2.3 Paper 2.3 - Accounting For Business - 1
2.3 Paper 2.3 - Accounting For Business - 1
Instructions:
1) Attempt any four questions out of six questions
2) All questions carry equal marks
3) Think carefully and write.
Ques 1.
J.K. Kapoor started a consulting firm, J.K. Consulting, on May 1, 2014. The following
transactions occurred during the month of May.
May 1 Kapoor invested $8,000 cash in the business in exchange for shares.
May 2 Paid $800 for office rent for the month.
May 3 Purchased $500 of supplies on account.
May 5 Paid $50 to advertise in the newspaper.
May 9 Received $3,000 cash for services provided.
May 12 Declared and paid a $700 cash dividend.
May 15 Performed $3,300 of services on account.
May 17 Paid $2,100 for employee salaries.
May 20 Paid for the supplies purchased on account on May 3.
May 23 Received cash payment of $2,000 for services provided on account on May
15.
May 26 Borrowed $5,000 from the bank on a note payable.
May 29 Purchased office equipment for $2,300 on account.
May 30 Paid $150 for utilities.
Instructions
a) Show the effects of the above transactions on the accounting equation.
b) Prepare an income statement for the month of May.
c) Prepare a statement of financial position at May 31, 2014.
Ques 2.
ABC Company, Inc. was organized on January 1, 2014. At the end of the first 6 months of
operations, the trial balance contained the accounts shown below.
Debit ($) Credit ($)
Cash 8,400 Notes Payable 20,000
Accounts Receivable 14,000 Accounts Payable 9,000
Equipment 45,000 Share Capital 22,000
Insurance Expense 2,880 Sales 58,280
Salaries and Wages Expense 30,000
Supplies Expense 3,900
Advertising Expense 1,900
Rent Expense 1,500
Utilities Expense 1,700
--------- ----------
109,280 109,280
Instructions
a) Journalize the adjusting entries at June 30. (Assume adjustments are recorded every 6
months)
b) Prepare an adjusted trial balance.
c) Prepare an income statement and a statement of financial position at June 30.
Ques 3.
JK Sports sells rolling skates, Xpress, that is popular with rolling skates enthusiasts.
Information relating to JK Sports’ purchases of Xpress skates during September is shown
below. During the same month, 121 Xpress rolling skates were sold. JK Sports’ uses a
periodic inventory system.
Instructions
a) Compute the ending inventory at September 30 and cost of goods sold using the FIFO
and average-cost methods.
b) For both FIFO and average-cost, calculate the sum of ending inventory and cost of
goods sold. What do you notice about the answers you found for each method?
Additional data regarding JK Sports’ sales of Xpress skates are provided below. Now,
assume that JK Sports uses a perpetual inventory system.
Instructions
a) Compute ending inventory at September 30 using FIFO and moving-average cost.
b) Compare ending inventory using a perpetual inventory system to ending inventory
using a periodic inventory system
c) Which inventory cost flow method (FIFO, moving-average cost) gives the same
ending inventory value under both periodic and perpetual? Which method gives
different ending inventory values?
Ques 4.
Milan Saree Centre has four assets, data on which are as follows:
Asset Date of Cost (Rs) Residual Useful Depreciation
Purchase Value (Rs) Life Method
Van Jan 1, 20X8 40,000 5,000 40,000 km Production-units
Counters Augt 1, 20X7 25,000 2,000 8 years Sum of the year digit
Name board Apr 1, 20X6 6,000 300 5 years WDV
Cash box Dec 1, 20X6 2,000 400 10 years Straight-line
Required
1) Compute the depreciation expense for the year ended June 30 in 20X6, 20X7, and
20X8. Round the amounts to the nearest rupee.
2) Present these assets on the balance sheet on June 30 each year.
Ques 5.
Forever Ltd is a leader in brand jewellery. It started its operations in 2003. It sells its products
to dealers in major cities across the country. Jewellery is subject to changes in fashion trends.
The company bills the dealers on delivery of products and recognise revenue immediately.
The dealers manage to sell a significant portion of their purchases and return the unsold
products to the company. Sales return in the industry have ranged between 19% and 26% in
the past five years. The following table gives the company’s sales and return for the past
three years in Rs ‘000s (March 31 fiscal year):
Year Sales Sales Returns Net Sales Net Profit
2006 6,412 1,375 5,037 2,015
2007 7,907 1,952 5,955 2,692
2008 9,109 2,066 7,043 3,505
The dealers are allowed to return any unsold products throughout the year. Over 70% of the
sales happen in the festival season and remaining sales are spread almost evenly throughout
the year. The company accounts for sales return during the year.
In 2008, Ram Malhotra, an analyst with a brokerage firm, questioned the Forever Ltd
accounting practice for sales return in his research report titled as ‘Dubious Accounting by
Forever Ltd.’ Relevant extracts from the report are as follows:
Forever Ltd has consistently outperformed its industry peers. The company’s sales
growth of over 18% and margin of 50 % are significantly superior to the industry
mean of 12% and 32% respectively. The company’s management is focused on the
upper end of the market. Almost all of the new products introduced in the last year
have done well. We believe that the companies biggest strength are its strong
brand, ingenious design, and a committed dealer network.
