Mock Examination

AC491
Financial Reporting, Accounting and Disclosure

2018/2019 syllabus candidates- Mock Exam

Instructions to candidates

This paper is divided into three sections. The first section (Section A) consists of multiple choice questions;
the two other sections (Sections B and C) consist of problems and/or essay questions, with two questions in
each section.

You are required to answer:

 all questions in Section A,
 one question from Section B and
 one question from Section C.

The multiple choice section carries 30 marks. Each of the questions in Sections B and C carries 35 marks.

For Sections B and C: show all your workings clearly and state any assumptions you need to make.

Time Allowed Reading Time: None

Writing Time: 2 hours

You are supplied with: No additional materials

You may also use: No additional materials

Calculators: Calculators are allowed in this examination.

 LSE ST 2019/AC491 Page 1 of 23

 SECTION A

MULTIPLE CHOICE

[Questions 1-9: 2 marks each; Questions 10-13: 3 marks each - 30 marks total]

REQUIRED:

Please answer all the questions from this section. Choose one answer only. Please write all question
numbers in your answer books and the letter corresponding to your answer after each question number.

1. Which of the following is not one of the reasons why net income differs from cash flows from operations?
a. Non-cash items, such as depreciation and amortization.
b. Changes in accounts receivable.
c. Gains and losses related to the sale of plant, property, and equipment.
d. Sale or repurchase of capital stock.
[2 marks]

2. Assume that a company reports under US GAAP; If a manager wants to increase cash flows from
operations, he should
a. delay interest payments to providers of capital.
b. increase amortisation of intangibles.
c. sell equipment that has increased in value so that the company can record a gain on
disposal.
d. all of the above.
e. none of the above.
[2 marks]

3. A decrease in prepaid expenses of $8,000 for the year is

a. added back to net income to compute cash flow from operations.
b. subtracted to net income to compute cash flow from operations.
c. does not change the cash position of the company.
d. a and c.
[2 marks]

4. If a manager wants to increase the company’s shareholders’ equity this period, she should
a. issue stock.
b. increase sales regardless of whether the company receives the cash from the sales in the
current accounting period.
c. increase the number of orders it receives from its customers even if the company needs to
postpone the delivery goods to the next accounting period.
d. a and b.
e. all of them.
[2 marks]

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5. When a firm incorrectly records the sale of a good sold on layaway
a. Sales and expenses are overstated, but there is no effect on the balance sheet.
b. Sales and expenses are overstated and assets increase.
c. Sales are overstated, expenses are understated, and assets increase.
d. Sales are overstated, expenses are understated, and assets decrease.
[2 marks]

6. At the beginning of 2018, Company A acquires 100% of the shares of company B for £1,000m. At the time
of the acquisition B’s showed net assets of £450m. Included within the assets there was a building with a
book value of £300 but a fair value of £350. At the end of the year, the net assets of Company B amount
to £475m. What is the goodwill on acquisition?
a. £550
b. £525
c. £475
d. £500
[2 marks]

7. An investor would be willing to pay more than book value for an interest in a company because the fair
market value of net assets may be
e. greater than the book value.
f. greater than the discounted future cash flows that the company will generate in the future.
g. less than the book value.
h. less than the historical costs.
[2 marks]

8. Suppose that a firm starts capitalizing research and development costs that should have been expensed.
As a result,
i. assets and shareholders’ equity will be higher.
j. cash flows from operations will be higher.
k. a and b.
l. none of the above.
[2 marks]

9. The entry to record the cash payment of salaries that had previously been accrued has what effect on the
basic accounting equation?
a. Decrease liabilities, decrease assets.
b. Decrease liabilities, decrease stockholders' equity.
c. Decrease assets, decrease stockholders' equity.
d. Decrease assets, increase stockholders' equity.
e. None of the above answers is correct.
[2 marks]

