Contemporary Accounting A Strategic Approach For Users 9th Edition Hancock Test Bank

Contemporary Accounting A Strategic
Approach for Users 9th Edition

Hancock Test Bank
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Chapter 9 – Liabilities and sources of financing
TRUE/FALSE
1. As the effect that the collapse of an airline has on the tourist industry is seen to be industry-specific,
it is a business risk.
ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Introduction.
2. Business risk is industry-specific, whereas financial risk is more firm-specific.

TOP: Introduction.
3. A company’s taxable income is the amount of profit determined by the tax commissioner on which
the current income tax liability is determined.

TOP: Taxation.
4. Temporary differences occur when an income or expense item enters into the calculations of
accounting profit and taxable income in different periods.

TOP: Taxation.
5. Given a situation in which a company depreciates an asset using the straight-line method, but the tax
rules stipulate that the asset should be depreciated using the reducing-balance method, this will,
under normal circumstances, initially give rise to a future tax benefit to the entity.
ANS: F PTS: 1 AACSB: Knowledge, Analytical

TOP: Taxation.
6. Tax expense is the amount an entity remits to the tax department, and is determined by adjusting the
tax-payable figure for increases/decreases in deferred tax payable.

TOP: Taxation.
7. If taxable income is $120 000, accounting profit is $130 000, interest receivable is $10 000, interest
is recognised for tax when received and the tax rate is 30%, then we know that tax payable is
$36 000, tax expense is $39 000 and a deferred tax liability of $3000 will be recorded in the balance
sheet.

TOP: Taxation.
8. If taxable income is $220 000, accounting profit is $200 000, interest payable is $20 000, interest is
recognised for tax when paid and the tax rate is 30%, then we know that tax payable is $66 000, tax
expense is $60 000 and a deferred tax asset of $6000 will be recorded in the balance sheet.
TOP: Taxation.
9. Accounting for income tax gives rise to temporary differences, which arise when the tax value and
the carrying value of assets and liabilities differ.

TOP: Taxation.
10. Working capital is represented by current assets less current liabilities for short-term working
capital, whereas long-term working capital is total assets less total liabilities.

TOP: Short-term finance.
11. Trade credit is the finance provided by suppliers from selling goods on credit.

12. Financing through accounts payable can result in opportunity costs where discounts are not taken up
by the entity.

13. Trade credit is widely used as a source of finance but the importance and use of trade credit varies
from industry to industry and within industries.

14. Financing through trade credit requires less security than financing through factoring.

15. A bank overdraft is normally securitised over assets, either as a fixed charge over specific assets or
as a floating charge over all assets; factoring is secured over specific assets being accounts
receivable; whereas accounts payable generally require no security.

16. Where an overdraft facility has been offered, the bank sees this as a semi-permanent source of
finance, and prefers to see the account consistently overdrawn, as it will receive more fees through
overdraft charges, thus reducing the risk of the finance.

17. The purchase of an asset using loan finance and the leasing of an asset under a finance lease will both
result in ownership of the asset being transferred at the time of acquisition/beginning of lease and not
when all payments have been made.
TOP: Medium-term finance.
18. Under a hire-purchase agreement, ownership of the asset remains with the financier until all
payments have been received.

19. A major difference between accounting for an operating lease and a finance lease, in the books of the
lessee, is that a finance lease will create an asset and a liability, whereas an operating lease will be
treated as an expense.

20. AKP enterprises have negotiated a lease for a photocopier. The useful life of the asset is eight years.
The lease is non-cancellable and provides that the term of the lease is over three years with the
present value of the lease payments being 55% of the fair value. Title will not pass at the end of the
lease period. Using the criteria in AASB 117, the lease would definitely constitute a finance lease.

21. A major discriminator between an operating lease and a finance lease is whether the risks and
rewards of ownership have been substantially transferred to the lessee.

22. Debentures are essentially the same as a long-term loan except that debentures are particular to
limited companies and have a fixed interest rate.

TOP: Long-term finance.
23. An entity that can only raise equity finance through a single owner’s contributions and retained
profits is a sole proprietorship.

24. Partnerships may have more ability to raise equity finance than sole proprietorships, as partnerships
tend to have more people to contribute funds, but limited companies have a wider range of equity
options than partnerships.

