SOLUTIONS MANUAL for Financial and Managerial Accounting for Decision Makers 4th Edition by Hanlon by ACADEMIAMILL

Chapter 1 Introducing Financial Accounting Learning Objectives – coverage by question MiniExercises

Exercises

LO1 – Identify the users of accounting information and discuss the costs and benefits of disclosure.

28, 34

LO2 – Describe a company’s business activities and explain how these activities are represented by the accounting equation.

19, 20, 21

27, 29, 32, 33

36, 37, 38, 43

LO3 – Introduce the four key financial statements including the balance sheet, income statement, statement of stockholders’ equity and statement of cash flows.

22, 23, 24

30, 31

37, 38, 39, 40, 41, 42, 43, 44, 45

46, 47, 49

LO4 – Describe the institutions that regulate financial accounting and their role in establishing generally accepted accounting principles.

LO5 – Compute two key ratios that are commonly used to assess profitability and risk – return on equity and the debt-to-equity ratio.

32, 33

LO6 – Appendix 1A: Explain the conceptual framework for financial reporting.

Problems

Cases and Projects

49, 50

36, 43, 44, 45

46, 47, 48, 49

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QUESTIONS Q1-1.

Organizations undertake planning activities that subsequently shape three major activities: financing, investing, and operating. Financing is the means used to pay for resources. Investing refers to the buying and selling of resources necessary to carry out the organization’s plans. Operating activities are the actual carrying out of these plans. (Planning is the glue that connects these activities, including the organization’s ideas, goals and strategies.)

Q1-2.

An organization’s financing activities (liabilities and equity = sources of funds) pay for investing activities (assets = uses of funds). An organization cannot have more or less assets than its liabilities and equity combined and, similarly, it cannot have more or less liabilities and equity than its total assets. This means: assets = liabilities + equity. This relation is called the accounting equation (sometimes called the balance sheet equation, or BSE), and it applies to all organizations at all times.

Q1-3.

The four main financial statements are: income statement, balance sheet, statement of stockholders’ equity, and statement of cash flows. The income statement provides information relating to the company’s revenues, expenses and profitability over a period of time. The balance sheet lists the company’s assets (what it owns), liabilities (what it owes), and stockholders’ equity (the residual claims of its owners) as of a point in time. The statement of stockholders’ equity reports on the changes to each stockholders’ equity account during the year. Some changes to stockholders’ equity, such as those resulting from the payment of dividends and unrealized gains (losses) on marketable securities, can only be found in this statement as they are not included in the computation of net income. The statement of cash flows identifies the sources (inflows) and uses (outflows) of cash, that is, from what sources the company has derived its cash and how that cash has been used. All four statements are necessary in order to provide a complete picture of the financial condition of the company.

Q1-4.

The balance sheet provides information that helps users understand a company’s resources (assets) and claims to those resources (liabilities and stockholders’ equity) as of a given point in time. An income statement reports whether the business has earned a net income (also called profit or earnings) or a net loss. Importantly, the income statement lists the types and amounts of revenues and expenses making up net income or net loss. The income statement covers a period of time.

Q1-5.

Your authors would agree with Mr. Buffett. A recent study of top financial officers suggests they find earnings and the year-to-year changes in earnings as the most important items to report. We would add cash flows particularly from operations, and the year-to-year changes.

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Q1-6.

The statement of cash flows reports on the cash inflows and outflows relating to a company’s operating, investing, and financing activities over a period of time. The sum of these three activities yields the net change in cash for the period. This statement is a useful complement to the income statement which reports on revenues and expenses, but conveys relatively little information about cash flows.

Q1-7.

Articulation refers to the updating of the balance sheet by information contained in the income statement or the statement of cash flows. For example, retained earnings is increased each period by any profit earned during the period (as reported in the income statement) and decreased each period by the payment of dividends (as reported in the statement of cash flows and the statement of stockholders’ equity). It is by the process of articulation that the financial statements are linked.

Q1-8.

Return refers to income, and risk is the uncertainty about the return we expect to earn. The lower the risk, the lower the expected return. For example, savings accounts pay a low return because of the low risk of a bank not returning the principal with interest. Higher returns are to be expected for common stocks as there is a greater uncertainty about the realized return compared with the expected return. Higher expected return offsets this higher risk.

Q1-9.

Companies often report more information than is required by GAAP because the benefits of doing so outweigh the costs. These benefits often include lower interest rates and better terms from lenders, higher stock prices and greater access to equity investors, improved relationships with suppliers and customers, and increased ability to attract the best employees. All of these benefits arise because the increased disclosure reduces uncertainty about the company’s future prospects.

Q1-10. External users and their uses of accounting information include: (a) lenders for measuring the risk and return of loans; (b) shareholders for assessing the return and risk in acquiring shares; and (c) analysts for assessing investment potential. Other users are auditors, consultants, officers, directors for overseeing management, employees for judging employment opportunities, regulators, unions, suppliers, and appraisers. Q1-11. Managers deal with a variety of information about their employers and customers that is not generally available to the public. Ethical issues arise concerning the possibility that managers might personally benefit by using confidential information. There is also the possibility that their employers and/or customers might be harmed if certain information is not kept confidential.

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Q1-12. Return on equity (ROE) is computed as net income divided by average stockholders’ equity (an average of stockholders’ equity for the current and previous year is commonly used, but the ratio is sometimes computed only with beginning or ending stockholders’ equity). The return on equity is a popular measure for analysis because it compares the level of return earned with the amount of equity invested to generate the return. Furthermore, it combines both the income statement and the balance sheet and, thereby, highlights the fact that companies must manage both well to achieve high performance. Q1-13. While businesses acknowledge the increasing need for more complete disclosure of financial and nonfinancial information, they have resisted these demands to protect their competitive position. These companies must weigh the benefits they receive from the market as a result of more transparent and revealing financial reporting against the costs of divulging proprietary information. Q1-14. Generally Accepted Accounting Principles (GAAP) are the various methods, rules, practices, and other procedures that have evolved over time in response to the need to regulate the preparation of financial statements. They are primarily set by the Financial Accounting Standards Board (FASB), an entity of the private sector with representatives from companies that issue financial statements, accounting firms that audit those statements, and users of financial information. Q1-15. International Financial Reporting Standards (IFRS) are the accounting methods, rules and principles established by the International Accounting Standards Board (IASB). The need for IFRS stems from the wide variety of accounting principles adopted in various countries and the lack of comparability that this variety creates. IFRS are intended to create a common set of accounting guidelines that will make the financial statements of companies from different countries more comparable. The IASB has no enforcement authority. As a consequence, the strict enforcement of IFRS is left to the accounting profession and/or securities market regulators in each country. Many countries have reserved the right to make exceptions to IFRS by applying their own (local) accounting rules in selected areas. Some accountants and investors argue that a little diversity is a good thing – variations in accounting practice reflect differences in cultures and business practices of various countries. However, one concern is that IFRS may create the false impression that everyone is following the same rules, even though some variation will continue to permeate international financial reporting.

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Q1-16. The auditor’s primary function is to express an opinion on whether the financial statements fairly present the financial condition of the company and are free from material misstatements. Auditors do not prepare the financial statements; they only audit them and issue their opinion on them. Q1-17.A The objectives of financial accounting are to provide information: • That is useful to investors, creditors, and other decision makers who possess a reasonable knowledge of business activities and accounting • To help investors and creditors assess the amount, timing and uncertainty of cash flows. This includes the information presented in the cash flow statement as well as other information that might help investors and creditors assess future dividend and debt payments • About economic resources and financial claims on those resources. This includes the information in the balance sheet and any supporting information that might help the user assess the value of the company’s assets and future obligations • About a company’s financial performance, including net income and its components (i.e., revenues and expenses) • That allows decision makers to monitor company management to evaluate their effective, efficient, and ethical stewardship of company resources Q1-18.A The four enhancing qualitative characteristics of accounting information are comparability, verifiability, timeliness, and understandability. Comparability refers to the use of similar accounting methods across companies. Comparability improves the users’ ability to interpret the information by making comparisons to other companies. Verifiability means that consensus among independent observers could be reached that reported information is a faithful representation. Verifiable financial information improves the quality of the information because auditing and interpretation of the reported data will be easier and more trusted. Timeliness means that the financial reporting information must be available to decision makers in time for the financial statement users to make decisions. Understandability means that the financial statements should be presented in such a way that users who have reasonable knowledge of business activities can understand the statements. This is difficult because organizations and transactions have become more complex over time (more global, expanding into new industries, etc.) and thus the reporting of such complexities is difficult. The more understandable the statements can be the better for users of the statements.

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MINI EXERCISES M1-19. (10 minutes) LO 2 ($ millions) Assets

Liabilities

$19,381

Equity

$13,720

$5,661

Macy’s receives more of its financing from creditors ($13,720 million) versus owners ($5,661 million). Its owner financing comprises 29.2%% of its total financing ($5,661 mil / $19,381 mil.).

M1-20. (10 minutes) LO 2 ($ millions) Assets

Liabilities

$87,896

Equity

$68,919

$18,977

Coca-Cola receives more of its financing from creditors ($68,919 million) than from owners ($18,977 million). Its owner financing comprises 21.6% of its total financing ($18,977 mil./ $87,896 mil.).

M1-21. (15 minutes) LO 2 ($ millions) Assets Hewlett-Packard Enterprises Co General Mills Harley-Davidson

Liabilities

Equity

$ 55,493

$ 34,219

(a) $ 21,274

$30,624.0 (c) $ 9,972.7

(b) $24,482.9 $ 8,128.4

$6,141.1 $1,844.3

The percent of owner financing for each company follows: Hewlett-Packard Ent. Co:

38.3% ($21,274 mil./ $55,493 mil.);

General Mills:

20.1% ($6,141.1 mil./ $30,624 mil.);

Harley-Davidson:

18.5% ($1,844.3 mil./ $9,972.7 mil.). continued next page

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The creditor percent of financing is computed as 100% minus the owner percent. Therefore, Hewlett Packard Enterprises Co is more owner-financed (38.3%) than the other two firms, while Harley-Davidson has the highest percentage of creditor (nonowner) financing (81.5% = 100% - 18.5%).

M1-22. (15 minutes) LO 3 For its annual report dated September 29, 2018, Apple reports the following amounts (in $ millions): Assets

Liabilities

Equity

$365,725

$258,578

$107,147

As shown, the accounting equation holds for Apple. Also, we can see that Apple’s creditor financing is 70.7% of its total financing ($258,578 mil./$365,725 mil).

M1-23. (20 minutes) LO 3 Nike, Inc. Statement of Shareholders' Equity For Year Ended May 31, 2017

Balance, May 31, 2016 Stock Issuance Net Income Dividends Other changes Balance, May 31, 2017

Contributed Capital $ 7,789 121

731 8,641

Retained Earnings $ 4,151

Other Stockholders' Equity $ 318

4,240 (1,159) (3,253) 3,979

(531) (213)

Total Stockholders' Equity $ 12,258 121 4,240 (1,159) (3,053) $ 12,407

Nike was more profitable in the fiscal year ending May 2017 versus in the fiscal year ending May 2018. Net income was $4,240 million in the fiscal year ending May 2017 compared to $1,933 in the fiscal year ending May 2018. Note: As reported in the text, ROE was 17.4% in the fiscal year ending May 2018 compared to 34.4% in the fiscal year ending May 2017.

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M1-24. (20 minutes) LO 3 a. BS

d. BS and SE

g. SCF and SE

b. IS

e. SCF

h. SCF and SE

c. BS

f. BS and SE

IS and SE

M1-25. (10 minutes) LO 1 There are many stakeholders affected by this business decision, including the following (along with a description of how): • • • •

You/Manager—your reputation, self-esteem, and potentially your livelihood can be affected. Creditors/Bondholders─ credit decisions based on inaccurate information can occur. Shareholders—buying or selling shares based on inaccurate information can occur. Management/Employees of your company—repercussions of your decision extend to them; also, your decision may suggest an environment condoning dishonesty

Indeed, our decisions can affect many more parties than we might initially realize.

M1-26. (10 minutes) LO 4 Internal controls are rules and procedures that involve monitoring an organization’s activities, transactions, and interactions with customers, employees and other stakeholders to promote efficiency and to prevent wrongful use of its resources. They help prevent fraud, ensure the validity and credibility of accounting reports, and are often crucial to effective and efficient operations. The absence or failure of internal controls can adversely affect the effectiveness of both domestic and global financial markets. Enron (along with other accounting scandals) provided a case in point. Because the failure of internal controls can have significant economic consequences, Congress is interested in making sure that publicly- traded companies have adequate internal controls and that any concerns about internal controls are properly reported.

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EXERCISES E1-27. (15 minutes) LO 2 ($ millions)

Assets

Motorola Solutions, Inc .....

$ 8,208

$ 9,950

$ (1,742)

Kraft Heinz Company........ $ 119,992

$53,958

$ 66,034

Merck & Co Inc. ................

$53,303

$34,569

$87,872

Liabilities

Equity

The percent of creditor financing for each company follows: Motorola Solutions: 121.2% ($9,950 mil./ $8,208 mil.); Kraft Heinz: 45.0% ($53,958 mil./ $119,992 mil.); Merck & Co: 60.7% ($53,303 mil./ $87,872 mil.). The owner percent of financing is computed as 100% minus the owner percent. Merck is more creditor-financed than Kraft Heinz. Motorola has negative equity so their liabilities are larger than their recorded assets.

E1-28. (15 minutes) LO 1 External users and some questions they seek to answer with accounting information from financial statements include: 1. Shareholders (investors), who seek answers to questions such as: a. Are resources owned by a business adequate to carry out plans? b. Are the debts owed excessive in amount? c. What is the current level of income (and its components)? 2. Creditors, who seek answers for questions such as: a. Does the business have the ability to repay its debts? b. Can the business take on additional debt? c. Are resources sufficient to cover current amounts owed? 3. Employees (and potential employees), who seek answers to questions such as: a. Is the business financially stable? b. Can the business afford to pay higher salaries? c. What are growth prospects for the organization?

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E1-29. (20 minutes) LO 2, 3 ($ millions) a. Using the accounting equation: ($ millions) Assets Intel ...................................$123,249

Liabilities $54,230

Equity $69,019

b. Starting with the accounting equation at the beginning of the year: ($ millions) Assets = Liabilities + JetBlue Airways ................. $9,323 $5,310 Using the accounting equation at the end of the year: ($ millions) Assets = Liabilities JetBlue Airways ................. $9,781 $4,947 ($9,323+$458) ($5,310$363)

Equity $4,013

Equity $4,834

Equity $53,905

Equity $46,152

Alternative approach to solving part (b): Assets($458) = Liabilities($-363) + Equity(?) where “” refers to “change in.” Thus:  Ending Equity = $458 + $363 = $821 and Ending equity = $4,013 + $821 = $4,834

c. Starting with the accounting equation at the end of the year: ($ millions) Assets = Liabilities Walt Disney ....................... $98,598 $44,693 ($49,637-$4,944) Using the accounting equation at the beginning of the year: ($ millions) Assets = Liabilities Walt Disney ....................... $95,789 $49,637 ($98,598-$2,809)

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E1-30. (10 minutes) LO 3 Computation of dividends Retained earnings, 2016 ........................................................................ $19,922 + Net income ............................................................................................. 2,024 – Cash dividends....................................................................................... (?) = Retained earnings, 2017 ........................................................................ $20,531 Thus, dividends were $1,415 million for 2017. This dividends amount comprises 70% ($1,415/ $2,024) of its 2017 net income.

E1-31. (20 minutes) LO 3 COLGATE-PALMOLIVE COMPANY Income Statement For the year ended December 31, 2017 ($millions)

Revenues Cost of goods sold

$15,454 6,099

Gross profit Other expenses, including income taxes Net income (or loss)

9,355 7,331 $ 2,024

E1-32. (15 minutes) LO 2, 5 a. Return on equity (ROE)

= = =

Net income / Average stockholders’ equity $12,662 / [($152,502 + $139,036)/2] 8.69%

b. Debt-to-equity

= = =

Total liabilities / Stockholders’ equity $44,793* / $152,502 29.4

*$44,793 = $197,295 - $152,502

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E1-33. (150 minutes) LO 2, 5 a. Return on equity (ROE)

= = =

Net income / Average stockholders’ equity €10,525 / [(€64,023 + €57,950)/2] 17.3%

b. Debt-to-equity

= = =

Total liabilities / Stockholders’ equity €191,582* / €64,023 2.99

*€191,582 = €255,605 - €64,023

E1-34. (20 minutes) LO 1, 4 a. Financial information provides users with information that is useful in assessing the financial performance of companies and, therefore, in setting securities prices. To the extent that securities prices are accurate, the costs of the funds that companies raise will accurately reflect their relative efficiency and risk of operations. Those companies that can effectively utilize capital better will be able to obtain that capital at a reasonable cost, and society’s financial resources will be effectively allocated. b. First, the preparation of financial statements involves and understanding of complex accounting rules and a significant amount of assumptions and estimation. Second, GAAP allows for differing accounting treatments for the same transaction. And third, auditors are at a relative information disadvantage vis-à-vis company accountants. As the capital markets place increasing pressures on companies to perform, accountants are often placed in a difficult ethical position to use the flexibility given to them under GAAP in order to bias the financial results. E1-35.A (15 minutes) LO 6 1.

10.

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PROBLEMS P1-36. (40 minutes) LO 2, 5 a. Year

Assets

Liabilities

Equity

Net Income

2016

$127,136

$69,153

$57,983

$10,508

2017

$118,806

$64,628

$54,178

$15,326

2018

$118,310

$66,984

$51,326

$9,750

b. 2017 ROE = $15,326 / [($57,983+$54,178)/2] = 27.3% 2018 ROE = $9,750 / [($51,326+$54,178)/2] = 18.5% P&G’s ROE decreased in 2018, however, it was above the median for Fortune 500 companies in both years.

c. 2017 debt-to-equity = $64,628 / $54,178 = 1.19 2018 debt-to-equity = $66,984 / $51,326 = 1.31 P&G’s debt-to-equity ratio increased in 2018 and it is below the median for Fortune 500 companies in both years.

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P1-37. (30 minutes) LO 2, 3 a. GENERAL MILLS, INC. Income Statement For Year Ended May 27,2018 ($ millions)

Sales ....................................................................... Cost of goods sold .................................................. Gross profit ............................................................. Other expenses, including income taxes ................ Net income ..............................................................

$15,740.4 10,312.9 5,427.5 3,264.5 $ 2,163

GENERAL MILLS, INC. Balance Sheet May 27, 2018 ($ millions)

Cash & cash equivalents Noncash assets Total assets

399 30,225 $30,624

Total liabilities Stockholders’ equity Total liabilities and equity

$24,131.6 6,492.4 $30,624

GENERAL MILLS, INC. Statement of Cash Flows For Year Ended May 27, 2018 ($ millions)

Net cash flows from operations ............................... Net cash flows from investing ................................. Net cash flows from financing ................................. Effect of exchange rates on cash ............................ Net change in cash ................................................. Cash, beginning year .............................................. Cash, ending year ...................................................

$ 2,841 (8,685.4) 5,445.5 31.8 (367.1) 766.1 $ 399

b. $6,492.4 /$30,624 = 21.2% contributed by owners

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P1-38. (30 minutes) LO 2, 3 a. ABERCROMBIE & FITCH Income Statement For Year Ended February 3, 2018 ($ millions)

Sales ....................................................................... Cost of goods sold .................................................. Gross profit ............................................................. Other expenses including income taxes ........... .…. Net income ..............................................................

$ 3,492.7 1,408.8 2,083.9 2,073.4 $ 10.5

ABERCROMBIE & FITCH Balance Sheet February 3, 2018 ($ millions)

Cash asset Noncash assets Total assets

675.6 1,650.1 $ 2,325.7

Total liabilities Stockholders’ equity Total liabilities and equity

$ 1,073.2 1,252.5 $ 2,325.7

ABERCROMBIE & FITCH Statement of Cash Flows For Year Ended February 1, 2014 ($ millions)

Net cash flows from operations ............................... Net cash flows from investing ................................. Net cash flows from financing ................................. Effect of exchange rate changes on cash ............... Net change in cash ................................................. Cash, beginning year .............................................. Cash, ending year ...................................................

