Question 1 (11 marks) D&D Construction Ltd. is based in Maitland, Nova Scotia. The company takes on construction jobs ranging from small contracts worth just a few thousand dollars to multi-million-dollar projects. It only prepares accrual and adjusting entries at year end. The following four significant transactions have occurred in 20X7, and may have possible yearend adjustment implications: a) Land D&D accounts for land using the revaluation model. The company has only one parcel of land. It is recorded in the statement of financial position by D&D at $3.2 million. In 20X7, the value of the land was assessed, and found to be $3 million. No revaluation adjustments have been recorded in the past. Required: Prepare the journal entry to record the change in value of the land. Intermediate Financial Reporting 1 Project 2 3 / 8 b) Plant and equipment Details of D&D's property, plant, and equipment are provided in the data file. Buildings, mobile equipment, automobiles, and office equipment are depreciated using the straight-line method. Tools and equipment are depreciated using the declining balance method. The depreciation rates on tools and equipment vary from 17.5% to 33% per year. Computer equipment is depreciated using a double-declining rate method at 62.5% per year. On January 1, 20X7, warehouse equipment with a cost of $85,600 was delivered. The equipment was immediately put into service. The useful life is expected to be 11 years, with an expected residual value of $10,500. This equipment is depreciated using the declining balance method at a rate of 17.5%. The invoice for this equipment was received and paid, but was inadvertently not recorded. On December 31, 20X7, the company disposed of several hand tools. The cost of these tools was $21,300, and accumulated depreciation as at December 31, 20X6, was $18,899. The equipment sold for total proceeds of $6,500. The funds received were recorded by the company as a gain on sale of property, plant and equipment of $6,500. Depreciation for 20X7 has not yet been recorded for any of the property, plant, and equipment (PPE) held by the company. Required: Prepare a ny necessary journal entries to record and correct the PPE transactions detailed above. c) Equipment patent D&D registered a patent on January 1, 20X0. The expected useful life of the patent was 10 years. The patent was capitalized at $110,000. The net book value at January 1, 20X7, was $33,000. On December 31, 20X7, the patent was tested for impairment and it was determined that it had no further value. Required: Prepare a ny necessary journal entries associated with D&D's equipment patent for 20X7. d) Saw patent During 20X7, D&D applied for a patent on a specialized saw; on December 20, 20X7, D&D was advised that the patent process was complete and the company's patent was properly registered as at that date. The saw saves on setup time, which is highly valuable in the construction business. It took several years to perfect the now-patented saw. Intermediate Financial Reporting 1 Project 2 4 / 8 The following is a breakdown of costs incurred by the company regarding the patent: D&D's owner believes that his own time spent working on the design and testing various prototypes over just the past five years is worth approximately $65,000. Fees paid to Canadian patent lawyers to help register the patent in Canada totalled $7,500. Fees paid to American patent lawyers to register the patent in the United States were $3,500 (in Canadian equivalent). Fees paid to technical investigators were $4,500. Fees paid to the patent offices to help register the patent were $2,300. In total, the costs related to the patent are $82,800, excluding any taxes. The amount paid for the owner's time is included in the accounting records in wages, salaries, and benefits. The fees to the patent offices were charged to the fees, licences, and registrations account. The other items paid to lawyers and technical investigators were all charged to professional fees when they were paid. The fees to lawyers, technical specialists, and patent offices were all paid during 20X7. The owner believes that he spent approximately an equal amount of time on the project for each of the years from 20X3 to 20X7. The patent is protected for 20 years in both Canada and the United States. Management believes that the patent will have value for the entire 20-year period of protection. Amortization on the patent will begin in the 20X8 fiscal year. Required: Prepare the journal entry to properly recognize the saw patent. Question 2 (24 marks) Eli Fish Corp. (EFI), a