Core 1 Retired Exam Set Case 1 MCQ Solutions PDF

Core 1 — Retired Exam Set — Case 1 Multiple-choice questions 1. Daffy Ltd. has cash of $200,000 that will be used to create an investment portfolio. The portfolio will be invested equally in two assets: an equity investment that has a beta of 1.50 and a risk-free, interest-bearing certificate. The current risk-free rate in the market is 5%, and the market requires a 5% risk premium for equity securities. What return should Daffy Ltd. expect to earn on its portfolio? A. $17,500 B. $15,000 C. $12,500 D. $25,000 Option A) is correct. The expected return on the equity security is calculated with the Capital Asset Pricing Model (CAPM) as the risk-free rate plus the market premium multiplied by the beta. Therefore, the return is calculated as follows: 5% + 1.5(5%) = 12.5%. Given that $100,000 was invested in the equity, the dollar return is $12,500. The expected return on the risk-free interest-bearing certificate is the same as the risk-free rate of 5%. Given that $100,000 was invested in the risk-free asset, the dollar return is $5,000. Therefore, the combined return of the portfolio is $17,500. Option B) is incorrect. This represents the returns on the portfolio if the beta is not used in CAPM to calculate the expected return of the equity security. Without the beta, the expected return on the equity security is 10% (5% risk free + 5% market premium). Therefore, the return on the equity is expected to be $10,000 plus the $5,000 return from the risk-free asset. Option C) is incorrect. This represents the return on the equity security alone. 5% + 1.5(5%) = 12.5%. Given that $100,000 was invested in the equity, the dollar return is $12,500. Option D) is incorrect. This is calculated by applying the expected return on equity of 12.5% to the entire $200,000 portfolio. © Chartered Professional Accountants of Canada. All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without the prior written consent of CPA Canada. For information regarding permissions, please contact [email protected]. 2024-01-08 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 2. DDD Co. (DDD) is one of the pioneers in the 3D printing industry. During the peak period of investors’ interest 10 years ago, it was not a problem to get venture- backed financing to spearhead its research and development activities. It used these funds to purchase required printing machinery and technology, along with more discretionary assets, such as original art and limited-edition furnishings, to decorate its post-modern offices. Several years have gone by, and DDD has yet to show any substantial sales. Management has forecasted enough cash flow for the next eight months of operations, and the most recent audited financial statements indicate there is a going concern issue. DDD has not found any additional investors willing to finance the company, but it has been actively searching. Trends show that the 3D printing industry is set to skyrocket in two years’ time, and DDD should be able to generate sales from that period onward. A competitor in the industry with five times DDD’s market capitalization is looking to purchase some of DDD’s printing machinery as soon as possible. From the competitor’s financial perspective, which one of the following is the best valuation method to consider when approaching DDD? A. Discounted cash flow value B. Liquidation value C. Appraisal value D. Replacement value Option A) is incorrect. From the financial perspective of the competitor, the preferred valuation method is the liquidation value as this is the minimum value the company would receive for the quick sale or liquidation of its assets. Option B) is correct. Liquidation value is the minimum value the company would receive for the quick sale or liquidation of its assets. As time is of the essence in DDD’s situation, given the lack of cash flow, investors, and substantial sales, the competitor may be able to capitalize on this through a lower valuation of their assets. Option C) is incorrect. From the financial perspective of the competitor, the preferred valuation method is the liquidation value as this is the minimum value the company would receive for the quick sale or liquidation of its assets. Option D) is incorrect. From the financial perspective of the competitor, the preferred valuation method is the liquidation value as this is the minimum value the company would receive for the quick sale or liquidation of its assets. 2 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 3. Which one of the following statements is correct? A. The purpose of a valuation based on liquidation values is to value a business based on its ability to turn its current assets into cash quickly. B. The purpose of a valuation based on capitalized earnings is to value a business with relatively stable earnings that approximate discretionary cash flows. C. The purpose of a valuation based on adjusted net book values is to value a business that is not a going concern. D. The purpose of a valuation based on discounted cash flows is to value a business based on the estimated fair market value of all of its net assets and to discount these amounts back to the present to reflect the estimated time lag that would be required to dispose of these net assets. Option A) is incorrect. The purpose of a valuation based on liquidation values would be to value a business that is not a going concern. This would include all of its assets including its current and fixed assets. Option B) is correct. A business that has relatively stable earnings that approximate discretionary cash flows would be valued based on capitalized earnings. Option C) is incorrect. The purpose of a valuation based on adjusted net book values would be to value a business where the assets could be adjusted to market values which, when accumulated, would represent the value of the business rather than valuing the cash flow stream of the business from its operations. Option D) is incorrect. A discounted cash flow approach should take the estimated cash flows of the business’s operations and discount them back to the present using an appropriate discount rate. This approach is not used when disposing of all of the net assets of a business such as in a wind up. 3 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 4. When assessing the fair market value of an early stage, high-growth mining company, the following factors should all be considered except for A. the past financial performance of the company. B. proven and unproven reserves. C. the forecasts and future prospects of the company. D. the past record of management with similar organizations. Option A) is correct. The past financial performance for this company would not be indicative of the future performance and therefore is not relevant when assessing its value. Option B) is incorrect. The proven and unproven reserves are likely to be the key asset of this organization at this early stage and are therefore relevant. Option C) is incorrect. The forecasts and future prospects would drive the inputs for any discounted cash flow valuation. Option D) is incorrect. Management’s track record would add credibility to the future viability of the company. 4 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 5. BioTek Corp. (BTC) is a technology start-up firm based in San Francisco. It has developed the latest app to monitor a user’s biometrics through the wireless transmitter in the user’s phone and the user’s body movements. The app has been downloaded over 500,000 times to date, but sales are generated through in- app purchases because the basic app is free to download. This revenue model is similar to that of other competitors in the sector and has been fuelled by the concept of low-price, high-volume transactions. Although there are a multitude of more established competitive apps in the marketplace, BTC believes it will be able to gain the majority of market share in four years’ time, as reflected in its mission statement: “To be the leader in biotechnology, today and in the future.” Part of its competitive advantage is strong financial management. It outsources customer troubleshooting to the vast number of skilled technicians in India who receive an average hourly rate in rupees. The economy in India and other emerging countries continues to grow exponentially compared to established economies such as those of the United States, the United Kingdom, and Germany. Cash on hand is kept at a minimum because BTC invests any significant free cash into five-year government bonds. Its financial risk management also includes separate insurance coverage for personal liability, business property, business interruption, legal action, bad debt receivables, and force majeure. BTC’s management is aware that the economy is not as strong as it was when they started the company five years ago. The unemployment rate has increased, the interest rate is volatile, the dollar has weakened, and the biotechnology sector is at risk of being oversaturated. Which one of the following would be the LEAST imperative financial risk for BTC to consider when updating its financial management policies? A. Foreign exchange risk B. Market risk C. Interest rate risk D. Bad debt risk 5 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions Option A) is incorrect. Foreign exchange risk would exist due to outsourcing arrangements with India. Option B) is incorrect. Market risk would exist as they invest in bonds and their success is driven by market factors in their industry. Option C) is incorrect. Interest rate risk would exist as they invest in bonds. Option D) is correct. Bad debt risk is mitigated in the insurance coverage. In addition, this industry is based on low-price, high-volume transactions. As such, there is minimal risk of significant bad debts. 