Quiz #2

Question 1

Question 1
The auditor for Table Catering is examining the financial statements and notices an increase in the year-end ratio of bad debt expense to accounts receivable.

This may indicate which one of the following scenarios?

a) More sales occurred toward the end of the year.
b) Bad debts occur randomly and cannot be predicted.
c) Credit controls may have been loosened.
d) Accounts receivable are over-recorded.

Answer 1

Option c) is correct. If credit controls are loosened, then a company would allow more customers to have higher credit limits. In this situation, the auditor would expect that accounts receivable would increase, resulting in increased credit risk and bad debts.

Question 2

The auditor for Callihan Software Co. is assessing the audit evidence gathered over the inventory cycle to ensure sufficient appropriate evidence has been obtained over the related accounts.

Which one of the following is the MOST reliable type of audit evidence over the inventory cycle?

a) Confirmation of bank balances for accounts from which supplier payments were made
b) Inspecting supplier invoices and bank statements showing payment
c) Footing (recalculating) the inventory subledger
d) Performing test counts of inventory

Answer 2

Option d) is correct. The auditor’s execution of procedures or controls is an externally generated type of audit evidence, which is the most reliable of the three types of audit evidence (internally generated, externally generated but held by the client, and externally generated).

Question 3

SHerman is inquiring with management of Illusion Pharmaceuticals (IP) about changes that have occurred in the year as part of the audit planning process. The CFO tells Herman that IP changed its depreciation accounting policy at the beginning of the year from the declining balance method to the straight-line method.

Which one of the following assertions is the main risk related to depreciation expense as a result of the change in accounting policy?

a) Accuracy
b) Occurrence
c) Completeness
d) Existence

Answer 3

Option a) is correct. As a result of the change to IP’s depreciation policy, depreciation expense may be recorded at the incorrect amount. This describes the accuracy of depreciation expense.

Question 4

Time Watch Co. (Time) manufactures watches that are sold on credit to retail customers across Canada.

Which one of the following is the BEST control that could be implemented to decrease the accuracy, valuation, and allocation risk in the accounts receivable (AR) balance?

a) A credit check is completed on each new customer before the first sale is made.
b) Sale prices on invoices are automatically applied from an approved price list.
c) Invoices are pre-numbered and sequence-checked for each sale.
d) Each month, an exception report that shows orders made but not yet shipped is created and reviewed.

Answer 4

Option b) is incorrect. This control increases the accuracy of sales revenue, as revenue that has been recorded is examined to ensure it is at the correct amount. Option a) is correct. By completing a credit check on each customer before selling watches to that customer, Time can select only creditworthy customers. This increases the likelihood that customers will pay, and thus that Time will be able to collect its AR from its customers. Time is less likely to have to write off its AR.

Question 5

On December 31, Thomas spent the day attending the inventory count of his audit client, Tack’s Wood Furniture. When the count was completed, Thomas received a copy of the count sheets and final inventory listing. He randomly selected a sample of 15 inventory items from the warehouse and counted each item, and then compared his count to the number of items on the count sheets and the final inventory listing. When performing this procedure, Thomas found that four of the 15 sample items from the warehouse were not included in the count sheets or inventory listing.

Which one of the following is the MOST likely implication of the issue discovered by Thomas at the inventory count?

a) The inventory balance does not exist.
b) The inventory balance is not valued accurately.
c) The inventory balance is not complete.
d) The inventory balance is not classified appropriately.

Answer 5

Option c) is correct. Thomas found that items that should have been recorded in inventory were not actually recorded, which means that the inventory listing is not complete. This is the description of a floor-to-sheet test.

Question 6

Roberta, the auditor for Robin Airlines, is performing procedures over expenses. When selecting a sample of expenses, Roberta noticed that many expenses seemed to be rounded to the nearest thousand dollars. Roberta showed this to the audit manager, and they both agreed it was odd to see so many rounded journal entries. As part of the audit response, the audit manager asked Roberta to perform an additional audit procedure using audit data analytics.

In which one of the following ways could audit data analytics be used to investigate this issue?

a) Examine the population of journal entries for all entries rounded to the nearest thousand dollars.
b) Recalculate all expense totals by developing an expectation of each expense and comparing it to the amounts recorded.
c) Reconcile the population of all journal entries to the financial statements.
d) Perform a test of controls to determine whether expense invoices and transactions were approved before posting.