passive investor, owns various investments in debt and equity securities. EFI's policy is to prepare journal entries for adjustments and accruals at year end. The company elects to reclassify reserves (accumulated other comprehensive income) to retained earnings upon derecognition of investments in equity securities at FVOCI-elect. EFI engaged in various investment-related transactions as detailed below. All interest and dividend payments were received on the scheduled payment dates. While the resulting journal entries will all be entered to the nearest dollar, EFI rounds all dollar-based calculations to the nearest whole cent (for example, $50.22) and percentages to four decimal places (for example, 11.9876%). You should do likewise in your supporting calculations. Intermediate Financial Reporting 1 Project 2 5 / 8 January 1, 20X1 i) EFI paid $17,500 for 500 common shares of Zoe Corp. and classified this investment at fair value through profit or loss (FVPL). ii) EFI paid $24,700 for 100 preferred shares of Meeks Inc. and irrevocably classified this investment at fair value through other comprehensive income (FVOCI-elect). The preferred shares each pay a dividend of $1.00 ($100 total) annually on June 30. iii) EFI paid $102,974 for a $100,000, 5.0% coupon bond issued by Zachary Ltd. that pays interest on June 30 and December 31 each year. The bond matures on December 31, 20X9. EFI classified this investment at FVPL. iv) EFI paid $176,618 for a $200,000, 3.0% coupon bond issued by Belle Inc. that pays interest on June 30 and December 31 each year. The bond matures on December 31, 20X7. EFI classified this investment at fair value through other comprehensive income (FVOCI). v) EFI paid $292,189 for a $300,000, 4.0% coupon bond issued by Canaan Corp. that pays interest on June 30 and December 31 each year. The bond matures on December 31, 20X6. EFI classified this investment at amortized cost. December 31, 20X1 vi) The market values of the investments were as follows: Zoe Corp. $17,100 Meeks Inc. $25,200 Zachary Ltd. $101,500 Belle Inc. $183,500 Canaan Corp. $287,600 January 1, 20X2 vii) EFI reclassified its investment in Zachary's bonds from FVPL to amortized cost. viii) EFI reclassified its investments in Belle's bonds from FVOCI to amortized cost. January 2, 20X2 ix) EFI sold some of its investments for the prices set out below: Zoe Corp. $17,400 Meeks Inc. $24,600 Canaan Corp. $288,000 Intermediate Financial Reporting 1 Project 2 6 / 8 Required: Record all journal entries pertaining to the purchase, income recognition, revaluation, reclassification, and derecognition of EFI's investments. Separate the journal entries into those required in 20X1 and those required up to and including June 30, 20X2. Ensure that the journal entries are dated and include a brief description of the pertinent details. Prepare a separate journal entry for each event and for each investment; supporting calculations are to be referenced or included in the description. Question 3 (12 marks) Carson Machinery Inc. (CMI) is a publicly traded, Canadian-based manufacturer of automotive parts. It operates production facilities in three provinces. Investors benchmark earnings compared to market expectations and to other similar companies. Wherever feasible, CMI prefers to adopt accounting policies that increase short-term profitability, to keep the equity base strong. As part of its compensation package, CMI awards bonuses to its executives on an annual basis. The primary criterion considered by the board of directors when determining the size of the bonuses to be awarded to the executives overseeing production is the firm's actual earnings before interest and taxes (EBIT) compared to the budgeted EBIT for the year. Projected financial results for its Quebec facility, which produces engine components for auto makers, is below. However, projections are subject to significant fluctuation, because demand for certain components is driven by consumer demand for the various automotive models. Demand is also driven by general economic conditions. CMI may anticipate demand for one component, but then the market heads in the opposite direction, which increases down time to retool the facility. Projected financial results Quebec production facility Year 1 Year 2 Year 3 Hours of production 4,800 5,760 5,500 Revenue1 $7,200,000 $8,640,000 $8,250,000 COGS2 2,880,000 3,559,680 3,500,970 Administration3 2,160,000 2,224,800 2,291,544 Earnings before interest, taxes, depreciation and amortization (EBITDA) $2,160,000 $2,855,520 $2,457,486 Depreciation4 1,000,000 1,000,000 1,000,000 EBIT $1,160,000 $1,855,520 $1,457,486 Intermediate Financial Reporting 1 Project 2 7 / 8 1 Based on expected hours of production; average revenue per hour is $1,500. Year 1: 4,800 production hours Year 2: 5,760 production hours Year 3: 5,500 production hours 2 Based on expected hours of production; $600 per hour, adjusted for inflation. Year 1: 4,800 hours $600 Year 2: 5,760 hours ($600 1.03) Year 3: 5,500 hours ($600 1.03 1.03 ) 3 Inflation factor of 3% per year. Will not be materially affected by changes in production. 