6 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 6. The following statement describes a significant advantage of one type of derivative financial instrument that can be used to mitigate specific financial risks for an entity: “They can create certainty because specific rates are locked in. They also are easily traded on an exchange in standard amounts and, thus, are very liquid.” This advantage is applicable to which one of the following derivative financial instruments? A. Option contract B. Forward contract C. Short sale D. Future contract Option A) is incorrect. An option contract provides the right, but not the obligation, to buy/sell an asset or financial instrument within a specified timeframe. Option B) is incorrect. A forward contract is a contract that must be completed and could lead to substantial losses. Forward contacts are often used to mitigate foreign exchange risks. They are typically tailor-made and not traded on exchanges making them illiquid. Option C) is incorrect. A short sale is not a financial instrument. Option D) is correct. A future contract is a specific locked in contract. They are traded on exchanges in standard amounts and are therefore very liquid. 7 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 7. Which one of the following statements about mergers and acquisitions is correct? A. A horizontal acquisition involves firms at different stages of the production process acquiring another firm (for example, a charter airline acquiring a chain of travel agencies). B. A leveraged buyout involves all of the equity of a public company being purchased by a small group of investors. C. In order to avoid a takeover acquisition, the target firm may seek a competing bid from another buyer who promises more favourable terms. This is referred to as a poison pill. D. A conglomerate acquisition involves the buying firm acquiring a firm in a different industry. One benefit may be diversification, which reduces risk and in turn increases overall debt capacity. Option A) is incorrect. This is the definition of a vertical acquisition. Option B) is incorrect. This explanation is actually one for a going private transaction. Option C) is incorrect. This explanation is actually referring to a white knight. Option D) is correct. The term “conglomerate acquisition” is used correctly. The diversification it provides helps reduce unsystematic risk, and a reduction of risk would translate to an increase in borrowing capacity. 8 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 8. On May 1 this year, Ling incorporated her business, which she started as a sole proprietorship three years ago. She chose May 1 as the first day of the fiscal year of the corporation. Her spouse, Ahmed, works for an international corporation on a full-time basis and has no involvement in Ling’s business. Which one of the following statements is incorrect with respect to income tax filing requirements? A. The corporation must file its corporate tax return before November 1 of the following year. B. The corporation must file its corporate tax return before April 30 of the following year. C. Ahmed must file his personal tax return before June 15 of the current year. D. Ling must file her personal tax return before June 15 of the current year. Option A) is incorrect. This statement is correct as the corporation’s filing deadline would be October 31 of the following year (six months after the end of each fiscal period). Option B) is correct. This statement is not correct as the corporation’s filing deadline would be October 31 of the following year (six months after the end of each fiscal period), not the end of the fiscal period. Option C) is incorrect. This statement is correct as an individual’s filing deadline is June 15 if their spouse has self-employment business income. Option D) is incorrect. This statement is correct as an individual’s filing deadline is June 15 if they have self-employment business income. 9 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 9. The following businesses were incorporated in Canada: Alpha Ltd. – 50% of the voting shares are owned by a non-resident. The remaining 50% are owned by a Canadian resident. Alpha Ltd.’s shares are not listed on any stock exchange. Beta Ltd. – 40% of the voting shares are owned by a non-resident. The remaining 60% are owned by a Canadian resident. Beta Ltd.’s shares are not listed on any stock exchange. Capricorn Ltd. – 70% of the issued common shares are listed on the Toronto Stock Exchange. The remaining 30% are owned by Canadian public corporations. Delta Ltd. – 60% of the voting shares are owned by non-residents. The remaining 40% are owned by a private Canadian corporation. Delta Ltd.’s shares are not listed on any stock exchange. Which one of the following lists contains only Canadian-controlled private corporations? A. Alpha Ltd., Capricorn Ltd B. Beta Ltd., Capricorn Ltd C. Beta Ltd., Delta Ltd. D. Alpha Ltd., Beta Ltd. Option A) is incorrect. Capricorn is not a CCPC as its shares are listed on a stock exchange. Option B) is incorrect. Capricorn is not a CCPC as its shares are listed on a stock exchange. Option C) is incorrect. Delta Ltd. is not a CCPC since it is controlled by non- residents. Option D) is correct. Alpha and Beta are both Canadian-controlled private corporations. The definition in ITA 125(7) states that a Canadian-controlled private corporation is a private corporation that is a Canadian corporation other than a corporation controlled, directly or indirectly in any manner whatsoever, by one or more non-resident persons, by one or more public corporations, or by a corporation a class of the shares of the capital stock of which is listed on a designated stock exchange. It also excludes a corporation a class of the shares of the capital stock of which is listed on a designated stock exchange. As both shareholders hold 50%, the non-resident does not control the corporation. 10 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 10. Which one of the following statements about the requirement to maintain books and records under the Excise Tax Act (Canada) is correct? A. Records must be kept by every person engaged in a commercial activity in Canada except those who are not required to register for GST/HST. B. Records may be kept outside of Canada unless the Minister of Finance has specifically requested that they remain in Canada. C. Records must be kept in English or French, must be complete, and must be in a form that contains enough information to determine any liabilities or refunds. D. Records must be kept along with every account and voucher necessary to verify the information contained therein, and retained until the expiration of five years from the end of the calendar year for which they were kept. Option A) is incorrect. As per the Excise Tax Act 240(1)(a), a small supplier is not required to register for GST/HST purposes. However, they must maintain adequate records to support their status as a small supplier under the Excise Tax Act. Option B) is incorrect. As per the Excise Tax Act 98(1), records must be kept at that person’s place of business in Canada. Option C) is correct. As per the Excise Tax Act 98(1), records and books of account must be kept in English or French at that person’s place of business in Canada in such form and containing such information as will enable the amount of taxes or other sums that should have been paid or collected, the amount of stamps that should have been affixed or cancelled or the amount, if any, of any drawback, payment or deduction that has been made or that may be made to or by that person, to be determined. Option D) is incorrect. As per the Excise Tax Act 98(1), records and books shall be retained and every account and voucher necessary to verify the information contained therein until the expiration of six years from the end of the calendar year in respect of which those records and books of account are kept. 11 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 11. Mac-Pac Corp. (MPC) has a December 31 taxation year end. In 2016, MPC purchased a $40,000 passenger vehicle for business use. On January 1, 2023, the UCC balance for this vehicle was $18,000. The vehicle was sold on May 1, 2023, for $19,000. On June 1, 2023, MPC purchased a new passenger vehicle for business use at a price of $50,000. MPC’s associated corporations have already used their $1,500,000 immediate expensing room for the year. What is the total maximum capital cost allowance deduction for both vehicles for 2023? A. $15,200 B. $16,200 C. $18,900 D. $10,800 Option A) is incorrect. This incorrectly deducts recapture of $1,000 on the vehicle sold from the $16,200 CCA [($36,000 × 1½ (AII adjustment) × 30%] on the new vehicle purchased. As the vehicle that is sold is considered a luxury car and was placed in Class 10.1, in the year of sale neither recapture nor terminal losses are recognized. Option B) is incorrect. Only the CCA on the vehicle purchased in 2023 was included. One-half of the normal CCA on the vehicle sold would also be deductible. Option C) is correct. Total CCA = $2,700 CCA on vehicle sold + $16,200 CCA on new vehicle purchased = $18,900. In the year of sale, one-half of the normal CCA on Class 10.1 assets may be deducted = $18,000 × 30% × ½ = $2,700. For the new vehicle purchased, $36,000 would be added to a separate Class 10.1 and the first year CCA under the accelerated investment incentive would be calculated as = $36,000 × 1½ (AII adjustment) × 30% = $16,200. Option D) is incorrect. The $10,800 is the CCA calculated on the new vehicle purchased ($36,000 × 30%) but the accelerated investment incentive was not applied. As well, the CCA of $2,700 on the vehicle sold was not added. 12 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 12. RHM Ltd. had income before taxes for accounting purposes of $175,000 this year. In the calculation of this amount, expenses included $50,000 for amortization, $2,000 in charitable donations, and $30,000 in entertainment expenses. The capital cost allowance claimed for the year is $60,000. What is the company’s net income for tax purposes for this year? A. $167,000 B. $180,000 C. $182,000 D. $197,000 Option A) is incorrect. This doesn’t adjust for the non-deductible portion of entertainment expense (50% × $30,000 = $15,000). Per ITA 67.1, 50% of entertainment is deductible. Option B) is incorrect. This doesn’t add back charitable donations. Charitable donations are a deduction to compute taxable income, not net income for tax purposes. [ITA 110.1] Option C) is correct. Accounting income $175,000 Add back: Amortization expense 50,000 Charitable donations 2,000 Non-deductible portion of entertainment ($30,000 ×.5) 15,000 Deduct: CCA (60,000) Net income for tax purposes $182,000 Option D) is incorrect. This adds back 100% of entertainment expense as a non- deductible adjustment. 50% of entertainment is deductible [ITA 67.1]. 