25. In an entity that is highly geared, the effect of a decrease in profits or an increase in interest rates will
have a greater negative impact on returns to shareholders than it will on an entity that is not so highly
geared.
26. A choice between debt finance and equity finance will result in a trade-off between risk and return.

27. A factoring company is a finance company that specialises in providing a service for the collection
of payments from accounts receivable.

28. The primary sources of revenue for a factoring company are the interest earned on the finance
provided and the fees for managing the collection of debt.

29. The sole source of equity finance for a company is contributed equity.

30. The notion of substance over form may result in certain types of preference shares being classified as
debt not equity.

31. Classifying preference shares as debt not equity, would alter the gearing (leverage) of a company.

32. The mix of debt finance and equity finance for a given entity is known as gearing.

MULTIPLE CHOICE
1. Which of the following terms best describes a firm-specific risk that an entity faces, as opposed to an
industry-specific risk?
A. Investment risk
B. Financial risk
C. Market risk
D. Business risk
ANS: B PTS: 1 AACSB: Knowledge, Analytical
TOP: Introduction.
2. Which of the following statements regarding tax-effect accounting is incorrect?
A. The tax-effect method of accounting for income tax determines that temporary differences
may arise, resulting in the recognition of either a liability or an asset.
B. The tax-effect method for calculating income tax expense is where the taxable income is
multiplied by the tax rate.
C. A tax loss can only be carried forward as a future tax benefit if it is probable that the entity
will earn taxable income in the future.
D. A deferred tax liability will occur where taxable income is less than accounting profit in the
current period.
TOP: Taxation.
3. AKP Ltd uses the accrual-basis method of accounting for accounting profit. In the current
accounting period, they have recognised income for interest not yet received. Taxable income is
determined on a cash basis. Based on this information, which of the following statements is correct?
A. Taxable income will be greater than accounting profit, and will give rise to a deferred tax
liability.
B. Taxable income will be less than accounting profit, and will give rise to a deferred tax
liability.
C. Taxable income will be greater than accounting profit, and will give rise to a deferred tax
benefit.
D. Taxable income will be less than accounting profit, and will give rise to a deferred tax
benefit.
TOP: Taxation.
4. AKP Ltd depreciates a non-current asset using the straight-line method. Tax law stipulates that the
asset should be depreciated using the reducing-balance method at 1.5 times the straight line rate.
Under normal circumstances, which of the following statements is correct?
A. After year 1, the tax base of the asset exceeds the accounting base and will give rise to a
deferred tax liability.
B. After year 1, the tax base of the asset is less than the accounting base and will give rise to a
deferred tax liability.
C. After year 1, the tax base of the asset exceeds the accounting base and will give rise to a
deferred tax asset.
D. After year 1, the tax base of the asset exceeds the accounting base and will give rise to a tax
asset.
TOP: Taxation.
5. Sporter Enterprises has incurred a tax loss in the current period. Under tax law, which of the
following statements is not correct?
A. A deferred tax asset can be recognised if it is probable that Sporter will earn taxable income
in the future.
B. Assuming all relevant tax laws have been adhered to, Sporter can carry the loss forward to
reduce taxable income in future periods.
C. A deferred tax liability is created, as Sporter will have to pay tax on taxable income in the
future.
D. Sporter cannot carry the loss forward as a deferred tax asset if it is probable that future
taxable income will not be earned.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Taxation.
6. Working capital is:

A. loan capital.
B. total assets less total liabilities.
C. current assets less current liabilities.
D. quick assets less current liabilities.
7. The term ‘working capital’ is used to describe the:

A. amount of equity (ownership) capital in the firm.
B. portion of capital actively employed in generating revenues.
C. amount of debt (borrowed) capital in the firm.
D. cushion of current assets over current liabilities.
ANS: D PTS: 1 AACSB: Knowledge, Analytical
8. Which of the following must be known in order to determine the firm’s total amount of working
capital?
Current assets Current liabilities

A. Yes Yes
B. Yes No
C. No Yes
D. No No
ANS: A PTS: 1 AACSB: Knowledge, Analytical
9. What is the total working capital for the following company?
Cash $10 000

Accounts Receivable $40 000
Accounts Payable $30 000
Land $100 000
Equipment $70 000
Long-term loan $40 000
A. $10 000
B. $20 000
C. $50 000
D. $150 000
10. Which of the following is not an example of short-term finance?