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10. Mulch Barn Company began business on January 1, 2018. The company manufactures and sells stereo
equipment. The company provides a warranty on its units, whereby the company will replace any
defective part for two and one-half years after the sale, at no additional cost to the customer. During
2018, Mulch Barn Company had sales of £700,000. The company estimates that the cost of the
warranties will be 3% of sales. No warranty claims were made in 2018. During 2019, warranty claims of
£14,900 were made. All warranty claims were satisfied and paid for. What transaction entry, if any, is
necessary for 2018 by Mulch Barn Company in connection with warranties?

a. No transaction entry is necessary.

b. Increase Asset (Prepaid Warranty ) 21,000, Increase Liability for Warranties 21,000
c. Decrease P&L (Warranty Expense) 21,000, Increase Liability for Warranties 21,000
d. Increase P&L (Warranty) 21,000, Decrease Liability(Unearned Warranties) 21,000
e. None of the above.
[3 marks]

11. Branagh Inc. started fiscal year 2018 with an inventory balance of £500,000. During 2018, it purchased
additional inventory in the amount of £2,500,000. The income statement reported sales of £3,200,000.
The sale price included a markup of 25% over the original cost of the inventory sold. A physical count of
inventory on December 31st, 2018, resulted in ending inventory of £300,000. Branagh suspects some
inventory has been taken by a new employee during 2018. What is the estimated cost of the missing
inventory?
a. £25,000.
b. £100,000.
c. £140,000.
d. £500,000.
e. £0.
[3 marks]

12. Below are excerpts of the balance sheet of Edgware Inc.

31/12/2018 31/12/2017
Inventory £40,000 £45,000
Accounts payable £3,000 £2,000

Edgware Inc. paid suppliers £80,000 during the year ended December 31st, 2018. What was
Edgware’s cost of goods sold in 2018?
a. £80,000
b. £86,000
c. £81,000
d. £76,000
e. £84,000
[3 marks]

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13. On December 31st, 2017, the balance of prepayments for Aldgate, Plc. was £3,000. This balance related
to Aldgate’s insurance policy. Aldgate had paid an annual premium of £6,000 on July 1 st, 2017. On July
1st, 2018, Aldgate made another annual insurance premium payment in the amount of £6,400, as well as
a £4,000 advance rent payment for a warehouse. The warehouse will be leased for one year starting
from January 1st, 2019. What amount should Aldgate report in prepayments in the balance sheet in its
December 31st, 2018 balance sheet?
a. £10,400.
b. £7,200.
c. £4,000.
d. £3,200.
e. None of the above.
[3 marks]

[Total: 30 marks]

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 SECTION B

Please answer either Question B.1 or Question B.2 from this section.

QUESTION B.1: Revenue and cost recognition

This problem consists of six questions: five essay questions and one numerical questions Please provide
short, concise answers to each question.

a) Marques de Caceres is a Spanish producer of wine. After pressing the grapes, the company ferments
the wine in vats for some years. Discuss when Marques de Caceres should recognise revenue along
with any unique issues the company may face in the recognition of expenses
[7 marks]

The principal revenue recognition issue for Marques de Caceres is whether it should recognise the
increase in value of wine while it is aging (that is, revalue the wine to market value each year) or wait until
the wine is sold at the end of the aging process. Most accountants would argue that the market values of
aging wine are too uncertain prior to sale to justify periodic revaluations and revenue recognition.

Marques de Caceres should include in the cost of the wine inventory not only the initial production costs
but also the cost incurred during the aging process. In this way, the firm can match total incurred costs
with revenues generated at the time of sale.

b) One of the most profitable products of Apple is the iPhone. When Apple sells an iPhone, the buyer
gets a phone, together with the right to free software upgrades. Discuss when Apple should recognize
revenue related to the iPhone along with any unique issues the company may face in the recognition
of revenue and expenses.
[7 marks]

Apple should recognize upfront a percentage of the sale, to reflect the proceeds from the sale of the
phone and the software included, and defer the rest, to reflect the future upgrades. At the time of sale, it
should also recognize the value of the phone as cost of goods sold to achieve matching. The
controversial issue is how much of the value of the sale should be recognized now and how much in the
future. Under the old accounting standards, Apple had to differ most of the value of the sale because the
hardware and software are inseparable and the price of the hardware was unverifiable. The new
accounting standards (introduced in September 2009) give Apple more flexibility. In particular, they will be
able to estimate now the value of the hardware (phone), current software and future upgrades.

