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ACCOUNTING 343 Assignment #3 Have one person in your group drop the group response in drop box before 8 AM on Tuesday April 6 Name your file: ACCT343Asgn3GroupXX (replace XX with your group number) Notice that this date is the correct date and is later than the one shown on the course outline (Late submissions without a valid excuse receive a grade of zero) Part A (This part has a significant majority of the marks for this assignment) It is now early February 20X2 and General Services Ltd. (GSL), a public company, has hired you as a consultant to assist the company with various accounting issues relating to the company’s financial statements for the year ended December 31, 20X1 year-end. GSL uses the services of a part-time accountant who is not very competent. The CEO of the company has asked you to review the following transactions to determine if the accountant has recorded them correctly. If you find that he incorrectly recorded any journal entries or failed to record journal entries, you are to explain his error in a memo to the CEO, stating why this happened and then provide her with the journal entry that the accountant needs to record to fix the error. (Provide the entry to “fix” the error, not the entry that the accountant recorded in the first place or the entry that he should have recorded in the first place as the client only wants the entry to “fix” the error made. Your job is to fix each transaction recorded or that the accountant should have recorded – it is not to fix a balance that arose from numerous transactions). On January 1, 20X1, immediately after its incorporation, GSL had a public issue of common shares and warrants. (Recall that a warrant is just like a call option, and we account for them in the same way that we account for employee stock options). The underwriter handling the initial issue decided that the best way to sell the 5,600,000 common shares was to sell two warrants with each of the common shares in an investment unit. When issued, each warrant gave the holder the right to buy a common share for $6 each between July 1, 20X1 and June 30, 20X2. The entire issue, including both the common shares and the warrants, raised $80,000,000, before considering underwriter fees. The underwriter fees and other costs relating to the issue were only $1,600,000. The journal entry to record the above was as follows: Cash78,400,000 Underwriting expenses1,600,000 Common shares80,000,000 Following their issue, the common shares traded in the market at $9 each while the warrants traded at $3 each. On July 1, 20X1, 90% of the warrant holders exercised their warrants. At that time, the accountant recorded: Cash60,480,000 Common shares60,480,000 The rest of the warrants were outstanding on December 31, 20X1. GSL did not just raise capital by issuing shares. The company also sold bonds on October 1, 20X1. The 5-year bonds have a face value of $20,000,000 and mature on September 30, 20X6. The buyers of the bonds were several pension funds that insisted that the bonds offer investors a right to convert the bonds into common shares at any time the bondholder chooses. The conversion feature allows the bondholder to convert each $1,000 bond into 120 common shares. When GSL sold the bonds, market interest rates were at 6% and the stated rate on the bonds was 8%. The bonds pay interest semi-annually on March 31 and September 30. On October 1, 20X1, the accountant recorded: Cash24,106,041 Bonds payable24,106,041 On December 31, 20X1, interest rates in the market had fallen to 5% and the board negotiated with one of the bondholders to convert one fifth of the bonds outstanding into common shares on that date. To do this however, the company paid the bondholder an inducement payment of $200,000 and interest relating to those bonds to date. The accountant recorded: Interest expense80,000 Cash80,000 Inducement expense200,000 Cash200,000 Bond payable4,000,000 Common shares4,000,000 When GSL began to operate, the board of directors was very keen to offer any employees an opportunity to own common shares in the company. Therefore, they allowed employees to enter into a subscription agreement on September 1. Employees could purchase 4,800,000 common shares at $8 each, payable in four equal instalments of $2 per share. Each instalment was due at the end of September, October, November, and December. For the first and second instalments, the company received $9,600,000 but for the third and fourth instalments, the company received $8,800,000 and $8,000,000 respectively. The subscription agreement specifies that the company can keep any partially paid instalments without issuing shares. Although the company’s lawyer issued the proper number of shares at the closing of the agreement on December 31, 20X1, the only entry recorded by the accountant regarding these subscribed shares was as follows: Cash36,000,000 Payable to share subscribers36,000,000 On December 31, 20X1, the company purchased equipment. The seller of the equipment was prepared to receive a non-interest, bearing note due in one year with a maturity value of $1,848,000 but at the last minute insisted on receiving 160,000 common shares instead. At