A. Trade credit
B. Factoring
C. Finance lease
D. Bank overdraft
11. A example of a source of medium-term finance is:

A. hire purchase.
B. debentures.
C. factoring.
D. equity finance.
12. Which of the following is not a characteristic of a finance lease?

A. It is generally non-cancellable.
B. The lessee guarantees that the lessor will receive a specific residual value from the sale of
the asset at the end of the lease term.
C. It is like a rental agreement.
D. The lessee has the right to use the leased asset.
13. The major accounting difference between a finance lease and an operating lease is that finance
leases:
A. involve larger amounts of funds.
B. are for longer periods of time.
C. involve the recognition of assets and liabilities.
D. are cancellable.
14. When a firm leases a resource for most of its useful life and controls the resource as though it had
been purchased, the lease is treated as:
A. an operating lease.
B. a finance lease.
C. a primary lease.
D. a producing lease.
15. If a lessee enters into a finance lease agreement, it will record:

A. an asset only.
B. a liability only.
C. an asset and a liability.
D. an expense only.
16. The Shifting Sands Company has negotiated to lease a piece of equipment. The equipment has a
useful life of 10 years. The lease is non-cancellable but there is only a minor penalty if the lessee
returns the equipment before the expiry of the lease. The lease terms provide that the lease is over
five years and the present value of the minimum lease payments is 60% of the fair value of the asset
at the commencement of the lease. Shifting Sands records the lease payments as an expense in the
statement of comprehensive income. Based on this information, which of the following statements is
correct?
A. Assets and liabilities are understated as the lease should be a finance lease.
B. Assets and liabilities are not affected as the lease is an operating lease.
C. The non-cancellable nature of the lease determines that it should be a finance lease.
D. There is insufficient information to determine whether the lease is a finance or an operating
lease.
17. Raffles Ltd began the financial year on 1 January with retained profits of $10 000 and by year end on
31 December retained profits had risen to $30 000. If a profit of $60 000 was earned during the year,
then the amount declared and/or paid in dividends during the period would be:
A. $20 000.
B. $30 000.
C. $40 000.
D. $50 000.
18. FF Ltd declared and paid $150 000 in dividends during the financial year ending 31 December.
Closing retained profits as at 31 December were $860 000. What was opening retained profits at the
beginning of the financial year on 1 January, if FF Ltd made a loss of $180 000 for the year ended 31
December?
A. $530 000
B. $860 000
C. $890 000
D. $1 190 000
19. When a holder of preference shares has the right to receive all previously omitted dividends before
ordinary shareholders receive any dividends, the preferred share is known as:
A. participating preferred.
B. cumulative preferred.
C. compensating preferred.
D. ex post rights preferred.
20. A preference share is preferred because:

A. it has a higher claim on dividends and assets than ordinary shares.
B. it is preferred by shareholders as a potentially better investment.
C. preferred shareholders have more voting rights than ordinary shareholders.
D. it has a higher claim on assets in liquidation than liabilities do.
21. Which of the following statements is incorrect?

A. Preference shares usually have a fixed dividend and rate higher than ordinary shares in a
situation where a company goes into liquidation.
B. A redeemable preference share with a fixed redemption date is classified as equity.
C. A non-redeemable cumulative preference share gives the right to be paid current or
accumulated dividends before ordinary shareholders.
D. A non-redeemable cumulative preference is normally classified as equity.
22. Which of the following statements is incorrect?

A. A redeemable preference share that is redeemable by the holder is classified as equity if it is
not probable that redemption will occur.
B. A redeemable preference share with a fixed redemption date is classified as debt.
C. Sole proprietorships, partnerships and limited companies can all raise equity finance from
owners’ contributions but only limited companies can issue ordinary shares.
D. A company distributes profits in the form of dividends, which is a reduction in retained
profits, whereas distributions of profits by partnerships and sole proprietors are reductions
in owners’ equity.
The following information applies to questions 23 and 24.
Kucinta Manufacturing Company started operations with the following capital:
Partners’ contribution of cash $25 000

Cash obtained from ABC Finance $15 000
Loan obtained from the local bank $5000
23. What is the amount of equity financing for this partnership?