c) On September 22, 2015, Volkswagen announced it was working to clarify irregularities concerning
software used in diesel engines. For approximately 11 million vehicles worldwide, these irregularities
resulted in the mismeasurement of emissions. It is estimated that almost half of the Volkswagen cars
affected in Europe will require major hardware changes, including the installation of new parts, in order
to meet pollution standards. Volkswagen is considering offering full refunds to customers who do not
want their car back. In addition, it faces the threat of fines of up to £11.7 billion from the US and
potential legal claims from shareholders and motorists. Please discuss the accounting implications of
this scandal. Be specific about the accounting transactions that Volkswagen likely recorded as the
scandal emerged.
[7 marks]
 LSE ST 2019/AC491 Page 6 of 23
 Volkswagen should record provisions for the expected refunds and costs of installing new parts, as well as
for probable lawsuits. These will increase liabilities and decrease P&L.

d) During 2015, the Securities and Exchange Commission (SEC) charged Stein Mart Inc., a Florida-
based retail chain. An SEC investigation found that Stein Mart frequently offered merchandise to
customers at retail price below original cost (referred to as Perm POS markdowns), and that
merchandise subject to such markdowns never reverted back to its original retail price. As a result,
according to the SEC, Stein Mart overstated its pre-tax income for the first fiscal quarter of 2012 by
almost 20%.

In light of inventory accounting rules, why do you think Stein Mart was charged by the SEC? Please
be specific about the transactions that Stein Mart should have recorded but didn’t, as well as the impact
of the failure to record these transactions on Stein Mart’s financial statements
[7 marks]

The “lower of cost or market” rule requires Stein Mart to write down the inventory that is permanently
impaired (i.e., Stein Mart should have reduced inventory and taken a charge to P&L). Because Stein
Mart did not record this transaction, both inventory and net income (and retained earnings) are
overstated.

e) Piccadilly, Inc. sells gift cards which can be redeemed for store merchandise. These cards expire
one year after their issuance. Below is some information about Piccadilly’s gift cards:

31/12/2018 31/12/2017
Unearned Revenue £25,000 20,000
Gift cards sold in fiscal year 127,000 125,000

How much revenue did Piccadilly recognize in fiscal year 2018? How much of this revenue relates
to gift cards sold during 2018? [6 marks]

The amount of revenue recognized in fiscal year 2014 was £122,000 of which £102,000 relates to
gift cards sold during 2014.

[7 marks]

[Total: 35 marks]

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QUESTION B.2: Revenues and assets

Urban Outfitters (UO) is an American multinational clothing corporation managing five separate brands,
including its namesake, Anthropologie, Free People, Terrain and BHLDN. Please consider the excerpts from
UO’s annual report for the fiscal year ended January 31, 2015 (hereafter, fiscal year 2015) on pages 9-11 and
answer the following questions. Please ignore any potential tax effects. With the exception of question 1, all
amounts in the questions below are in thousands.

REQUIRED:

a) UO’s customers can buy gift certificates for amounts ranging from $10 to $1,000. How do you think UO
accounts for the sale of these gift certificates?
[4 marks]

Gift certificates are initially recorded as a liability (NOTE 6: “Gift certificates and merchandise credits”),
and recognized as revenue as they are redeemed or expire.

b) Assuming that the liability balance related to merchandise credits did not change during fiscal year 2015
and that the amount of gift certificates sold during 2015 was $500,000, what percentage of the net sales
number on the income statement relates to gift certificates that have been redeemed or have expired
during 2015?
[5 marks]

Gift certificates and merchandise credit:

CB=OB+gift certificates sold-gift certificate revenue recognized

47,943=44,311+500,000-gift certificates revenue recognized

gift certificates revenue recognized=496,368

gift certificates revenue recognized/net revenue=496,368/3,323,077=15%

c) Suppose that during fiscal year 2015 UO recorded a bad debt expense of $500. What was the amount
of write-offs?
[5 marks]
CB = OB + bad debt expense- write-offs
850 = 1711 + 500 – write-offs
Write-offs = 1,361

d) How do you think UO accounts for product returns? Assuming that items in the amount of $77,675 were
returned during fiscal year 2015, what was the amount by which net sales were reduced during 2015 as
a result of sales returns or projected sales returns? What percentage of the total sales made in 2015 is
expected to be returned?
[6 marks]
UO records a provision (accrual) for returns in the same period that the corresponding sales are made
(See notes to statements).