$ 285.7 (106.8) (74.8) 24.3 128.4 547.2 $ 675.6

b. $1,252.5 / $2,325.7 = 53.9% contributed by owners $1,073.2 / $2,325.7 = 46.1% contributed by creditors

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P1-39. (30 minutes) LO 3 TILLY’S, INC. Income Statements For years ended February 3, 2018 and January 28, 2017 ($ thousands)

Fiscal year ending Sales Cost of goods sold

2018 $576,899 401,529

2017 $568,952 400,493

Gross profit

175,370

168,459

Other expenses, including income taxes

160,670

157,049

Net income

$ 14,700

$ 11,410

TILLY’S, INC. Balance Sheets February 3, 2018 and January 28, 2017 ($ thousands)

Cash asset Noncash assets

2018 $ 53,202 236,909

2017 $ 78,994 211,512

Total assets

$290,111

$290,506

Total liabilities Stockholders’ equity

$ 129,686 160,425

$ 101,286 189,220

Total liabilities and stockholders’ equity

$290,111

$290,506

TILLY’S, INC. Cash Flow Statements For years ended February 3, 2018 and January 28, 2017 ($ thousands)

Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities

2018 $32,708 (40,878) (17,622)

2017 $48,509 (21,658) 1,123

Change in cash Cash balance, beginning of the year

(25,792) 78,994

27,974 51,020

Cash balance, end of the year

$53,202

$78,994

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P1-40. (30 minutes) LO 3 TESLA , INC. Income Statements For years ended December 31, 2017 and 2016 ($ millions)

2017 $11,758.8 9,536.3

2016 $ 7,000.1 5,400.9

Gross profit

2,222.5

1,599.2

Other expenses, including income taxes

4,183.9

2,274.2

$ (1,961.4)

$ (675.0)

Sales Cost of goods sold

Net income (loss)

TESLA, INC. Balance Sheets December 31, 2017 and 2016 ($ millions)

Cash asset Noncash assets

2018 $ 3,367.9 25,287.5

2017 $ 3,393.2 19,270.9

Total assets

$28,655.4

$22,664.1

Total liabilities Stockholders’ equity

$23,420.8 5,234.6

$ 17,126 5,538.1

Total liabilities and stockholders’ equity

$28,655.4

$22,664.1

TESLA, INC. Cash Flow Statements For years ended December 31, 2017 and 2016 ($ millions)

Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Effect of exchange rate changes on cash

2017 $(60.7) (4,419) 4,414.9 39.5

2016 $(123,8) (1,416.4) 3,744.0 (7.4)

Change in cash Cash balance, beginning of the year Cash balance, end of the year

(25.3) 3,393.2 $3,367.9

2,196.3 1,196.9 $3,393.2

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P1-41. (15 minutes) LO 3 CROCKER CORPORATION Statement of Stockholders’ Equity For Year Ended December 31, 2019 Contributed Capital December 31, 2018 ...............................

$ 70,000

Issuance of common stock ....................

30,000

Retained Earnings $ 30,000

Stockholders’ Equity $100,000 30,000

Net income ............................................

50,000

Cash dividends ......................................

_______

(25,000)

December 31, 2019 ...............................

$100,000

$ 55,000

$155,000

P1-42. (15 minutes) LO 3 DP SYSTEMS, INC. Statement of Stockholders’ Equity For Year Ended December 31, 2019

December 31, 2018 ................................

Stockholders’ Equity

Common Stock

Retained Earnings

$ 550

$2,437

$2,987

859

Net income ............................................. Cash dividends .......................................

____

(281)

December 31, 2019 ................................

$ 550

$3,015

$3,565

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P1-43. (15 minutes) LO 2, 3, 5 a. Return on equity is net income divided by average stockholders’ equity. Nokia’s ROE: €-1,458 / [(€16,218 + €20,975)/2] = -0.078 or -7.8%. b. Debt-to-equity is total liabilities divided by stockholders’ equity. Nokia’s debt-to-equity: (€41,024 − €16,218) / €16,218 = 1.53. c. Revenues less expenses equal net income. Taking the revenues and net income numbers for Nokia, yields: €23,147 million − Expenses = €-1,458 million. Therefore, expenses must equal €24,605 million.

P1-44. (20 minutes) LO 3, 5 a. BEST BUY CO., INC. Income Statement For the year ended February 3, 2018 ($ millions)

Sales revenue ………………………………… Cost of goods sold ………………………….. Gross profit …………………………………… Other expenses, including income taxes …… Net income (or loss) ………………………….

$42,151 32,275 9,876 8,876 $ 1,000

b. Best Buy’s ROE = $1,000 mil. / [($4,709 mil. + $3,612 mil.)/2] = 24.0%. c. Best Buy’s debt-to-equity = ($13,049 - $3,612) / $3,612 = 2.61

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P1-45. (20 minutes) LO 3, 5 a. FACEBOOK, INC. Income Statement For the years ended December 31, 2017 and 2016 ($ millions)

Revenue Operating expenses Gross profit from operations Other expenses, including income taxes Net income b. Stockholders’ equity:

2017 $ 40,653 20,450

2016 $ 27,638 15,211

20,203 4,269

12,427 2,210

$ 15,934

10,217

2017 -- $84,524 mil. - $10,177 mil. = $74,347 mil. 2016 -- $64,961 mil. - $5,767 mil. = $59,194 mil.

2017 ROE = $15,934 mil. / [($74,347 mil. + $59,194 mil.)/2] = 23.9.0%. 2016 ROE = $10,217 mil. / [($59,194 mil. + $44,218 mil.)/2] = 19.8%. c. 2017 debt-to-equity = $10,177 / $74,347 = 0.14. 2016 debt-to-equity = $5,767 / $59,194 = 0.10.

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CASES and PROJECTS C1-46. (40 minutes) LO 3, 5 a. STARBUCKS CORPORATION Income Statement For the years ended September 30,2018 and October 1, 2017 ($ millions)

Sales revenue Cost of goods sold Gross profit on sales Other expenses, including income taxes Net income b.

2018 $ 24,719.5 10,174.5 14,545.0 10,027 $4,518.0

2017 $ 22,386.8 9,034.3 13,352.5 10,467.6 $ 2,884.9

2018 stockholders’ equity: $24,256.4 mil. – $22,980.6 mil. = $1,275.8 mil. 2017 stockholders’ equity: $14,365.6 mil. -- $8,908.6 mil. = $5,457 mil. 2018 ROE: $4,518 / [($1,275.8 + $5,457)/2] = 134.2% 2017 ROE: $2,884.9 / [($5,457 + $5,890.7)/2] = 50.8%

2018 debt-to-equity: $22,980.6 / $1,275.8 = 18.01 2017 debt-to-equity: $8,908.6 / 5,457 = 1.63

2018 ROE restated: ($4,518.0 - $3,700) / [($1,275.8- $3,700 + 5,457)/2] = 53.9% The unrecorded potential litigation cost of $3,700 is subtracted from the net income number and from the 2018 stockholders’ equity amount to arrive at this number. This does not take into account the effect of income taxes.

The primary cost to Starbucks of disclosing information about the pending litigation is that the disclosure may cause potential investors and creditors to hold a less favorable view of the company. A concern about the disclosure is that such disclosure may actually affect the outcome of the litigation. The primary benefit to disclosure is that by disclosing information about the lawsuit before its completion, the company cannot be accused of withholding relevant information from stakeholders. This prevents potential lawsuits from investors or creditors and contributes to the company’s reputation for reliable financial reporting. ©Cambridge Business Publishers, 2021

Solutions Manual, Chapter 1

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C1-47. (40 minutes) LO 2, 3, 5 a. The Gap, Inc.: Nordstrom, Inc.:

ROE = $848 / [($3,144 + $2,904)/2] = 28.00% ROE = $437 / [($977 + $870)/2] = 47.3%

Nordstrom had the higher ROE. b. The Gap, Inc.: Nordstrom, Inc.:

Debt-to-equity = ($7,989 - $3,144) / $3,144 = 1.54 Debt-to-equity = ($8,115 - $977) / $977 = 7.31

Nordstrom relies more on debt than The Gap. c. THE GAP, INC. 2018 Income Statement ($millions)

Revenues Cost of goods sold Gross profit Other expenses, including income taxes Net income (or loss)

$15,855 9,789 6,066 5,218 $ 848

NORDSTROM, INC. 2013 Income Statement ($millions)

Revenues Cost of goods sold Gross profit Other expenses, including income taxes Net income (or loss) The Gap:

$15,478 9,890 5,588 5,151 $ 437

$6,066 / $15,855 = 38.3%

Nordstrom: $5,588 / $15,478 = 36.1% d. Nordstrom earned a higher ROE than The Gap (47.3% vs. 28%). Nordstrom’s debtto-equity ratio is 7.31 vs. about 1.54 for The Gap. The Gap reported a slightly higher gross profit per dollar of sales revenue (38.3% vs. 36.1% for Nordstrom). These two percentages are very close, reflecting the similarity of their retail operations. One important difference (not provided or apparent in the information supplied) is that Nordstrom has a larger consumer credit business than The Gap.

©Cambridge Business Publishers, 2021 1-22

Financial & Managerial Accounting for Decision Makers, 4th Edition

C1-48. (30 minutes) LO 5 a. JetBlue: Southwest: b. JetBlue: Southwest: c. JetBlue: Southwest:

ROE = $1,147 / {[($9,781-$1,108) + ($9,323 - $1,444)] /2} = 13.9% ROE = $3,488 / {[($25,110-$13,973) + ($23,286-$14,845)] /2} = 35.6% Debt-to-equity = $1,108 / ($9,781 - $1,108) = 0.13 Debt-to-equity = $13,973 / ($25,110 - $13,973) = 1.25 $1,147 / $7,015 = 16.4% $3,488 / $21,171 = 16.5%

d. JetBlue’s ROE was 13.9% for the year. In comparison, Southwest earned an ROE of 35.6% in 2017. Both of these ROE numbers are at or above the average for Fortune 500 companies. Currently, Southwest uses more creditor financing. This has changed over time, JetBlue carried more debt just 5 years ago. Southwest’s debt-to-equity ratio is 1.25 compared to a debt-to-equity ratio of 0.13 for JetBlue. In terms of income per dollar of sales, both companies look very similar. JetBlue’s reported net income equaled 16.4% of revenues, while Southwest reported net income equal to 16.5% of revenues. The numbers for both airlines have improved significantly in recent years.

C1-49. (20 minutes) LO 1, 3, 5 a. $285,000 Assets - $45,000 Liabilities = $240,000 Net Assets. $72,000 Average Annual Income / $240,000 Investment = 30% return. Seale's return would be 24% ($72,000 Average Annual Income / $300,000 Investment), assuming no adjustment is made for Meg’s salary. (See part b.) b. No. Withdrawals do not affect net income, because they are not part of the firm's operating activities. However, in calculating Krey's return in part a, Seale might wish to "impute" an amount for Krey's half-time work in computing Krey's return on investment. Thus, if Seale believes that Krey's services are worth $18,000 (half of the $36,000 salary she expects to pay a full-time manager), annual income should be calculated at $54,000 instead of $72,000. If Seale hires a full-time manager at $36,000, her return will be only 12% [($72,000 - $36,000)/$300,000]. c. Yes, the difference between net income shown in the financial statements and net income shown on the tax return can be legitimate, because income tax rules for determining revenues and deductions from revenues differ from Generally Accepted Accounting Principles. Seale may obtain additional assurance about the propriety of the financial statements by engaging a licensed professional accountant to audit the financial statements and render a report on them. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 1

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C1-50. (15 minutes) LO 1, 4 a. It is important for a CPA to be independent when performing audit services because third parties will be relying on the audited financial statements in making decisions. The financial statements are the representations of the corporation's management. The audit by a CPA adds credibility to the financial statements. Only if third parties believe that the CPA is independent will a CPA be able to add credibility to financial statements. b. Jackie is not independent for two reasons: (1) her brother is president and chair of the board of directors of the company to be audited and (2) Jackie is on the board of directors of the company to be audited. The auditing profession takes the position that Jackie's other activities for the company—consulting and tax work—do not impair a CPA's independence. This last point may generate some discussion, particularly in this case when the potential auditor is the same person (Jackie) who is doing the consulting work. Usually, when the same CPA firm does both auditing and consulting work, those tasks are assigned to different persons to ensure auditor independence.

©Cambridge Business Publishers, 2021 1-24

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 2 Constructing Financial Statements Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Describe and construct the balance sheet and understand how it can be used for analysis.

14, 17, 19, 21 - 27, 29 - 31

34-44, 46, 47

49 - 57, 59, 60, 62, 66, 67, 69

LO2 – Use the financial statement effects template (FSET) to analyze transactions.

18, 29 - 31

44 - 47

57, 62, 67, 69

LO3 – Describe and construct the income statement and discuss how it can be used to evaluate management performance.

19 - 23, 28, 31

35, 37, 39 - 44, 47

49 - 51, 54, 57, 61, 62, 64 - 67, 69

71, 72

LO4 – Explain revenue recognition, accrual accounting, and their effects on retained earnings.

18 - 20, 22, 23, 25, 26, 28, 29, 31

39, 44, 47

57, 62, 67, 69

LO5 – Illustrate equity transactions and the statement of stockholders’ equity.

18, 21 - 24, 27, 31

35 - 37

53, 66, 67, 69

LO6 – Use journal entries and Taccounts to analyze and record transactions.

32, 33

45, 48

58, 63, 68, 70

34, 36, 38, 41, 42, 46

52, 55, 56, 59, 60

LO7 – Compute net working capital, the current ratio, and the quick ratio, and explain how they reflect liquidity.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

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QUESTIONS Q2-1.

An asset is something that we own that is expected to provide future benefits. A liability is a current obligation that will require a future sacrifice. Equity is the difference between assets and liabilities. It represents the claims of the company’s owners to its income and assets. The following are some examples of each: Assets

Liabilities

Equity

• Cash • Receivables • Inventories • Plant, property and equipment • Accounts payable • Accrued liabilities • Notes payable • Long-term debt • Contributed capital (common and preferred stock) • Additional paid-in capital • Earned capital (retained earnings) • Treasury stock

Q2-2.

The revenue recognition principle requires that revenues be recognized when earned. Revenues are earned when the product has been delivered to the buyer and is usually signified by a formal transfer of title. A good test of whether revenue has been earned is whether the rights, risks and obligations of ownership have been transferred to the buyer. If a service is involved, revenues are not earned until the service has been provided. The expense recognition principle prescribes that expenses be recognized when assets are diminished (or liabilities increased) as a result of earning revenue or carrying out the company’s operations. When these two principles are followed, income can be properly measured in a given accounting reporting period.

Q2-3.

Accrual accounting entails the recognition of revenue under the revenue recognition principle (record revenues when goods or services are transferred to the customer), and the recognition of expenses when net assets decrease from the process of earning revenue or supporting the company’s operations. The recognition of revenues or the expenses does not require that cash be received or disbursed. For example, the recognition of revenues on sale can lead to an account receivable, and wage expense can be accrued using a wages payable (accrued) liability account.

©Cambridge Business Publishers, 2021 2-2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q2-4.

The statement of stockholders’ equity provides information relating to all events that impact stockholders’ equity during the period. It contains information relating to stock sales and repurchases, net income, dividends, and the use of stock for other purposes including occasional acquisition of assets. This statement, also referred to as the statement of owners’ equity, also includes the effects of some transactions that are not captured in the determination of net income. These items are included in what is called “other comprehensive income.” One example of such an item is the loss or gain on the translation of the assets and liabilities of foreign owned subsidiaries into United States currency.

Q2-5.

An asset must be “owned” and it must provide “future benefits.” Owning means we have title to the asset (some leased assets are also recorded on the balance sheet as we will discuss in Chapter 10). Future benefits can mean the future inflows of cash. Or, it could relate to some other benefit, such as the reduction of expenditures, an increase in another asset, or the reduction of a liability.

Q2-6.

Liquidity generally refers to cash. That is, how much cash do we have, how much cash is being generated, and how much cash can we raise quickly. Liquidity is essential to the survival of the business. After all, we can only pay our loans with cash, and our employees will only accept cash for their wages. Some assets are more liquid than others in the sense that they can be converted more easily to cash. Money market accounts and accounts receivable, which can be sold, provide examples. Inventories are considered more liquid than plant assets. We will address liquidity issues more formally in Chapters 4 and 9.

Q2-7.

Current means that the asset will be liquidated (converted to cash) within the next year (or the operating cycle if longer than 1 year).

Q2-8.

Historical costs are used by accountants because they are less subjective and, therefore, more reliable than using market values. Market values can be biased for two reasons: first, we may not be able to measure them accurately (consider our inability to accurately measure the market value of a production facility, for example), and second, managers may intervene in the reporting process to intentionally bias the results in order to achieve a particular objective (i.e. enhancing the stock price). The use of historical costs in accounting records does not negate the importance of market values. For example, a firm offering to pledge land as collateral for a loan will be expected to use the market value of that land rather than its historic cost. The same would be true if a corporation were considering the sale of the land. Finally, we shall see that certain assets are reported at market value in the balance sheet; securities that are available to be sold provide an example.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-3

Q2-9.

An intangible asset is an asset that we cannot touch. To be included on the balance sheet, it has to meet the tests of an asset (e.g., we own it, and it will provide future benefits). In addition, recognized intangible assets are always acquired in a transaction with an independent party. Internally generated intangible assets, however, are not recorded on the balance sheet. Some examples are goodwill, patents and trademarks, contractual agreements like royalties, leases, and franchise agreements. All of the intangible assets, though not recorded if internally generated, are recorded if purchased, as in an acquisition of another company, for example.

Q2-10. Both the current ratio and quick ratio are measures of a firm’s ability to pay its obligations as they come due; measures of a firm’s liquidity. The current ratio is computed by dividing the firm’s current assets by its current liabilities. Current ratios that exceed 1.0 are deemed to represent a strong current liquidity position. The quick ratio is an even more conservative measure of a firm’s liquidity as it excludes inventory from the calculation. The quick ratio is computed by dividing the firm’s sum of cash and cash equivalents, marketable securities and accounts receivable by its current liabilities. Q2-11. The three conditions necessary to recognize a liability are: 1. The liability reflects a probable future sacrifice on the part of the organization. 2. The amount of the obligation is known or can be reasonably estimated. 3. The transaction that caused the obligation has occurred. Q2-12. Net working capital = Current assets – Current liabilities. Increasing the amount of trade credit (e.g., accounts payable to suppliers) increases current liabilities and reduces net working capital. As trade credit increases, we are using someone else’s cash rather than our own. As a business grows, its net working capital grows, as the growth of inventories and receivables are generally greater than that of accounts payable and accrued liabilities. Net working capital is an asset category that must be financed just like fixed assets. Q2-13. $700,000 Assets - $220,000 Liabilities = $480,000 Stockholders' equity $480,000 Stockholders’ equity – $300,000 Common stock = $180,000 Retained earnings

©Cambridge Business Publishers, 2021 2-4

Financial & Managerial Accounting for Decision Makers, 4 th Edition

MINI EXERCISES M2-14. (10 minutes) LO 1 Use the accounting equation. a. Cash Accounts receivable Supplies Equipment Accounts payable Common stock Retained earnings b. Retained Earnings: December 31, 2018 January 1, 2018 Increase Add: Dividends Net Income

$ 8,000 23,000 9,000 138,000 178,000 $ 11,000 110,000

121,000 $ 57,000

$ 57,000 30,000 27,000 12,000 $ 39,000

M2-15. (5 minutes) LO 1 a. $200,000 - $85,000 = $115,000 equity b. $32,000 + $28,000 = $60,000 assets c. $93,000 - $52,000 = $41,000 liabilities

M2-16. (5 minutes) LO 1 a. $375,000 - $105,000 = $270,000 equity b. $43,000 + $11,000 = $54,000 assets c. $878,000 - $422,000 = $456,000 liabilities

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-5

M2-17. (5 minutes) LO 1 a. $450,000 - $326,000 = $124,000 equity b. $618,000 - $165,000 = $453,000 liabilities c. $400,000 + $200,000 + $185,000 = $785,000 assets

M2-18. (10 minutes) LO 2, 4, 5 a. no effect

e. increase

b. decrease

f. increase

c. decrease

g. increase

d. no effect

M2-19. (15 minutes) LO 1, 3, 4 a. Balance sheet

e. Balance sheet

Income statement

b. Income statement

f. Balance sheet

Income statement

c. Balance sheet

g. Balance sheet

k. Balance sheet

d. Income statement

h. Balance sheet

Balance sheet

M2-20. (20 minutes) LO 3, 4 a. Net income computation Service revenue (record when earned) …………… Wage expense …………………………………………. Net income ………………………………………………

$100,000 (60,000) $ 40,000

b. Yes, recognizing the wage liability would cause wage expense to increase by $10,000 and net income would decrease by the same amount (before taxes).