A. $30 000
B. $25 000
C. $45 000
D. $20 000
24. What is the amount of debt financing for this partnership?

A. $5000
B. $45 000
C. $20 000
D. $15 000
25. When a company obtains financial resources from owners, it is termed:

A. debt.
B. operating.
C. equity.
D. risk-free.
26. The following amounts of capital were obtained to start operations of Yuppie Manufacturing at the
beginning of the financial year:
Owners’ contribution of cash $80 000

Owners’ contribution of machinery & equipment 46 000
Loan from the owner 18 000
$144 000
What is the amount of equity financing for this firm?

A. $18 000
B. $62 000
C. $98 000
D. $126 000
27. Deep Lake Lodging Company was established at the beginning of the financial year with the
following capital:
Partners’ cash contributions $46 000

Cash obtained from XYZ Credit 30 000
Loan obtained from the local bank 10 000
Total $86 000
What is the amount of equity financing for this firm?

A. $10 000
B. $40 000
C. $46 000
D. $76 000
28. Which of the following provide resources to an organisation in exchange for future returns?
Owners Liabilities creditors

A. No Yes
B. No No
C. Yes Yes
D. Yes No
TOP: Chapter 10.
29. Which type of shares has a higher claim on dividends and assets than ordinary shares?
A. Voting
B. Preference
C. Senior
D. Favoured
30. Which of the following represent capital that has been earned by the profitable operation of a
company?
Paid-in capital Retained profits

A. Yes Yes
B. Yes No
C. No Yes
D. No No
31. Retained profits can best be described as:

A. cash receipts minus expenses after adjustments.
B. net profit minus expenses after adjustments.
C. undistributed profits.
D. net profit minus cash disbursements after adjustments.
32. The term ‘retained profits’:

A. is representative of the cash that the corporation has available to pay dividends as of the
balance sheet date.
B. is found among the assets on the balance sheet of any profitable corporation.
C. refers to an item whose value is always as large as, or larger than, that of cash on the balance
sheet.
D. refers to an account balance found on the balance sheet of a corporation that has paid
dividends of lesser amount than profits since the beginning of the corporation.
33. Wilmington Fisheries had a Retained Profits account balance on 1 January of $12 000. During the
year, the firm had net profit of $7200 and paid a $3600 cash dividend. What is the balance in
Retained Profits at the end of the financial year on 31 December?
A. $12 200
B. $15 600
C. $19 600
D. $21 200
34. Dividends on ordinary shares are:

A. expensed when paid.
B. expensed when incurred.
C. expensed at year end.
D. a reduction of retained profits.
35. Blue Nose Cold Storage Company was incorporated two years ago on 1 January. Since then, the
following shares have been issued:
Preference shares, 5%, $25 8000 shares

Ordinary shares, $20 10 000 shares
On 31 December this year, the company declared and paid a total of $50 000 in dividends. This was
the first dividend declared by the firm. That is, until this date no dividends had been declared or paid
during the first two years of operations. If the preference shares are cumulative, what is the most that
will be available out of the $50 000 dividend for payment to the ordinary shareholders?
A. $20 000
B. $30 000
C. $40 000
D. $50 000
36. Identify the correct statement below.

A. Bank overdrafts are classified as long-term loans in Australia.
B. Commitments are disclosed on the statement of comprehensive income because they affect
net profit but not cash flow.
C. Finance leases are accounted for as if the leased items had been purchased.
D. The expense associated with operating leases is reported on the cash flow statement under
the category of investing activities.
TOP: Chapter 10.
37. A shareholder makes an investment in a company. The net effect of this contribution is an increase
in:
A. share capital only.
B. both assets and share capital.
C. both assets and liabilities.
D. both liabilities and share capital.
38. Davis Computer Company has total liabilities of $50 000, total assets of $280 000 and paid-up
capital of $120 000. What is the amount of retained earnings and/or reserves?
A. $20 000
B. $110 000
C. $140 000
D. $160 000
39. The sources of equity finance for a company are:

