450 | 2009 | Practice Midterm

COMMERCE 450 SUMMER 2009 – TERM 2 MID-TERM EXAMINATION This examination consists of six questions worth a total of 60 marks. Students should attempt all questions. This is a CLOSED BOOK examination. Use of a financial calculator is permitted. You must show your calculations to obtain part marks. Problem # 1 2 3 4 5 6 Review Total

Suggested Time 25 minutes 32 minutes 25 minutes 30 minutes 25 minutes 13 minutes 150 minutes 30 minutes 180 minutes

Available Marks 10 13 10 12 10 5 60

Question 1 (10 marks) The following information is available for Boyle Corporation, whose shares are traded on the Toronto Stock Exchange: • Boyle’s net income for the year ended December 31, 2008 was $183,000. • Boyle’s tax rate is 30%. • On January 1, 2008, Boyle had 500,000 common shares outstanding. • On May 1, 2008, Boyle issued 50,000 common shares for land. • On October 1, 2008, Boyle issued 200,000 common shares for cash. • Throughout 2008, Boyle had 15,000 $0.30 cumulative, convertible preferred shares. The terms of issue stated that each preferred share is convertible into 2 common shares. On January 1, 2008, the 2007 dividends on these shares had not been declared. • On December 31. 2008, Boyle paid the 2007 and 2008 annual dividends on the preferred shares and issued a stock dividend of 10% on the common shares. • Throughout 2008, Boyle had $500,000 of 8% convertible bonds outstanding. The terms of issue state that the bonds are convertible into 50 common shares for each $1,000 of bonds. No bonds have been converted to date. Interest expense on the bonds was $40,000 in 2008. • Stock options were issued to senior executives in 2007. These options entitle the holders to purchase 25,000 common shares at an exercise price of $20. each. The options are exercisable on any date between June 30, 2009 and December 31, 2012. • All conversion rights and options are protected against dilution due to stock splits and/or stock dividends. (There had been no stock splits or dividends prior to 2008.) • The average share price of the company’s common shares during 2008 was $22. Required: (a) Compute Boyle Company’s basic earnings per share for 2008. (b) Compute Boyle Company’s diluted earnings per share for 2008. If any securities are not included in your calculation of diluted earnings per share, show calculations to justify their omission. *****

Question 2 (13 marks) The following is a summarized income statement of Chaldese Company for the year ended December 31, 2008: Sales 400,000 Dividend income Cost of goods sold Amortization expense Warranty expense Other expenses Net income before income tax

50,000 450,000 200,000 75,000 15,000 100,000 390,000 60,000

Additional information: (a) The dividend income arises from investments in taxable Canadian companies and is not taxable. (b) Capital cost allowance for the year is $70,000. On December 31, 2007, the net book value of the amortizable capital assets was $100,000 greater than the company’s undepreciated capital cost (UCC). (c) The warranty provision at December 31, 2008 amounted to $20,000 (December 31, 2007 -- $15,000). (d) The company’s balance sheet at December 31, 2007 included a future income tax asset (current) related to the warranty provision amounting to $5,250 and a future income tax liability (long-term) related to the capital assets amounting to $35,000. (e) The tax rate for 2008 is 33% (enacted in April 2008). Required: (a) (b)

Calculate the net income of Chaldese Company for the year ended December 31, 2008. Provide a reconciliation between the statutory tax rate applied to the accounting income and the income tax expense for the year ended December 31, 2008. *****

Question 3 (10 marks) On May 1, 2008, the Interurban Transportation Corporation (ITC) issued bonds with a face value of $6,000,000 and a stated annual interest rate of 6% for a price that would yield a market interest rate of 8%. The bonds pay interest semi-annually on April 30 and October 31 and mature on April 30, 2016. Issue costs associated with the bonds amounted to $80,000. ITC uses the effective interest rate method to amortize any premium or discount on issue and the straightline method to amortize issue costs. On May 1, 2012, ITC redeemed bonds with a face value of $3,000,000 for $2,750,000. Required: Provide the journal entries that the company would make on: (a) May 1, 2008 (b) October 31, 2008 (c) December 31, 2008 (d) May 1, 2012 *****

