods sold Gross profit Net income Current assets Total assets Current liabilities Total liabilities Shares outstanding Required:

A) Compute the net profit margin ratio for 2007 $66.1 $475 = 0.1392

B) Compute the total asset turnover ratio for 2007 $475 = 0.5 ($311 + 293.3) $475 $302.15 = 1.5721

C) Compute the return on assets ratio for 2007 $66.1 = 0.5 ($311 + 293.3) $66.1 $302.15 = 0.2188

D) Compute the earnings per share for 2007 $66.1 0.5 (22.0 + 20.0) = $66.1 21 = 3.1476

E) Compute the debt to equity ratio for 2007 $191.9 $311 – 191.9 = $191.9 $119.1 = 1.6113


Question 5 (8 Marks) The answers to the following questions must appear in the space provided. a) The article “Global Positioning: The New Direction” described the proposed future direction for accounting standards in Canada. Briefly discuss the proposed direction.

The accounting standards for Canadian public companies will move to International Financial Reporting Standards. Canadian companies that are registered with the SEC will be able to use US GAAP.


Various articles and lectures have discussed management manipulation of accounting earnings. Briefly discuss reasons that managers would want to manipulate earnings.

Reasons for managers to manipulate earnings include: - increase earnings in order to increase share price - increase their own compensation through bonuses or stock options - make the company look more stable in order to reduce interest rates on debt or make it easier to get/keep loans


Briefly discuss two reasons why a company may choose to report “pro forma earnings.”

- Report “pro forma earnings” in order to make the company look more successful - Focus the attention of readers on information that managers consider to be more relevant in understanding the company


The article “Capital Pains: Big Cash Hoards” discusses the growth of cash balances in US companies. Briefly discuss reasons why investors may be concerned about excess levels of cash.

- Companies earn a low rate of return on cash - Managers may make poor investment decisions because the cash is readily available - Difficult for investors to evaluate the performance of the company if a significant portion of earnings come from investment of excess cash


Question 6 (21 marks) Choose the correct response from the answers provided. There is no mark penalty for incorrect responses. Mark the correct responses by completing the University of Waterloo answer card, using a black lead HB pencil only. Write your name and student number on the answer card and mark your student number in the appropriate ovals. You do not need to complete the section number and card number. Answers recorded on the following pages will not be marked.

1. On January 1, 2007, Grover Inc., started the year with a $22,000 credit balance in its retained earnings account. During 2007, the company earned net income of $40,000 and declared and paid dividends of $10,000. Also, the company received cash of $15,000 as an additional investment by its owners. Therefore, the balance in retained earnings on December 31, 2007, would be A) $67,000. B) $42,000. C) $57,000. D) $52,000. E) None of the amounts is correct.

2. Assume a company's January 1, 2007, financial position was: Assets, $40,000 and Liabilities, $15,000. During January 2007, the company completed the following transactions: (a) paid on a note payable, $4,000 (no interest); (b) collected accounts receivable, $4,000; (c) paid accounts payable, $2,000; and (d) purchased a truck, $1,000 cash, and $8,000 notes payable. The company's January 31, 2007, financial position is Assets $42,000 $44,000 $43,000 $42,000 Liabilities $ 9,000 $17,000 $18,000 $17,000 Stockholders' Equity $33,000 $27,000 $25,000 $25,000

A) B) C) D)

3. Hill's Copy Service performed photocopy services during December, 2006, but had not collected any cash (or other assets) from its customers by the end of the accounting period, December 31, 2006. What effect did performing these services have on the fundamental accounting model? A) Increased assets and increased liabilities. B) Increased assets and increased stockholders' equity. C) Increased assets and decreased stockholders' equity. D) Decreased liabilities and decreased stockholders' equity. E) These services will not affect the accounting model until the cash is actually collected.


4. The qualitative characteristic that says accounting information can influence users' decisions is A) comparability. B) materiality. C) relevance. D) reliability. E) None of these is correct.

5. On July 1, 2006, Childe Company paid the premium in advance of $2,400 for a twoyear fire insurance policy on machinery. At that time, the full amount paid was recorded as prepaid insurance. On December 31, 2006, the end of the accounting year, the required adjusting entry should include a A) $2,400 credit to prepaid insurance. B) $2,400 debit to insurance expense. C) $600 debit to prepaid insurance. D) $600 debit to insurance expense. E) None of the responses is correct.

6. Which of the following is true? A) An extraordinary gain would decrease net income. B) A cumulative effect of a change in an accounting principle would be shown as a current asset on the balance sheet. C) Current assets are resources that are expected to be realized in cash, consumed, or sold within a year or the operating cycle, whichever is longer. D) When land is included in the category Property, Plant and Equipment, its acquisition cost should be depreciated over time to reflect its use. E) None of these statements is true.

7. The article "Hide and Seek" discussed a number of 'accounting tricks.' "Big Bath Accounting" refers to the practice of: A) Moving debt off the Balance Sheet so that the liability section will be smaller (i.e., cleaner). B) Highlighting all the positive developments and ignoring the bad stuff in press releases and earnings announcements. C) Transferring assets and liabilities into the financial statements of subsidiaries so that financial ratios of the parent company will appear stronger. D) Writing off weak assets to produce a large loss in the current period.