A. contributed equity.
B. retained profits.
C. general reserves.
D. all of the above.
40. Where preference shares are redeemable at the discretion of the issuer, and shareholders have not
been advised of the company’s intention to redeem the shares they:
A. meet the definition of a liability.
B. represent debt.
C. are recognised as equity.
D. are recognised as a financial liability.
SHORT ANSWER
1. Describe the nature and importance of working capital to a business entity.
ANS:
Working capital is represented by the excess of currents assets over current liabilities and is the basis
of funding the day-to-day operations of an entity. Thus, it is an important determinant of solvency.
PTS: 1 AACSB: Knowledge, Analytical

2. Describe the nature of trade credit, factoring and bank overdrafts as sources of short-term finance.
ANS:
Trade credit refers to the short-term funding of goods (services) by the suppliers of the goods
(services). The period of time involved and amount of credit depends on a number of factors,
including the terms of trade of the industry, the creditworthiness of the business and its importance to
the supplier.
Factoring refers to the realisation of accounts receivable prior to the due date through a third-party
factoring entity who assumes responsibility for collecting the accounts receivable when they accrue.
The factoring entity charges interest for the service, based on the finance provided, and a fee for
managing the collection of the receivables.
A bank overdraft is a financing facility that may be drawn upon, up to a certain amount, to meet the
needs of the borrower as and when required. Interest is only charged when the facility is used.
PTS: 1 AACSB: Knowledge, Analytical, Communication

3. Describe the nature and major sources of equity finance.
ANS:
Equity finance is long-term permanent finance associated with the ownership of a business entity.
The two major sources of the finance are contributed equity and retained profits.

4. Distinguish between an operating lease and a finance lease and describe how the separate classes of
lease are accounted for in the books of the lessee.
ANS:
An operating lease is a strict rental agreement. A finance lease, on the other hand, arises where
leasing is used as a means of financing the ‘acquisition’ of the asset concerned. Where a lease is
classified as an operating lease, the lease instalments are simply treated as expenses to the lessee.
However, where a finance lease is involved, the lessee is required to recognise, at the inception of the
lease, an asset and liability equal to the present value of the minimum lease payments *; all future
lease instalments are separated between interest and principal; and the leased asset is amortised.
*
Note: AASB 117 Leases, provides for the measurement of the asset (liability) at the fair value of the
asset, or, if lower, the PV of the minimum lease payments, each determined at the inception of the
lease.

5. Explain the concept of leverage. Why is this concept important for management?
ANS:
Leverage is the practice of using borrowed funds and amounts received from preferred shareholders
in an attempt to earn an overall return that is higher than the cost of these funds. This is important
because the total return should be larger than the cost.

TOP: Financing structures and financial risk.
6. Why do companies manage their working capital?
ANS:
Companies manage their working capital because they want to keep an appropriate amount on hand.
This means that they want to have enough on hand to finance their day-to-day operations plus have a
reserve on hand for the unexpected. If a company has too little working capital it risks not having
enough liquidity. If a company has too much working capital the company risks not putting its assets
to their best use, resulting in decreased profitability.

PROBLEM
1. On 1 January, the Harglo Construction Company leased a bulldozer from ASIS Sales Corporation.
The lease meets the criteria for classification as a finance (capital) lease and requires Harglo to make
annual payments of $30 000 at the end of each of the next 10 years with the first payment due at the
end of each year on 31 December. The present value of the lease payments is $200 000 based on an
interest rate of 8%.
How would the lessee record:
(a) On the inception of the lease on 1 January?

(b) The first lease payment on 31 December?
(c) Depreciation on the bulldozer for the first year of the lease, assuming the straight-line
method is used over the life of the lease, and zero residual value?
ANS:
(a) Increase Leased Property by $200 000 and increase Obligation Capital Lease by
$200 000 to record acquisition of bulldozer under lease from AIS Sales Corporation.
(b) Increase Interest Expense by (8%  $200 000) $16 000, decrease Capital Lease
Obligation by $14 000, and decrease Cash by $30 000 to record lease payment for
bulldozer.
(c) Increase Amortisation Expense by [($200 000 – $0) ÷ 10] $2000 and increase
Accumulated Amortisation: Leased Property by $20 000 to record annual amortisation
on leased bulldozer.