©Cambridge Business Publishers, 2021 2-6

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M2-21. (10 minutes) LO 1, 3, 5 a. Balance sheet b. Income statement, Statement of stockholders’ equity c. Balance sheet d. Income statement e. Statement of stockholders’ equity f. Statement of stockholders’ equity g. Balance sheet h. Income statement i.

Statement of stockholders’ equity, Balance sheet

M2-22. (10 minutes) LO 1, 3, 4, 5 a. Balance sheet b. Balance sheet c. Income statement, Statement of stockholders’ equity d. Statement of stockholders’ equity, Balance sheet e. Balance sheet f. Income statement g. Balance sheet h. Balance sheet

M2-23. (10 minutes) LO 1, 3, 4, 5 a. Balance sheet b. Income statement c. Statement of stockholders’ equity, Balance sheet d. Income statement e. Statement of stockholders’ equity f. Balance sheet g. Balance sheet h. Balance sheet ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-7

M2-24. (15 minutes) LO 1, 5 Ending retained earnings = Beginning retained earnings + Net income – Dividends + the effects of other adjustments. And, the ending retained earnings for one period is the beginning retained earnings for the following period. Fiscal year ending:

Jan. 28, 2017

Beginning retained earnings (deficit) ………… Net income (loss) …………… Dividends paid ……………

(258) 1,158 (1,268)

Other net changes in retained earnings ……… Ending retained earnings (deficit) ……………

Feb. 3, 2018 $

(359) $

(727)

(727) 983 (686) (321)

(751)

M2-25. (10 minutes) LO 1, 4 a. Increase assets (Cash); Increase equity (Service Revenues) b. Increase assets (Office Supplies) Increase liabilities (Accounts Payable) c. Increase assets (Cash) Increase equity (Contributed Capital or Common Stock) d. Decrease liabilities (Accounts Payable) Decrease assets (Cash) e. Increase assets (Cash) Increase liabilities (Notes Payable) f. Increase assets (Accounts Receivable) Increase equity (Service Revenues) g. Increase assets (Office Equipment) Decrease assets (Cash) h. Decrease equity (Interest Expense) Decrease assets (Cash) i.

Decrease equity (Utilities Expense) Increase liabilities (Accounts Payable)

©Cambridge Business Publishers, 2021 2-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M2-26. (10 minutes) LO 1, 4 a. Increase assets (Office Equipment) Decrease assets (Cash) b. Increase assets (Accounts Receivable) Increase equity (Service Revenue) c. Decrease equity (Rent Expense) Decrease assets (Cash) d. Increase assets (Cash) Increase equity (Service Revenue) e. Increase assets (Cash) Decrease assets (Accounts Receivable) f. Increase assets (Office Equipment) Increase liabilities (Accounts Payable) g. Decrease equity (Salaries Expense) Decrease assets (Cash) h. Decrease liabilities (Accounts Payable) Decrease assets (Cash) i.

Decrease equity (Retained Earnings) Decrease assets (Cash)

M2-27. (10 minutes) LO 1, 5 JOHNSON & JOHNSON Statement of Retained Earnings For Year Ended December 31, 2017 Retained earnings, January 1, 2017 ................................................. Add:

$70,418

Net income............................................................................

1,300

Less: Dividends ..............................................................................

(8,943)

Other retained earnings changes ..........................................

(2,615)

Retained earnings, December 28, 2014 ...........................................

$60,160

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-9

M2-28. (10 minutes) LO 3, 4

Revenues .................................................................... Expenses ..................................................................... Net income ..................................................................

2018 $350,000 200,000 $150,000

2019 $ 0 0 $ 0

Explanation: All of the revenue is reported in 2018 when services are provided—per the revenue recognition principle. Likewise, the expense is reported in 2018 when it is incurred—because a liability was incurred to generate the revenue. The timing of receipts or payments of cash does not affect the recording of revenues, expenses, and net income.

M2-29. (15 minutes) LO 1, 2, 4 Balance Sheet Transaction a. Issue stock for $20,000 cash.

Cash Asset +20,000 Cash

Noncash Assets

b. Pay $2,000 rent in advance.

-2,000 Cash

+2,000 Prepaid rent

c. Purchase computer equipment for $7,000 cash.

-7,000 Cash

+7,000 Computer Equipment

d. Purchase inventory for $13,000 on account

+13,000 Inventory

e. Pay supplier of inventory in part d.

-13,000 Cash

Totals

-2,000

22,000

Earned Capital

Revenues

Expenses

+13,000 Accts = Payable

Income Statement

Contrib. = Liabil-ities + Capital + +20,000 Common = Stock

-13,000 Accts Payable 0

20,000

Net Income

©Cambridge Business Publishers, 2021 2-10

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M2-30 (15 minutes) LO 1, 2 Balance Sheet Transaction

Cash Asset

a. Borrow €19,000 from local bank.

+19,000 Cash

b. Pay €3,000 insurance premium for covered for following year.

-3,000 Cash

c. Purchase vehicle for €32,000 cash.

-32,000 Cash

= Liabilities

d. Purchase and receive €2,500 of office supplies on account (pay supplier later).

-16,000

Contrib. + Capital

Earned Capital

+19,000 Note Payable

Revenues -

Expenses

+3,000 Prepaid insurance

+32,000 Vehicle

NO ENTRY =

+2,500 Supplies Inventory

e. Place order for €1,000 of additional supplies to be delivered next month. Totals

Noncash Assets

Income Statement

37,500

Net Income

+2,500 Accts Payable

21,500

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-11

M2-31. (15 minutes) LO 1, 2, 3, 4, 5 Balance Sheet Transaction a. Receive merchandise inventory costing $9,000, purchased with cash

Cash Asset

-9,000 Cash

Noncash Assets

= Liabilities +

Income Statement Contrib. + Capital

Earned Capital

Revenues -

b. Sell half of inventory in (a) for $7,500 on credit.

-4,500 Inventory +7,500 Accounts Receivable

c. Place order for $5,000 of additional merchandise inventory to be delivered next month.

-4,500

e. Pay $7,000 rent for use of premises during the month.

-7,000 Cash

f. Receive full payment from customer in part b.

+7,500 Cash

Totals

-12,500

Net Income

+7,500

+4,500 Cost of Goods Sold +7,500 Revenue

NO ENTRY =

-4,000 Cash

+9,000 Inventory =

d. Pay employee $4,000 for compensation earned during the month.

Expenses

-4,000 =

+4,000 Wage Expense

+7,000 Rent Expense

15,500

-7,000 =

-4,500

+7,500

-4,000 =

-7,000

-7,500 Accounts Receivable

4,500

-8,000

7,500

-8,000

©Cambridge Business Publishers, 2021 2-12

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M2-32. (10 minutes) LO 6 a. Inventory (+A) .......................................................................... Cash (-A)...........................................................................

9,000

b. Cost of goods sold expense (+E, -SE) ..................................... Inventory (-A) ..................................................................... Accounts receivable (+A) ........................................................ Sales revenue (+R, +SE) ..................................................

4,500

9,000

4,500 7,500 7,500

c. NO ENTRY

d. Wage expense (+E, -SE) ......................................................... Cash (-A)............................................................................

4,000

e. Rent expense (+E, -SE) ........................................................... Cash (-A)............................................................................

7,000

f. Cash (+A) …………………………………………………….. Accounts receivable (-A) ………………………………..

7,500

4,000

7,000

7,500

M2-33. (10 minutes) LO 6 + (f)

Cash (A) 7,500 (a) (d) (e)

+ 9,000 4,000 7,000

(b)

+ +

Inventory (A) 9,000 (b)

Sales (R) (b)

7,500

4,500 +

Wage Expense (E) 4,000

Rent Expense (E) 7,000

(d) -

Cost of Goods Sold (E) 4,500

(b) (a)

Accounts Receivable (A) 7,500 (f)

+ 7,500 (e)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-13

EXERCISES E2-34. (25 minutes) LO 1, 7 Use the accounting equation to determine Retained Earnings as of May 31, 2019. a. & b. BEAVER, INC. Balance Sheets May 31, 2019

June 1, 2019

Assets Cash Accounts receivable Supplies Equipment Total assets

$ 12,200 18,300 16,400 55,000 $101,900

3,200 18,300 16,400 70,000 $107,900

Liabilities Accounts payable Notes payable

$ 5,200 20,000

$ 5,200 33,000

Total liabilities

25,200

38,200

42,500 34,200 76,700 $101,900

42,500 27,200 69,700 $107,900

Stockholders' Equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

c. Net working capital = Current assets – Current liabilities $32,700 = ($3,200 + $18,300 + $16,400) – $5,200

©Cambridge Business Publishers, 2021 2-14

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E2-35. (30 minutes) LO 1, 3, 5 Use the accounting equation and the information on changes in contributed capital and retained earnings. Beginning equity (= Beginning assets – Beginning liabilities) + Common Stock Issued + Net income (= Revenues – Expenses) – Dividends Ending equity (= Ending assets – Ending liabilities) a. Equity, Beginning ($28,000 - $18,600) Equity, Ending ($30,000 - $17,300) Increase Add: Net Capital Withdrawn ($5,000 - $2,000) Net Income Add: Expenses Revenues

$ 9,400 12,700 3,300 3,000 6,300 8,500 $14,800

b. Equity, Beginning ($12,000 - $5,000) Add: Net Capital Contributed ($4,500 - $1,500) Add: Net Income ($28,000 - $21,000) Equity, Ending

$ 7,000 3,000 10,000 7,000 $17,000

Assets, Ending Equity, Ending Liabilities, Ending,

$26,000 17,000 $ 9,000

c. Equity, Beginning ($28,000 - $19,000) Add: Net Income ($18,000 - $11,000) Less: Dividends Equity, Ending ($34,000 - $15,000) Common Stock Issued d. Common Stock Issued Net Income ($24,000 - $17,000) Cash Dividends Increase in Equity Equity, Ending ($40,000 - $19,000) Equity, Beginning Add: Liabilities, Beginning Total Assets, Beginning

$ 9,000 7,000 16,000 1,000 15,000 19,000 $ 4,000 $ 3,500 7,000 10,500 6,500 4,000 21,000 17,000 9,000 $26,000 ©Cambridge Business Publishers, 2021

Solutions Manual, Chapter 2

2-15

E2-36 (30 minutes) LO 1, 5, 7 Use the accounting equation to determine stockholders’ equity balances. a. LANG SERVICES Balance Sheets December 31, 2018 2017 Assets Cash Accounts receivable Supplies Equipment Total assets

$10,000 22,800 4,700 32,000 $69,500

$ 8,000 17,500 4,200 27,000 $56,700

Liabilities Accounts payable Notes payable Total liabilities

$25,000 1,800 26,800

$25,000 1,600 26,600

Stockholders’ equity Equity Total liabilities and stockholders’ equity

42,700 $69,500

30,100 $56,700

b. Equity, December 31, 2018 Equity, December 31, 2017 Increase Add: Dividends Less: Common Stock issued Net Income for 2018

$42,700 30,100 12,600 17,000 29,600 5,000 $24,600

c. Current ratio = ($10,000 + $22,800 + $4,700)/$25,000 = 1.50 Quick ratio = ($10,000 + $22,800)/$25,000 = 1.31 d. Lang’s liquidity position is satisfactory as its current ratio meets the industry norm, and its quick ratio is also above the industry average. The firm appears to have invested about the “right” amount in liquid assets—neither too much, nor too little.

©Cambridge Business Publishers, 2021 2-16

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E2-37. (30 minutes) LO 1, 3, 5 Use the accounting equation to determine Retained Earnings balances. a. LYNCH SERVICES Balance Sheets December 31, 2018 2017 Assets Cash Accounts receivable Supplies Land Building Equipment Total assets Liabilities Accounts payable Mortgage payable Total liabilities Stockholders’ equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders’ equity

$ 23,000 42,000 20,000 40,000 250,000 43,000 $418,000

$ 20,000 33,000 18,000 40,000 260,000 45,000 $416,000

6,000 90,000 96,000

220,000 102,000 322,000 $418,000

9,000 100,000 109,000

220,000 87,000 307,000 $416,000

b. Retained Earnings, December 31, 2018 Retained Earnings, December 31, 2017 Increase during 2018 Add: Dividend for 2018 Net Income for 2018

$102,000 87,000 15,000 10,000 $ 25,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-17

E2-38. (30 minutes) LO 1, 7 Use the accounting equation to determine Retained Earnings as of September 30, 2019. The two transactions have the following effects: • •

Equipment purchase increases the equipment asset by $11,000, decreases the cash asset by $3,000, and increases the notes payable liability by $8,000. Dividend payment decreases the cash asset by $3,000 and decreases the retained earnings equity by $3,000.

a. & b. BROWNLEE CATERING SERVICE Balance Sheets September 30, 2019

October 1, 2019

Assets Cash Accounts receivable Supplies inventory Equipment Total assets

$10,000 17,000 9,000 34,000 $70,000

$ 4,000 17,000 9,000 45,000 $75,000

Liabilities Accounts payable Notes payable Total liabilities

$24,000 12,000 36,000

$24,000 20,000 44,000

Stockholders’ equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders’ equity

27,500 6,500 34,000 $70,000

27,500 3,500 31,000 $75,000

September 30 Current ratio (10,000 + 17,000 + 9,000) ÷ 24,000 = 1.50 Quick ratio

(10,000 + 17,000) ÷ 24,000 = 1.13

October 1 (4,000 + 17,000 + 9,000) ÷ 24,000 = 1.25 (4,000 + 17,000) ÷ 24,000 = 0.88

d. Quite a few possibilities exist, from increasing long-term borrowing to issuing new stock to selling unneeded equipment.

©Cambridge Business Publishers, 2021 2-18

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E2-39. (15 minutes) LO 1, 3, 4 Income statement

Balance sheet

Sales................................. $30,000 Wages expense ................ 12,000 Net income (loss) .............. $18,000

Cash....................................................... $ 8,000 Accounts receivable ...............................30,000 Total assets............................................ $38,000 Wages payable ...................................... $12,000 Common stock ...................................... 8,000 Retained earnings ..................................18,000 Total liabilities and equity ....................... $38,000

E2-40. (15 minutes) LO 1, 3 a. Procter & Gamble ($ millions)

Amount

Classification

Net sales ...................................................................... $ 65,058 Income tax expense ..................................................... 3,063

I I

Retained earnings ........................................................96,124 Net earnings .................................................................15,411 Property, plant and equipment (net) .............................19,893 Selling, general and administrative expense ................18,568 Accounts receivable ..................................................... 4,594 Total liabilities ...............................................................64,268 Stockholders' equity .....................................................56,138 Net earnings from continuing operations 10,194

B I B I B B B I

b. Total assets = Total liabilities + Stockholders’ equity Total assets = $64,268 + $56,138 = $120,406

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-19

E2-41. (15 minutes) LO 1, 3, 7 a. Shoprite Holdings Ltd (rand millions)

Amount

Classification

Sales of merchandise Depreciation and amortization Reserves (Retained earnings) Property, plant and equipment Cost of goods and services

R 141,000 2,176 18,838 18,407 107,174

I I B B I

Trade and other payables Total assets

17,414 55,723

B B

Total equity Employee benefits expense Total non-current assets Total non-current liabilities

27,749 10,498 24,572 1,492

B I B B

b. Total liabilities = Total assets minus total equity Total liabilities = R 55,723 – R 27,749 = R 27,974 million.

c. Current ratio = Current assets/Current liabilities = [R 55,723 – R 24,572] / [R 27,974 – R 1,492] = R 31,151 / R 26,482 = 1.18

©Cambridge Business Publishers, 2021 2-20

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E2-42. (15 minutes) LO 1, 3, 7 a. El Puerto de Liverpool (Mexican peso thousands)

Amount

Classification

Total revenue Retained earnings Inventory Administration expenses Total assets

$122,168,279 82,963,786 18,486,423 33,549,108 168,266,121

I B B I B

Long-term debt Financing costs (expenses)

33,358,545 7,137,563

Total current assets Total stockholders’ equity Prepaid expenses Total non-current liabilities

67,351,290 90,082,378 1,913,794 38,849,994

B I B B B B

b. Total liabilities = Total assets - Stockholders’ equity Total liabilities = $168,266,121 - $90,082,378 = $78,183,743 Current liabilities = $78,183,743 - $38,849,994 = $39,333,749

c. Quick ratio = [Cash + Marketable securities + Accts. receivable] / Current Liabilities = [Current assets – Inventory – Prepaid expenses] / Current liabilities = [$67,351,290 - $18,486,423 - $1,913,794] / $39,333,749 = 1.19

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-21

E2-43. (15 minutes) LO 1, 3 a. Kimberly-Clark ($ millions)

Amount

Classification

Net sales ...................................................................... $18,259 Cost of goods sold........................................................11,706 Retained earnings ........................................................ 6,730 Net income ................................................................... 2,319 Property, plant & equipment, net .................................. 7,436

I I B I B

Marketing, research and general expenses ................. 3,227 Accounts receivable, net .............................................. 2,315 Total liabilities ...............................................................14,269 Total stockholders' equity ............................................. 882

I B B B

b. Total assets = Total liabilities + Stockholders’ equity Total assets = $14,269 + $882 = $15,151 Total revenue – Total expenses = Net income $18,259 – Total expenses = $2,319 Thus, Total expenses = $15,940 c. Debt-to-equity ratio = Total liabilities / Stockholders’ equity = $14,269 / $882 = 16.18

©Cambridge Business Publishers, 2021 2-22

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E2-44. (15 minutes) LO 1, 2, 3. 4 Balance Sheet Transaction

Cash Asset

(1) Receive €50,000 in exchange for common stock.

+50,000

(2) Borrow €10,000 from bank.

+10,000

Noncash Assets

Liabilities

Income Statement +

Contrib. + Capital

Earned Capital

Revenues -

Expenses

Net Income

+50,000

Cash

Common Stock

+10,000

Cash

(3) Purchase €2,000 of supplies inventory on credit.

+2,000 Inventory

Notes Payable +2,000

Accounts Payable

(4) Receive €15,000 cash from customers for services provided.

+15,000

(5) Pay €2,000 cash to supplier in part (3).

- 2,000

Cash

Accounts Payable

(6) Receive order for future services with €3,500 advance payment.

+3,500

(7) Pay €5,000 cash dividend to shareholders.

- 5,000

(8) Pay employees €6,000 cash for compensation earned.

- 6,000

(9) Pay €500 cash for interest on loan in (2).

- 500 Cash

Totals

65,000

Cash =

+15,000

Retained Earnings

Revenue

+15,000

+3,500

Cash =

Unearned Revenue

- 5,000

Cash

Retained Earnings

- 6,000

Cash

+6,000

Retained Earnings

- 500

2,000

13,500

50,000

- 6,000

+500

Retained Earnings

Wages Expense

3,500

15,000

Interest Expense

6,500

- 500

8,500

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-23

E2-45. (20 minutes) LO 2, 6 a. 1. Cash (+A) ...............................................................................50,000 Common stock (+SE) ......................................................... Receive €50,000 in exchange for common stock.