Sales returns reserves:

 LSE ST 2019/AC491 Page 8 of 23
 CB=OB+ provision added-provision used
19,804=17,089+provision added-77,675
Provision added=80,390

e) During fiscal year 2015, UO spent $229,804 to acquire and build new property and equipment, and sold
some property and equipment at a loss of $3,189.

a) Assuming there were no impairments, what was the accumulated depreciation on the property and
equipment sold during fiscal year 2015?
[5 marks]
Accumulated depreciation
CB = OB + depreciation expense - accumulated depreciation on PPE sold
933,332 = 834,129 + 131,414 – accumulated depreciation on PPE sold
Accumulated depreciation on PPE sold = 32,211

b) What was the original acquisition cost of the property and equipment items sold during fiscal year
2015?
[5 marks]
Gross PPE
CB = OB+PPE purchased-original acquisition cost of PPE sold
1,822,564 = 1,641,038+229,804-original acquisition cost of PPE sold
Original acquisition cost of PPE sold=48,278

c) What were the proceeds from the sale of these property and equipment items?
[5 marks]

Loss on sale of PPE = Proceeds - NBV PPE sold

NBV PPE sold = 48,278 (question 20.b) - 32,211 (question 20.a) = 16,067
Proceeds = NBV PPE sold - loss on sale of PPE = 16,067-3,189 = 12,878

[Total: 35 marks]

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 LSE ST 2019/AC491 Page 12 of 23
 SECTION C

Please answer either Question C.1 or Question C.2 from this section.

QUESTION 2: Cash Flows and Shareholders’ Equity

Refer to the information provided in the 2009 Consolidated Statement of Earnings, Consolidated Balance
sheet, Consolidated Statement of Cash Flows, and Consolidated Statement of Stockholders’ Equity of
General Mills on pages 14-17.

REQUIRED:

Please answer the following questions:

a) Estimate cash collected from customers (State all your assumptions).

[5 marks]

Collections = Beg. AR + Sales – End. AR = 1,081.6 + 14,691.3 – 953.4 = 14,819.5

Or if assume no write-offs:
Collections = Beg. AR, gross + Sales – End. AR, gross = (1,081.6+16.4) + 14,691.3 – (953.4+17.8) =
14,818.1

b) Estimate cash paid to suppliers. Assume that all Accounts Payable and Notes Payable relate to Suppliers.
[5 marks]
Purchases = Cost of sales + End. Inventory – Beg. Inventory
= 9,457.8 + 1,346.8 – 1,366.8 = 9,437.8

Cash paid to suppliers = Beg. Payables + Purchases – End. Payables

= (937.3 + 2,208.8) + 9,437.8 – (803.4 + 812.2) = 10,968.3

c) Assume the Company measures bad debt expenses as 2% of beginning gross receivables. Calculate the
amount of bad debts written off.
[5 marks]
Write-offs = Beg. Allowance + Bad Debt Expense – End. Allowance
= 16.4 + 2%*(1,081.6 + 16.4) – 17.8 = 20.56

d) Calculate dividends declared per share.

[3 marks]
$1.72 (Provided in Stockholders’ Equity Statement)

e) What is the effect of “gain on insurance settlement” on cash flows from operating activities?
[3 marks]

No effect

 LSE ST 2019/AC491 Page 13 of 23

f) How many shares did the Company repurchase during fiscal 2009? What was the average price per
repurchased share?
[5 marks]
20.2 million shares are repurchased from 1,296.4 / 20.2 = $64.18 per share

g) What is the number of outstanding shares at the end of fiscal year 2009?
[3 marks]
377.3 – 49.3 = 328 million shares

h) What is the meaning of earnings per se, diluted?