13 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 13. Which one of the following statements BEST describes the taxation of dividend income received by a minor child from a private corporation, when the shares in question were acquired for them by one of their parents? A. Dividends received by the child will be taxed to the child at the top personal tax rate. B. Dividends received by the child will be included in the parent’s income for tax purposes. C. Dividends received by the child will be split equally between the income for tax purposes of each of their parents. D. Dividends received by the child will be taxed twice: once at the child’s regular tax rate and once at the top personal tax rate. Option A) is correct. Since the child is a specified individual (under age 18) and is receiving split income (dividends from a private corporation), the minor child pays tax on split income at the top rate that applies to high-income taxpayers [ITA 120.4(1)]. Option B) is incorrect. The dividends were received from a private corporation and therefore will not attribute back to the parents as they would if the dividends were received from a public company, and the parent had provided the funds to purchase the public company shares. Option C) is incorrect. For purposes of determining whether corporations are associated, shares owned by a child under age 18 are deemed to be owned by each parent unless it can reasonably be considered that the child manages the business and affairs of the corporation and does so without a significant degree of influence by the parent [ITA 256(1.3)]. However, this rule has no impact on the taxation of dividends received in this situation. Option D) is incorrect. Split income is deducted from income for regular tax purposes [ITA 20(1)(ww)]. Therefore, the dividend income is taxed only once. 14 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 14. Jason transferred a parcel of land with an adjusted cost base (ACB) of $200,000 and fair market value (FMV) of $140,000 to his common-law partner for $150,000. He also transferred a parcel of land with an ACB of $250,000 and FMV of $225,000 to his brother for $225,000. Assuming no elections are made, what is the total capital loss that Jason will recognize on the two transfers? A. $0 B. $25,000 C. $60,000 D. $85,000 Option A) is incorrect. This assumes a rollover has occurred on both the transfer of land to Jason’s common-law partner and brother. The transfer of land to Jason’s brother is not eligible for a tax-free rollover under ITA 73(1) and ITA 73(1.01). Option B) is correct. ITA 73(1) and ITA 73(1.01) provide an automatic rollover of capital assets to a spouse or common-law partner at the assets’ ACB. As no election has been made to elect out of the automatic rollover, Jason would not recognize a capital loss on the transfer to his common-law partner ($200,000 deemed proceeds – $200,000 ACB). Jason would recognize a capital loss of $25,000 ($225,000 – $250,000) on the transfer to his brother as the proceeds are equal to FMV. Option C) is incorrect. This assumes a capital loss as a result of the land transfer to Jason’s common-law partner and that a rollover has occurred on the land transferred to his brother. The transfer of land to Jason’s brother is not eligible for a tax-free rollover under ITA 73(1) and ITA 73(1.01) and Jason must elect out of the automatic rollover to his common-law partner. Option D) is incorrect. This records a capital loss on both properties. ITA 73(1) and ITA 73(1.01) provide an automatic rollover of capital assets to a spouse or common-law partner at the assets’ ACB. Jason would not recognize a capital loss on the transfer to his common-law partner. 15 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 15. Barb Rockefeller, a Canadian resident, received the following amounts in Canadian dollars during 2023: $10,000 of eligible dividends from taxable Canadian corporations $10,000 of other-than-eligible dividends from taxable Canadian corporations $10,000 of foreign dividends from which the foreign payer withheld $1,500 in foreign tax (net cash received: $8,500) With respect to these amounts, how much income for tax purposes will be included on Barb’s tax return? A. $25,300 B. $33,800 C. $34,500 D. $35,300 Option A) is incorrect. The foreign dividend has been excluded ($35,300 – $10,000 = $25,300). Option B) is incorrect. The foreign dividend has been reduced by the foreign tax paid ($35,300 – $1,500 = $33,800). The foreign tax paid is not deducted to arrive at income for tax purposes. Option C) is incorrect. All three dividends have been grossed up by the other-than- eligible rate of 15% ($30,000 × 115% = $34,500). Option D) is correct. Eligible dividends ($10,000 × 138%) $13,800 Other-than-eligible dividends ($10,000 × 115%) 11,500 Foreign dividend 10,000 Income for tax purposes $35,300 16 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 16. Wilma and Serge separated in 2022, and Serge took custody of their child. At that time, Wilma and Serge signed a written separation agreement requiring Wilma to pay Serge $1,500 per month in spousal support and $1,200 per month in child support. Wilma made all the required payments in 2022. However, in 2023, Wilma made only eight months of payments, which totalled $21,600. How much of the 2023 payments can Wilma deduct on her 2023 personal income tax return? A. $7,200 B. $12,000 C. $18,000 D. $21,600 Option A) is correct. Only payments in excess of the required non-deductible child support will be deductible as spousal support as priority is given to child support payments. Total payments $21,600 Less: child support 12 × $1,200 (14,400) Spousal support deduction $ 7,200 Option B) is incorrect. Wilma cannot deduct eight months of spousal support payments (8 × $1,500 = $12,000). Only payments in excess of the required non- deductible child support will be deductible as spousal support. Option C) is incorrect. Wilma cannot deduct 12 months of spousal support payments (12 × $1,500 = $18,000). Only payments in excess of the required non- deductible child support will be deductible as spousal support. Option D) is incorrect. The total payments are not deductible. Only payments in excess of the required non-deductible child support will be deductible as spousal support. 17 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 17. The following information pertains to trusts A, B, C, and D: Trust A – Brenda settled Trust A by transferring $100,000 to it for the benefit of her five-year-old daughter, who lives with her. Trust B – Clark’s will provides for $500,000 of specific assets to be held in Trust B, established at his death, for his wife. Trust B is required to pay Clark’s wife, during her lifetime, all of the annual income generated by the trust. Trust C – Basil settled Trust C by transferring $1 million to it. Under the terms of the trust, no one other than his wife is to benefit from the trust assets during her lifetime. On the death of Basil’s wife, the trust assets are to be distributed equally between his children. Trust D – Martha’s will provides for her assets to be held in Trust D, established at her death, for the benefit of her son and granddaughter. Which two of the above trusts are testamentary trusts? A. Trust A and Trust C B. Trust C and Trust D C. Trust B and Trust D D. Trust B and Trust C Option A) is incorrect. Trust A and C were established during the lifetime of the settlor, and as a result are not testamentary trusts. Option B) is incorrect. Trust C was established during the lifetime of the settlor, and as a result is not a testamentary trust. Option C) is correct. Under ITA 108(1), a “testamentary trust” is one that arose on and as a consequence of the death of an individual. Option D) is incorrect. Trust C was established during the lifetime of the settlor, and as a result is not a testamentary trust. 18 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 18. Regarding reserves in the year of death (for example, reserves for doubtful debts of an unincorporated business), which one of the following statements is true? A. The prior year reserve must be included in the deceased’s income, and a reserve may be deducted in the year of death. B. The prior year reserve must be included in the deceased’s income, and a reserve cannot be deducted in the year of death. C. The prior year reserve does not need to be included in the deceased’s income, and a reserve cannot be deducted in the year of death. D. The prior year reserve does not need to be included in the deceased’s income, and a reserve may be deducted in the year of death. Option A) is correct. In the year of death, reserves taken in a prior year must be included as income. While limited in the types of reserves that can be claimed, the deceased is not prohibited from deducting a reserve with respect to the bad debts of the business. The only exception where a bad debt reserve cannot be deducted is when a reserve is specifically listed in ITA 72(1). ITA 20(1)(n) reserves are denied, but there is no indication in the question that the accounts receivable are to be collected over more than two years. Option B) is incorrect. The deceased is allowed to deduct reserves with respect to the bad debts of the business under ITA 20(1)(p), or a reasonable allowance under par. 20(1)(l). Option C) is incorrect. Last year’s reserve must be included as income in the year of death. Option D) is incorrect. Last year’s reserve must be included as income in the year of death. 19 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 19. When an individual wishes to dispute a Notice of Assessment received from the Canada Revenue Agency, how much time does that individual have to file a Notice of Objection? A. 90 days from the date on the Notice of Assessment or Reassessment B. One year from the filing deadline of the tax return of the year in question C. 90 days from the date on the Notice of Assessment or one year from the filing deadline of the tax return, whichever is later D. 90 days from the date on the Notice of Assessment or one year from the filing deadline of the tax return, whichever is sooner Option A) is incorrect. This is the deadline for taxpayers other than individuals. Option B) is incorrect. The CRA can issue a notice of assessment anytime during the normal reassessment period [ITA 152(3.1)] which extends out past one year from the due date of the tax return. Option C) is correct. Due to ITA 165(1), an individual must file a notice of objection within one year of the required tax return filing date of the year in question or within 90 days of the day the notice of assessment is dated, whichever is later. Option D) is incorrect. This specifies that whichever option is sooner should be chosen which is inconsistent with ITA 165(1). 