50,000

2. Cash (+A) ...............................................................................10,000 Notes payable (+L)............................................................. Borrow €10,000 from bank.

10,000

3. Inventory (+A)......................................................................... 2,000 Accounts payable (+L) ....................................................... Purchase €2,000 supplies inventory on account.

2,000

4. Cash (+A) ...............................................................................15,000 Revenue (+R, +SE) ............................................................ Recognize €15,000 revenue for services provided.

15,000

5. Accounts payable (-L) ............................................................ 2,000 Cash (-A)............................................................................ Pay supplier €2,000 cash.

2,000

6. Cash (+A) ............................................................................... 3,500 Unearned revenue (+L) ...................................................... Receive €3,500 advance from customer.

3,500

7. Retained earnings (-SE) ......................................................... 5,000 Cash (-A)............................................................................ Pay €5,000 cash dividend to shareholders.

5,000

8. Wages expense (+E, -SE) ...................................................... 6,000 Cash (-A)............................................................................ Pay employees €6,000

6,000

9. Interest expense (+E, -SE) ..................................................... Cash (-A)............................................................................ Pay €500 interest on note.

500 500

©Cambridge Business Publishers, 2021 2-24

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. + (1) (2) (4) (6) Bal.

+ (3) Bal. -

+ (8) Bal. + (9) Bal.

Cash (A) 50,000 2,000 10,000 5,000 15,000 6,000 3,500 500 65,000

Supplies Inventory (A) 2,000 2,000

Revenue (R) 15,000 15,000

(5) (7) (8) (9)

Accounts Payable (L) 2,000 2,000 0

(5)

Unearned Revenue (L)

+ (3) Bal. +

3,500 3,500 -

Notes Payable (L) 10,000 10,000

Interest Expense (E) 500 500

(7) Bal.

+ (2) Bal.

Common Stock (SE) 50,000 50,000

+ (1) Bal.

Retained Earnings (SE) 5,000 5,000

(4) Bal.

Wages Expense (E) 6,000 6,000

(6) Bal.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-25

E2-46. (20 minutes) LO 1, 7 a. & b. BETTIS CONTRACTORS Balance Sheets June 30, 2019 Assets Cash Accounts receivable Supplies Current assets Land Equipment Total assets Liabilities Accounts payable Current liabilities Notes payable Total liabilities Stockholders’ equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders’ equity

July 2, 2019

$ 14,700 9,200 30,500 54,400 25,000 98,000 $177,400

8,900 8,900 30,000 38,900

100,000 38,500 138,500 $177,400

2,200 9,200 30,500 41,900 25,000 108,000 $174,900

8,900 8,900 33,000 41,900

100,000 33,000 133,000 $174,900

c. CR = $54,400 / $8,900 = 6.11 QR = ($14,700 +$9,200) / $8,900 = 2.69 d. Bettis’ current ratio indicates a strong liquidity position. The firm might want to consider investing some of its cash in assets that contribute to the firm’s earning power. The quick ratio is reasonable as a company does not want to tie up too much of its assets in a nonearning asset (cash). A quick glance at the data indicates that the firm's liquidity position has weakened since June.

©Cambridge Business Publishers, 2021 2-26

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E2-47. (15 minutes) LO 1, 2, 3, 4 Balance Sheet Transaction 1. Receive $20,000 cash in exchange for common stock.

Cash Asset

= Liabilities +

Contrib. + Capital

+20,000

Cash

Common Stock

2. Purchase $2,000 of inventory on credit.

+2,000 Inventory

3. Sell inventory for $3,000 on credit. 4. Record cost of goods sold in 3. 5. Collect $3,000 cash from transaction 3.

Noncash Assets

Income Statement

8. Pay $5,000 cash on a note payable.

-5,000

9. Pay $2,000 cash dividend.

-2,000

TOTALS

15,000

Accts Payable +3,000

+3,000

Sales

-2,000

Inventory

Retained Earnings

Accounts Receivable

-1,000

Retained Earnings

Cash

Net Income

+5,000

Equipment

Notes = Payable

COGS Expense

-1,000

- 2,000

+ 1,000

Retained Earnings

+3,000

+ 2,000

+5,000

Cash

Expenses

+2,000

+3,000

-3,000

7. Pay wages of $1,000 in cash.

Revenues -

Accounts Receivable

+3,000

6. Acquire $5,000 of equipment by signing a note.

Earned Capital

Wages Expense

- 1,000

-5,000

Cash

Notes Payable

-2,000 =

Cash +

5,000

Retained Earnings 2,000

20,000

-2,000

3,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-27

E2-48. (20 minutes) LO 6 a. 1. Cash (+A) ............................................................................... 20,000 Common stock (+SE) .........................................................

20,000

2. Inventory (+A) ......................................................................... 2,000 Accounts payable (+L)........................................................

2,000

3. Accounts receivable (+A) ........................................................ 3,000 Sales (+R, +SE) .................................................................

3,000

4. Cost of goods sold (+E, -SE) .................................................. 2,000 Inventory (-A)......................................................................

2,000

5. Cash (+A) ............................................................................... 3,000 Accounts receivable (-A) ....................................................

3,000

6. Equipment (+A)....................................................................... 5,000 Notes payable (+L) .............................................................

5,000

7. Wages expense (+E, -SE) ...................................................... 1,000 Cash (-A) ............................................................................

1,000

8. Notes payable (-L) .................................................................. 5,000 Cash (-A) ............................................................................

5,000

9. Retained earnings (-SE) ......................................................... 2,000 Cash (-A) ............................................................................

2,000

©Cambridge Business Publishers, 2021 2-28

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. +

Cash (A) 20,000 1,000 3,000 5,000 2,000

(1) (5)

(7) (8) (9) -

Inventory (A) 2,000 2,000

(2)

Accounts Receivable (A) 3,000 3,000 Equipment (A) 5,000

(8)

Accounts Payable (L) 2,000

Notes Payable (L) 5,000 5,000

(3)

(5) -

(7)

Cost of Goods Sold (E) 2,000

+ (6)

Sales Revenue (R) 3,000

(1)

(4) (4)

(3)

Common Stock (SE) 20,000

(9)

Wages Expense (E) 1,000

Retained Earnings (SE) 2,000

(2)

+ (6)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-29

PROBLEMS P2-49. (30 minutes) LO 1, 3 a. Comcast, Apple, Target and Harley-Davidson are financed primarily by debt (between 63% and 82% of total assets). Nike is financed more by equity (47% debt). b. The highest ratios of income to assets were Nike (18.2%), Apple (12.9%) and Comcast (12.2%). Possible reasons include the firms’ ability to command a premium price for their brands and, in the case of Nike and Apple, the ability to outsource a significant amount of their production (and avoid investments in productive capacity). c. Apple has the highest estimated ROE at 36%. (The ROE is estimated because we have only this year’s equity.) Nike has the second highest ROE at 34%, and Comcast is at just under 33%. Both Apple and Nike are able to reduce expenses through outsourcing production to Asia.

P2-50. (30 minutes) LO 1, 3 a. While Apple is 64% debt financed, Hewlett-Packard’s liabilities exceed its total assets. (It has negative stockholders’ equity.) Hewlett-Packard is the more heavily leveraged firm. Some of the difference can be attributed to HPQ’s expensive acquisitions that resulted in subsequent write-offs. b. Hewlett-Packard's net income to asset ratio is 7.7% while Apple’s is 12.9%. The ratios are not close, which might not be expected given the similarities of their activities. More heavily leveraged firms are open to greater risk and for this reason we might expect a greater return to be earned on Hewlett-Packard’s assets to compensate for the higher risk. But that turns out not to be the case. Apple’s return exceeds Hewlett-Packard’s, suggesting that Apple has superior products or is more efficient in its operations. c. Hewlett-Packard’s gross profit as a percent of sales is 18.4% while Apple’s is 38.5%. The implication is that Apple does have the more efficient production operation and/or product designs that allow it to command a premium price from consumers.

©Cambridge Business Publishers, 2021 2-30

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-51. (30 minutes) LO 1, 3 a. Comcast is 63% financed with debt, while Verizon is 83% financed with debt. High debt financing is not uncommon in an industry with large investments in property, plant and equipment. Verizon’s debt percentage is particularly high as it repurchased a significant portion of its common stock that had been held by Vodafone Group, thereby reducing shareholders’ equity. b. Comcast has the slightly higher net income to total asset ratio at 12.2% compared to 11.9% for Verizon. This small difference can be explained by the larger amount of interest expense that Verizon pays on its debt financing. c. Verizon has a slightly lower return on total assets while reporting much higher leverage (debt), so it is likely that Comcast would have better access to additional capital.

P2-52. (30 minutes) LO 1, 7 a. 3M at 69% is the more heavily debt-financed firm. Abercrombie and Fitch is the lowest debt financed at 46%. Apple is 64% financed by debt. b. Apple has the most working capital, but it is a much larger firm than 3M or Abercrombie & Fitch. A better measure of the comparative differences in working capital is the current ratio, which is the ratio of the firm’s current assets to its current liabilities. This ratio is greatest for Abercrombie & Fitch at 2.5.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-31

P2-53. (30 minutes) LO 1, 5 a.

BARTH COMPANY Balance Sheet December 31, 2018 Assets Cash Accounts receivable Equipment Land

$ 8,800 18,400 9,000 50,000

Total assets

$86,200

Liabilities Accounts payable

$ 7,500

Equity Stockholders’ equity Total liabilities & equity

78,700 $86,200

b. Increase in Equity Add: Dividends Net Income for 2018

($78,700-$67,500)

$11,200 12,000 $23,200

c. Increase in Equity Add: Dividends

($78,700-$67,500)

$11,200 21,000 32,200 13,500 $18,700

Less: Additional Investment Net Income for 2018

P2-54. (20 minutes) LO 1, 3 a. ANF

JWN

Total assets (Total liabilities and equity)

$2,326

$8,115

Total expenses (Sales – Net income)

3,482

14,700

Total expenses as percent of sales

99.7% ($3,482/$3,493)

97.1% ($14,700/$15,137)

b. ANF Return on average equity…

$11 [($2,326-$1,074)+$1,252]/2

JWN = 0.9%

$437 [($8,115-$7,138)+$870]/2

= 47.3%

©Cambridge Business Publishers, 2021 2-32

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-55. (30 minutes) LO 1, 7 a. ($ millions)

Current Assets

Noncurrent Assets

Total Assets

Current Liabilities

Noncurrent Liabilities

Total Liabilities

2014 ……

$5,559

$9,967

$15,526

$6,226

$8,301

$14,527

$999

2015 ……

5,426

9,416

14,842

6,349

8,453

14,802

2016 ……

5,115

9,487

14,602

5,846

8,639

14,485

117

2017 ……

5,211

9,940

15,151

5,858

8,411

14,269

882

Equity

b. Kimberly Clark’s current assets most likely include cash, accounts receivable, inventories, and prepaid assets. Its long-term assets most likely include property, plant and equipment (PPE), goodwill, and other intangible assets that have arisen from acquisitions. c. 2016: Working capital = $5,115 - $5,846 = $(731) Current ratio = $5,115 / $5,846= 0.87 2017: Working capital= $5,211 - $5,858 = $(647) Current ratio $5,211 / $5,858 = 0.89 d. Kimberly Clark’s liquidity ratios have remained stable over this four year period. In 2014, the current ratio was 0.89, the same as 2017. The company has reduced investment in current assets and current liabilities proportionately over the last four years.

P2-56. (30 minutes) LO 1, 7 a. ($ millions)

Current Assets

Noncurrent Assets

Total Assets

Current Liabilities

Noncurrent Liabilities

Total Liabilities

Equity

2014 …… 2015 …… 2016 …… 2017 ……

$ 5,863 6,045 4,996 3,812

$ 7,322 5,292 4,366 3,450

$13,185 11,337 9,362 7,262

$ 5,595 5,438 4,681 4,915

$ 8,535 7,855 8,505 6,070

$14,130 13,293 13,186 10,985

$ (945) (1,956) (3,824) (3,723)

b. We might reasonably predict inventories to comprise the bulk of its current assets. In fact, SHLD’s inventory is more than 80% of its current assets. c. 2014: $5,863 / $5,595= 1.05 2017: $3,812 / $4,915 = 0.78

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-33

d. SHLD’s deteriorating condition can been seen in the decline in current assets, noncurrent assets and its shareholders’ equity. In fact, beginning in 2014, SHLD’s shareholders’ equity was negative, indicating that the book value of its liabilities exceeded the book value of its assets. This situation has only become worse over the past three years as the negative balance in equity in 2017 is nearly four times as large as it was in 2014.

P2-57. (30 minutes) LO 1, 2, 3, 4 a. Balance Sheet Transaction 1. Issued common stock $7,000. 2. Paid rent $750.

Cash Asset +7,000 Cash

Noncash Assets

= =

-750 Cash

= +15,000 Cash

5. $1,200 cash received for services.

+1,200 Cash

+500 Accounts Payable

+6,800 Accounts Receivable

Revenues -

+15,000 Notes Payable

Expenses

-500 Retained Earnings

6. Billed clients $6,800 for services.

Earned Capital

-750 Retained Earnings

3. Received $500 invoice for advertising expense. 4. Borrowed $15,000 cash from bank.

Liabilities

Income Statement Contrib. + + Capital +7,000 Common Stock

Net Income

= +750 Rent Expense +500 Advertising Expense

-750

-500

+1,200 Retained Earnings

+1,200 Counseling Services Revenue

+1,200

+6,800 Retained Earnings

+6,800 Counseling Services Revenue

+6,800

7. Paid $2,200 cash for salary.

-2,200 Cash

-2,200 Retained Earnings

+2,200 Salary Expense

-2,200

8. Paid $370 cash for utilities.

-370 Cash

-370 Retained Earnings

+370 Utilities Expense

-370

9. Paid $900 cash dividend.

-900 Cash

-900 Retained Earnings

10. Acquired land for $13,000.

-13,000 Cash

11. Paid $100 interest in cash.

-100 Cash

Totals

$5,880

+13,000 Land

= -100 Retained Earnings

$19,800

$15,500

$7,000

$3,180

$8,000

+100 Interest Expense

-100

$3,920

$4,080

©Cambridge Business Publishers, 2021 2-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

LAMBERT SERVICES Income Statement For the Month of December 2018 Counseling services revenue Expenses Rent expense $ 750 Advertising expense 500 Salary expense 2,200 Utilities expense 370 Interest expense 100 Total expenses Net income

$8,000

3,920 $4,080

P2-58. (30 minutes) LO 6 a. 1. Cash (+A) ............................................................................... 7,000 Common stock (+SE) .........................................................

7,000

2. Rent expense (+E,-SE)........................................................... 750 Cash (-A) ............................................................................

750

3. Advertising expense (+E, -SE)................................................ 500 Accounts payable (+L)........................................................

500

4. Cash (+A) ............................................................................... 15,000 Notes payable (+L) .............................................................

15,000

5. Cash (+A) ............................................................................... 1,200 Counseling services revenue (+R,+SE) .............................

1,200

6. Accounts receivable (+A) ........................................................ 6,800 Counseling services revenue (+R,+SE) .............................

6,800

7. Salary expense (+E,-SE) ........................................................ 2,200 Cash (-A) ............................................................................

2,200

8. Utilities expense (+E,-SE) ....................................................... 370 Cash (-A) ............................................................................

370

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-35

a. continued 9. Retained earnings (dividend paid) (-SE) ................................. 900 Cash (-A) ............................................................................

900

10. Land (+A) ................................................................................ 13,000 Cash (-A) ............................................................................

13,000

11. Interest expense (+E,-SE) 100 Cash (-A) ............................................................................

100

b. + (1) (4) (5)

Cash (A) 7,000 750 15,000 2,200 1,200 370 900 13,000 100

(2) (7) (8) (9) (10) (11)

Accounts Receivable (A) 6,800

+ (10)

Rent Expense (E) 750

Salary Expense (E) 2,200

Interest Expense (E) 100

(2)

(7)

+ (11)

Common Stock (SE) 7,000

Retained Earnings (SE) 900

Counseling Services Rev. (R) 1,200 6,800

Advertising Expense (E) 500

(9)

+ (3)

+ (8)

(3)

Land (A) 13,000

Notes Payable (L) 15,000

(6)

Accounts Payable (L) 500

Utilities Expense (E) 370

(4)

(1)

(5) (6)

©Cambridge Business Publishers, 2021 2-36

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-59. (30 minutes) LO 1, 7 a. ($ millions)

Current Assets

Noncurrent Assets

Total Assets

Current Liabilities

Noncurrent Liabilities

Total Liabilities

Equity

2014 …… 2015 …… 2016 …… 2017 ……

$68,531 89,378 106,869 128,645

$ 163,308 201,101 214,817 246,674

$231,839 290,479 321,686 375,319

$63,448 80,610 79,006 100,814

$ 56,844 90,514 114,431 140,458

$120,292 171,124 193,437 241,272

$ 111,547 119,355 128,249 134,047

b. For a computer company we might reasonably expect inventories and cash to be the predominant items in current assets. The reality is that inventory is not a large dollar amount (less than 1% of total assets) because the company’s business model depends on high inventory turnover—that is, it works diligently to minimize the quantity of inventory to avoid product obsolescence. The surprise is that 37% of Apple’s current assets are cash and short-term marketable securities. Long-term assets are primarily concentrated in financial securities, with property, plant and equipment a distant second. c. The percentage of Apple’s assets that is financed with liabilities has increased over this time period. AAPL has started to pay shareholder dividends and to repurchase its common stock, but it has borrowed money to do so. d. 2017: $128,645/$100,814 = 1.28; 2014: $68,531/$63,448 = 1.08 e. Apple’s current ratio is below the industry average. A probable cause of this decrease is the increasing size of the company. Net working capital has increased since 2014. So, even though these measures are low, Apple’s size and the monetary “cushion” of AAPL’s financial assets gives them a relatively strong liquidity position.

P2-60. (30 minutes) LO 1, 7

a. (RMB millions) 2016 … 2017 … 2018 …

Current Assets 20,792 26,516 40,949

Noncurrent Assets

Total Assets

Current Liabilities

Noncurrent Liabilities

Total Liabilities

35,675 47,114 73,377

56,467 73,630 114,326

8,071 13,623 21,651

9,696 12,919 22,619

17,767 26,542 44,270

Equity 38,700 47,088 70,056

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-37

b. Alibaba’s current assets are likely to be primarily comprised of cash, accounts receivable, inventories and prepaid expenses. Its long-term assets will likely be primarily comprised of property, plant and equipment (PPE) for its operations, financial investments, and goodwill and other intangible assets arising from acquisitions. c. Current ratio:

2016: 20,792 / 8,071 = 2.58 2018: 40,949 / 21,651 = 1.89

d. Working capital:

2016: 20,792 - 8,071 = 12,721 2018: 40,949 - 21,651 = 19,298

P2-61. (30 minutes) LO 3 a. ($ millions)

Revenues

Cost of Goods Sold

Gross Profit

Operating Expenses

Operating Income

Other Expense

Net Income

2014 …… 2015 …… 2016 …… 2017 ……

$ 27,799 30,601 32,376 34,350

$ 15,353 16,534 17,405 19,038

$12,446 14,067 14,971 15,312

$ 8,766 9,892 10,469 10,563

$ 3,680 4,175 4,502 4,749

$ 987 902 742 509

$ 2,693 3,273 3,760 4,240

b. The gross profit percentage (also called gross profit margin) for each year follows: Nike, Inc. Gross Profit Percentage 2014 ....................... 44.8% 2015 ....................... 46.0% 2016 ....................... 46.2% 2017 ....................... 44.6% Nike’s sales, gross profit and net income have remained steady over this period, reflecting continued strength. The company's operating expenses have increased at about the same pace as sales. c. Wages, advertising and promotion, and general and administration expenses are likely to be the major cost categories for Nike.