2. On 1 March, the Red Dour Inn Company purchased a motel for $1 000 000, paying 25% in cash and
financing the remainder with a 20-year, 12% mortgage that requires monthly payments of $8258.14.
How would the Red Dour Inn record:
(a) The acquisition of the building on 1 March?

(b) The first mortgage payment on 1 April?
(c) The second mortgage payment on 1 May?
ANS:
(a) Increase Motel by $1 000 000, decrease Cash by (1 000 000  25%) $250 000.00, and
increase Mortgage Payable by $750 000.00 to record purchase of motel with $250 000
cash payment and a 20-year, 12% mortgage.
(b) Increase Interest Expense by ($750 000  1%) $7500.00, decrease Mortgage Payable
by ($8258.14 – $7500.00) $758.14, and decrease Cash by $8258.14 to record monthly
mortgage payment.
(c) Increase Interest Expense by [($750 000 – $758.14)  1%] $7492.42, decrease
Mortgage Payable by ($8258.14 – $7492.42) $765.72, and decrease Cash by $8258.14
to record monthly mortgage payment.

CASE
1. The operating net profit before income tax of Fraxinus Ltd for the year ended 30 June – the entity’s
first year of operation – was $8 000 000. The figure was derived using the accrual approach to
measuring profit. The company determines tax based on a cash basis.
Additional information
1. Prepaid expenses at 30 June $25 000.
2. Accrued expenses at 30 June $32 500.
3. Cash received from customers for the year $94 975 000.
4. Accounts receivable outstanding at 30 June $325 000 (gross).
5. Provision for doubtful debts $20 000.
6. Revenue received in advance at 30 June $300 000
7. Depreciation for accounting purposes $4 000 000
8. Depreciation as a taxation deduction $5 000 000.
9. The company income taxation rate is 30%.
Taking into consideration the additional information provided above, you are required to:
(a) Calculate the accounting income taxation expense for the company for the
financial year.
(b) Calculate the taxable income of the company for the financial year.
(c) Calculate the income taxation payable to the ATO for the financial year.
(d) Assuming that the difference between (a) and (c) are attributable to temporary
differences, calculate the amount of the deferred tax liability and deferred tax asset
arising out of the difference between the accounting profit (income taxation
expense) before taxation and taxable income (income taxation liability).
ANS:
(a) Accounting income taxation expense: $8 000 000 x 30% = $2 400 000.
(b)
Taxable income
Accounting net profit before tax $8 000 000
Prepaid expenses -25 000
Accrued expenses 32 500
Accounts receivable -325 000
Doubtful debts expense 20 000
Revenue received in advance 300 000
Depreciation differential -1 000 000
7 002 500
(c) Income taxation payable: $7 002 500 x 30% = $2 100 750.
(d)
Deferred tax liability: $405 000
Prepaid expenses 25 000 x 30% 7500
Accounts receivable 325 000 x 30% 97 500
Depreciation differential 1 000 000 x 30% 300 000
405 000
Deferred tax asset: $105 750

Accrued expenses 32 500 x 30% 9750
Doubtful debts expense 20 000 x 30% 6000
Revenue received in advance 300 000 x 30% 90 000
105 750