that time, market interest rates were 5% and GSL common shares were trading actively, during the last week in December, at $11 per share. The accountant recorded: Equipment1,848,000 Common shares1,848,000 In conjunction with the sale of common shares and warrants to the public on January 1, 20X1, the company also sold preferred shares to the CEO of the company. As part of her compensation package, the CEO was able to purchase 80,000 preferred shares that pay a 5% cumulative dividend. Each preferred share has a stated value of $100 and the company must redeem half of the shares on December 31, 20X4 and the rest on December 31, 20X8. The CEO was only able to pay for 75% of the shares. Nonetheless, GSL issued all 80,000 shares on January 1, 20X1. The CEO agreed to apply any dividends declared on her shares against the balance she owes GSL for her shares because she has no available cash. The accountant has only made one entry relating to these shares as follows: Cash6,000,000 Preferred shares6,000,000 Later, on April 1, 20X1, the CEO expressed the need for some extra cash and the board decided that rather than giving her an advance on her pay, they would instead authorize the company to buy back 10% of her preferred shares at a price of $90 per share. The CEO agreed to this and the accountant recorded the following: Preferred shares720,000 Cash720,000 GSL granted the CEO 1,600,000 stock options on common shares on January 1, 20X1. Each option gives the CEO the right to buy one common share at $8 each. The options are compensation arising from the signing of a two-year employment contract at the beginning of the year. Half of the options vest on December 31, 20X1 while the other half vest one year later. Because the CEO has not exercised any options, the accountant has recorded no entries pertaining to these options. You have performed some preliminary calculations of the fair value of these stock options using the Black Scholes model. You determined that on January 1, 20X1, the options vesting in one year on December 31, 20X1 had a fair value of $2 each while those vesting one year later, on December 31, 20X2 had a fair value of $4 each. By the end of December 31, 20X1, the options vesting on December 31, 20X2 had a fair value of $5 each. The CEO was not the only employee to receive stock options with an $8 exercise price. The company granted the Executive VP 640,000 stock options (which have a fair value of $2 each) on January 1 when he joined the company. He bargained aggressively for his three-year compensation package and consequently, his options vested on January 1, 20X1. He exercised 480,000 of his options on July 1 but the following day he left the company, forfeiting any unexercised options. The accountant recorded only this entry relating to his options on July 1: Cash3,840,000 Common shares3,840,000 You have noticed from the above, that the market price of a common share on January 1, 20X1 was $9 while on December 31, 20X1 it was $11. The average price for a common share during 20X1 was $10. The preferred shares do not trade on any exchange and there is no evidence to suggest that the price has changed since the last preferred share transaction. On December 31, 20X1, the board of directors, realizing that a cash surplus did not exist, declared a cash dividend of only 3% on all preferred shares outstanding. The payment date was set for January 10, 20X2. The board declared no dividends on the common shares. The accountant made no entries for the dividends because the company has not yet paid these dividends. Please note that the tax rate is 30% and, for the sake of simplicity, let us assume that any amount recorded in the income statement (except for dividends) is taxable or tax deductible (we are going to assume away permanent and temporary differences). Before considering any adjustments, you might make, net income was $6,800,000. Required: Prepare the following items for the CEO in excel - please make sure that the columns are not too wide: 1. A title page worksheet with the following statement: We verify that this formal report is prepared using our own work and we have copied no portion from another source (other than the text, or CPA Handbook). Furthermore, we have not and will not lend this report (electronic or hardcopy) to any other student, either now or in the future. We have not received or used reports prepared by other individuals during the current or in other semesters when doing our work on this assignment. Each student in the group must have their name on the cover page immediately below the above statement indicating their compliance with that statement. By placing your name on this page, you are agreeing to the above statement. 2. A schedule tracking the movement (each row will represent a transaction for each event affecting the account) in the number of shares, if applicable, and dollar value of every equity and non-current liability account from the beginning to the end of 20X1. Be sure to use multiple contributed surplus accounts – one for each source. This schedule should only show correct amounts. Please do not show incorrect ones recorded by the client. Make sure that columns are no wider than the amounts in each column so