©Cambridge Business Publishers, 2021 2-38

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-62. (30 minutes) LO 1, 2, 3, 4 a. Balance Sheet Transaction

Cash Asset

1. Issued common stock for cash.

+$50,000

2. Rent paid in cash $4,800.

-4,800

Noncash Assets

Earned Capital

Revenues

Common Stock

-4,800

+1,600 Accounts Payable

-1,600 -

Retained Earnings -900

Cash

Retained Earnings

-1,800

+1,800

Cash

Prepaid Insurance

6. Flight services collected in cash; $22,700.

+22,700

Cash

Retained Earnings

Flight Services Revenue

+15,900

Accounts Receivable

Retained Earnings

Flight Services Revenue

7. Billed for flight services ; $15,900.

8. Paid $1,500 on accounts.

-1,500

9. Received $13,200 on account.

+13,200

-13,200

Cash

Accounts Receivable

10. Paid wages in cash: $16,000.

-16,000

Cash

Rent Expense

+1,600 Entertainment = Expense

-4,800

-1,600

Advertising Expense

-900

+22,700

+15,900

-1,500 = Accounts Payable

-16,000

11. Invoice received for fuel; $3,500.

Cash

+16,000 -

Retained Earnings +3,500

-3,500

= Accounts Payable

$57,900

Net Income

+900 -

5. July insurance premium prepaid in cash: $1,800.

TOTALS

+4,800 -

Retained Earnings

-900

-3,000

Expenses

Cash

12. Cash dividend paid; $3,000.

+$50,000

Cash

3. Invoice for entertainment expense: $1,600. 4. Cash paid for advertising: $900.

= Liabilities

Income Statement Contrib. Capital

Wages expense

-16,000

-3,500

+3,500 -

Retained Earnings

Fuel Expense

-3,000 =

Cash +

$4,500

Retained Earnings $3,600

$50,000

$8,800

$38,600

= $26,800

$11,800

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-39

OUTBACK FLIGHTS Income Statement For the Month of June 2019 Revenue Services fees earned Expenses Rent expense Entertainment expense Advertising expense Wages expense Fuel expense Total expenses Net income

$38,600 $ 4,800 1,600 900 16,000 3,500 26,800 $11,800

Note: The insurance premium paid is for the next month (July) and is not an expense at the end of June.

P2-63. (30 minutes) LO 6 a. 1. Cash (+A) ................................................................................ 50,000 Common stock (+SE)..........................................................

50,000

2. Rent expense (+E,-SE) ........................................................... 4,800 Cash (-A) ............................................................................

4,800

3. Entertainment expense (+E,-SE) ............................................ 1,600 Accounts payable (+L) ........................................................

1,600

4. Advertising expense (+E,-SE) ................................................. 900 Cash (-A) ............................................................................

900

5. Prepaid insurance (+A) ........................................................... 1,800 Cash (-A) ............................................................................

1,800

6. Cash (+A) ............................................................................... 22,700 Flight services revenue (+R,+SE) .......................................

22,700

7. Accounts receivable (+A) ........................................................ 15,900 Flight services revenue (+R,+SE) .......................................

15,900

continued next page

©Cambridge Business Publishers, 2021 2-40

Financial & Managerial Accounting for Decision Makers, 4 th Edition

a. continued 8. Accounts payable (-L) ............................................................. 1,500 Cash (-A) ............................................................................

1,500

9. Cash (+A) ................................................................................ 13,200 Accounts receivable (-A) .....................................................

13,200

10. Wages expense (+E,-SE) ....................................................... 16,000 Cash (-A) ............................................................................

16,000

11. Fuel expense (+E,-SE)............................................................ 3,500 Accounts payable (+L) ........................................................

3,500

12. Retained earnings (dividend paid) (-SE) ................................. 3,000 Cash (-A) ............................................................................

3,000

b. + (1) (6) (9)

Accounts Receivable (A) 15,900 (9)

Prepaid Insurance (A) 1,800

(7)

(5)

+ (2)

+ (4)

Cash (A) 50,000 4,800 22,700 900 13,200 1,800 1,500 16,000 3,000

Rent Expense (E) 4,800

Advertising Expense (E) 900

(2) (4) (5) (8) (10) (12)

(8)

13,200

(12)

Accounts Payable (L) 1,500 1,600 3,500

Common Stock (SE) 50,000

+ (1)

Flight Services Revenue (R) 22,700 15,900

+ (6) (7)

Entertainment Expense (E) 1,600

Wages Expense (E) 16,000

(10)

+ (11)

(3) (11)

Retained Earnings (SE) 3,000

(3)

Fuel Expense (E) 3,500

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-41

P2-64. (30 minutes) LO 3 a. ($ millions)

Revenues

Cost of Revenues

Gross Profit

Operating Expenses

Operating Income

Other Expense

Net Income

2014 ……

$ 16,447.8

$ 6,858.8

$9,589.0

$ 6,507.9

$ 3,081.1

$ 1,013.4

$2,067.7

2015 ……

19,162.7

7,787.5

11,375.2

7,774.2

3,601.0

841.7

2,759.3

2016 ……

21,315.9

8,511.1

12,804.8

8,632.9

4,171.9

1,353.0

2,818.9

2017 ……

22,386.8

9,038.2

13,348.6

9,213.9

4,134.7

1,249.8

2,884.9

b. The gross profit percentage (also called gross profit margin) for each year follows: Starbucks, Inc. 2014 2015 2016 2017

Gross Profit Percentage 58.3% 59.4% 60.1% 59.6%

SBUX gross profit percentage edged up in 2015 and 2016, but decreased slightly in 2017. It is still quite high. c. Selling, general and administrative expenses are the major operating expense categories for Starbucks. Most store operating expenses (rent, utilities, coffee, etc.) are included in the Cost of Revenues category.

©Cambridge Business Publishers, 2021 2-42

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-65. (30 minutes) LO 3

a. (€ millions)

Revenues

Cost of Goods Sold

Gross Profit

Operating Expenses

Operating Income

Other Expense

Net Income

2014 ……

€ 71,227

€ 50,869

€ 20,358

€ 13,751

€ 6,607

€ 1,100

€ 5,507

2015 ……

75,636

53,789

21,847

15,805

6,042

(1,338)

7,380

2016 ……

79,645

55,826

23,819

16,500

7,319

1,735

5,584

2017 ……

83,049

58,021

25,028

17,337

7,691

1,512

6,179

b. The gross profit percentage (also called gross profit margin) for each year follows: Siemens AG 2014 2015 2016 2017

Gross Profit Percentage 28.6% 28.9% 29.9% 30.1%

Siemens’ gross profit percentage increased steadily between 2014 and 2017. The increase reflects the improved economic conditions and Siemens’ increasing sales over the period. c. The principal items in Siemens’ operating expenses include selling and general administrative expenses and research and development expenses.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-43

P2-66. (25 minutes) LO 1, 3, 5 a. GEYER, INC. Income Statement For Year Ended December 31, 2018 Service fees ........................................................................................... $67,600 Supplies expense ................................................................................... $ 9,700 Insurance expense ................................................................................. 1,500 Salaries expense .................................................................................... 30,000 Advertising expense ............................................................................... 1,700 Rent expense ......................................................................................... 7,500 Miscellaneous expense .......................................................................... 200 Total expenses ................................................................................. 50,600 Net income ............................................................................................. $17,000 b. GEYER, INC. Statement of Stockholders’ Equity For Year Ended December 31, 2018 Common Stock

Balance at December 31, 2017 ..............$4,000 Stock issuance ..................................... 1,400 Dividends ............................................. Net income ..........................................._____ Balance at December 31, 2018 ..............$5,400

Retained Earnings

Total Stockholders’ Equity

$6,200

$10,200 1,400 (13,500) 17,000 $15,100

(13,500) 17,000 $9,700

c. GEYER, INC. Balance Sheet December 31, 2018 Cash ...................................... Supplies ................................ Total assets ...........................

$14,800 6,100 $20,900

Accounts payable ................................ $ 1,800 Notes payable .....................................4,000 Total liabilities ……………… 5,800 Common stock ………………. 5,400 Retained earnings* …………. 9,700 Total liabilities and equities .. $20,900

* $6,200 beginning balance + $17,000 net income - $13,500 dividend

©Cambridge Business Publishers, 2021 2-44

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-67. (45 minutes) LO 1, 2, 3, 4, 5 a & b. Balance Sheet Transaction

Cash Asset

Beg. Balances

+5,000

1. Paid $600 cash toward accounts payable

-600

2. Paid rent in cash: $3,600

Noncash Assets

= Liabilities

+5,200

Cash

Earned Capital

+5,500

+1,200

Revenues

Expenses

Net Income

= Accounts Payable

-3,600

Cash

Accounts Receivable

Retained Earnings +11,500

+11,500

Retained Earnings

Services Revenue

+500

5. Cash collected on account: $10,000

+10,000

-10,000

Cash

Accounts Receivable

6. Paid wages expense in cash: $2,400

-2,400

7. Invoiced for utility expense: $680

-680 Retained Earnings

Retained Earnings

+11,500

-500

Wages Expense

Retained Earnings

Utilities Expense

Interest Expense

-20

-900

-2,400

-680

-20

+680

= Accounts Payable -20

-3,600

+2,400

Retained Earnings +680

Cash

Advertising Expense

+500 -

Retained Earnings

-2,400

Cash

Rent Expense

-500

= Accounts Payable

+3,600

= +11,500

4. $500 invoice received for advertising

9. Paid $900 cash dividend

+3,500

Contrib. Capital +

-600

3. Billed clients $11,500

8. Paid $20 cash for interest on note

Income Statement

+20

-900

Cash

10. Paid $4,000 cash for sound equipment

-4,000

+4,000

Cash

Equipment

TOTALS

$3,480

$10,700

$4,080

$5,500

$4,600

$11,500

$7,200

$4,300

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-45

c. SCHRAND AEROBICS, INC. Income Statement For Month Ended January 31, 2019 Services revenue..........................................................................................$11,500 Expenses ..................................................................................................... Rent expense .......................................................................................... 3,600 $3,600 Advertising expense ................................................................................ 500 Wages expense............................................................................................ 2,400 Interest expense ...................................................................................... 20 Utilities expense ...................................................................................... 680 Total expenses ............................................................................................. 7,200 Net income .............................................................................................. $4,300 d. SCHRAND AEROBICS, INC. Statement of Stockholders’ Equity For Month Ended January 31, 2019 Common Retained Total Stock Earnings Stockholders’ Equity Balance at January 1, 2019 ....................$5,500 $1,200 $ 6,700 Stock issuance ..................................... Dividends ............................................. (900) (900) Net income ..........................................._____ 4,300 4,300 Balance at January 31, 2019 ..................$5,500 $4,600 $10,100 e. SCHRAND AEROBICS, INC. Balance Sheet January 31, 2019 Cash ...................................... $ 3,480 Accounts receivable .............. 6,700 Equipment ............................. 4,000 Total assets ……………. $14,180

Accounts payable ............................. $ 1,580 Notes payable .................................. 2,500 Total liabilities .................................... 4,080 Common stock .................................. 5,500 Retained earnings ............................ 4,600 Total liabilities and equity .................. $14,180

©Cambridge Business Publishers, 2021 2-46

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-68. (30 minutes) LO 6 a. 1. Accounts payable (-L) ............................................................. 600 Cash (-A) ............................................................................

600

2. Rent expense (+E,-SE) ........................................................... 3,600 Cash (-A) ............................................................................

3,600

3. Accounts receivable (+A) ........................................................ 11,500 Services revenue (+R,+SE) ................................................

11,500

4. Advertising expense (+E, -SE) ................................................ 500 Accounts payable (+L) ........................................................

500

5. Cash (+A) ................................................................................ 10,000 Accounts receivable (-A) .....................................................

10,000

6. Wages expense (+E, -SE) ...................................................... 2,400 Cash (-A) ............................................................................

2,400

7. Utilities expense (+E, -SE) ...................................................... 680 Accounts payable (+L) ........................................................

680

8. Interest expense (+E, -SE) ......................................................20 Cash (-A) ............................................................................

9. Retained earnings (-SE).......................................................... 900 Cash (-A) ............................................................................

900

10. Equipment (+A) ....................................................................... 4,000 Cash (-A) ............................................................................

4,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-47

b. + Beg. Bal. (5)

End Bal.

Cash (A) 5,000 600 10,000 3,600 2,400 20 900 4,000 3,480

(1) (2) (6) (8) (9) (10)

+ Beg. Bal. (3) End Bal.

Accounts Receivable (A) 5,200 10,000 11,500 6,700 + Equipment (A) (10) 4,000 End Bal. 4,000 +

Wages Expense (E) 2,400 2,400

(6) End Bal. + (2) End Bal. + (4) End Bal.

Rent Expense (E) 3,600 3,600 Advertising Expense (E) 500

(1)

2,500 Common Stock (SE) 5,500

(5)

(9)

+ (7) End Bal. -

+ (8) End Bal.

Accounts Payable (L) + 600 1,000 Beg. Bal. 500 (4) 680 (7) 1,580 End Bal. Notes Payable (L) + 2,500 Beg. Bal. End Bal. + Beg. Bal.

5,500 End Bal. Retained Earnings (SE) + 900 1,200 Beg. Bal. 300 End Bal. Services Revenue (R) 11,500 11,500

Utilities Expense (E) 680 680

Interest Expense (E) 20 20

(3) End Bal.

500

©Cambridge Business Publishers, 2021 2-48

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-69. (45 minutes) LO 1, 2, 3, 4, 5 a & b. Balance Sheet Transaction

Cash Asset

Beg.Balances

+6,700

1. Paid $950 cash for rent.

Noncash Assets

= Liabilities +

Contrib. Capital +

Earned Capital

+14,800

+6,000

+12,400

+3,100

-950

-8,800

Cash

Accounts Receivable

3. $500 paid on accts. payable.

-500

5. Borrowed $5,000 signed note.

+5,000

Expenses

Net Income

+950 -

Rent Expense

-$950

+8,100

-4,000

-410

-500 =

Cash +1,600

Retained Earnings

+8,800

4. Received $1,600 cash for services.

Revenues

-950

Cash

2. Received $8,800 cash on account.

Accts Payable

Cash

+1,600

Retained Earnings

Services Revenue

+1,600

+5,000 =

Cash

6. Billed $8,100 for services. 7. Paid $4,000 for cash salary.

Income Statement

Notes Payable

+8,100 Accounts Receivable

-4,000

+8,100

Retained Earnings

Services Revenue

-4,000 =

Cash

8. Received invoice for utilities: $410.

9. Paid $6,000 dividend.

-6,000

10. Paid $9,800 cash for vehicle.

-9,800

+9,800

Cash

Vehicles

11. Paid $50 cash interest on note.

-50 Cash

TOTALS

$800

+4,000

Retained Earnings +410

-410

Accts Payable

Retained Earnings

Salary Expense

Utilities Expense

+410

-6,000 =

Cash

Retained Earnings

-50 =

$23,900

+50

Retained Earnings $8,010

$6,000

$10,690

$9,700

Interest Expense

-50

$5,410

$4,290

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-49

c. KROSS, INC. Income Statement For Month Ended January 31, 2019 Services revenue ................................................................... Rent expense………………………………………………... Utilities expense……………………………………………. Salary expense………………………………………….… Interest expense………………………………………….… Total expenses ...................................................................... Net income .......................................................................

$9,700 $ 950 410 4,000 50 5,410 $4,290

d. KROSS, INC. Statement of Stockholders’ Equity For Month Ended January 31, 2019 Common Retained Total Stock Earnings Stockholders’ Equity Balance at January 1, 2019 ....................$6,000 $12,400 $18,400 Stock issuance ..................................... Dividends ............................................. (6,000) (6,000) Net income ..........................................._____ 4,290 4,290 Balance at January 31, 2019 ..................$6,000 $10,690 $16,690 e. KROSS, INC. Balance Sheet January 31, 2019 Cash ......................................$

800

Accounts payable .............................. $ 510

Accounts receivable .............. 14,100

Notes payable ...................................7,500

Equipment ............................. 9,800

Total liabilities....................................8,010

Total assets ...........................$24,700 Common stock ..................................6,000 Retained earnings ............................. 10,690 Total liabilities and equity .................. $24,700

©Cambridge Business Publishers, 2021 2-50

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P2-70. (30 minutes) LO 6 a. 1. Rent expense (+E,-SE) ........................................................... 950 Cash (-A) ............................................................................

950

2. Cash (+A) ................................................................................ 8,800 Accounts receivable (-A) .....................................................

8,800

3. Accounts payable (-L) ............................................................. 500 Cash (-A) ............................................................................

500

4. Cash (+A) ................................................................................ 1,600 Services revenue (+R,+SE) ................................................

1,600

5. Cash (+A) ................................................................................ 5,000 Notes payable (+L) .............................................................

5,000

6. Accounts receivable (+A) ........................................................ 8,100 Services revenue (+R, +SE) ...............................................

8,100

7. Salary expense (+E,-SE) ........................................................ 4,000 Cash (-A) ............................................................................

4,000

8. Utilities expense (+E,-SE) ....................................................... 410 Accounts payable (+L) ........................................................

410

9. Retained earnings (-SE).......................................................... 6,000 Cash (-A) ............................................................................

6,000

10. Vehicles (+A) .......................................................................... 9,800 Cash (-A) ............................................................................

9,800

11. Interest expense (+E,-SE).......................................................50 Cash (-A).............................................................................

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-51

b. + Beg. Bal. (2) (4) (5)

+ Beg. Bal. (6)

Accounts Receivable (A) 14,800 8,800 8,100

+ (10)

+ (1) + (7)

Cash (A) 6,700 950 8,800 500 1,600 4,000 5,000 6,000 9,800 50

Vehicles (A) 9,800

Rent Expense (E) 950 Salary Expense (E) 4,000

(1) (3) (7) (9) (10) (11)

(8)

(2)

(3)

Utilities Expense (E) 410

Interest Expense (E) 50

Accounts Payable (L) + 500 600 Beg. Bal. 410 (8)

Notes Payable (L) + 2,500 Beg. Bal. 5,000 (5)

Common Stock (SE) + 6,000 Beg. Bal.

(11)

Retained Earnings (SE) + 6,000 12,400 Beg. Bal.

Services Revenue (R) + 1,600 8,100

(9) -

©Cambridge Business Publishers, 2021 2-52

Financial & Managerial Accounting for Decision Makers, 4 th Edition

(4) (6)

CASES and PROJECTS C2-71. (30 minutes) LO 1, 3, 4, 5 WILDLIFE PICTURE GALLERY Income Statement For the month of March 2019

a. Revenues Commissions earned Expenses Rent expense Wages expense Utilities expense Delivery expense Total expenses Net income b.

$28,500 $ 900 4,900 350 1,700 7,850 $20,650

WILDLIFE PICTURE GALLERY Statement of Stockholders’ Equity For the month of March 2019 Common Retained Stock Earnings Balance at March 1, 2019 ...................... $ 0 $ 0 Stock issuance ..................................... 6,500 Dividends ............................................. Net income ..........................................._____ 20,650 Balance at March 31, 2019 ....................$6,500 $20,650

Assets Cash Advance receivable*

Total assets

WILDLIFE PICTURE GALLERY Balance Sheet March 2019 Liabilities $51,200 Payable to artists** 500 Notes payable Accounts payable Total liabilities Stockholders’ equity Total liabilities and $51,700 stockholders’ equity

Stockholders’ Equity $ 0 6,500 20,650 $27,150

$12,500 10,000 2,050 24,550 27,150 $51,700

* It is important to recognize that the Wildlife Picture Gallery is a separate entity from its shareholder/operator, Sarah Penney. The $500 payment for airfare is not an expense of the business, but rather a payment on behalf of an employee. Sarah will have to reimburse the company or have the amount deducted in future compensation, as recognized in the advance receivable asset for Wildlife Picture Gallery. ** 70% x ($95,000) – $54,000 is owed to artists. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 2

2-53

C2-72. (30 minutes) LO 3 Andrea faces a dilemma when she prepares her expense reimbursement request. She has, in essence, been asked by her supervisor to join him in overcharging expenses to the company. Should Andrea not file a reimbursement request for the Luxury Inn lodging costs, the company should question why she and her supervisor stayed at different locations. Discussion of this case should focus on the options available to Andrea. The options include the following: 1.