8. Which of the following is a cash flow from operating activities? A) Purchase of merchandise for resale. B) Sale of a piece of land no longer used in operations. C) Sale of long-term investments in common stock. D) Payment of a note payable.

9. The financial statements of Juliet Company show the following:

Sales: $154,000 Beginning Balance $28,000 21,000 Ending Balance $22,000 25,000

Accounts Receivable Accounts Payable

Cash collected from customers is A) $148,000. B) $150,000. C) $154,000. D) $160,000.

10. If a business declared and paid a $500 dividend, it would appear on the A) Income statement only. B) Balance sheet only. C) Statement of retained earnings and statement of cash flows. D) Statement of retained earnings only. E) Income statement and statement of retained earnings.

11. On December 31, 2007, (end of the accounting period), Cube Company recorded amortization on its company truck of $3,000. Transaction analysis of the amortization should reflect the following: A) decrease shareholders' equity and increase liabilities. B) decrease shareholders' equity and decrease assets. C) decrease assets and increase liabilities. D) decrease assets and increase shareholders' equity. E) None of the responses is correct.


12. Failure to make an adjusting entry to recognize accrued salaries payable would cause an A) understatement of expenses and liabilities and an overstatement of shareholders' equity. B) overstatement of expenses and liabilities. C) understatement of expenses, liabilities and shareholders' equity. D) understatement of assets and shareholders' equity. E) understatement of expenses and shareholders' equity.

13. Which of the following statements about the quality of income ratio is true? A) When sales are growing, receivables and inventory normally increase faster than accounts payable so the ratio increases. B) Seasonal variations in sales have no impact on the quality of income ratio. C) Failure to accrue appropriate expenses will inflate net income and reduce the quality of income ratio. D) All the statements are true.

14. On January 1, 2007, Wilkins Company purchased a delivery truck that cost $20,000. Cash of $15,000 was paid, and the balance of $5,000 was payable on January 31, 2007. The truck has an estimated useful life of four years and no residual value. The company uses the straight-line method for amortizing all trucks. Considering only these facts, amortization expense (on the truck) for 2007, would be A) $20,000. B) $15,000. C) $10,000. D) $ 5,000. E) None of the amounts is correct.

15. If Papa John's reports an asset turnover ratio of 2.34 for 2006 and their competitor Pizza Hut reports 3.79 for their 2006 ratio, it means that Papa John's A) is better able to pay their current obligations with their current assets B) has been more effective in managing the use and level of its assets C) has been less effective in managing the use and level of its assets D) is less able to pay off their current obligations with their current assets

16. Shortway Company purchased a piece of land to build a warehouse. In its statement of cash flows, the purchase of land would be shown as cash flow used in A) Operating activities. B) Financing activities. C) Investing activities. D) Purchasing activities. E) None of these activities is correct.


17. On January 1, 2007, the ledger of Global Corporation correctly showed supplies inventory of $500. During 2007, supplies purchases amounted to $700. A count (inventory) of supplies on hand at December 31, 2007, showed $400. The 2007 income statement should report supplies expense amounting to A) $ 1,200. B) $ 1,100. C) $ 800. D) $ 700. E) None of the amounts is correct.

18. Matlock Company reported total sales revenue of $55,000 and total expenses amounting to $45,000 (i.e., net income $10,000) on its income statement for the year ended December 31, 2007. During 2007, accounts receivable decreased by $4,000, merchandise inventory decreased by $6,000, accounts payable increased by $2,000 and amortization of $8,000 was recorded. Therefore, based only on this information, the net cash flow from operating activities for 2007 was: A) $10,000. B) $18,000. C) $19,000. D) $30,000. E) None of the amounts is correct.

19. Select the statement which best describes the primary purpose of closing entries. A) To facilitate adjusting entries. B) To reduce the balances of revenue and expense accounts to zero so that they may be used to accumulate the revenues and expenses of the next period. C) To complete the recording of various transactions which are begun in one period and concluded in a later period. D) To determine the amount of net income or net loss for the period. E) None of these statements is correct.

20. Brooks Company sold equipment for $100,000, purchased a building for $80,000, sold long-term investments for $20,000 and repaid a note payable for $25,000 plus $1,500 of interest. The net cash flow from investing activities was (parentheses indicate an outflow): A) $15,000. B) $40,000. C) ($45,000). D) $13,500.


21. The asset turnover ratio is used to assess A) whether the company can pay their bills currently due with their existing cash and receivables B) whether the company can borrow money from the bank C) whether the company is using its assets effectively in generating sales revenue D) All of these can be assessed by the asset turnover ratio E) None of these can be assessed by the asset turnover ratio


Price- Earnings Ratio Market Price Net Income Total Liabilities Owners’ Equity _____Net Sales_____ Average Total Assets ____Net Income____ Average Total Assets __Net Income Available to Common Shareholders__ Weighted-Average Number of Common Shares Outstanding during the Period _Net Income_ Net Sales __Cash Flow from Operating Activities__ Net Income ____Cash Flow from Operating Activities____ Cash Paid for Property, Plant, and Equipment ________Net Income________ Average Shareholders’ Equity

Debt to Equity Ratio

Total Asset Turnover Ratio

Return on Assets

Earnings per Share

Net Profit Margin

Quality of Income Ratio

Capital Acquisition Ratio

Return on Equity


Answer Key for Multiple Choice Questions
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. D D B C D C D A D C B A C D C C C D B B C


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