[3 marks]

Diluted earnings per share, also called diluted EPS, is a profitability calculation that measures the
amount of income each share will receive if all of the dilutive securities are realized. In other words, it
shows the effect of dilutive securities like stock options, rights to purchase common shares, bond and
preferred stock that can be converted to common shares on the basic earnings per share.

i) How much did the company pay to repurchase its own stock in 2009?
[3 marks]
$1,296.4

[Total: 35 marks]

 LSE ST 2019/AC491 Page 14 of 23

 Consolidated Statements of Earnings
GENERAL MILLS, INC. AND SUBSIDIARIES
(In Millions, Except per Share Data)

Fiscal Year
2009 2008 2007

Net sales $ 14,691.3 $ 13,652.1 $ 12,441.5

Cost of sales 9,457.8 8,778.3 7,955.1

Selling, general, and administrative expenses 2,953.9 2,625.0 2,389.3

Divestitures (gain), net (84.9) — —

Restructuring and other exit costs 41.6 21.0 39.3

Operating profit 2,322.9 2,227.8 2,057.8

Interest, net 390.0 421.7 426.5

Earnings before income taxes 1,932.9 1,806.1 1,631.3

Income taxes 720.4 622.2 560.1

After-tax earnings from joint ventures 91.9 110.8 72.7

Net earnings $ 1,304.4 $ 1,294.7 $ 1,143.9

Earnings per share - basic $ 3.93 $ 3.86 $ 3.30

Earnings per share - diluted $ 3.80 $ 3.71 $ 3.18
Dividends per share $ 1.72 $ 1.57 $ 1.44

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 Consolidated Balance Sheets
GENERAL MILLS, INC. AND SUBSIDIARIES
(In Millions, Except Par Value)

May 31, May 25,

2009 2008
ASSETS
Current assets:
Cash and cash equivalents $ 749.8 $ 661.0
Receivables less allowance for doubtful accounts of 17.8 and 16.4 respectively 953.4 1,081.6
Inventories 1,346.8 1,366.8
Deferred income taxes 15.6 —
Prepaid expenses and other current assets 469.3 510.6

Total current assets 3,534.9 3,620.0

Land, buildings, and equipment 3,034.9 3,108.1

Goodwill 6,663.0 6,786.1
Other intangible assets 3,747.0 3,777.2
Other assets 895.0 1,750.2

Total assets $ 17,874.8 $ 19,041.6

LIABILITIES AND EQUITY

Current liabilities:
Accounts payable $ 803.4 $ 937.3
Current portion of long-term debt 508.5 442.0
Notes payable 812.2 2,208.8
Deferred income taxes — 28.4
Other current liabilities 1,481.9 1,239.8

Total current liabilities 3,606.0 4,856.3

Long-term debt 5,754.8 4,348.7

Deferred income taxes 1,165.3 1,454.6
Other liabilities 1,931.7 1,923.9

Total liabilities 12,457.8 12,583.5

Minority interests 242.3 242.3

Stockholders’ equity:

Common stock, 377.3 shares issued, $0.10 par value 37.7 37.7
Additional paid-in capital 1,249.9 1,149.1
Retained earnings 7,235.6 6,510.7
Common stock in treasury, at cost, shares of 49.3 and 39.8 (2,473.1) (1,658.4)
Accumulated other comprehensive income (loss) (875.4) 176.7

Total stockholders’ equity 5,174.7 6,215.8

Total liabilities and equity $ 17,874.8 $ 19,041.6

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 Consolidated Statements of Cash Flows
GENERAL MILLS, INC. AND SUBSIDIARIES
(In Millions)
Fiscal Year
2009 2008 2007
Cash Flows - Operating Activities
Net earnings $ 1,304.4 $ 1,294.7 $ 1,143.9
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization 453.6 459.2 417.8
After-tax earnings from joint ventures (91.9) (110.8) (72.7)
Stock-based compensation 117.7 133.2 127.1
Deferred income taxes 215.8 98.1 26.0
Tax benefit on exercised options (89.1) (55.7) (73.1)
Distributions of earnings from joint ventures 68.5 108.7 45.2
Pension and other postretirement benefit plan
contributions (220.3) (14.2) (60.6)
Pension and other postretirement benefit plan
(income) expense (27.5) 5.5 5.6
Divestitures (gain), net (84.9) — —
Gain on insurance settlement (41.3) — —
Restructuring, and other exit costs (income) 31.3 (1.7) 39.1
Changes in current assets and liabilities 176.9 (126.7) 149.1
Other, net 15.0 (60.4) 3.8