Answer 6

Option a) is correct. This is an audit data analytic procedure that could be performed to determine whether there are widespread journal entries that are rounded to the nearest thousand dollars. The auditor could then inquire with management about the purpose of the entries found and request documentation to support the entries, to ensure the underlying transactions occurred.

Question 7

Xavier is performing audit procedures over the payroll cycle at Highlights Clothing Corp. (HCC). Xavier recalculates the expected payroll liability at year end based on the average payroll expense per pay period and the number of days in the final pay period from the year under audit.

Which one of the following statements BEST describes how the procedure performed by Xavier addresses the risks identified in the payroll cycle?

a) This procedure supports the cutoff of the payroll liability at year end.
b) This procedure supports the occurrence of payroll expense for the year.
c) This procedure supports the completeness of the payroll liability at year end.
d) This procedure supports the classification of the payroll liability at year end.

Answer 7

Option c) is correct. In performing this procedure, Xavier will determine whether the payroll liability related to the final pay period of the year has been recorded as owed, which is completeness of the liability.

Question 8

Verde Inc. is being audited for its June 30 year end. Sally is the junior auditor on the audit team, and she has been asked to perform audit procedures over the purchases, payables, and payments cycle. For one procedure, Sally examines the accounts payable (AP) listing and records the five vendors with the highest balances owed. When Sally compares the results of this procedure to that of the prior year, she notes that the three vendors with highest balances owed in the prior year were not included in the AP listing this year at all.

Which one of the following tables shows the risk of material misstatement tested as a result of this audit procedure?

a)

Expenses Accounts payable
Existence X
Occurrence X
Completeness
Accuracy
b)

Expenses Accounts payable
Existence X
Occurrence
Completeness X
Accuracy X
c)

Expenses Accounts payable
Existence X
Occurrence
Completeness X
Accuracy
d)

Expenses Accounts payable
Existence X
Occurrence
Completeness X
Accuracy X

Answer 8

Option c) is correct. With this test, Sally is determining whether vendors with amounts owed are missing from the current-year AP listing. The concern is that the AP and expense balances may be understated. Sally is testing to ensure that the AP balance and expenses are complete; that is, all payables and expense that should have been recorded are actually recorded.

Question 9

Kima Inc. had credit sales of $600,000 and cash collections of $450,000 last year. The ending balance in accounts receivable was $175,000. The allowance for doubtful accounts (AFDA) has a current credit balance of $2,600. Based on an aging analysis, Kima has estimated that the AFDA is 4% of the gross amount of outstanding receivables.

How much is the bad debt expense for the year?

a) $4,400
b) $6,000
c) $7,000
d) $9,600

Answer 9

Option a) is correct. The AFDA should be 4% × $175,000 = $7,000. Therefore, the journal entry required is Dr. Bad debts $4,400 ($7,000 – $2,600) and Cr. AFDA $4,400.

Question 10

LMN Inc. manufactures environmental testing equipment and reports under ASPE. The following is information for Years 3 and 4:

Year 3 Year 4
Sales $2,500,000 $2,600,000
Gross profit $1,000,000 $1,200,000
Net income $125,000 $150,000
Beginning inventory $275,000 $300,000
Ending inventory $300,000 $245,000
The industry average for inventory turnover is 5.00 times.

Which one of the following statements about LMN’s inventory turnover ratio is true?

a) LMN’s inventory turnover has worsened, and it is also worse than industry.
b) LMN’s inventory turnover has worsened, but it is better than the industry average.
c) LMN’s inventory turnover is improving, and it is better than the industry average.
d) LMN’s inventory turnover is improving, but it is worse than the industry average.

Answer 10

Option b) is correct. The inventory turnover is 5.22 times in Year 3 [($2,500,000 sales – $1,000,000 gross profit) / {($300,000 ending inventory balance + $275,000 beginning inventory balance) / 2}]. Inventory turnover is 5.14 times in Year 4 [($2,600,000 sales – $1,200,000 gross profit) / {($245,000 ending inventory balance + $300,000 beginning inventory balance) / 2}]. A higher inventory turnover ratio is better, so LMN’s ratio is worsening, but it is still better than the industry average of 5.00 times.

Question 11

JS Corp.’s income statement for the last two years is as follows (in thousands):

Year ended December 31 Year 2 Year 1
Sales $1,545 $1,390
Sales returns 55 60
Net sales 1,490 1,330
Cost of goods sold 815 905
Gross profit 675 425
Administrative expenses 160 140
Selling expenses 135 105
Profit or loss $380 $180
Earnings per share ? ?