File an expense reimbursement request for the Luxury Inn and, therefore, minimize the likelihood of jeopardizing her relationship with her supervisor.

File an expense reimbursement request for the Spartan Inn and let future events take whatever course they follow.

Report the situation to her supervisor's boss.

Discuss the situation with her supervisor and indicate that she (Andrea) is not comfortable with filing the Luxury Inn receipt. Perhaps encourage the supervisor to seek a change in company policy to provide daily allowances for lodging and meal costs rather than reimbursing actual costs.

Leave the employ of the company.

There is no single correct answer to the problem. The first choice is not a good solution for the long run as it starts a slippery slope for Andrea, which is likely to lead to further concessions to improper behavior and more serious problems. Additional and more serious situations increase the chances her behavior is likely to be discovered and she could be fired or even sent to jail. One would hope that sleepless nights would intervene long before this time. It is better to draw the line here. Talking to her supervisor is a good idea and perhaps instituting a policy that avoids any temptation. Leaving the company would be a fallback choice if discussion of the situation does not lead to a resolution of the situation that preserves Andrea’s ethical requirements.

©Cambridge Business Publishers, 2021 2-54

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Chapter 3 Adjusting Accounts for Financial Statements Learning Objectives – coverage by question MiniExercises

Exercises

21 - 23, 25,

33, 35,

29, 30

36, 38

23, - 25,

32 - 36,

29, 30

Problems

Cases and Projects

LO1 – Identify the major steps in the accounting cycle. LO2 – Review the process of journalizing and posting transactions.

LO3 – Describe the adjusting process and illustrate adjusting entries.

LO4 – Prepare financial statements from adjusted accounts.

40 - 42, 46, 47, 49,

55 - 58

52 - 54 40 - 43, 46 - 49,

55 - 58

52 - 54 40 - 42,

44, 47, 49,

55, 58

50, 53, 54 LO5 – Describe the process of closing temporary accounts.

LO6 – Analyzing changes in balance sheet accounts.

27, 28, 30

24, 25, 29

31, 33, 37, 39

34 - 36, 38

42, 44, 45, 49 - 51

53, 54 40, 42, 49 52 - 54

55, 56, 58

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-1

QUESTIONS Q3-1.

The five major steps in the accounting cycle are: 1. Analyze business activity using transaction analysis based on the related source documents. 2. Record results of the transaction analysis chronologically in the general journal and create a trial balance. 3. Adjust the recorded data to update all accounts for expense and revenue recognition not previously recognized. 4. Report the adjusted financial data in the form of financial statements. 5. Close the books by posting the adjusting and closing entries, which “zero out” the temporary accounts.

Q3-2.

The fiscal year is the annual accounting period adopted by a firm. A firm using a fiscal year ending on December 31 is on a calendar-year basis.

Q3-3.

Examples of source documents that underlie business transactions are invoices sent to customers, invoices received from suppliers, bank checks, bank deposit slips, cash receipt forms, and written contracts.

Q3-4.

A general journal is a book of original entry that may be used for the initial recording of any type of transaction. It contains space for dates and for accounts to be debited and credited, columns for the amounts of the debits and credits, and a posting reference column for numbers of the accounts that are posted.

Q3-5.

When entries are posted, the page number and identifying initials of the appropriate journal are placed next to the amounts in the appropriate accounts. The account number is entered beside the related amount posted in the journal's posting reference column. This procedure enables interested users to trace amounts in the ledger back to the originating journal entry and permits us to know which entries have been posted.

Q3-6.

An adjusting journal entry is a journal entry made at the end of an accounting period to reflect accural accounting. It usually affects a balance sheet account and an income statement account and rarely involves cash.

Q3-7.

A chart of accounts is a list of the accounts appearing in the general ledger, with the account numbering system indicated. Normally the accounts are classified as asset, liability, owners' equity, revenue, and expense accounts, and often the numbering system identifies the account classification. For example, a coding system might assign the numbers 100–199 to assets, 200–299 to liabilities, and so on.

©Cambridge Business Publishers, 2021 3-2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q3-8.

Many of the transactions reflected in the accounting records through the first two steps of the accounting cycle affect the net income of more than one period. Therefore, adjustments to the account balances are ordinarily necessary at the end of each accounting period to record the proper amount of revenue and to match expenses with revenue properly. This process is also intended to achieve a more accurate picture of financial position by adjusting balance sheet amounts to show unexpired costs, up-to-date amounts of obligations, and so on.

Q3-9.

1. Allocating assets to expense to reflect expenses incurred during the period. Example: Recording supplies used by debiting Supplies Expense and crediting Supplies. 2. Allocating payments received in advance by crediting the revenue account to reflect revenues earned during the period. Example: Recording service fees earned by debiting Unearned Service Fees and crediting Service Fees Earned. 3. Accruing expenses to reflect expenses incurred during the period that are not yet paid or recorded. Example: Recording unpaid wages by debiting Wages Expense and crediting Wages Payable. 4. Accruing revenues to reflect revenues earned during the period that are not yet received or recorded. Example: Recording commissions earned by debiting Commissions Receivable and crediting Commissions Earned.

Q3-10. Jan. 31

Insurance expense (+E, -SE) Prepaid insurance (-A) To record insurance expense for January ($1,872/24 = $78).

78 78

Q3-11. A contra account is an account that is related to, and deducted from, another account when financial statements are prepared or when book values are computed. Accumulated depreciation is deducted from the cost of a depreciable asset in computing and portraying the asset's book value. Q3-12. The building is five years old by the end of 2015, so the accumulated depreciation of $800,000 represents five years of depreciation at an annual rate of $160,000 ($800,000/5). If the annual depreciation is $160,000, then the expected life of the building must be 25 years. At the end of 2022, the building will be twelve years old, and the accumulated depreciation will be 12×$160,000, or $1,920,000. The book value of the building (defined as original cost less accumulated depreciation) will be $2,080,000.

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Q3-13. (a)

(b)

Jan. 1

Cash (+A) Subscriptions received in advance (+L) To record receipt of two-year subscriptions. Jan. 31 Subscriptions received in advance (-L) Subscriptions revenue (+R,+SE) To record subscription revenue earned during January ($9,720/24 = $405).

Q3-14. Jan. 31

Q3-15. Jan. 31

9,720 9,720

405 405

Wages expense (+E, -SE) Wages payable (+L) To record unpaid wages for Jan. 30–31 [($475/5)  2 = $190].

190

Interest receivable (+A) Interest income (+R,+SE) To record interest earned during January.

360

190

360

Q3-16. The temporary accounts—sometimes called nominal accounts—are closed at year-end. They consist principally of the income statement accounts (expense and revenue accounts). (The Income Summary account and the Dividend account are also closed if they are used.) Q3-17. Step 1) Close revenue accounts: Debit each revenue account for an amount equal to its balance, and credit the Retained Earnings account for the total of revenues. Step 2) Close expense accounts: Credit each expense account for an amount equal to its balance, and debit the Retained Earnings account for the total of expenses. Q3-18. A post-closing trial balance ensures that an equality of debits and credits has been maintained throughout the adjusting and closing procedures and that the general ledger is in balance to start the next period. Only balance sheet accounts appear in a post-closing trial balance. Depreciation Expense and Supplies Expense are temporary accounts that should have been closed and should not appear in the post-closing trial balance.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q3-19. The cost principle and the matching concept support Dehning's handling of its catalog costs. Prepaid Catalog Costs is an asset account that is initially recorded at the amount that the catalogs cost Dehning. This is consistent with the cost principle that states that assets are initially recorded at the amounts paid to acquire the assets. The catalogs help Dehning generate sales revenues. The matching concept states that the catalog costs should be matched as expenses with the revenues they help generate. Dehning does this by expensing the catalog costs over their estimated useful lives. Q3-20. (a) Supplies Expense ($825 + $260 − $630 = $455) for the period is omitted from the income statement, overstating net income by $455 (ignoring taxes). (b) Both Supplies and Owners' Equity are overstated by $455 on the January 31 balance sheet (again, before considering taxes).

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MINI EXERCISES M3-21. (45 minutes) LO 2 a. Balance Sheet Transaction

Cash Asset

June 1. Invested $12,000 cash.

+12,000

June 2. Paid $950 cash for June rent.

-950

June 3

= Liabilities +

Cash

+6,400 Office Equipment

-1,800

+3,800

Cash

Supplies

Accounts Receivable

Net Income

+950 -

Retained Earnings

Accounts Payable

Rent Expense

-950

+2,000 Accounts Payable

June 17. Collected $3,250 on accounts.

+3,250

-3,250

Cash

Accounts Receivable

June 19. Paid $3,000 on office equipment account.

-3,000

Cash

= Accounts Payable

June 25. Paid cash dividend of $900.

-900

+4,700

Retained Earnings

Service Fees Earned

+4,700

-900

Cash

Retained Earnings

-350

Cash

5,750

Expenses

+4,700

TOTALS

+6,400

-2,500

Revenues

-950

Cash

June 30. Paid $2,500 salaries.

Earned Capital

Common Stock

June 11. $4,700 billed for services.

June 30. Paid $350 utilities.

Contrib. Capital + +12,000

Purchased $6,400 of office equipment on account.

June 6. Purchased $3,800 of supplies; $1,800 cash, $2,000 on account.

Noncash Assets

Income Statement

+350 -

Utilities Expense

Salaries Expense

3,800

-2,500

Cash +

11,650

5,400

12,000

+2,500

4,700

-350

-2,500

900

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. June 1

Cash (+A) Common stock (+SE) Owner invested cash for stock.

12,000 12,000

Rent expense (+E, -SE) Cash (-A) Paid June rent.

950 950

Office equipment (+A) Accounts payable (+L) Purchased office equipment on account.

6,400

Supplies (+A) Cash (-A) Accounts payable (+L) Purchased $3,800 of supplies; paid $1,800 down with balance due in 30 days.

3,800

6,400

1,800 2,000

11 Accounts receivable (+A) Service fees earned (+R,+SE) Billed clients for services.

4,700

17 Cash (+A) Accounts receivable (-A) Collections from clients on account.

3,250

19 Accounts payable (-L) Cash (-A) Payment on account.

3,000

25 Retained earnings (-SE) Cash (-A) Issued dividends.

900

30 Utilities expense (+E, -SE) Cash (-A) Paid utilities bill for June.

350

30 Salaries expense (+E, -SE) Cash (-A) Paid salaries for June.

2,500

4,700

3,250

3,000

900

350

2,500

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c. + June 1 17

+ June 11

Cash (A) 12,000 950 3,250 1,800 3,000 900 350 2,500

June 2 6 19 25 30 30

Supplies (A) 3,800

Office Equipment (A) 6,400

June 6

June 3

Accounts Receivable (A) 4,700 3,250 June 17

June 19

Accounts Payable (L) + 3,000 6,400 June 3 2,000 June 6

Common Stock (SE) 12,000

June 25

Retained Earnings (SE) 900

Rent Expense (E) 950

June 2

+ June 30

Utilities Expense (E) 350

+ June 1

Service Fees Earned (R) 4,700

+ June 11

+ June 30

Salaries Expense (E) 2,500

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M3-22. (45 minutes) LO 2 a. Balance Sheet Transaction

Cash Asset

April 1

Invested $9,000 in cash.

+9,000

Paid $2,850 cash for lease.

-2,850

+2,850

Cash

Prepaid Van Lease

Borrowed $10,000.

+10,000

Purchased $5,500 equipment for $2,500 cash with rest on account.

-2,500

+5,500

Cash

Equipment

Paid $4,300 cash for supplies.

-4,300

+4,300

Cash

Supplies

Paid $350 cash for ad.

-350

April 2

April 3

April 4

April 7

Noncash Assets

= Liabilities

Income Statement Contrib. Capital +

Earned Capital

Revenues

Expenses

+9,000 =

Cash

Common Stock

+10,000 =

Cash

Note Payable +3,000

Accounts Payable

-350 =

Cash

April 21 Billed $3,500 for services

Retained Earnings

+3,500 Accounts Receivable

+350 -

+3,500

Retained Earnings

Cleaning Fees Earned

Ad. Expense

April 23 Paid $3,000 cash on account.

-3,000

Cash

= Accounts Payable

April 28 Collected $2,300 on account.

+2,300

-2,300

Cash

Accounts Receivable

April 29 Paid $1,000 cash dividend.

-1,000

April 30 Paid $1,750 cash for wages.

-1,750

April 30 Paid $995 cash for gas. TOTALS

-350

+3,500

-1,000 =

Cash

Retained Earnings -1,750

Cash

Retained Earnings

-995

+1,750 -

Wages Expense

Van Fuel Expense

3,095

-995

Cash 4,555

Net Income

13,850

10,000

9,000

-595

+995

3,500

-1,750

-995

405

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3-9

b. April

Cash (+A) Common stock (+SE) Owner invested cash for stock.

9,000

Prepaid van lease (+A) Cash (-A) Paid six months' lease on van.

2,850

Cash (+A) Notes payable (+L) Borrowed money from bank for one year at 10% interest.

10,000

Equipment (+A) Cash (-A) Accounts payable (+L) Purchased $5,500 of equipment; paid $2,500 down with balance due in 30 days.

5,500

Supplies (+A) Cash (-A) Purchased supplies for cash.

4,300

Advertising expense (+E, -SE) Cash (-A) Paid for April advertising.

350

21 Accounts receivable (+A) Cleaning fees earned (+R, +SE) Billed customers for services.

3,500

23 Accounts payable (-L) Cash (-A) Payment on account.

3,000

28 Cash (+A) Accounts receivable (-A) Collections from customers on account.

2,300

29 Retained earnings (-SE) Cash (-A) Issued cash dividends.

1,000

30 Wages expense (+E, -SE) Cash (-A) Paid wages for April.

1,750

9,000

2,850

10,000

2,500 3,000

4,300

350

3,500

3,000

30 Van fuel expense (+E, -SE) Cash (-A) Paid for gasoline used in April.

2,300

1,000

1,750 995 995

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. + April 1 3 28

Cash (A) 9,000 2,850 April 2 10,000 2,500 3 2,300 4,300 4 350 7 3,000 23 1,000 29 1,750 30 995 30

April 4

Supplies (A) 4,300

April 23

Accounts Payable (L) 3,000 3,000

+ April 3

Common Stock (SE) 9,000

+ April 1

+ April 7

Advertising Expense (E) 350

+ April 30

Van Fuel Expense (E) 995

Accounts Receivable (A) 3,500 2,300 April 28

Prepaid Van Lease (A) 2,850

April 21

April 2 + April 3

April 29 -

+ April 30

Equipment (A) 5,500

Notes Payable (L) 10,000

Retained Earnings (SE) 1,000

Cleaning Fees Earned (R) 3,500

+ April 21

Wages Expense (E) 1,750

April 3

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3-11

M3-23. (20 minutes) LO 2, 3 a. Balance Sheet Cash Asset

Transaction 1. Received $20,100 in advance for contract work.

Jan.

Noncash Assets

= Liabilities

+20,100

Cash

Unearned = Service Fees

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

1 Cash (+A) Unearned service fees (+L) To record fee received in advance.

Net Income

20,100 20,100

b. Balance Sheet Transaction

Cash Asset

Noncash Assets

2. Adjusting entry for work completed by Jan. 31.

Income Statement Earned Capital

Revenues

-3,350

+3,350

Unearned = Service Fees

Retained Earnings

Service Fees

= Liabilities

Contrib. Capital +

Jan. 31 Unearned service fees (-L) Service fees (+R, +SE) To reflect January service fees earned on contract ($20,100/6 = $3,350).

Expenses

Net Income

+3,350

3,350 3,350

c. Balance Sheet Transaction 3. Adjusting entry for fees earned but not billed.

Jan. 31

Cash Asset

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

+570

Fees Receivable

Retained Earnings

Service Fees

Fees receivable (+A) Service fees (+R, +SE) To record unbilled service fees earned at January 31.

Expenses

Net Income

+570

570 570

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M3-24. (15 minutes) LO 3, 6 1. Balance Sheet Cash Asset

Transaction

1. Adjusting entry for prepaid insurance

Jan.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

-185

+185

Prepaid Insurance

Retained Earnings

Insurance Expense

Insurance expense (+E, -SE) Prepaid insurance (-A) To record January insurance expense ($6,660/36 = $185).

Net Income

-185

185 185

2. Balance Sheet Cash Asset

Transaction

2. Adjusting entry for supplies used

Jan.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

-1,080

+1,080

Supplies Inventory

Retained Earnings

Supplies Expense

Supplies expense (+E, -SE) Supplies inventory (-A) To record January supplies expense ($1,930 − $850 = $1,080).

Net Income

-1,080

1,080 1,080

3. Cash Asset

Transaction

3. Adjusting entry for depreciation of equipment.

Jan.

Noncash Assets

Balance Sheet Contra Liabil= Assets ities

Income Statement +

Contrib. + Capital

+62 Accum. Deprecn.

Earned Capital

Revenues

-62 Retained Earnings

Depreciation expense—Equipment (+E, -SE) Accumulated depreciation—Equipment (+XA, -A) To record January depreciation on office equipment ($5,952/96 = $62).

Expenses

+62 Deprec. Expense

62 62

Continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-13

Net Income -62

4. Balance Sheet Transaction

Cash Asset

Noncash Assets

4. Adjusting entry for rent

Jan.

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

+875

Retained Earnings

Rent Revenue

-875 Unearned = Rent Liability

31 Unearned rent liability (-L) Rent revenue (+R, +SE) To record portion of advance rent earned in January.

Expenses

Net Income

+875

875 875

5. Balance Sheet Transaction

Cash Asset

Noncash Assets

5. Adjusting entry for accrued salaries

Jan.

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

+490

-490

+490

Salaries Payable

Retained Earnings

Salaries Expense

31 Salaries expense (+E, -SE) Salaries payable (+L) To record accrued salaries at January 31.

Net Income

-490

490 490

M3-25. (15 minutes) LO 2, 3, 6 (All amounts in thousands of Mexican pesos.) a. Balance Sheet Transaction Inventory purchases (total)

Cash Asset

Noncash Assets

+78,023,979 Inventory

Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

+78,023,979 =

Accounts Payable

Inventories (+A)……………………………………. Accounts payable (+L)……………………… To record total purchases made at various dates.

78,023,979 78,023,979

b. Beginning AP balance + Purchases – Payments = Ending AP balance. So, $15,210,743 + $78,023,979 - Payments = $22,535,802. Thus, Payments = $70,698,920.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Balance Sheet Transaction

Cash Asset

Adjusting entry for cost of goods sold for 2013.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

–73,387,487

Inventory

Retained Earnings

Revenues

Expenses

Net Income

+73,387,487 -

Cost of Goods Sold

= –73,387,487

* Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv balance. So, $13,849,931 + $78,023,979 – COGS = $18,486,423. Thus, COGS = $73,387,487

Cost of goods sold (+E, -SE)…………………................... Inventories (-A)………………………………… To record cost of goods sold for the year ended 12/31/2017.

73,387,487 73,387,487

(Note: the COGS figure can be verified from the firm’s financial statements. Purchases cannot be so determined, but could be established by working backwards. See M3-29.)