Net cash provided by operating activities 1,828.2 1,729.9 1,751.2

Cash Flows - Investing Activities

Purchases of land, buildings, and equipment (562.6) (522.0) (460.2)
Acquisitions — 0.6 (83.4)
Investments in affiliates, net 5.9 64.6 (100.5)
Proceeds from disposal of land, buildings, and equipment 4.1 25.9 13.8
Proceeds from divestitures of product lines 244.7 — 13.5
Proceeds from insurance settlement 41.3 — —
Other, net (22.3) (11.5) 19.7

Net cash used by investing activities (288.9) (442.4) (597.1)

Cash Flows - Financing Activities

Change in notes payable (1,390.5) 946.6 (280.4)
Issuance of long-term debt 1,850.0 1,450.0 2,650.0
Payment of long-term debt (370.3) (1,623.4) (2,323.2)
Settlement of Lehman Brothers forward purchase contract — 750.0 —
Repurchase of Series B-1 membership interests in GMC — (843.0) —
Repurchase of General Mills Capital, Inc. preferred stock — (150.0) —
Proceeds from sale of Class A limited membership
interests in GMC — 92.3 —
Proceeds from common stock issued on exercised options 305.2 191.4 317.4
Tax benefit on exercised options 89.1 55.7 73.1
Purchases of common stock for treasury (1,296.4) (1,432.4) (1,320.7)
Dividends paid (579.5) (529.7) (505.2)
Other, net (12.1) (0.5) (9.1)

Net cash used by financing activities (1,404.5) (1,093.0) (1,398.1)

Effect of exchange rate changes on cash and cash equivalents (46.0) 49.4 13.7

Increase (decrease) in cash and cash equivalents 88.8 243.9 (230.3)

 LSE ST 2019/AC491 Page 17 of 23

 Consolidated Statements of Stockholders’ Equity and Comprehensive Income
GENERAL MILLS, INC. AND SUBSIDIARIES
(In Millions, Except per Share Data)

$0.10 Par Value Common Stock (1 Billion Shares Authorized)

Issued Treasury
Retained Accumulated
Shares Par Amount APIC Shares Amount Earnings Other CI
Balance as of May 25, 2008 377.3 37.7 1149.1 -39.8 -1658.4 6510.7 176.7
Comprehensive income:
Net earnings 1304.4
Other comprehensive loss -1052.1
Total comprehensive income
Cash dividends declared ($1.72 per share) -579.5
Stock compensation plans 23 9.8 443.1
Shares purchased -20.2 -1296.4
Shares issued for acquisition 16.4 0.9 38.6
Unearned compensation for restricted stock awards -56.2
Earned compensation 117.6
Balance as of May 31, 2009 377.3 37.7 1249.9 -49.3 -2473.1 7235.6 -875.4

 LSE ST 2019/AC491 Page 18 of 23

QUESTION C.2: Cash Flow Statement

The Cash Flow Statement of Wiley, a major US publishing company, is provided on pages 20-21, together
with selected information from the balance sheet and notes to the financial statements. Wiley publishes and
sells books, together with subscriptions to journals and other periodic publications.

NOTE: For the purpose of this exercise, ignore the “reserve for returns, doubtful accounts and
obsolescence”.

REQUIRED:

Using only the information provided, answer the following questions.

a) List the largest source of cash and the 2 largest uses of cash for 2003.