In Year 1, JS had 1,000 common shares and 800 preferred shares outstanding throughout the year. On January 1, Year 2, JS issued an additional 1,000 common shares. The preferred shares pay a non-cumulative dividend of $50 per share, which was paid in Year 2 but not in Year 1.

Which one of the following statements BEST explains JS’s change in earnings per share between Years 1 and 2?

a) JS increased its advertising between Year 1 and Year 2, causing sales to increase by over 11%.
b) JS paid dividends in Year 2, but not in Year 1.
c) JS found a new supplier for its main raw material, which decreased inventory costs.
d) JS’s non-operating expenses increased between Years 1 and 3.

Answer 11

Option a) is incorrect. Selling expenses increased by $30,000 and sales increased by $155,000 between Year 1 and Year 2, but earnings per share decreased, so this is not the best explanation for the change.
Option b) is correct. Earnings per share decreased between Years 1 and 2 because JS paid dividends on its preferred shares in Year 2, but not in Year 1.

Earnings per share in Year 1: $180,000 ÷ 1,000 = $1.80
Earnings per share in Year 2: [$380,000 – (800 × $50)] ÷ 2,000 = $1.70

Question 12

On January 1, Year 3, Fletcher Machinery (Fletcher) sold a piece of equipment to Custom Draperies (Custom) in exchange for a $120,000 non-interest bearing note receivable due on January 1, Year 5. On January 1, Year 3, the prime interest rate was 7.2%. Fletcher’s term loans have an 8% interest rate, and Customer has an incremental borrowing rate of 8.8%. Fletcher reports under IFRS.

At which one of the following amounts will the note receivable be recorded in the books of Fletcher on January 1, Year 3?

a) $101,373
b) $102,881
c) $104,422
d) $120,000

Answer 12

Option b) is incorrect. This uses Fletcher’s term loan interest rate of 8%, but the borrower’s incremental borrowing rate should be used. Incorrect calculation: FV = 120,000; PMT = 0; N = 2; I/Y = 8%; CPT PV = -$102,881.
Option a) is correct. The note is recorded at its present value, calculated using Custom’s incremental borrowing rate of 8.8%. The discount rate used is the more easily determinable of the rate implicit in the note when the cash price is known, and the borrower’s incremental borrowing rate. In this situation, the cash price is unknown, so Custom’s incremental borrowing rate is used. Correct calculation: FV = 120,000; PMT = 0; N = 2; I/Y = 8.8%; CPT PV = -$101,373.

Question 13

On January 1, Year 12, Ames Equipment Corp. (AEC) sold a piece of customized machinery with a cash price of $550,000 in return for a four-year, non-interest bearing note with a face value of $675,000. AEC reports under ASPE and has a December 31 year end. AEC uses the straight-line method to calculate interest revenue.

Which one of the following is the amount at which AEC will report the note receivable on its balance sheet on December 31, Year 13?

a) $581,250
b) $609,303
c) $612,500
d) $675,000

Answer 13

Option c) is correct. Annual amortization of the note discount under the straight-line method is ($675,000 – $550,000) / 4 = $31,250. The amortized cost of the note receivable on December 31, Year 13, is $550,000 + ($31,250 × 2) = $612,500.

Question 14

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Question 14
Consider the following select data from Winslow Inc.’s financial statements, in thousands:

                                                                 Year 3	   Year 2   	Year 1 Accounts receivable (AR)	                         $630	      $576    	$490 Sales	                                                             4,235    	4,270	 Credit sales	                                                 3,560    	3,470	

Which one of the following statements BEST explains Winslow’s AR turnover for Years 2 and 3?

a) AR turnover increased between Years 2 and 3, which may have been caused by Winslow increasing its collections calls to customers in Year 3.

b) AR turnover increased between Years 2 and 3, which may have been caused by Winslow allowing more customers to purchase goods on credit.

c) AR turnover decreased between Years 2 and 3, which may be caused by Winslow decreasing the price of its most popular product in Year 3.

d) AR turnover decreased between Years 2 and 3, which may be caused by Winslow increasing its credit limit for all customers by 10%.

Answer 14

Option a) is incorrect. Increasing collections calls to customers should lead to a decrease in AR and AR turnover, as Winslow is more likely to collect its receivables quickly. While the AR turnover did decrease between Year 2 and 3, AR actually increased.

Option d) is correct. AR turnover decreased between Years 2 and 3. Increasing the customers’ credit limits has caused AR to increase, leading to a decrease in AR turnover.