Question 4 (12 marks) The following transactions were undertaken by Scifi Inc. during 2008: 1. The company was been sued for wrongful dismissal by a former employee. The company’s lawyer believes that the suit can be settled by paying the former employee $120,000. The company also has an unrecorded contingent gain of $40,000 from a claim on another matter which the company’s lawyer considers is almost certain to be successful. The estimated legal cost (which has not been accrued) to conclude these matters is $20,000. 2. On July 1, 2008, the company issued a note payable in the amount of $250,000 for the purchase of land. The note is due on June 30, 2010 and is non-interest bearing. A similar note would have had a commercial interest rate of 8%. 3. On January 1, 2008, the company had 10,000 stock warrants outstanding, each warrant allowed the purchase of 3 of the company’s common shares at a price of $26 per share. The company’s shareholders’ equity accounts at January 1, 2008 included an amount of contributed surplus relating to these warrants of $210,000. On February 1, 2008, 30% of the warrants were exercised when the market value of the company’s shares was $30. On October 31, 2008, 50% of the remaining warrants expired. 4. On July 1, 2008, stock options were granted to senior employees allowing the purchase of 20,000 shares at $30 per share. The options are exercisable on or after June 30, 2010, to holders who are still employees of the company at that date. The fair value of the options on the date of issue was $60,000. On December 31, 2008, an employee holding options for 4,000 shares resigned from the company. Required: All journal entries for 2008 with respect to each of the transactions listed. Ignore income taxes. ***** Question 5 (10 marks) On January 1, 2008, Mount Elgon Corporation has the following shareholders’ equity: SHAREHOLDERS' EQUITY Shareholders' equity Preferred shares, no par, $1 annual dividend, cumulative, 60,000 shares issued and outstanding Common shares, no par value, 400,000 shares issued and outstanding Contributed surplus -- retirement of common shares Retained earnings, January 1, 2008 Accumulated other comprehensive income, January 1, 2008 Total shareholders' equity

180,000 600,000 10,000 875,000 75,000 1,740,000

There were no dividends in arrears at January 1, 2008; the annual dividend on the preferred shares is declared on December 10 each year.

During 2008, the following transactions occurred: January 3: The company reacquired and retired 1,000 preferred shares at a cost of $4.50 per share. March 31: The company reacquired and retired 10,000 of its common shares for $4 per share. September 1: The board of directors declared and distributed a 10% stock dividend on its common shares. The market price of the common shares on that date was $5. The company recorded the dividend at the market value. December 10: The board of directors declared a dividend of $0.50 per common share as well as the annual dividend on the preferred shares. December 20: The company paid the dividends declared on December 10. December 31: The company reported net income of $800,000 for the year, including an extraordinary loss of $200,000 net of tax and other comprehensive income for the year of $50,000. Required: (a) Prepare the journal entries to record these events. (b) Show a calculation of retained earnings at December 31, 2008. ***** Question 6 (5 marks) Kitum Corporation had the following incomes (losses) before income taxes for both accounting and tax purposes for the years 2002 to 2009. 2002 2003 2004 2005 2006 2007 2008 2009

$ 80,000 160,000 250,000 80,000 (160,000) (380,000) 130,000 145,000

Income tax rates were 40% from 2002 to 2006 and were 36% for 2007 to 2009. The company will carry losses back to prior years before carrying losses forward to future years. (Future years’ rates were not known when preparing the year end financial statements.) Required: Prepare the journal entries for each of the years 2005 to 2009 to record income tax expense and the effects of the tax loss carrybacks and carryforwards, assuming that it is more likely than not that the company will generate substantial taxable income in the future. END OF EXAMINATION