20 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 20. The management of Real-Time Marketing Corp., an advertising agency reporting under IFRS, is working on the implementation of a real-time accounting and reporting system to satisfy its investors’ and stakeholders’ need for more timely financial information. The CEO explains that, to achieve this, the statement of profit or loss and the statement of financial position numbers need to be updated every day and published for the users. He is interested in understanding the key hurdles to setting up such a system. Which one of the following challenges is the MOST significant when implementing a real-time accounting and reporting system? A. Providing the numerous users access to dashboards and summaries B. Configuring the information system to accept real-time transactions when booked C. Training all of the company’s employees to close the books on a daily basis D. Posting and publishing reliable un-audited real-time transactions Option A) is incorrect. Many information systems in the current technological environment are already capable of having a multitude of users with a variety of privileges. This is the case with even the most basic accounting systems as well as online customer portals. Option B) is incorrect. Many information systems in the current technological environment are already capable of handling real-time transactions. This is the case with shipping and receiving, banking, investments, etc. The difficulty is not configuring the systems to handle real-time data, but rather, the reliability of the data once it is entered. Option C) is incorrect. In the current financial reporting environment, accounting employees already enter transactions and information on a daily basis. While there are some end-of-month closing transactions that are left out from day-to-day activities, they may not require an exhaustive amount of training or re-directing resources to execute on a more-frequent basis. Option D) is correct. The reliability of real-time data is the largest risk to a real-time accounting system. Reliability is inversely proportional to timeliness. When data is highly reliable, it usually takes a lot of time to prepare it and thereby may not be timely. When data is timely, there is likely a lack of sufficient review or verification and thereby may not be reliable. Having data available real-time is pushing this relationship to its limits by having unprocessed and potentially erroneous data feed right into the system. 21 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 21. In Year 1, the provincial government approved financial assistance with employee wages for GUM Ltd. (GUM). Under the terms of the agreement, GUM is required to maintain staffing levels at Year 1’s level for each of Year 2, Year 3, and Year 4. In return, the government will provide a grant of $100,000 for each year that the staffing level requirement is met. In Year 1, the company had 50 employees. In Year 2, GUM still had 50 employees, but it may have to lay off a few employees in Year 3. Assuming no amount has yet been recorded for Year 2 and the income approach is used, how much of the grant should be recognized in Year 2, when reporting under ASPE? A. $0 B. $100,000 C. $200,000 D. $300,000 Option A) is incorrect. Potential future layoffs are irrelevant as the criteria by the government is assessed on an annual basis and future layoffs will not affect the qualification for Year 2. Option B) is correct. In Year 2 GUM has met the criteria for the government funding by maintaining 50 employees. It is therefore appropriate to record this amount. Option C) is incorrect. Recognizing more than $100,000 of revenue is inappropriate as GUM has yet to earn the government funding for Year 3 or Year 4. The remaining funding should be recognized when GUM has earned it by maintaining employment levels in those years. Option D) is incorrect. Recognizing more than $100,000 of revenue is inappropriate as GUM has yet to earn the government funding for Year 3 or Year 4. The remaining funding should be recognized when GUM has earned it by maintaining employment levels in those years. 22 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 22. On June 30, Year 12, Cruisers Ltd. purchased a new cruise ship. The cost of the purchase was $25,690,000. Although ships generally have a life of 25 years, it is common in the industry for the various components of a ship to be replaced at different times throughout its life. The total cost of the ship is allocated to the following components: Component Replacement Rate Percentage of Total Cost Ship engines 5 years 30% Decking 10 years 35% Galley fixtures 10 years 30% Other 25 years 5% In the December 31, Year 12, annual financial statements prepared following IFRS, what is the depreciation expense for the newly acquired ship if straight-line depreciation is used? A. $513,800 B. $1,631,315 C. $1,027,600 D. $3,262,630 Option A) is incorrect. This is the straight-line depreciation for the total cost of the ship for 25 years, taking into account that the ship has only been owned for six months, which would be a total depreciation of $513,800 ($25,690,000 / 25 years × 6/12 months). Option B) is correct. According to IAS 16.43, “each part of an item of property, plant, and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.” Based on the depreciation calculation below, and acknowledging that only six months of depreciation should be taken at the end of Year 12 (because the date of purchase was June 30), the total depreciation would be $1,631,315 ($3,262,630 × 6/12 months). Percentage of Allocated Expected Annual Component Total Cost Cost Life Amortization Ship Engines 30% $7,707,000 5 $1,541,400 Decking 35% $8,991,500 10 $899,150 Galley Fixtures 30% $7,707,000 10 $770,700 Other 5% $1,284,500 25 $51,380 Total 100% $25,690,000 $3,262,630 23 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions Option C) is incorrect. This is the straight-line depreciation for the total cost of the ship of 25 years, which would be a total amortization of $1,027,600 ($25,690,000 / 25 years). Option D) is incorrect. This calculation is adequately done by component, but does not consider that the ship was only owned for 6 months; therefore the total depreciation is calculated at the full year amount of $3,262,630. 24 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 23. R Ltd. (R) is an online merchandiser and reports under ASPE. It sells products on its website and accepts payment either by credit or debit card. All of its products are from one manufacturer, M Ltd. (M). R has set its selling prices at M’s suggested retail price, which results in a net margin of 50% to R. The products are ordered from M when payment is received from the customer and are sent directly from M to the customer. The process is automated. Shipping is paid by the customer. Details of a sale are as follows: September 4 Sales order and payment received by R from customer for $100,000 September 6 Product shipped by M September 10 Product received by customer On what date and at what amount will the revenue be recorded by R? A. On September 6 for $50,000 B. On September 6 for $100,000 C. On September 4 for $100,000 D. On September 10 for $50,000 Option A) is correct. Facts support that R is an agent, not a principal, and therefore the net of $50,000 should be recorded as revenue. The transaction should be recorded when performance is achieved on September 6 when all criteria per Section 3400 have been met as R is not responsible for the shipment. Option B) is incorrect. Facts support R that is an agent, not a principal, and therefore revenue should be recorded on a net basis. Option C) is incorrect. Facts support that R is an agent, not a principal, and therefore revenue should be recorded on a net basis. In addition, performance has not taken place September 4, as goods have not been shipped yet. Option D) is incorrect. The revenue recognition criteria are met as of September 6, when the goods are shipped. 25 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 24. IOK Corp. (IOK), a public company that operates franchises, holds a 12-month note receivable and receives payments based on the contractual terms of the note. The note is recorded at fair value through other comprehensive income and has a face value of $560,000. Loans such as this note have historical default rates of 1%; however, IOK’s management predicts the probability of default is likely 2%. Management uses a present value factor of 0.8 in their calculations. What is the amount of the credit loss to be recognized under the general approach model described in IFRS 9, on the day the note was issued? A. $11,200 B. $8,960 C. $4,480 D. $5,600 Option A) is incorrect. This does not take into account the time value of money and simply applies the projected default rate to the face value of the note: $560,000 × 2% = $11,200. The present value (rather than face value) of the note receivable should be adjusted by management’s expected rate of default to arrive at the expected credit loss. Option B) is correct. The present value of the note receivable is adjusted by management’s expected rate of default (to incorporate a forecast of future economic conditions) to arrive at the expected credit loss, as follows: Face Present Present Projected Expected value ($) value factor value ($) default rate credit loss ($) $560,000 0.80 $448,000 2% $(8,960) Option C) is incorrect. This uses the historical default rate: $560,000 × 0.80 × 1% = $4,480. The present value of the note receivable should be adjusted by management’s expected rate of default (to incorporate a forecast of future economic conditions) to arrive at the expected credit loss rather than using historical default percentages. Option D) is incorrect. This does not take into account the time value of money and uses the historical default rate: $560,000 × 1% = $5,600. The present value (rather than the face value) of the note receivable should be adjusted by management’s expected rate of default (to incorporate a forecast of future economic conditions) to arrive at the expected credit loss rather than using historical default percentages. 