Year 2 AR turnover: $3,470 / [($490 + $576) / 2] = 6.5
Year 3 AR turnover: $3,560 / [($576 + $630) / 2] = 5.9

Question 15

Landry Fine Goods (Landry) provides credit to well-established customers on 2/10, net 30 terms. New customers who are granted credit are given 30-day terms but are offered no discount for early payment.

Details of Landry’s sales-related transactions in May of Year 8 follow:

Sold $35,000 of goods to established customers on credit terms
Sold $15,000 of goods to new customers on credit terms
Sold $20,000 of goods for cash
Within 10 days of sale: received payment on account from established customers for $22,000 of merchandise sold
More than 10 days after sale: received payment on account from established customers for $16,000 of merchandise sold
Received payment on account from new customers for $14,000 of merchandise sold
Landry uses the net method to record its AR.

How much is the total amount of cash received from customers during May of Year 8?

a) $51,560
b) $70,560
c) $71,560
d) $72,000

Answer 15

Option d) is incorrect. The 2% discount on receivables collected within 10 days of the sale was not included for established customers. Incorrect calculation: $22,000 + $16,000 + $14,000 + $20,000 = $72,000.

						Option c) is correct. Following is a breakdown of the amount of cash received by Landry during May of Year 8:

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From established customers — discount: $22,000 × (1 – 2%) = $21,560
From established customers — no discount: $16,000
New customers — no discount: $14,000
Cash sales: $20,000

Amount of cash received in May Year 8: $71,560

Question 16

Question 16
The following accounts were taken from Blue Monkey Inc.’s unadjusted trial balance on December 31, Year 2:

Accounts receivable $850,000
Unadjusted allowance for doubtful accounts (AFDA) January 1, Year 2 (debit balance) $11,000
Net credit sales $2,950,000
Blue Monkey estimates that 1.5% of the gross accounts receivable will become uncollectable. Blue Monkey reports under ASPE.

How much is the bad debts expense for Year 2?

a) $1,750
b) $12,750
c) $23,750
d) $55,250

Answer 16

Option c) is correct. $850,000 × 1.5% = $12,750 desired credit balance of AFDA + $11,000 debit balance of AFDA before adjustment = $23,750.

Question 17

Alexander Co. regularly purchases investments in bonds, mortgages, and loans. The company classifies its investments in these financial instruments at fair value through other comprehensive income (FVOCI), a decision that is consistent with its business model. Alexander has a December 31 year-end and reports under IFRS.

At the end of Year 4, Alexander has an investment in one bond. Pertinent details follow:

Book value of the bond on December 31, Year 4 (prior to year-end adjustments) $228,500
Cash interest received on the bond during Year 4 and recorded as revenue 16,770
Interest revenue earned in Year 4 using amortized cost (no adjustment made) 18,981
Market value of the bond on December 31, Year 4 240,000
Which one of the following is included in the adjusting journal entry on December 31, Year 4, to bring the investment to its fair value?

a) Dr. Investment in financial asset at FVOCI $11,500
Cr. Interest revenue $2,211
Cr. OCI $9,289

b) Dr. Investment in financial asset at FVOCI $11,500
Cr. OCI $11,500

c) Dr. Investment in financial asset at FVOCI $9,289
Cr. Interest revenue $2,211
Cr. OCI $11,500

d) Dr. Investment in financial asset at FVOCI $11,500
Cr. Interest revenue $2,211
Cr. OCI $13,711

Answer 17

Option d) is incorrect. This entry incorrectly treats the amortization of the bond discount as a debit (decrease) to interest revenue rather than a credit (increase). As a result, the adjustment to OCI is calculated incorrectly. Incorrect calculation: ($240,000 – $228,500) + ($18,981 – $16,770) = $13,711.
Option a) is correct. Based on the T-account below, an entry to the investment account is required to:

Investments at FVOCI
Balance December 31, Year 4 (prior to adjustment): $228,500
Amortization of discount December 31, Year 4 ($18,981 – $16,770): $2,211
Carrying value December 31, Year 4, before fair value adjustment: $230,711
Required adjusting entry: $9,289
Required balance December 31, Year 4 (fair value): $240,000

Question 18

Brown Inc. (BI) reports an investment in bonds using the amortized cost method. The bonds have a face value of $1,000,000 and were purchased on January 1, Year 1. The market interest rate is 8%, and the bonds pay interest at a rate of 6%. Interest payments are made every June 30 and December 31. The bonds mature 10 years from the date of purchase, on December 31.