Sources:
1. Cash flows from operations - sales
Uses:
1. Additions to P,P&E
2. Additions to product development assets
[3 marks]

b) Wiley defers part of its revenue, related to subscriptions to journals and other publications. If Wiley had
not deferred any revenue, net income would have been (circle one)
lower
higher by (how much)_____3,810

If Wiley had no deferred any revenue, it would have recognised all the cash received from the new
subscriptions. We can estimate the difference between the amount of cash received and the revenue
recognised by analysing the deferred revenue account. Since:

o.b. Deferred subscription revenues + new subscriptions – revenue recognised = c.b deferred subscription
revenue

change in deferred subscription revenue = $3,810 = new subscriptions – revenue recognised

Hence, Wiley’s net income would have been $3,810 higher.
[5 marks]

c) In 2003, Wiley’s revenue on an accrual basis was $853,971 (in thousands). How much was Wiley’s 2003
revenue on a cash basis? Hint: what do you need to do about unearned revenue?
[6 marks]
Revenue on a cash basis = Revenue on an accrual basis – increase in accounts receivables + increase in
deferred subscription revenues = 853,971 – 17,862 + 3,810 = 839,919

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d) Refer to the cash flow statement and the notes at the end of problem (Additional information from the
notes to the financial statements). What do composition costs reflect? Why is Wiley capitalising these
costs?
[4 marks]
Composition costs, primarily representing the costs incurred to bring an edited commercial manuscript to
publication including typesetting, proofreading, design and illustration, etc. are capitalized and generally
amortized on a double-declining basis over the estimated useful lives, ranging from 1 to 3 years.

They are capitalised because they meet the asset definition criteria:
1. The future economic benefit is quantifiable
2. They are the result of a past transaction or event.

e) How much net income would have Wiley reported in 2003 if instead of capitalising composition costs it
had expensed them? You can ignore taxes.
[6 marks]

Since Wiley capitalises composition costs, net income is reduced by the amortisation of capitalisation
costs, 29,923 (from the cash flow statement). However, if the costs were to be expensed then net income
would be reduced by total cost (capitalised cost) for the year.

The composition costs capitalised during the year can be estimated using the composition cost account:

o.b. Composition cost asset + additions (costs for the year) – amortisation = c.b. composition cost asset
cost for the year or additions = change in composition costs + amortisation= 2,454 + 29,923 = 32,377.

Net income under expensing = net income under capitalising + amortisation - cost for the year = 87,275
+29,923 – 32,377 = 84,821

f) Assume that all the costs incurred during the year for product development (composition costs and royalty
advances to authors) have been paid in cash. How much did the company pay as royalty advances to
customers?
[6 marks]
Additions to product developments (from CFI) = Additions to composition costs (from question 4) +
additions to royalty advances to authors
51,835 = 32,377 + additions to royalty advances to authors

Hence, additions to royalty advances to authors = 19,458

g) Assume that the 2003 opening balance of the Property, Plant and Equipment account, net value, is
$100,000 (in thousands) (the accumulated depreciation is $55,000). Using the information in the cash flow
statement only, what is the closing balance of PP&E (original cost)?
[5 marks]
Use gross amounts (or original costs)
OB + additions – disposals – impairments = CB
155,000 + 63,221 – 0 – 0 = 218,221 = CB

[Total: 35 marks]

 LSE ST 2019/AC491 Page 20 of 23

 LSE ST 2019/AC491 Page 21 of 23
Selected information from the 2002 Balance Sheet (dollars in thousands)

2003 2002

Composition costs, net 31,959 29,505

Additional information from the notes to the financial statements:

1. Product development assets: consist of composition costs and royalties advances to authors. Cost
associated with developing any publication are expensed until the product is determined to be
commercially viable. Composition costs, primarily representing the costs incurred to bring an edited
commercial manuscript to publication including typesetting, proofreading, design and illustration, etc. are
capitalized and generally amortized on a double-declining basis over the estimated useful lives, ranging
from 1 to 3 years. Royalty advances to authors are capitalized and, upon publication, are recovered as
royalties are earned by the authors based on the sales of published works.

 LSE ST 2019/AC491 Page 22 of 23

 LSE ST 2019/AC491 Page 23 of 23