26 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 25. On the last day of Year 1, Ranger Inc. (Ranger) sold items to Sirius Corporation (Sirius). Related to that transaction, $100,000 was included in revenue and accounts receivable. At the time, Ranger had every expectation of collecting the amount. At the end of Year 2, Ranger’s management estimated that the most likely amount it could recover was $50,000, based on its best estimate at the time and having heard that Sirius might be undergoing creditor protection. Two months into Year 3, Sirius was acquired by a new parent company and received a cash infusion that allowed it to repay the account in full, including accrued interest of $4,000. Excluding the $100,000 of revenue from the sale already recorded on the last day of Year 1, what is the impact of the transaction on Ranger’s income for Years 1, 2, and 3, respectively, according to ASPE? A. Year 1: $0; Year 2: $(50,000); Year 3: $54,000 B. Year 1: $0; Year 2: $0; Year 3: $4,000 C. Year 1: $(100,000); Year 2: $0; Year 3: $104,000 D. Year 1: $(50,000); Year 2: $0; Year 3: $54,000 Option A) is correct. In Year 1, since management expected to recover the full amount, there is no impairment. At the reporting date for Year 2, management’s best estimate is that the account was impaired in the amount of $50,000, so there is an impairment of $50,000 to be recognized in the financial statements. When the account was settled in Year 3, a full reversal of $50,000 plus the interest collected in the amount of $4,000 need to be recognized. The event which allowed Sirius to repay the account did not occur until after Year 2 and therefore is accounted for in Year 3. Option B) is incorrect. The information available at the end of Year 2 indicates that the balance was impaired and should be allowed for in Year 2 despite subsequent repayment. Option C) is incorrect. The information available at the time the sale occurred indicated that collection was reasonably assured; therefore recognition of the revenue was appropriate and no adjustment for the sales amount is necessary. Option D) is incorrect. The writedown should not have been adjusted to the time that the account was established since in Year 1, management expected to recover the full amount. 27 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 26. If inventory costs are expected to increase, which one of the following sets of accounting policies would result in the HIGHEST annual income in the short term for a new company using ASPE? A. Inventory valuation method: FIFO; capital assets depreciation method: straight-line B. Inventory valuation method: weighted average; capital assets depreciation method: straight-line C. Inventory valuation method: weighted average; capital assets depreciation method: declining D. Inventory valuation method: FIFO; capital assets depreciation method: declining Option A) is correct. FIFO provides a higher income since old (lower) costs are recognized in the income statement as prices increase. Straight-line generates lower amortization in the first years. Option B) is incorrect. Weighted average generates lower income compared to a FIFO valuation method. Option C) is incorrect. Weighted average generates lower income compared to a FIFO valuation method. Accelerated amortization, such as declining balance, will generate lower income than a straight-line depreciation method in the first years. Option D) is incorrect. Accelerated amortization, such as declining balance, will generate lower income in the first years than a straight-line depreciation method. 28 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 27. Simcoe Industrial Ltd. (SIL) purchased a specialized piece of equipment to be used in its manufacturing process. It did not take SIL a substantial period of time to get the asset ready for its intended use. SIL paid for this equipment as follows: $12,475 cash upfront. $12,475 per annum payable at year end of each year for five years. The current market interest rate for a note with similar payment terms is 6%. In accordance with IFRS, what amount should SIL record for the initial value of the equipment (rounded to the nearest thousand dollars)? A. $53,000 B. $61,000 C. $65,000 D. $75,000 Option A) is incorrect. This calculates the present value of five payments of $12,475 and ignores the $12,475 paid upfront ($12,475 × PVIFA 5,6% [4.21] = $52,520 or $53,000 rounded) Option B) is incorrect. This calculates the present value of six years of payments of $12,475, ignoring the fact that the first one is paid up front ($12,475 × PVIFA 6, 6% [4.92] = $61,377 or $61,000 rounded) Option C) is correct. This calculates the present value of five payments of $12,475 and includes the $12,475 paid upfront. $12,475 + ($12,475 × PVIFA 5,6% [4.21]) = $12,475 + $52,520 = $64,995 = $65,000 (rounded) Option D) is incorrect. This does not calculate the present value of the note and therefore capitalizes the interest component to the equipment account. ($12,475 × 6 = $74,850 or $75,000 rounded). The asset is not a qualifying asset as defined in IAS 23 for the capitalization of interest as it does not take an extended period of time to get ready for its intended use. 29 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 28. JRM Ltd. is a company, listed on the Toronto Stock Exchange, that operates only in Canada. The differences between net income and taxable income for Year 1, its first year of operations, were as follows: Depreciation expense was $280,000 and capital cost allowance was $350,000. Deferred rental revenue of $80,000 was taxable in Year 1 and would be recorded as earned in Year 2. Assuming a tax rate of 35% for Year 1 and Year 2, how will the deferred taxes be presented on JRM Ltd.’s statement of financial position at the end of Year 1? A. $24,500 non-current deferred tax liability; $28,000 current deferred tax asset B. $3,500 non-current deferred tax asset C. $24,500 non-current deferred tax asset; $28,000 current deferred tax liability D. $3,500 non-current deferred tax liability Option A) is incorrect. The deferred rental revenue is taxable in Year 1, which generates a current deferred tax asset at the end of Year 1 of $28,000 ($80,000 × 35%). The CCA in excess of depreciation creates a long-term deferred tax liability [($350,000 – $280,000) × 35% = $24,500]. However, where an entity presents current and non-current assets and liabilities separately, deferred tax should not be shown as part of current assets or liabilities. Option B) is correct. This correctly offsets the non-current deferred tax liability and the current deferred tax asset given that they are legally enforceable and settle in the same year and are with the same taxation authority. Option C) is incorrect. This incorrectly treats the deferred tax asset related to deferred rental revenue as a deferred tax liability and the deferred tax liability related to depreciation as a deferred tax asset. Further, where an entity presents current and non-current assets and liabilities separately, deferred tax should not be shown as part of current assets or liabilities. Option D) is incorrect. This incorrectly treats the asset as a liability, and vice versa. 30 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 29. Steelie Rims Inc. is a publicly traded automotive parts manufacturer. The company keeps a significant number of parts in its inventory, including rims. In the first quarter of Year 4 (Q1), the market price of rims declined drastically from $120 to $80 per rim due to a competitor entering the market. The loss was not expected to be recovered in Year 4 because of the increased competition. However, in the second quarter of Year 4 (Q2), the competitor was shut down by the transportation regulatory authority, which resulted in a market price recovery in the third quarter of Year 4 (Q3). The recovery was in excess of the first-quarter decline, and the market price for a rim climbed to $130. The cost of rims remained stable during Year 4, at $90 per rim. Which one of the following statements accurately describes the effect of the market price fluctuation on the value of inventory in Year 4? A. No impact on the per unit value in Q1, but an increase of $10 in the per unit value in Q3. B. A decrease of $10 in the per unit value in Q1, and then an increase of $10 in the per unit value in Q3. C. No impact on the per unit value in either Q1 or Q3. D. A decrease of $40 in the per unit value in Q1, and then an increase of $50 in the per unit value in Q3. Option A) is incorrect. A decline in inventory that is not expected to be recovered (that is other than temporary) should be shown in the quarter of the decrease. Accordingly, Q1 would have to be adjusted by the amount of the decrease. Option B) is correct. A decline in inventory that is not expected to be recovered (that is other than temporary) should be shown in the quarter of the decrease. A subsequent recovery of the market value should be recognized as a cost recovery in the period of increase up to the original cost. Both Q1 and Q3 would be affected by the changes in market price. Option C) is incorrect. A decline in inventory that is not expected to be recovered (that is other than temporary) should be shown in the quarter of the decrease. A subsequent recovery of the market value should be recognized as a cost recovery in the period of increase up to the original cost. Both Q1 and Q3 would be affected by the changes in market price. Option D) is incorrect. This assumes that inventory is carried at market value. In addition, a subsequent recovery of the market value should never be recorded above original cost. 31 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 30. A Ltd. (AL) reports under ASPE and acquired 1,000 of its own shares on December 31, Year 1, for $95 per share. It cancelled the shares on February 28, Year 2. The shares were initially issued for $100 each. Which one of the following statements is correct? A. On the December 31, Year 1, balance sheet, the shares will be included in non-monetary assets at $95,000. B. On the December 31, Year 1, balance sheet, the shares will be deducted from shareholders’ equity at $100,000. C. In the December 31, Year 2, financial statements, a loss of $5,000 will be included in retained earnings. D. In the December 31, Year 2, financial statements, $95,000 will be deducted from shareholders’ equity. Option A) is incorrect. On the December 31, Year 1 balance sheet, the shares are not assets to AL since it is not possible to own part of yourself. Rather, ASPE 3240.06 indicates that the cost of the shares are shown as a deduction from the total shareholders’ equity until cancelled. Option B) is incorrect. On the December 31, Year 1 balance sheet, the shares should be deducted at cost ($95,000), and not par value ($100,000). Option C) is incorrect. In the December 31, Year 2 financial statements there is no gain/loss on purchase and cancellation of a company’s own shares, since it is considered to be a capital transaction. Option D) is correct. When the shares are acquired, they need to be recorded at cost as a deduction of shareholders’ equity per ASPE 3240.06. In this case, they would be shown at the end of Year 1 as a deduction from shareholders’ equity at $95,000. As for the subsequent transaction of cancelling the shares, an amount equal to the par value is deducted from share capital, with the difference going to contributed surplus. Therefore, in the December 31, Year 2 financial statements, a net $95,000 will be deducted from total shareholders’ equity as the $5,000 difference is credited to contributed surplus per ASPE 3240.09. 