M3-26. (15 minutes) LO 4 ARCHITECT SERVICES COMPANY Statement of Stockholders’ Equity For Year Ended December 31, 2018 Common Stock Balance at December 31, 2017 ..............$30,000 Stock issuance ..................................... 6,000 Dividends .............................................. Net income ........................................... _____ Balance at December 31, 2018 ..............$36,000

Retained Earnings $18,000 (9,700) 29,900 $38,200

Total Stockholders’ Equity $48,000 6,000 (9,700) 29,900 $74,200

M3-27. (5 minutes) LO 5 Ending balance = Beginning balance + Credit from closing revenue – Debit from closing expenses: $137,600 = $99,000 + $347,400 - $308,800

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3-15

M3-28. (15 minutes) LO 5 a.

Date 2018 Description

Debit

Dec. 31 Commissions revenue (-R) Retained earnings (+SE) To close the revenue account. 31 Retained earnings (-SE) Wages expense (-E) Insurance expense (-E) Utilities expense (-E) Depreciation expense (-E) To close the expense accounts.

84,900

Credit 84,900

55,900 36,000 1,900 8,200 9,800

Closing the revenue and expense accounts into retained earnings has the effect of increasing the retained earnings balance by an amount equal to net income (revenue minus expenses). The balance of Smith’s Retained Earnings after closing entries are posted is: $101,100 credit ($72,100 + $84,900 - $55,900). b. + Bal. Bal. + Bal. Bal. + Bal. Bal.

Wages Expense (E) 36,000 36,000 0

(2) Dec. 31

+ Bal. Bal.

Utilities Expense (E) 8,200 8,200 0

Insurance Expense (E) 1,900 1,900 (2) Dec. 31 0

- Commissions Revenue (R) + (1) Dec. 31 84,900 84,900 0

Depreciation Expense (E) 9,800 9,800 (2) Dec. 31 0

(2) Dec. 31

- Retained Earnings (SE) + 55,900 72,100 Bal. 84,900 (1) Dec.31 101,100 Bal. Dec.31

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Bal. Bal.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M3-29. (30 minutes) LO 2, 3, 6 (All amounts in $ millions.) a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Recognize cost of goods sold

= Liabilities

Income Statement +

Contrib. Capital +

-111,934 Merchandise Inventory

Earned Capital

Revenues

Expenses

-111,934 =

Net Income

-111,934

+111,934 -

Retained Earnings

Cost of Goods Sold

Cost of goods sold (+E,-SE) .................................................... 111,934 Merchandise Inventory(-A) .................................................. To recognize the cost of goods sold.

111,934

b. Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv balance. So $11,461 + Purchases - $111,934 = $16,047. Thus purchases = $116,520 Balance Sheet Transaction

Cash Asset

Recording inventory purchases.

Noncash Assets

= Liabilities

+116,520 Merchandise Inventory

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

+116,520 =

Account Payable

Merchandise inventory(+A) ...................................................... Accounts payable (+L) ........................................................

116,520 116,520

To recognize the purchases on account.

c. Beginning AP balance + Purchases – Payments = Ending AP balance So, $25,309 + $116,520 - Payments = $34,616. Thus, Payments = $107,213

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M3-30 (10 minutes) LO 2, 3, 5 a. Balance Sheet Transaction

Cash Asset

a. Dec. 31 Interest earned.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

+600 Interest Receivable

Earned Capital

Revenues

+600

Retained Earnings

Interest Income

Dec. 31 Interest receivable (+A) Interest income (+R, +SE) To record accrued interest income. b. Dec. 31

Expenses

Net Income

+600

600 600

Interest income (-R) Retained earnings (+SE) To close the Interest Income account.

2,400 2,400

c. Balance Sheet Transaction c. Jan. 31 Receipt of $900 interest

Cash Asset

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

+900

-600

+300

Cash

Interest Receivable

Retained Earnings

Interest Income

2019 Jan. 31 Cash (+A) Interest income (+R, +SE) Interest receivable (-A) To record cash receipt of interest.

Expenses

Net Income

+300

900 300 600

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

EXERCISES E3-31. (30 minutes) LO 5 a. Dec. 31

Service fees earned (-R) Retained earnings (+SE) To close the revenue account.

80,300 80,300

Retained earnings (-SE) Rent expense (-E) Salaries expense (-E) Supplies expense (-E) Depreciation expense (-E) To close the expense accounts.

82,300 20,800 45,700 5,600 10,200

b. + Bal. Bal.

Rent Expense (E) 20,800 20,800 0

+ (2)

Bal. Bal. + Bal. Bal.

+ Bal. Bal.

Salaries Expense (E) 45,700 45,700 0

(2)

Retained Earnings (SE) 82,300 67,000 80,300 65,000

+ Bal. (1) Bal.

(2)

(1)

Supplies Expense (E) 5,600 5,600 0 Depreciation Expense (E) 10,200 10,200 0

Service Fees Earned (R) 80,300 80,300 0

(2) (2)

Bal. Bal.

Brooks Consulting earned a loss during the period (expenses exceeded revenues by €2,000), so the ending retained earnings is lower than the beginning retained earnings (even though no dividends were paid).

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E3-32. (30 minutes) LO 3 a. Income Statement

Balance Sheet Noncash Assets -

Contra Assets

= Liabilities

1. Adjusting entry for depreciateion: equipment.

+610

2. Adjusting entry for utilities expense.

Transaction

Cash Asset

Contrib. Capital +

-700

+390

-390

Utilities Payable

Retained Earnings

5. Adjusting entry for wage expense.

-400

+610

610

Contract Liabilities

Retained Earnings

Premium Revenue

+965

-965

Wages Payable

Retained Earnings

887

+700

-610

-390

-700

+468

+965

-965

+300

-1,897

Wages Expense

+300

Retained Earnings

Interest Income

-1,897

768

b. 1. Depreciation expense—Equipment (+E,-SE) Accumulated depreciation—Equip (+XA, -A) To record depreciation for the period.

Rent Expense +468

+390

+468

Net = Income

Utilities Expense

-468

Interest Receivable 0

Expenses

Retained Earnings

4. Adjusting entry for premium revenues.

+300

Depreciation Expense

-700

Prepaid Rent

6. Adjusting entry for interest earned.

Revenues

Retained Earnings

Earned Capital -610

Accum. Depreciation

3. Adjusting entry for rent expense.

TOTALS

2,665

610 610

2. Utilities expense (+E, - SE) Utilities payable (+L) To record accrued utilities expense.

390

3. Rent expense (+E,-SE) Prepaid rent (-A) To record rent expense for the month ($2,800/4 = $700).

700

4. Contract liabilities (-L) Premium revenue (+R,+SE) To record premium revenue earned [($624/12)  9 = $468].

468

390

700

468

Continued next page

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. continued 5. Wages expense (+E,-SE) Wages payable (+L) To record accrued wages at the end of the period.

965

6. Interest receivable (+A) Interest income (+R,+SE) To accrue interest earned but not yet received.

300

965

300

E3-33. (15 minutes) LO 2, 3, 5 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

a. Adjusting entry for salaries expense.

= Liabilities =

Income Statement +

Contrib. Capital +

Earned Capital

+4,700

-4,700

Salaries Payable

Retained Earnings

2018 Dec. 31 Salaries expense (+E,-SE) Salaries payable (+L) To record accrued salaries payable.

Revenues

Expenses

Salaries Expense

+4,700

Net Income -4,700

4,700 4,700

31 Retained earnings (-RE) Salaries expense (-E) To close the Salaries Expense account.

250,000 250,000

c. Balance Sheet Transaction c. Paid salaries.

2019 Jan.

Cash Asset

Noncash Assets

= Liabilities

-12,000 Cash

Income Statement +

Contrib. Capital +

Earned Capital

+4,700

-7,300

Salaries Payable

Retained Earnings

7 Salaries payable (-L) Salaries expense (+E,-SE) Cash (-A) To record payment of salaries.

Revenues

Expenses

Salaries Expense

+7,300

Net Income -7,300

4,700 7,300 12,000

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E3-34. (20 minutes) LO 3, 6 a. Balance, January 1 = $960 + $800 − $620 = $1,140. b. Amount of premium = $82  12 = $984. Therefore, five months' premium ($984 − $574 = $410) has expired by January 31. The policy term began on and has been in effect since September 1, 2018. c.

Wages paid in January = $3,200 − $500 = $2,700.

d. Monthly depreciation expense = $8,700/60 months = $145. Fields has owned the truck for 18 months ($2,610/$145 = 18).

E3-35. (30 minutes) LO 2, 3, 6 a. Balance Sheet Transaction

Cash Asset

1.7/31 Adjusting entry for rent expense.

Noncash Assets

-475

Liabilities

Income Statement +

Contrib. Capital +

-210

Revenues

-475

Prepaid Rent

2. 7/31 Adjusting entry for ad. expense.

Earned Capital

+475

-475

-210

-1,900

+800

+300

-1,485

Retained Earnings -1,900

+800

Fees Receivable

Retained Earnings

Refinish. Revenue

Retained Earnings

5. 7/31 Adjusting entry for fees revenue. =

-300

+300

Retained Earnings

Refinish. Revenue

-1,485

1,100

+1,900 Supplies Expense

Performance Obligation Liability -300

+210 Advertising Expense

4. 7/31 Adjusting entry for fees revenue.

-1,785

Net Income

-1,900 Supplies Inventory

Rent Expense

- 210

Prepaid Advertising

Expenses

Retained Earnings

3. 7/31 Adjusting entry for supplies expense.

TOTALS

2,585

©Cambridge Business Publishers, 2021 3-22

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. July 31 Rent expense (+E,-SE) Prepaid rent (-A) To record July rent expense ($5,700/12 = $475).

475 475

31 Advertising expense (+E,-SE) Prepaid advertising (-A) To record July advertising expense ($630/3 = $210).

210

31 Supplies expense (+E,-SE) Supplies inventory (-A) To record supplies expense for July ($3,000 − $1,100 = $1,900).

1,900

31 Fees receivable (+A) Refinishing fees revenue (+R,+SE) To record unbilled revenue earned during July.

800

210

1,900

800

31 Performance obligation liability (-L) 300 Refinishing fees revenue (+R,+SE) To record portion of advance fees earned in July ($600/2 = $300).

300

c. + Prepaid Rent (A)

Bal.

5,700

475

Bal.

5,225

Bal. Bal.

+ Prepaid Advertising (A) 630 210 420

+ Supplies (A) (1)

(2)

Bal.

3,000

Bal.

1,100

(3)

- Performance Obligation Liability (L) + (5) 300 600 Bal. 300 Bal.

+ Fees Receivable (A) (4)

1,900

- Refinishing Fees Revenue (R) +

800

2,500 800 300 3,600 +

Supplies Expense (E)

(3)

1,900

Advertising Expense(E) -

(2)

210

+ (1)

Bal. (4) (5) Bal.

Rent Expense (E)

475

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-23

E3-36. (30 minutes) LO 2, 3, 6 (All amounts in $ thousands.) a. Balance Sheet Cash Asset

Transaction

Recognize inventory purchases

Noncash Assets +1,433,446 Inventory

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

+1,433,446 = Accounts Payable

Inventory (+A) ......................................................................... 1,433,446* Accounts payable (+L) ........................................................ To recognize inventory purchases.

1,433,446

* Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv. So, $399,795 + Purchases $1,408,848 = $424,393. Thus, purchases = $1,433,446

b. Beginning compensation payable + Compensation expense – Compensation paid = Ending compensation payable, so $37,235 + $650,000 – Payments = $65,045 Payments = $622,190 c. The balances of accrued compensation on February 3, 2018 and January 28, 2017 are reported as a current liability.

E3-37. (30 minutes) LO 5 a. Dec. 31

Service fees revenue (-R) Interest income (-R) Retained earnings (+SE) To close the revenue accounts.

92,500 2,200

Retained earnings (-SE) Salaries expense (-E) Advertising expense (-E) Depreciation expense (-E) Income tax expense (-E) To close the expense accounts.

64,700

94,700

41,800 4,300 8,700 9,900

©Cambridge Business Publishers, 2021 3-24

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. - Retained Earnings (SE) + 64,700 42,700 94,700 72,700

(2)

Bal. (1) Bal.

- Service Fees Revenue (R) + 92,500 92,500 0 - Interest Income (R) + 2,200 2,200 0

(1)

+ Salaries Expense (E) 41,800 41,800 0 + Depreciation Expense (E) 8,700 8,700 0

Bal. Bal. Bal. Bal.

(2)

Bal. Bal.

(2)

Bal. Bal.

Bal. Bal. Bal. Bal.

+ Advertising Expense (E) 4,300 4,300 0 + Income Tax Expense (E) 9,900 9,900 0

(2)

E3-38. (15 minutes) LO 2, 3, 6 a. Balance Sheet Transaction (1) Collect deposits from customers. (2) Recognize income on completed customer orders.

(1)

(2)

Cash Asset +200,000 Cash

+565,387 Cash

Noncash Assets

= =

Liabilities +200,000 Customer Deposits

-197,998 Customer Deposits

Income Statement +

Contrib. Capital

Earned Capital

Revenues

+763,385 Retained Earnings

+763,385 Sales Revenue

Cash (+A) ……………………………………………… Customer deposits* (+L) ……………………… To record unearned customer deposits.

Expenses

= =

200,000

Customer deposits* (-L) ........................................................... 197,998 ** Cash (+A)………………………………………………… 565,387 Sales revenue (+R, +SE) ..................................................... To record sales revenue and recognized deposits earned.

200,000

763,385

* Also sometimes called Unearned Customer Deposits ** $60,958 + $200,000 – Deposits earned = $62,960; Deposits earned = $197,998.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-25

Net Income

+763,385

b. Balance Sheet Transaction

Cash Asset

Record inventory purchases

Noncash Assets

= Liabilities

+330,822

Inventory

= Accounts Payable

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Inventory (+A) ......................................................................... Accounts Payable (+L) ...................................................... To recognize inventory purchases. BI +Purchases – EI = COGS. So $162,323 + Purchases - $149,483 = $343,662. Thus: Cost of acquiring inventory =$330,822

Net Income

330,822 330,822

c. Customer Deposits are reported as a current liability.

E3-39. (40 minutes) LO 4, 5 a. SOLOMON CORPORATION Income Statement For Year Ended December 31, 2018 Service fees revenue.............................................................................. $71,000 Rent expense ......................................................................................... (18,000) Salaries expense .................................................................................... (37,100) Depreciation expense……………………………….…………….. (7,000) Net income ............................................................................................. $ 8,900 SOLOMON CORPORATION Statement of Stockholders’ Equity For Year Ended December 31, 2018 Common Stock Balance at December 31, 2017 .............. $43,000 Stock issuance ....................................... Dividends ................................................ Net income ............................................. _______ Balance at December 31, 2018 .............. $43,000

Retained Earnings $20,600*

Total Stockholders’ Equity $63,600

(8,000) 8,900 $21,500

(8,000) 8,900 $64,500

*12,600 + 8,000 The dividend was paid and debited to retained earnings prior to the end of the period. continued next page ©Cambridge Business Publishers, 2021 3-26

Financial & Managerial Accounting for Decision Makers, 4 th Edition

a. continued SOLOMON CORPORATION Balance Sheet December 31, 2018 Assets Liabilities Cash $ 4,000 Notes payable Accounts receivable 6,500 Total Liabilities Equipment $78,000 Less:Accumulated depreciation 14,000 64,000 Owners’ Equity Common stock Retained earnings Total Liabilities and Owners’ Total Assets $74,500 Equity

$10,000 10,000

43,000 21,500 $74,500

b. 1.

Service fees revenue (-R) ....................................................... 71,000 Retained earnings (+SE) ....................................................

71,000

Retained earnings (-SE).......................................................... 18,000 Rent expense (-E)...............................................................

18,000

Retained earnings (-SE).......................................................... 37,100 Salaries expense (-E) .........................................................

37,100

Retained earnings (-SE)..........................................................7,000 Depreciation expense (-E) .................................................

7,000

The cash dividend has already been paid and is already reflected in the adjusted trial balance. c. Only the T-accounts affected by closing process are shown here.

Bal. Bal

+ Depreciation Expense (E) 7,000 7,000 0

Bal. Bal.

+ Salaries Expense (E) 37,100 37,100 0

(4)

(1)

- Service Fees Revenue (R) + 71,000 71,000 0 +

(3)

Bal. Bal

(2-4)

Bal. Bal.

Rent Expense (E) 18,000 18,000 0

- Retained Earnings (SE) + 62,100 12,600 71,000 21,500

(2)

Bal. (1) Bal.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-27

PROBLEMS P3-40. (90 minutes) LO 2, 3, 6 a., b. &d. +

Cash (A)

Apr. 1 5 18

11,500 1,800 4,900

Bal.

2,880 6,100 1,000 675

Apr. 1 2 2 29

100 2,500

30 30

4,945

+ Apr. 1 Unadj. bal. Adj bal.

Prepaid Insurance (A) 2,880 2,880 120 2,760 +

Apr. 2 Bal.

+ Apr. 30 Bal.

Bal.

5,500 4,000 4,600

+ Apr. 5 Unadj. bal. Adj. bal.

Supplies (A) 1,200 1,200 800 400 +

(d) Apr. 30

Equipment (A) 3,100 3,100

Apr. 2 Bal. -

+ Apr. 12 30 Unadj. bal. (d) 30

9,950

Apr. 30 Adj. Bal.

Apr. 12 30

4,900

Apr. 18

(d) Apr. 30

Roofing Fees Revenue (R) 5,500 4,000 9,500 450

Accounts Receivable (A)

Trucks (A) 6,100 6,100 Accounts Payable (L) 2,100 1,200 3,300

Apr. 30

+ Apr. 2 5 Bal.

Contract Liability (L) + 1,800 Apr. 5 (d) 450 1,800 Unadj. bal 1,350 Adj. Bal

Adj. Bal.

Supplies Expense (E) (d) 800 800

Advertising Expense (E) 100 100

Common Stock (SE) 11,500 11,500 +

Apr. 29 Bal.

Fuel Expense (E) 675 675

+ Apr. 1 Bal. -

continued next page

©Cambridge Business Publishers, 2021 3-28

Financial & Managerial Accounting for Decision Makers, 4 th Edition

a. continued + Apr. 30 Adj. Bal.

Insurance Expense (E) (d) 120 120

+ Apr. 30 Bal.

Wages Expense (E) 2,500 2,500

+ Depreciation Expense – Equip. (E) Apr. 30 (d) 35 Adj. Bal. 35

- Accumulated Deprec. – Equip. (XA) + 35 (d) Apr. 30 35 Adj. Bal.

+ Depreciation Expense - Trucks (E) Apr. 30 (d) 125 Adj. Bal. 125

- Accumulated Deprec. – Trucks (XA) + 125 (d) Apr. 30 125 Adj. Bal

b. Balance Sheet Transaction

Cash Asset

Noncash + Assets

4/1 Cash +11,500 received for Cash stock.

Liabilities

Income Statement Contrib. Capital +

Earned Capital

Revenues

+11,500 Common Stock

Expenses

4/1 Purchase liability insurance.

-2,880 Cash

+2,880 Prepaid Insurance

4/2 Purchase truck for cash.

-6,100 Cash

+ 6,100 Truck

4/2 Purchase equipment.

-1,000 Cash

4/5 Purchase supplies on account. 4/5 Cash in advance for roofing repairs.

+3,100 = Equipment

+2,100 Accts Payable

+ 1,200 Supplies

+1,200 Accts Payable

+1,800 Contract Liability

+5,500 Roofing Fees Revenue

+1,800 Cash

4/12 Bill customers for services.

+5,500 = Accts Receivable

+5,500 Retained Earnings

4/18 Collected cash on account.

+4,900 Cash

-4,900 = Accts Receivable

4/29 Paid cash for fuel.

-675 Cash

-675 Retained Earnings

4/30 Paid cash for ads.

-100 Cash

-100 Retained Earnings

4/30 Paid cash wages.

-2,500 Cash

-2,500 Retained Earnings

+4,000 = Accounts Receivable

+4,000 Retained Earnings

+4,000 Roofing Fees Revenue

6,225

9,500

4/30 Bill customers for services. Totals

4,945

17,880

5,100

11,500

+675 Fuel Expense

+5,500

-675

+100 = Ad. Expense

-100

+2,500 Wages Expense

3,275

-2,500

+4,000

6,225

continued next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

Net Income

3-29

b. continued Date 2019 Description Apr. 1 Cash (+A) Common stock (+SE) Owner invested cash.