4 Depreciation expense excluding the EX8500 robotics equipment To reduce downtime (and hopefully smooth results), CMI is automating as much of its Quebec facility as possible. Francois Leroy, the company's chief financial officer, has asked you, the financial controller and a CPA, to make recommendations with respect to an appropriate depreciation method for a brand-new class of robotics equipment recently purchased by CMI for the Quebec facility. Details of the equipment The EX8500 costs $8 million. The manufacturer advises that the machine can be run up to 8,500 hours per year. Your engineering staff has indicated that this is probably on the high side and could only be achieved in ideal circumstances. Your counterparts in other manufacturing sectors that use similar machinery advise that the maximum capacity of this machine, when allowing for shutdowns for maintenance and emergency repairs, is closer to 7,500 hours per year. They also advise that, as the machine ages, the capacity declines by about 5% per year, because the time lost for maintenance and repair shutdowns increases as the machine ages. The manufacturer advises that the estimated useful life of the EX8500 varies depending on its usage, as shown in the following table: Yearly production (% of maximum) Estimated maximum useful life 75% to 100% 10 years 85,000 hours 50% to 75% 15 years 96,000 hours 25% to 50% 25 years 107,000 hours Your research has determined that it is difficult to resell equipment like the EX8500 that is more than five years old because of the ongoing advances of technology for this type of equipment, as well as the high dismantling and shipping costs. Intermediate Financial Reporting 1 Project 2 8 / 8 Other information CMI uses the cost model to subsequently measure the value of all its PPE. CMI currently uses the straight-line method to depreciate all its depreciable non-production PPE. The depreciation method used by CMI to depreciate PPE directly involved in production is governed by the nature of the PPE. Straight-line, double-declining-balance, and units-of-production methods are all used in various circumstances. When CMI uses the double-declining-balance method of depreciation, the rate used is two times the percentage used in the straight-line method. CMI operates the Quebec facility for 16 hours a day, 300 days a year. CMI just signed a 15-year contract with the auto maker it supports, so the facility will be active for at least that period of time, though volumes produced will continue to vary based on consumer preferences. CMI expects the equipment to be in use, on average, 5,400 hours per year over the 15-year period. The senior vice-president of production has suggested that CMI should adopt the straightline method to depreciate the EX8500 because he would like to produce the same volume of auto parts each year. Required: Write a memo to Francois Leroy analyzing each of the three most widely used depreciation methods. Your memo should include a summary of pertinent information and do the following: Identify and explain what each of the methods entails, and then evaluate the advantages and disadvantages of each method. Determine whether each of the three depreciation methods would be suitable and explain why or why not. Recommend the estimated equipment life to be used (however, use management's assumptions of a 15-year useful life when calculating depreciation expense). Determine the estimated residual value to be used when calculating depreciation expense. Recommend a depreciation method. Quantify the impact on CMI's projected EBIT for each option under consideration. Your response should be supported by a quantitative and qualitative analysis that considers the precepts of the IFRS Conceptual Framework and the requirements of IFRS; CMI's financial reporting environment and financial reporting goals; and the potential biases of stakeholders. It is recommended that you use point form in your memo and use language appropriate for a financially sophisticated user, as Francois is the CFO of a public company.