32 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 31. Perfect Pets Ltd. reports under ASPE. The following information on some of its balance sheet accounts as of December 31, Year 1 and 2, is available: December 31 Year 1 Year 2 Variance Chequing account (overdraft) $12,000 $(4,000) $(16,000) Savings account (required deposit for loan security) 2,500 2,000 (500) Preferred shares in public company X 6,000 5,000 (1,000) 90-day guaranteed investment certificate 1,000 0 (1,000) Big Bank 90-day money market investments (mature March 1, Year 2) 1,500 0 (1,500) Total $23,000 $ 3,000 $(20,000) How much will the net decrease be on the company’s December 31, Year 2, cash flow statement? A. $19,500 B. $18,500 C. $20,000 D. $16,500 Option A) is incorrect. The $19,500 includes everything except the savings account — excluding the savings account is correct as it is security for debt but the preferred shares should also be excluded since they are not readily convertible and equity investments are excluded from cash equivalents. $16,000 + $1,000 + $1,000 + $1,500 = $19,500 Option B) is correct. The $18,500 includes everything except the savings account, which is excluded since it is security for debt, and the preferred shares, which is excluded since they are not readily convertible and equity investments are excluded from cash equivalents. $16,000 + $1,000 + $1,500 = $18,500 Option C) is incorrect. The $20,000 includes everything, which is not correct. The savings account should be excluded as it is security for debt and the preferred shares should be excluded since they are not readily convertible and equity investments are excluded from cash equivalents. $16,000 + $500 + $1,000 + $1,000 + $1,500 = $20,000 Option D) is incorrect. The $16,500 includes the chequing and saving accounts only which is not correct. The savings should be excluded as it is security for debt and the GICs and money market funds should be included as they are readily convertible. $16,000 + $500 = $16,500 33 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 32. For Year 6, a manufacturer’s research and development (R&D) department incurred the following costs to design a new manufacturing process: Testing materials $ 40,000 Research staff salaries $120,000 Staff training costs $ 20,000 During training, it was found that the new process would not work effectively with the existing equipment and staff. Consequently, the process cannot yet be implemented and the R&D department will have to redesign the process. What costs should be capitalized for Year 6, if reporting under IFRS? A. $120,000 B. $160,000 C. $180,000 D. $0 Option A) is incorrect. This capitalizes the research and staff salaries which is not correct as no capitalization is permitted since at least one of the development criteria has not been met. Option B) is incorrect. This capitalizes the research and staff salaries as well as the testing materials which is not correct as no capitalization is permitted since at least one of the development criteria has not been met. Option C) is incorrect. This capitalizes all of the costs which is not correct as no capitalization is permitted since at least one of the development criteria has not been met. Option D) is correct. This capitalizes none of the costs which is correct. Since the process did not work, there is no future economic benefit yet. Therefore, all costs should be expensed in Year 6. No capitalization is permitted as at least one of the development criteria has not been met. 34 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 33. LISS Ltd. is a private company and reports under ASPE. Its new controller wants to change from applying the future taxes method to the taxes payable method because it is easier to calculate. The balance sheet shows a future income tax liability. Which one of the following statements about this proposed change is accurate? A. It is not permitted because it will not result in more reliable information. B. It is not permitted because the taxes payable method is not an acceptable method. C. It will affect the prior period’s comparative information. D. It must be approved by the company’s auditors. Option A) is incorrect. An entity may change its accounting policy to account for income taxes using the taxes payable method or the future income taxes method without having to meet the criterion of requiring the policy change to result in information that is more reliable and relevant. Option B) is incorrect. Both the taxes payable method and the future income taxes method are acceptable under ASPE. Option C) is correct. Accounting policy changes are applied retrospectively unless the information is not available; therefore this change will affect the prior period’s comparative information. Option D) is incorrect. There is no requirement for accounting changes to be approved by auditors. 35 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 34. Fox Incorporated, a public company reporting under IFRS, entered into a lease for equipment with a fair value of $315,000. The interest rate implicit in the lease is 6%, with annual lease payments of $64,000 payable at the beginning of each year. The lease has a term of five years and a guaranteed residual value of $49,500. What is the value of the lease liability at the inception of the lease, rounded to the nearest thousand? A. $323,000 B. $259,000 C. $307,000 D. $315,000 Option A) is incorrect. This is the value of the leased asset at the present value of minimum lease payments at the inception of the lease. Option B) is correct. This values the lease liability at the present value of minimum lease payments less the initial payment. PV = 6%, 5, 64000,49500,1 = 322,756 – the initial payment of $64,000 = $259,000 (rounded). Option C) is incorrect. This values the lease liability at the present value of minimum lease payments but assumes the payments are made at the end of the period. However, the annual lease payments of $64,000 are payable at the beginning of each year. Option D) is incorrect. This values the lease liability at the market value of the leased asset, not the present value of the lease payments that have not been paid. 36 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 35. CLT Manufacturing (CLT) is a public company that has occasional foreign sales. On June 12, Year 3, it sold its products to a customer in the United States for US$150,000. This was the only sale to a foreign customer in Year 3. CLT has a December 31 year end. Which one of the following exchange rates should be used to record this sale in Canadian dollars for the Year 3 financial statements? A. Average rate for Year 3; US$1 = C$1.031 B. Exchange rate on June 12, Year 3; US$1 = C$1.021 C. Exchange rate on December 31, Year 3; US$1 = C$1.042 D. Average rate of June 12 to December 31, Year 3; US$1 = C$1.035 Option A) is incorrect. It is appropriate to use the average rate when revenues occur evenly over the course of the year. In this case, there was only one foreign sales transaction on June 12, therefore the average rate is not the correct rate for translation. Revenue should be recorded at the rate in effect on the date the transaction occurred (that is at the June 12 rate). Option B) is correct. The exchange rate in effect on the date the transaction occurred should be used. Option C) is incorrect. Revenues should not be recorded at the rate in effect at year end unless the transaction occurred on that date. Option D) is incorrect. The average rate between date of sales and date of year end is not the rate that should be used. Revenue should be recorded at the rate in effect on the date the transaction occurred (that is the June 12 rate). 37 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 36. Company X has long-term investments in the shares of two companies, Y and Z. Company X has significant influence, but no controlling interest, over Company Y and no significant influence or controlling interest over Company Z. In accordance with IFRS, how should Company X record regular cash dividends it receives from Company Y and Company Z, respectively? A. Company Y: reduction of the investment; Company Z: dividend revenue B. Company Y: dividend revenue; Company Z: dividend revenue C. Company Y: dividend revenue; Company Z: reduction of the investment D. Company Y: reduction of the investment; Company Z: reduction of the investment Option A) is correct. The equity method should be used to account for the investment in Company Y since significant influence exists but there is no controlling interest. Under the equity method, receipt of dividends from Company Y would be recorded as a reduction of the investment in Company Y’s shares. The fair value method should be used to account for the investment in Company Z since no significant influence exists. Under the fair value method dividends are recognized as dividend revenue when received or receivable. Option B) is incorrect. This assumes the fair value method for both investments which is not correct. Only the investment in Company Z should be accounted for using the fair value method since no significant influence exists. Option C) is incorrect. This assumes the fair value method for Company Y and the equity method for Company Z which is not correct. The investment in Company Y should be accounted for using the equity method since significant influence exists but there is no controlling interest. The investment in Company Z should be accounted for using the fair value method since no significant influence exists. Option D) is incorrect. This assumes the equity method for both investments which is not correct. Only the investment in Company Y should be accounted for using the equity method since significant influence exists but there is no controlling interest. 