Intermediate Financial Accounting and Analysis – SCS 0982-084

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, 2014 financial statements. 123 Inc. is a Canadian privately held 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:

1. 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 2014 or fiscal 2015). Include reversing entries where applicable. Also, you must explain why the original entry was incorrect. Part marks available for incorrect answers but only if you show your work. (80% of available marks)
2. 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). (10% of available marks)
3. Describe (UP or DOWN) the impact your proposed entries (on a combined basis) will have on the following metrics, as at fiscal 2014 AND fiscal 2015 if any: (10% of available marks)
4. EBITDA (earnings before interest taxes depreciation and amortization) b. Current ratio
5. Interest coverage ratio

123’s CEO has given you the following information:

1. During October 2014 a number defects were being reported by customers for cups produced during one particular manufacturing run which occurred during September 2014. On October 26, 2014 it was decided to issue a recall.
   • In October $50,000 of refunds were issued to the customers who had complained and were recorded as:

Dr. COGS $50,000

Cr. A/R. $50,000

• 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.

1. On June 1, 2014 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, 2014). 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 company’s bonds’ offer.

On June 1, 2014 the following entry was made:

Dr. Cash $841,031

Cr. Long-term debt $800,000

Cr. Gain on sale of bond $ 41,031

On September 1, 2014 the following entry was made:

Dr. Interest expense $24,000

Cr. Cash $24,000

(N.B. 123’s accounting policies require the effective interest rate method.)

• In order to take advantage of a tax incentive 123 Inc. decided to buy new machinery on August 1, 2014 which had a cost of $300,000. For income tax purposes this machinery has a special CCA rate of 45% (the ½ year rule applies). 123 Inc.’s corporate tax rate is 30%. 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:

On August 1, 2014 the following entry was made:

Dr. Capital assets $300,000

Cr. Accounts payable $300,000

(N.B. You will need to calculate depreciation and future taxes. Remember you need to present both fiscal 2014 and fiscal 2015 calculations.)