Which one of the following journal entries records the acquisition of the bonds on January 1, Year 1?

a) Dr. Investment in bonds $664,496
Cr. Cash $664,496

b) Dr. Investment in bonds $864,097
Cr. Cash $864,097

c) Dr. Investment in bonds $880,405
Cr. Cash $880,405

d) Dr. Investment in bonds $1,000,000
Cr. Cash $1,000,000

Answer 18

Option c) is incorrect. This assumes payments are at the beginning of the period (January 1 and July 1) instead of the end (June 30 and December 31). Incorrect calculation: FV = $1,000,000; PMT = $30,000 ($1,000,000 × 6% / 2); N = 20 (10 years × 2 payments per year); I/Y = 4% (8% / 2 to reflect 20 half-year periods); BGN, CPT PV = –$880,405.

Option b) is correct. The investment in bonds is recorded at its present value using the effective interest method. FV = $1,000,000; PMT = $30,000 ($1,000,000 × 6% / 2); N = 20 (10 years × 2 payments per year); I/Y = 4% (8% / 2 to reflect half-year periods); CPT PV = –$864,097.

Question 19

Long River has the following assets on December 31, Year 3:

Asset Amount
Canadian chequing and savings bank accounts $575,300
Investment in common shares of Tulle Inc. (a private company) 22,000
Investment in preferred shares of Tulle Inc., acquired December 1, Year 3, non-redeemable and paying 9.5% per year 120,000
Term deposit (matures January 10, Year 4) 55,000
U.S. dollar savings account (US$13,727 or C$18,519) 18,519
Long River reports under IFRS and has a December 31 year end.

Which one of the following is the cash and cash equivalent balance reported in Long River’s statement of financial position on December 31, Year 3?

a) $593,819
b) $644,027
c) $648,819
d) $768,819

Answer 19

Option c) is correct. The Canadian cash, term deposit, and U.S. dollar savings account are all considered cash or cash equivalents. $575,300 + $55,000 + $18,519 = $648,819.

Question 20

Max, a CPA, works for Hydrostone Inc., a real-estate development firm that recently completed a downtown condo building. Hydrostone reports under ASPE.

Which one of the following related-party transactions is in the normal course of operations?

a) Hydrostone sold a condo to the daughter of its majority shareholder. Terms and conditions of the sale were consistent with those of sales to unrelated parties.
b) Hydrostone sold furniture from its head office to a member of its board of directors. The furniture, which did not match the newly painted head office, was sold at market price to the director.
c) Hydrostone repaid a shareholder loan that had been outstanding for two years.
d) Hydrostone issued preferred shares to a related party to finance a large condo development.

Answer 20

Option b) is incorrect. Office furniture is a capital asset, and paragraph 27 of Section 3840 Related Party Transactions states that “examples of transactions not in the normal course of operations include the sale or purchase of capital assets.” Option a) is correct. This is a transaction in the normal course of operations, as Hydrostone is a real-estate development firm that recently completed a condo building. Per paragraph 25 of Section 3840 Related Party Transactions: “Usually, a related party transaction that is in the normal course of operations occurs within a normal business relationship and on terms and conditions that are similar to those of transactions with unrelated parties.” As noted in paragraph 24, examples of transactions in the normal course of operations include “a sale or purchase of real estate by an enterprise that is in the business of selling real estate as part of its ongoing activities.”

Question 21

Genette Inc. (GI) provides environmental consulting services and reports under ASPE. In the current year, GI exchanged five unused computers for a piece of testing equipment with a related company, TD Services. GI and TD Services are owned by the same individual.

Which one of the following describes how GI should account for this transaction?

a) Measure the transaction at the carrying amount, and record any difference between the carrying amounts exchanged in income.
b) Measure the transaction at the carrying amount, and record any difference between the carrying amounts exchanged in equity.
c) Measure the transaction at the exchange amount, and record any difference between the carrying amounts exchanged in income.
d) Measure the transaction at the exchange amount, and record any difference between the carrying amounts exchanged in equity.

Answer 21

Option a) is incorrect. It is true that the transaction is accounted for at carrying amount; however, any difference between the carrying amounts of items exchanged is included as a charge to equity. Option b) is correct. The sale of computers is not in the normal course of operations for GI, an environmental consulting business, and the change of ownership over the computers is not substantive, as one individual owns both GI and TD Services. Therefore, the transaction is measured at the carrying amount for the computers. When related party transactions are measured at the carrying amount, any difference between the carrying amounts of items exchanged is included as a charge to equity. Gains are credited to contributed surplus. Losses are debited to any existing contributed surplus from prior related party transactions, and the remainder is debited to retained earnings.