38 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 37. Travel Incorporated (TI), a travel agency, reports under ASPE. For which one of the following events would TI be MOST likely to accrue an estimate in the financial statements, rather than include a note disclosure alone? A. TI provided a full refund to its customers for cancellations of hotel reservations with a major hotel chain after a tsunami disaster. This chain has historically provided a full refund to the travel agency for any cancellations. B. A lawsuit has been filed against TI by a number of its customers who became ill on a cruise ship due to an influenza outbreak. They have filed damages ranging from $50,000 to $250,000. TI’s lawyers indicate that, based on past case law, a payment is probable. C. TI booked tickets for March break on a major airline for a large number of its customers. The airline filed for bankruptcy protection on the date many of the passengers were to depart. TI was able to make reservations on other airlines for these customers. TI may receive a refund from the government for its costs. D. When the major airline went bankrupt, TI had customers stranded in tourist destinations. Many of these customers made their own arrangements and paid for their tickets to get home. Some of these customers may apply to TI for reimbursement, while others will receive reimbursement through their credit card companies. Option A) is incorrect. This is a contingent gain and should not be accrued for in the financial statements. Option B) is correct. A contingent loss should be accrued if likely and measurable. Legal opinion indicates that the lawsuit is probable and there is an estimate of the possible damages. Option C) is incorrect. The costs to make alternative reservations for their customers would have actually been recorded. There is no need to estimate an accrual. Any possible reimbursement by the government would be a contingent gain which cannot be accrued Option D) is incorrect. This is a contingent loss, but in order to be recorded in the financial statements it must be both likely and measurable. Even though the loss is likely it is not possible to provide an estimate of the amount. 39 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 38. Etheridge Corporation (EC) is a heating and cooling company that prepares its financial statements using ASPE. In Year 4, EC engaged in R&D for the first time with a project to develop more efficient air conditioners. EC has tracked detailed expenses for the project. On July 17, Year 4, a breakthrough confirmed that the new method would work and the sale of more efficient air conditioners would be profitable. At that time, EC made a request to its board of directors to continue the project. On September 3, Year 4, the board of directors approved funding for the rest of the project and committed EC to completing the project and selling air conditioners using the new technology. Which one of the following statements regarding EC’s treatment of its costs related to this project is correct? A. EC is required to capitalize project costs as incurred. B. EC is required to capitalize project costs starting on July 17, Year 4. C. EC is required to capitalize project costs starting on September 3, Year 4. D. EC is not required to capitalize project costs. Option A) is incorrect. Expenditure on research (or on the research phase of an internal project) should not be capitalized and shall be recognized as an expense when it is incurred. Additionally, under ASPE it is an accounting policy choice whether the company expenses or capitalizes internally generated intangible assets in the development phase. Option B) is incorrect. At this stage all six of the criteria to capitalize as development costs have not been met. Additionally, under ASPE it is an accounting policy choice whether the company expenses or capitalizes internally generated intangible assets in the development phase. Option C) is incorrect. At this stage all six criteria have been met; however, there is no requirement to capitalize. Option D) is correct. There is an accounting policy choice to either expense expenditures on internally generated intangible assets during the development phase or capitalize such expenditures as an intangible asset (provided all six of the criteria are met).This accounting policy choice shall be applied consistently to expenditures on all internal projects in the development phase. Since EC has not previously engaged in such projects and therefore has not yet selected an accounting policy, there is no requirement that costs ever be capitalized. 40 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 39. Takun Corp. (Takun), a wholesaler, sold 1,000 water filtration units for $300 each on January 10, Year 2. They were carried on Takun’s books as inventory at $150 each. The sales contract allows the purchaser to return defective products for a full refund over a period of up to one year from the time of purchase. Management expects 5% of units sold to be returned, and Takun pays for transportation to get the units back from the clients. It costs $30 on average to have each unit shipped back to Takun. In accordance with IFRS, how much net revenue should Takun recognize for the January 10 sale, and what amount should Takun recognize as an asset related to the right to recover returned products? A. Net revenue of $300,000; asset related to expected returns of $7,500 B. Net revenue of $285,000; asset related to expected returns of $6,000 C. Net revenue of $300,000; asset related to expected returns of $6,000 D. Net revenue of $285,000; asset related to expected returns of $9,000 Option A) is incorrect. The amount recorded for net revenue represents the full amount of sale (1,000 × $300 = $300,000). However, Takun can only recognize revenue up to the amount it expects to be entitled (that is, excluding the products expected to be returned). In addition, the amount recorded for the asset for expected returns (50 × $150 = $7,500) does not take into account the expected costs to recover each unit. Option B) is correct. The right of return has been recognized and the sale revenue reduced to the net amount of $285,000 (1,000 unit × $300 × 95%). Revenue has not been recognized for the products expected to be returned. The amount recorded for the asset related to the right of recovery has been measured at the former carrying amount of the product less expected costs to recover those products (including any potential decreases in the value to the entity of returned products).The asset value per unit is the inventory cost of $150 less the $30 to recover each unit [1,000 units × 5% × ($150 – $30) = $6,000]. Option C) is incorrect. The amount recorded for net revenue represents the full amount of sale (1,000 × $300 = $300,000). However, Takun can only recognize revenue up to the amount it expects to be entitled (that is, excluding the products expected to be returned). Option D) is incorrect. The amount recorded for the asset for expected returns includes the shipping costs as an increase in the asset value. [(1,000 units × 5% × ($150 + $30)] but this would reduce the asset amount since an asset recognized for an entity’s right to recover products from a customer on settling a refund liability shall be initially measured by reference to the former carrying amount of the product less expected costs to recover those products (including any potential decreases in the value to the entity of returned products). 41 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 40. Geraldton Amusement Park Ltd. (GAP) acquired 20,000 (20%) of the outstanding shares in Foxwood Video Games Corp. (FVG) for $240,000 on January 1, Year 5, when FVG’s shares were trading at $12 per share. GAP incurred $12,000 in transaction costs to acquire the shares. GAP sold the shares on December 31, Year 7, for $15 per share less $10,000 in transaction costs. The fair values per share during that period were as follows: December 31, Year 5 $14.00 December 31, Year 6 $12.50 December 31, Year 7 $15.00 During the period that GAP held the shares, significant influence did not exist and the investment was appropriately designated as a financial asset measured at fair value through profit and loss. In accordance with IFRS, which one of the following represents the impact of holding the shares in each of the three-year period on GAP’s profit and loss before taxes? A. Year 5: $28,000 gain; Year 6: $30,000 loss; Year 7: $40,000 gain B. Year 5: $0 gain/loss; Year 6: $0 gain/loss; Year 7: $38,000 gain C. Year 5: $12,000 loss; Year 6: $0 gain/loss; Year 7: $50,000 gain D. Year 5: $40,000 gain; Year 6: $30,000 loss; Year 7: $50,000 gain Option A) is correct. This expenses the transaction cost at the time of purchase and measures the investment at fair value at each subsequent reporting period. The gain in Year 5 is calculated as $240,000 – $12,000 – $280,000 = $28,000; The loss in Year 6 is calculated as $280,000 – $250,000 = ($30,000); The gain in Year 7 is calculated as $300,000 – $10,000 – $250,000 = $40,000. Option B) is incorrect. This records nothing on the investment until the sale, when the full gain (net of transaction costs) is recorded (that is, $28,000 – $30,000 + $40,000 = $38,000 gain for Year 7). Option C) is incorrect. This only expenses the transaction cost at the time of purchase, and defers all the gains (net of transaction costs for the sale) until the actual sale of the investment (that is, $38,000 gain net of transaction costs + $12,000 already expensed = $50,000 gain for Year 7). Option D) is incorrect. This ignores the transaction costs on the purchase and sale and only performs the fair value adjustments. 