TOP: Taxation.
2. The following is an excerpt from a 2002 press release by the US corporation, Pacific Gas and
Electric (PG&E).
Accounting for PG&E NEG Synthetic Leases
The Corporation announced on Feb. 21 that it was initiating a thorough review of the
accounting treatment of several synthetic leases used to finance power plant development
at the PG&E NEG (National Energy Group). The review confirmed that payments to the
independent equity owners during construction reduced the investor’s equity below the
minimum requirement to maintain these leases off balance sheet. As a result, the
Corporation’s statements now include these financings on balance sheet. The change in
accounting treatment resulted in no restatement of prior year earnings, a less than $1
million impact on earnings for the fourth quarter 2001, an increase in total assets and
liabilities of $118 million in 1999, $861 million in 2000, and $1.058 billion in 2001.
Additional information
Synthetic leases involve the use of a special purpose entity (SPE) who holds title to the asset(s) (in
this instance, power plants) and raises the debt to finance the assets. The assets are then leased to a
single lessee – here, PG&E. The accounting objective of synthetic leases is to finance the acquisition
of an asset and at the same time keep the corresponding debt off the balance sheet of the acquiring
company. The SPE typically leases the property to the lessee at rates below those of a traditional
lease. Prior to 31 January 2003, the presumption in favour of consolidating an SPE could be avoided
if the following two conditions were met:
(i) there was an minimum acceptable outside equity investment in the SPE. The SEC
determined, minimum acceptable outside equity investment was 3% of total capital;
and
(ii) the independent owner had control over the SPE. Control was defined as a majority
voting interest.
The independent equity owner in the case of PG&E was an independent third-party lessor.
Required:
Discuss the accounting and ethical issues involved in the case.
ANS:
The issues that may be discussed include the following:
Accounting issues:
• broadly, the accounting issues concern the strategy of keeping debt off balance sheet,
and the consequences of doing so for the various stakeholders involved.
• Favourable financial consequences for shareholders of PG&E include: the cost
savings associated with the reduced leasing fees – which is obviously acceptable to the
independent equity holder; the reduced cost of capital that might ensue from PG&E’s
lower leverage level; avoidance of any adverse economic consequences that might
ensue from existing debt contracts in the event that the debt was brought on balance
sheet.
• With respect to the issue of consolidation, the practice was within USGAAP at the
time, subject to the consolidation conditions being met.
• The implications of the synthetic lease arrangement, per se, for the
decision-usefulness criterion of general purpose reporting by PG&E. The decision
usefulness criterion is underpinned by the first principles – substance over form,
relevance and reliability. From the perspective of the decision-usefulness basis for
consolidation and accounting for leases, these principles were ‘defined’, in this
instance, by regulation.
• The issue of transparency (disclosure) for all concerned.
Ethical issues:
• Debtholders: off balance sheet financing may hold adverse consequences for
debtholders, where transparency does not prevail. Adverse consequences for
debtholders favour shareholders. This issue may elicit discussion concerning the
question of whether management’s first duty is to shareholders; and the broader issue
of self-interest as a fundamental attribute of market economies/capitalism.
• Evaluating PG&E management’s actions in terms of good and bad consequences
reflects a utilitarian approach to ethics.
• The actions of management may be evaluated from a deontological perspective.
• A lack of transparency prevailed when the leases were left off balance sheet i.e., when
conditions for doing so no longer prevailed? This raises the question of the role of the
external auditor in this matter.
PTS: 1 AACSB: Knowledge, Analytical, Ethics


Contemporary Accounting A Strategic Approach For Users 9th Edition Hancock Test Bank

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Contemporary Accounting A Strategic

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ANS: T PTS: 1 AACSB: Knowledge, Analytical

2. Business risk is industry-specific, whereas financial risk is more firm-specific.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: F PTS: 1 AACSB: Knowledge, Analytical

ANS: F PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: F PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: F PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: F PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: F PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

ANS: T PTS: 1 AACSB: Knowledge, Analytical

6. Working capital is:

7. The term ‘working capital’ is used to describe the:

Current assets Current liabilities

9. What is the total working capital for the following company?

Cash $10 000

10. Which of the following is not an example of short-term finance?

11. A example of a source of medium-term finance is:

12. Which of the following is not a characteristic of a finance lease?

15. If a lessee enters into a finance lease agreement, it will record:

20. A preference share is preferred because:

21. Which of the following statements is incorrect?

22. Which of the following statements is incorrect?

The following information applies to questions 23 and 24.

Kucinta Manufacturing Company started operations with the following capital:

Partners’ contribution of cash $25 000

23. What is the amount of equity financing for this partnership?

24. What is the amount of debt financing for this partnership?

25. When a company obtains financial resources from owners, it is termed:

Owners’ contribution of cash $80 000

What is the amount of equity financing for this firm?

Partners’ cash contributions $46 000

What is the amount of equity financing for this firm?

Owners Liabilities creditors

Paid-in capital Retained profits

31. Retained profits can best be described as:

32. The term ‘retained profits’:

34. Dividends on ordinary shares are:

Preference shares, 5%, $25 8000 shares

36. Identify the correct statement below.

39. The sources of equity finance for a company are:

1. Describe the nature and importance of working capital to a business entity.