Question 22

On April 15, Year 3, Big Co. bought 10,000 shares of Stripes Inc. for $22 per share and reported this purchase as an investment at fair value through profit or loss (FVPL). On September 1, Year 3, Stripes declared a dividend of $0.25 per share that is payable on September 20, Year 3. On December 15, Year 3, Stripes declared a dividend of $0.30 per share payable on January 15, Year 4.

On December 31, Year 3, the market value of Stripes shares was $20 per share. Big has a December 31 year-end and reports under IFRS.

How much will Big report on its December 31, Year 3, statement of comprehensive income pertaining to its investment in Stripes?

a) $20,000 loss
b) $17,500 loss
c) $14,500 loss
d) $5,500 income

Answer 22

Option b) is incorrect. This does not include the $3,000 income from the dividend declared on December 15. Incorrect calculation: ($0.25 × 10,000) + [($20 – $22) × 10,000] = ($17,500). Option c) is correct. The following items will influence the statement of comprehensive income:

Dividend income received | $0.25 × 10,000 | $2,500 |
| Dividend income receivable | $0.30 × 10,000 | $3,000 |
| Holding loss on shares | ($20 – $22) × 10,000 | ($20,000) |
| Total | | ($14,500) |

Question 23

Whirlwind Inc. (WI) was approved for a grant from the Canadian government at the end of Year 5. The grant will provide a maximum of $475,000 to purchase a building to be used as a production facility. WI is entitled to this grant if it finds and purchases a suitable property within one year of grant approval. The funds will be received by WI at the end of Year 6. Once the building is purchased, it will require approximately $100,000 in renovations, which are expected to be undertaken in Year 7. WI expects to begin production using the building at the beginning of Year 8 and the building is expected to have a life of 40 years.

WI applies IFRS and presents the grant using the gross method.

Which one of the following is the effect on WI’s deferred government grant liability in Year 6?

a) Decrease of $11,875
b) Increase in $463,125
c) Increase of $475,000
d) No effect

Answer 23

Option c) is correct. The grant funds are received in Year 6 and the building’s amortization will not start until Year 8, meaning that the deferred amount will not start to decrease until then.

Question 24

During the year, the federal government provided land to Bomb Inc. (BI) to use in its business operations into the foreseeable future. The land had a fair market value of $55,000, and BI paid $0 to the federal government for the land use. BI uses IFRS to prepare its financial statements.

Which one of the following BEST describes how to account for this grant?

a) The land was received for free by BI, so a transaction is not recorded. However, note disclosure is required.
b) BI has the option of recording the grant and related asset at fair value or assigning a nominal amount to the grant and related asset.
c) BI records a deferred grant at fair value and recognizes the grant over the expected period of usage of the land.
d) BI must obtain an appraisal for the land and record the grant and related asset at fair value.

Answer 24

Option b) is correct. Per IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, paragraph 23: “A government grant may take the form of a transfer of a non-monetary asset, such as land or other resources, for the use of the entity. In these circumstances, it is usual to assess the fair value of the non-monetary asset and to account for both grant and asset at that fair value. An alternative course that is sometimes followed is to record both asset and grant at a nominal amount.”

Question 25

In Year 7, Seawalk Scoops Inc. (SSI) celebrated the fifth anniversary of its program that employs people who have served time in prison and who are being reintegrated into society. At this time, to recognize SSI’s success with this program, the Prince Edward Island government provided a grant that covered 10% of SSI’s salary costs associated with the employees in the program from the prior five fiscal years. The government hopes that this will encourage other companies to employ people who have served time in prison. SSI reports under IFRS.

Which one of the following BEST describes how to account for this grant?

a) The grant should be recognized in income evenly over the next five years.
b) The entire grant should be recognized in Year 7 as it relates to costs incurred in prior periods.
c) The grant should be recognized in the periods to which it relates. Financial statements would need to be restated for the prior five years if the grant is material.
d) The grant must be netted against Year 6 payroll expenses; if the grant exceeds Year 6 payroll expenses, the remaining grant money should be deferred to Year 7 and netted against Year 7 payroll costs.

Answer 25

Option c) is incorrect. The prior periods do not need to be restated because at that time, SSI did not know it would receive the grant. Option b) is correct. Per IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, paragraph 20: “A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate financial support to the entity with no future related costs shall be recognized in profit or loss of the period in which it becomes receivable.”