42 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 41. Fancy Fashions Inc. (FFI) sells clothes. The company began a loyalty program through which customers who sign up for the program earn one point for every dollar spent. Each point can be redeemed for $0.10 of clothing. FFI marks up its products by 50%. Currently, the full amount of sales is recognized as revenue immediately when the customer purchases the clothes. All customers have signed up for the loyalty program. During Year 1, 3.8 million points were issued to customers and 900,000 points were redeemed. Industry statistics for similar clothing retailers indicate that 60% of points issued will be redeemed. According to IFRS, how should the loyalty program be recorded in the financial statements for Year 1 (rounded to the nearest hundred)? A. As a reduction of revenue and an increase in deferred revenue in the amount of $164,200 B. As an increase in promotion expense and an increase in promotion liability in the amount of $152,000 C. As an increase in promotion expense and an increase in promotion liability in the amount of $146,200 D. As a reduction of revenue and an increase in deferred revenue in the amount of $228,000 Option A) is correct. The points provide a material right to customers that they would not have received without purchasing items from FFI. Therefore, IFRS requires that the promise to provide points to the customer be recognized as a performance obligation. FFI would allocate the transaction price to the products and points on a relative stand-alone selling price basis as follows: Stand-alone selling price Transaction price (TP) (SSP) Clothes $3,800,000 $3,584,900 3,800,000 points × $3.8 million × ($3.8 $1/point million/$4.028 million) Loyalty points $228,000 $215,100 60% × points × $0.10 $228,000 × ($3.8 million/$4.028 million) Total $4,028,000 $3,800,000 The amount of points unredeemed at the end of the year = 3,800,000 – 900,000 = 2,900,000. The amount of revenue related to the unredeemed points = (2,900,000 / 3,800,000) × $215,100 = $164,200 (rounded). Option B) is incorrect. The $152,000 is calculated using the cost value of the points ($0.10/1.5 × 60% × $3,800,000 = $152,000). 43 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions Option C) is incorrect. This is an erroneous calculation of the liability by using the markup information, which is not relevant to the calculation, and ignores the points redeemed: Stand-alone selling price Transaction price (TP) (SSP) Clothes $3,800,000 $3,653,800 3,800,000 points × $3.8 million × ($3.8 $1/point million/$3.952 million) Loyalty points $152,000 $146,200 60% × points × $0.10/1.5 $152,000 × ($3.8 million/$3.952 million) Total $3,952,000 $3,800,000 Option D) is incorrect. This distractor does not allocate the transaction price on a relative stand-alone selling price basis. Instead, it calculates the revenue to be differed based on the stand-alone selling price of the loyalty points only. 44 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 42. In Year 10, a lawsuit was initiated against Benall Corp. (Benall) by a competitor. The lawsuit had not been settled by the end of the year, but Benall’s lawyers expect that Benall will have to compensate its competitor for an amount between $750,000 and $1,500,000. How should this ligation be reflected in the Year 10 financial statements, when reporting under ASPE? A. Accrue $750,000 and disclose the details of the possible loss in the notes. B. Accrue $1,500,000 and disclose the details of the possible loss in the notes. C. Accrue $1,125,000 and disclose the details of the possible loss in the notes. D. Do not accrue any amount and disclose the range of the possible loss in the notes. Option A) is correct. The company is expecting to incur a loss. Therefore, an estimate of the amount of the contingent loss must be accrued. According to ASPE Section 3290.13, when there is a range of possible losses and no amount is a better estimate than the other amounts, the minimum amount of $750,000 should be accrued. Also, because the lawsuit is an unusual event, it should be disclosed in the notes. Option B) is incorrect. This is the maximum amount of the range and therefore is not correct. Option C) is incorrect. This is the average of the range and therefore is not correct. Option D) is incorrect. The contingent loss can be estimated, making this choice incorrect. 45 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 43. Olio Ltd.’s (Olio) year-end shareholders’ equity at December 31, Year 13, consisted of the following: Common shares, 500,000 issued and outstanding $5,000,000 Preferred shares, 8% cumulative, 90,000 issued and outstanding $6,300,000 Retained earnings $2,700,000 On April 1, Year 14, Olio issued 300,000 common shares for $3 million cash. In Year 14, the company reported net income after taxes of $1.5 million. No dividends were declared or paid during Year 14. In accordance with IFRS, what is Olio’s basic earnings per share for Year 14 (rounded to the nearest cent)? A. $1.37 B. $1.25 C. $1.99 D. $2.07 Option A) is correct. Net income available for common shareholders = $1,500,000 – (8% × $6,300,000) = $1,500,000 – $504,000 = $996,000 (the preferred dividends are cumulative and should be deducted even though they were not declared or paid). The weighted average number of shares outstanding = 500,000 + (300,000 × 9/12) = 725,000. Therefore, basic EPS = Net income available for common shareholder / Weighted average common shares outstanding = $996,000/725,000 = $1.37 Option B) is incorrect. This uses non-weighted number of shares: $996,000/800,000 = $1.25. Option C) is incorrect. This uses the beginning number of shares: $996,000/500,000 = $1.99. Option D) is incorrect. This does not deduct preferred dividends: $1,500,000/725,000 = $2.07. 46 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 44. KAR Industries manufactures a specialized washing brush for oversized vehicles. The following costs are incurred in producing and selling one batch of washing brushes: Direct labour $240 Direct materials $ 80 Allocated overhead directly associated with manufacturing the brushes $ 40 Storage costs after production but prior to selling $ 15 Selling costs $ 8 Delivery costs to the wholesaler $ 2 In accordance with ASPE, what is the cost of inventory for one batch of brushes? A. $375 B. $320 C. $360 D. $385 Option A) is incorrect. This includes the storage cost which is not part of the cost of inventory and is to be expensed in the period. $240 + $80 + $40 + $15 = $375 Option B) is incorrect. This does not include the allocated overhead. $240 + $80 = $320 Option C) is correct. The cost associated with production including an allocation of overhead is to be recorded as part of the cost of inventory. Therefore, inventory should be recorded at $240 + $80 + $40 = $360. Option D) is incorrect. This includes all costs as part of ending inventory. Storage and selling costs are not added to inventory costs and are to be expensed in the period. $240 + $80 + $40 + $15 + $8 + $2 = $385 47 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 45. FRG is a waste water treatment company that started its operations on January 1, Year 3. FRG entered into a lease agreement on its first day of operations to rent 10 turbines, for a total amount of $10,000 a year. The turbines are specifically designed with a technology that only FRG is using in the industry. On January 1 of Year 3, each turbine had a fair value of $6,000, and experts agreed that the depreciation for this type of asset would be around 10% annually. The lease term expires on December 31, Year 7. The key features of the lease agreement are as follows: There is no provision to allow a transfer of ownership to FRG by the end of the lease term. FRG has the option to purchase the 10 turbines for $36,000 at the end of the lease term. The economic life of the turbines is estimated at 10 years. FRG may extend its lease for another year at a total price of $5,000. According to IFRS, which one of the following facts would determine that FRG should record a right-of-use (ROU) asset and a lease liability? A. FRG has the option to purchase the turbines for $36,000 at the end of the lease term. B. The turbines are specifically designed with a technology that only FRG is using in the industry. C. FRG may extend the lease for another year at a total price of $5,000. D. The lease term expires on December 31, Year 7. Option A) is incorrect. If $36,000 was sufficiently lower than the fair value at that date to be reasonably certain that the option will be exercised, the bargain purchase option would be included in the lease liability calculation but it would not determine whether FRG should record an ROU asset and a lease liability. Option B) is incorrect. Whether or not the leased assets are of a specialized nature such that only the lessee can use them without major modification is not a determining factor in whether FRG should record an ROU asset and a lease liability. Option C) is incorrect. Whether or not the lessee has the ability to continue the lease for a secondary period is not a determining factor in whether FRG should record an ROU asset and a lease liability. 48 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions Option D) is correct. The lease term is five years; IFRS 16 Leases requires leases be recognized as an asset with a related lease obligation. The asset represents an ROU asset for a period of time and the obligation represents the payments required under the lease agreement. Short-term leases of one year or less and leases for low-value items are exempted from this treatment. 49 / 82 Core 1 — Retired Exam Set — Case 1 Multiple-Choice Questions 46. Gold-Firsch Corp. (GFC) is a multinational food processing facility. GFC entered into a joint arrangement with Cheese-Straws Inc. (CSI) to secure access to additional inventory, as well as warehouse space, and further expand its product line. This arrangement is structured through a separate vehicl

Core 1 Retired Exam Set Case 1 MCQ Solutions PDF

Document Details

Tags

Related

Summary

Full Transcript

Upgrade to continue