Even so, we have an issue with the company’s accounting for sales return. While
the company accounts for all actual returns, it does not account for returns that are
probable as of the balance sheet date. What this means is that product sold in a
year may be returned in the following year, because they are no longer the flavour
of the season. This would increase the revenue in a year of sale and reduce the
revenue in the year of return.
Industry trend suggests that sales return exceed 20%. Our view is that the
company’s delay in recognition of sales returns could result in overstatement of
revenue, and what is worse, allow the company to move its revenue from one
period to another.
In view of the above we recommend SELL on Forever Ltd’s share.
The company has issued following press release in response to the research report:
Forever Ltd is the industry leader in design, innovation and branding and has
received a number of awards competing with international jewellers. Sales growth
and margin are consistently above the industry peers. The company’s shares have
returned over 70% over the past three years (as against the NSE 500 return of
34%) and are now a matter of pride for its investors, much the same its products
are for its customers. We are deeply disappointed by the negative research reports.
The company recognizes revenue in accordance with the two major conditions in
the accounting standards:
i. The seller of the goods has transferred to the buyer the significant risk and
rewards of ownership of the goods and the seller retains no effective control of
the goods transferred to a degree usually associated with ownership; and
ii. No significant uncertainty exists regarding the amount of the consideration
that will be derived from the sale of the goods.
The company has complied with both these conditions. While there is some
probability that the goods may be returned by our dealers, the amount of
consideration is certain. Once the company sells the products, ownership passes to
the dealers and the company has no control over the goods. Therefore, company
cannot record return of such products. The company accounts for returns from its
dealer immediately and refunds the amount promptly. In our view, accounting for
expected returns as contrasted with actual returns, is fraught with risk. That kind of
accounting would be based on estimation and not on facts.
Required
a) Evaluate the analyst’s comment and the company’s response on the company’s
accounting for sales returns.
b) Develop an accounting policy for revenue recognition including sales returns.
Ques 6.
Benefice Limited, a pharmaceutical firm, has grown by the acquisition of companies engaged
in drug discovery and development. Oncocure, another pharmaceutical firm, owns the rights
to several product candidates. It is only engaged in R & D in immunotherapy, a new field that
offers great promise in the treatment of cancer with fewer side effects. Recently Benefice
acquired Oncocure Limited, including the rights to all of its product candidates and testing
and development equipment, and hires all of the scientists formerly employed by Oncocure
who were working on the development of the acquired product candidates. Rupali Agarwal,
Benefice’s controller, is pondering the company’s accounting for acquisitions. The
management of Benefice has considerable experience in making acquisitions. It has a robust
system of identifying potential targets, performing due diligence, valuing the target,
negotiating deals, complying with securities, tax and accounting requirements and integrating
the acquiree successfully. While there have been some problem cases, most acquisitions have
worked well. Of particular relevance to this case is the valuation of the acquiree’s business.
Inventories and trade receivables are valued at realizable amounts. Property, plant and
equipment items are valued based on current or recent transaction prices. Patents and in-
process research and development (IPR & D) are the most contentious assets. The target
company’s owners often build their case for a high valuation based on these assets.
Also, there is a great deal of unease within Benefice on how to allocate the purchase price
among the various assets. Spot-on, Benefice’s valuers for many years, uses standard methods
based on income and cash flows. Even then, Rupali feels that there is much scope for
discretion in distributing the purchase price. Since the acquirees often do not have established
products, the numbers available are less consistent than for established businesses. Rupali
recalled her professor’s comment in a financial statement analysis course that valuation was
ultimately a matter of opinion.
The auditors had raised concerns about the valuation methodology on Benefice’s last
acquisition. They felt that the company was pushing the envelope too far in valuing IPR & D.
Some in the management were in favour of assigning as much of the purchase price to IPR &
D. Others preferred a more conservative approach of expensing as much of IPR & D as
possible as part of the acquisition related costs.
Rupali is beginning to wonder if Benefice’s accounting requires rethinking. The trigger is the
aggressive action being taken by the Securities and Exchange Board of India (SEBI) and the
Ministry of Corporate Affairs on acquisition-related accounting including allocation of the
purchase price to intangible assets. A major worry is the effect of any changes in the current
accounting practice on earnings. Benefice’s investor relations manager has cautioned her
against a negative surprise in earnings because of the fallout on stock prices. Rupali plans to
meet with Benefice’s chief financial officer, Srikant Kelkar, to discuss her concerns. Before
the meeting she has asked for data from the research staff.
Required
1) What issues should Rupali consider in her decision?
2) How will decision affect Benefice’s current and future earnings?
3) What can we learn from the accounting for IPR & D about Benefice’s business
prospects?