You are working for an elite accounting consulting firm and have been hired by One-two-three Incorporated (123 Inc.) to assist them with a number of questions which have arisen while preparing their October 31, 2016 financial statements. 123 Inc. is a Canadian public manufacturer of high-end paper coffee cups on the cutting edge of rim rolling prize technology.

For each of the situations presented on the attached page please present the following:

The appropriate journal entry (or entries) which should have been entered to account for the situation described. Indicate which reporting period your entries need to be recorded in (i.e. fiscal 2016 or fiscal 2017). Part marks available for incorrect answers but only if you show your work. (80% of available marks)

A short description of why the entry is necessary in plain language that the CEO of 123 Inc. will understand (she has an engineering background not an accounting one). (15% of available marks)

Describe (UP or DOWN) the impact your proposed entries (on a combined basis) will have on the following metrics for fiscal 2015 (5% of available marks).

EBITDA (earnings before interest taxes depreciation and amortization)

Current ratio

Interest coverage ratio

Please format your answers as follows:

1.

A. B.

C.

NOT

A.

1. 2.

3.

Question 1 (10 marks):

During October 2016 a number defects were being reported by customers for cups produced during one particular manufacturing run which occurred during September 2016. On October 26, 2016 it was decided to issue a recall.

In October 2016 $50,000 of refunds were issued to the customers who had already complained.

The sale price of the entire production run for which refunds will be provided was $700,000 (including refunds which have already been issued).

It is unknown what additional costs relating to the recall will be but it is likely that there will be at least an additional $100,000. It is not determinable what further costs there will be but they may be up to a further $200,000.

Question 2 (10 marks):

On June 1, 2016 a 3-year bond was issued to a private investor to fund an international expansion. The bond had a face value of $800,000 and makes quarterly interest payments of $24,000 (the first payment was made on time on September 1, 2016). The bond was sold for $841,031. Also - 123 Inc.s CEO just attended a corporate finance seminar and learned about bond yields, she would like you to calculate the yield that her companys bonds offer. (Note: this may require you to reach beyond the material covered in class.)

Hint: you need to show the journal entries required for the 2016 and 2017 fiscal year ends, and for each interest payment paid in 2016 and 2017.

Question 3 (10 marks):

In order to take advantage of a tax incentive 123 Inc. decided to buy new machinery on August 1, 2016 which had a cost of $300,000. For income tax purposes this machinery has a special CCA rate of 45% (the year rule applies). 123 Inc.s corporate tax rate is 20%. The deprecation for accounting purposes is going to be based on usage. The machinery is expected to have a useful life of 1.3 billion coffee cups produced, and has an expected net salvage value of $25,000. The expected usage is as follows:

Fiscal year: 2016	2017	2018	2019	2020
# of units: 0.1B	0.2B	0.4B	0.4B	0.2B

On August 1, 2016 the following entry was made:

Dr. Capital assets $300,000

Cr. Accounts payable $300,000

Hint: You will need to calculate depreciation and future taxes. Remember you need to present both fiscal 2016 and fiscal 2017 calculations.

Question 4 (10 marks):

On May 1, 2016 123 Inc. issued 600, ten-year 8% bonds for $1,000 each. The bonds pay interest annually on April 30. These bonds can be converted by the bondholders into common shares at a rate of 25 common shares for each bond converted (so far no bonds have been converted).

Required:

You have been asked to calculate what impact these bonds had on the earnings per share. Net income for 2016 was $2 million and there are 500,000 common shares (and no preference shares) outstanding. Assume a tax rate of 20%.

Question 5 (10 marks):

123 acquired 25% of the outstanding common shares of another public company, Alphabet Soup Inc. on November 1, 2015. The purchase price was $2.5M for 125,000 shares. Alphabet declared and paid a $1.50 per share cash dividend on January 15, and again on August 15, 2016. Alphabet reported net income of $1,040,000 on its October 31, 2016 financial statement. The fair market value of Alphabet's shares was $20.25 per share at October 31, 2016.

Required

Given the complex circumstances of this acquisition it is unclear whether 123 can exercise significant influence over Alphabet. Accordingly you have been asked to prepare two sets of journal entries depending on whether 123 must use the equity method of accounting or FV-OCI.

Indicate which method of accounting will result in a higher level of net income and explain why that occurred.