Debit 11,500

11,500

Prepaid insurance (+A) Cash (-A) Paid two-year premium on liability insurance policy.

2,880 2,880

Trucks (+A) Cash (-A) Purchased used truck for $6,100 cash.

6,100

Credit

6,100

Equipment (+A) 3,100 Cash (-A) Accounts payable (+L) Purchased ladders and other equipment, $1,000 down with $2,100 balance due in 30 days. Supplies (+A) Accounts payable (+L) Purchased supplies on account.

1,200

Cash (+A) Contract liability (+L) Received advance payment for services.

1,800

Accounts receivable (+A) Roofing fees revenue (+R,+SE) Billed customers for services.

5,500

Cash (+A) Accounts receivable (-A) Collection on account from customers.

4,900

Fuel expense (+E,-SE) Cash (-A) Paid truck fuel bill for April.

675

Advertising expense (+E,-SE) Cash (-A) Paid for April newspaper advertising.

100

1,000 2,100

1,200

1,800

5,500

4,900

675

100

Wages expense (+E, -SE) Cash (-A) Paid wages.

2,500

Accounts receivable (+A) Roofing fees revenue (+R, +SE) Billed customeers for services.

4,000

2,500

4,000

©Cambridge Business Publishers, 2021 3-30

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. LOUGEE ROOFING SERVICE Unadjusted Trial Balance April 30, 2019 Debit $ 4,945 4,600 1,200 2,880 6,100 3,100

Cash Accounts Receivable Supplies Prepaid Insurance Trucks Equipment Accounts Payable Contract liability Common Stock Roofing Fees Revenue Fuel Expense Advertising Expense Wages Expense

Credit

$ 3,300 1,800 11,500 9,500 675 100 2,500 $26,100

$26,100

d. Balance Sheet Transaction

Cash Asset

1. Recognize one month of insurance expense.

Noncash Assets

-120

= Liabilities

Income Statement +

Contrib. Capital

-800

Expenses

+120

4. Recognize depreciatio n expense on equipment.

5. Recognize roofing fees earned.

+125

+35

-35

-450

+450

Retained Earnings

Roofing Fees Revenue

-630

450

+800

+125

+35

1,080

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

-800

-125

-35

+450

-630

Depreciation Expense

Contract liability -450

-120

Depreciation Expense

Retained Earnings

160

Retained Earnings

Accum. Depreciation

Supplies Expense

-125

Net = Income

Insurance Expense

-800

Accum. Depreciation

-920

Retained Earnings

3. Recognize depreciatio n expense – Trucks.

Revenues

Retained Earnings

Supplies

Earned Capital -120

Prepaid Insurance

2. Recognize supplies expense.

Totals

Contra Assets

3-31

d. continued Date 2019 Description April 30 Insurance expense (+E,-SE) Prepaid insurance (-A)

Debit 120

Credit 120

To record April insurance expense ($2,880/24 months = $120).

Supplies expense (+E,-SE) Supplies (-A)

800

Depreciation expense—Trucks (+E,-SE) Accumulated depreciation—Trucks (+XA,-A)

125

800

To record April supplies expense ($1,200 − $400 = $800).

125

To record April depreciation on trucks.

Depreciation expense—Equipment (+E,-SE) Accumulated depreciation—Equipment (+XA,-A)

35 35

To record April depreciation on equipment.

Contract liability (-L) Roofing fees revenue (+R,+SE)

450 450

To record portion of advance payment earned in April ($1,800/4 = $450).

P3-41. (40 minutes) LO 2, 3 a.

Cash Accounts Receivable Prepaid Rent Prepaid Insurance Supplies Equipment Accounts Payable Performance Obligations Common Stock Photography Fees Revenue Wages Expense Utilities Expense

SNAPSHOT COMPANY Unadjusted Trial Balance December 31, 2018 Debit $2,150 3,800 12,600 2,970 4,250 22,800

Credit

$1,910 2,600 24,000 34,480 11,000 3,420 $62,990

______ $62,990

©Cambridge Business Publishers, 2021 3-32

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Balance Sheet Transaction

Cash Asset

1. Fees earned but not received.

Noncash Assets

+925

Liabilities

Income Statement +

Contrib. Capital +

Fees Receivable

2. Recognize depreciati on expense for one year.

3. Recognize utilities expense.

+2,280

Accum. Depreciation

4. Recognize rent expense for year.

-6,300

-990

-2,730

-9,095

-2,280

+2,280 Depreciation Expense

+2,600 Retained Earnings

+2,600

2,280

-375

Wages Payable

Retained Earnings

-1,825

-9,550

+6,300

= +2,600

+990

-990

Insurance Expense -

+2,730

= -2,730

Supplies Expense -

+375

-375

Wages Expense 3,525

13,075

= -9,550

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

-400

= -6,300

-2,730

+375

+400

Photo Fees Revenue

Retained Earnings =

= -2,280

Rent Expense

-990

+925

Utilities Expense

Retained Earnings -

Net = Income =

Retained Earnings

-6,300

-2,600 Performance Obligations

Expenses

Retained Earnings

+925 Photo Fees Revenue

-400

Supplies

8. Recognize wages expense.

+925

Retained Earnings

Prepaid Insurance

7. Recognize supplies expense.

Revenues -

Retained Earnings

+400

6. Recognize insurance expense.

Earned Capital

Utilities Payable

Prepaid Rent

5. Recognize photo revenues.

Totals

Contra Assets

3-33

c. Date 2018 Description Dec. 31 Fees receivable (+A) Photography fees revenue (+R, +SE) `

Debit 925

Credit 925

To record revenue earned but not billed.

Depreciation expense (+E,-SE) Accum. depreciation—Equipment (+XA, -A)

2,280 2,280

To record depreciation for the year ($22,800/10 years = $2,280).

Utilities expense (+E, -SE) Utilities payable (+L)

400 400

To record estimated December utilities expense.

Rent expense (+E, -SE) Prepaid rent (-A)

6,300 6,300

To record rent expense for the year ($12,600/2 years = $6,300).

Performance obligations (-L) Photography fees revenue (+R, +SE)

2,600 2,600

To record advance payments earned during the year.

Insurance expense (+E, -SE) Prepaid insurance (-A)

990 990

To record insurance expense for the year ($2,970/3 years = $990).

Supplies expense (+E,-SE) Supplies (-A)

2,730 2,730

To record supplies expense for the year ($4,250 − $1,520 = $2,730).

Wages expense (+E, -SE) Wages payable(+L)

375

To record unpaid wages at December 31.

©Cambridge Business Publishers, 2021 3-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

375

d. + Cash (A) Unadj. bal. 2,150 Adj. bal. 2,150 + Accounts Receivable (A) Unadj. bal.

3,800

Adj. bal.

3,800

- Accounts Payable (L) + 1,910 Unadj. bal. 1,910 Adj. bal. - Performance Obligations (L) + Dec.31

+ Fees Receivable (A) -

(5) 2,600

2,600

Unadj. bal.

Adj. bal.

- Utilities Payable (L) +

Dec. 31

(1) 925

400

(3) Dec.31

Adj. bal.

925

400

Adj. bal.

+ Prepaid Rent (A) Unadj. bal.

12,600

Adj. bal.

6,300

- Wages Payable (L) +

6,300 (4) Dec.31

+ Prepaid Insurance (A) Unadj. bal.

2,970

Adj. bal.

1,980

Unadj. bal. Adj. bal.

+ Supplies (A) 4,250 2,730 (7) Dec.31 1,520

Unadj. bal. Adj. bal.

+ Equipment (A) 22,800 22,800

+ Supplies Expense (E) -

(8) Dec.31

375

Adj. bal.

- Common Stock (SE) +

990 (6) Dec.31

- Accum. Depreciation – Equip. (XA) + 2,280 (2) Dec.31 2,280 Adj. Bal.

375

24,000

Unadj. bal.

24,000

Adj. bal.

- Photo Fees Revenue (R) + 34,480 Unadj. bal 925 (1) Dec.31 2,600 (5) Dec.31 38,005 Adj. bal. + Wages Expense (E) Unadj. bal. 11,000 Dec.31 (8) 375 Adj. Bal. 11,375 + Utilities Expense (E) Unadj. bal. 3,420 Dec.31 (3) 400 Adj. Bal. 3,820 + Depreciation Expense – Equip. (E) -

Dec. 31

(7) 2,730

Dec.31

(2) 2,280

Adj. bal.

2,730

Adj. Bal.

2,280

+ Insurance Expense (E) -

+ Rent Expense (E) -

Dec. 31

(6) 990

Dec.31

(4) 6,300

Adj. bal.

990

Adj. Bal.

6,300

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-35

P3-42. (90 minutes) LO 2, 3, 4, 5, 6 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Contra Assets

= Liabilities

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

1. Recognize rent expense.

-775 Prepaid Rent

-775 Retained Earnings

+775 Rent Expense

-775

2. To recognize supplies expense.

-1,700 Supplies

-1,700 Retained Earnings

+1,700 Supplies Expense

-1,700

3. To recognize depreciation expense.

+74 = Accum. Deprec.

-74 Retained Earnings

+74 = Depreciation Expense

-74

4. To recognize wages expense.

+210 Wages Payable

-210 Retained Earnings

+210 Wages Expense

-210

5. To recognize utilities expense.

+300 Utilities Payable

-300 Retained Earnings

+300 Utilities Expense

-300

+380 Accounts Receivable

+380

-2,095

-2,679

6. To recognize fees earned.

Totals

510

+380 Retained Earnings

+380 Service Fees Revenue

-2,679

380

3,059

b. Date 2019 Description June 30 Rent expense (+E, -SE) Prepaid rent (-A)

Debit 775

Credit 775

To record June rent expense ($3,100/4 months = $775).

30 Supplies expense (+E, -SE) Supplies (-A)

1,700 1,700

To record June supplies expense (2,520 − $820 = $1,700).

30 Depreciation expense—Equip (+E, -SE) Accum. depreciation—Equipment (+XA, -A)

74 74

To record June depreciation ($4,440/60 months = $74).

30 Wages expense (+E, -SE) Wages payable (+L)

210 210

To record unpaid wages at June 30.

30 Utilities expense (+E, -SE) Utilities payable (+L)

300 300

To record estimated June utilities expense.

30 Accounts receivable (+A) Service fees revenue (+R, +SE)

380 380

To record fees earned but not billed in June. ©Cambridge Business Publishers, 2021 3-36

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. + Cash (A) Unadj. bal 1,180 Adj. bal. 1,180 + Accounts Receivable (A) Unadj. bal Jun. 30 Adj. bal.

- Accounts Payable (L) + 760 760 - Wages Payable (L) +

Unadj. bal Adj. bal.

450

210

(4) Jun.30

(6) 380

210

Adj. bal.

830 - Utilities Payable (L) +

+ Prepaid Rent (A) Unadj. bal

3,100

Adj. bal.

2,325

300

(5) Jun.30

300

Adj. bal.

- Retained Earnings (SE) +

775 (1) Jun.30

5,300

+ Rent Expense (E) -

Unadj. bal.

- Common Stock (SE) +

Jun.30

(1) 775

2,000

Unadj. bal

Adj. bal.

775

2,000

Adj. bal.

Unadj. bal Adj. bal.

+ Supplies (A) 2,520 1,700 (2) Jun.30 820

Unadj. bal Adj. bal.

+ Equipment (A) 4,440 4,440

- Accum. Depreciation – Equip.(XA) + 74 (3) Jun.30 74 Adj. Bal.

- Service Fees Revenue (R) + 4,650 Unadj. bal 380 (6) Jun.30 5,030 Adj. bal. + Wages Expense (E) Unadj. bal 1,020 Jun.30 (4) 210 Adj. bal. 1,230 + Utilities Expense (E) Jun.30 (5) 300 Adj. bal. 300 + Depreciation Expense – Equip.(E) -

+ Supplies Expense (E) Jun. 30

(2) 1,700

Jun.30

(3) 74

Adj. bal.

1,700

Adj. bal.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-37

d. MURDOCK CARPET CLEANERS Income Statement For Year Ended June 30, 2019 Revenues Service fees…………………………………….… $5,030 Expenses Rent expense…………………………………… $ 775 Wages expense………………………………… 1,230 Supplies expense………………………………… 1,700 Utilities expense…………………………………. 300 Depreciation expense…………………………… 74 Total expenses…………………………………… 4,079 Net income………………………………………… .......................................... $ 951 MURDOCK CARPET CLEANERS Balance Sheet June 30, 2019 Assets Liabilities Cash $ 1,180 Accounts payable Accounts receivable 830 Wages payable Supplies 820 Utilities payable Prepaid rent 2,325 Total Liabilities Equipment $ 4,440 Less: Accumulated 74 4,366 Owners’ Equity depreciation Common stock Retained earnings Total Assets $9,521 Total Liabilities and Owners’ Equity

$ 760 210 300 1,270

2,000 6,251 $9,521

©Cambridge Business Publishers, 2021 3-38

Financial & Managerial Accounting for Decision Makers, 4 th Edition

e. 1. 2. 3.

4. 5. 6.

1. 2. 3. 4. 5.

Retained earnings (-SE) ........................................................ Rent expense (-E) ..............................................................

775

Retained earnings (-SE) ......................................................... Supplies expense (-E) ........................................................

1,700

Retained earnings (-SE) ......................................................... Wages expense (-E) ..........................................................

1,230

Retained earnings (-SE) ......................................................... Utilities expense (-E ) .........................................................

300

Retained earnings (-SE) ......................................................... Depreciation expense (-E) .................................................

Service fees revenue (-R) ...................................................... Retained earnings (+SE)....................................................

5,030

- Retained Earnings (SE) + 5,300 775 1,700 1,230 300 74 5,030 6,251

Bal.

1,230 0

1,230

+ Depreciation Expense (E) 74 74 0

1,700 1,230

300 74 5,030

Bal.

+ Rent Expense (E) 775 775 0

Bal.

+ Supplies Expense (E) 1,700 1,700 0

6. Bal.

+ Wages Expense(E) Bal.

775

+ Utilities Expense (E) 3.

Bal.

300 0

300

- Service Fees Revenue (R) + 5,030 5,030 Bal. 0

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-39

P 3-43. (30 minutes) LO 3 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Contra Assets

Income Statement

= Liabilities +

Contrib. Capital +

Earned Capital

Revenues

- Expenses

Net Income

1. Accrue salary expense.

+720 Salaries Payable

-720 Retained Earnings

+720 Salaries Expense

-720

2. Accrue interest expense.

+200 Interest Payable

-200 Retained Earnings

+200 Interest Expense

-200

+900 Retained Earnings

+900

-400 Retained Earnings

+400 Maint. Expense

-400

-300

+300 Ad. Expense

-300

+160 Rent Expense

-160

+38

+2,175 = Depreciation Expense

-2,175

3. Accrue fees receivable.

+900 Fees Receivable

4. Accrue maintenance expense.

-400 Prepaid Maintenance

5. Accrue ad. Expense.

-300 Prepaid Advertising

6. Accrue rent expanse. 7. Accrue interest revenue.

+38

Totals

+238

Retained Earnings -

+160 Rent Payable

-160 Retained Earnings

+38 Retained Earnings

+2,175 = Accum. Depreciation

-2,175 Retained Earnings

2,175

Interest Receivable

8. Accrued depreciation expense.

+900 Printing Revenue

1,080

-3,017

+38 Interest Revenue

938

3,955

©Cambridge Business Publishers, 2021 3-40

Financial & Managerial Accounting for Decision Makers, 4 th Edition

-3,017

b. Date Dec 31

Description Debit Salaries expense (+E, -SE) 720 Salaries payable (+L) To accrue salaries at December 31 ($1,800  2/5 = $720). Interest expense (+E, -SE) Interest payable (+L) To accrue interest expense at December 31.

200

Fees receivable (+A) Printing revenue (+R, +SE) To record revenue earned but not yet billed.

900

Maintenance expense (+E ,-SE) Prepaid maintenance (-A) To record December maintenance expense. ($2,400 / 6 = $400).

400

Advertising expense (+E, -SE) Prepaid advertising (-A) To record December advertising expense ($900  1/3 = $300).

300

Rent expense (+E, -SE) Rent payable (+L) To accrue one-half month's rent expense [(400  $0.80)/2 = $160].

160

Interest receivable (+A) Interest income (+R, +SE) To accrue interest earned in December.

Credit 720

200

900

400

300

160

Depreciation expense—Equipment (+E, -SE) Accum. depreciation—Equipment (+XA) To record annual depreciation on equipment.

2,175 2,175

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-41

P3-44. (40 minutes) LO 4, 5 a. TRUEMAN CONSULTING INC. Income Statement For the Year Ended December 31, 2018 Revenue Service fees Expenses Rent expense Salaries expense Supplies expense Insurance expense Depreciation expense—Equipment Interest expense Total Expenses Net Income

$58,400 $12,000 33,400 4,700 3,250 720 630 54,700 $ 3,700

TRUEMAN CONSULTING INC. Statement of Stockholders’ Equity For the Year Ended December 31, 2018 Retained Earnings $3,305

Total Stockholders’ Equity $4,305

Net income ............................................. _____

3,700

Balance at December 31, 2018 .............. $1,000

$7,005

$8,005

Common Stock Balance at December 31, 2017 .............. $1,000 Stock issuance ....................................... Dividends ................................................

TRUEMAN CONSULTING Balance Sheet December 31, 2018 Assets Cash Accounts receivable Supplies Prepaid insurance Equipment Less: Accumulated depreciation

$ 6,400 1,080

Total Assets

Liabilities $ 2,700 Accounts payable 3,270 Long-term notes payable 3,060 Total Liabilities 1,500 Owners’ Equity 5,320 Common stock

$15,850

Retained earnings Total Liabilities and Owners’ Equity

$ 845 7,000 7,845

1,000 7,005 $15,850

©Cambridge Business Publishers, 2021 3-42

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Date 2018 Description Dec. 31 Service fees revenue (-R) Retained earnings (+SE) To close the revenue account. 31 Retained earnings (-SE) Rent expense (-E) Salaries expense(-E) Supplies expense (-E) Insurance expense (-E) Depreciation expense—Equip (-E) Interest expense (-E) To close the expense accounts.

Debit 58,400

Credit 58,400

54,700 12,000 33,400 4,700 3,250 720 630

P3-45. (30 minutes) LO 5 a. Date 2018 Dec. 31

Description Service fees revenue (-R) Miscellaneous income (-R) Retained earnings (+SE) To close the revenue accounts.

Debit 97,200 4,200

Retained earnings (-SE) Salaries expense (-E) Rent expense (-E) Insurance expense (-E) Depreciation expense (-E) Income tax expense (-E) To close the expense accounts.

74,800

Credit

101,400

42,800 13,400 1,800 8,000 8,800

b. After the closing entries are posted, Retained Earnings has a $45,700 credit balance ($19,100 + $26,600 net income).

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-43

c. Wilson Company Post-Closing Trial Balance December 31, 2018 Debit Cash Accounts Receivable Prepaid Insurance Equipment Accumulated Depreciation Accounts Payable Income Tax Payable Common Stock Retained Earnings

Credit

$8,500 8,000 3,600 72,000 $12,000 600 8,800 25,000 45,700 $92,100

______ $92,100

P3-46. (30 minutes) LO 2, 3 a. Balance Sheet Transaction

Cash Asset

1. Recognize Advertising expense.

Noncash Assets

-400

Contrib. Capital +

-1,140

+1,300

-1,300

Wages Payable*

Retained Earnings

+1,000

-540

-400

-1,300

-1,140

+2,400

+1,000

560

Performance Obligations

Retained Earnings

Service Fee Revenue

+1,140 Insurance Expense

+2,400

-1,100

+1,300 Wages Expense

+2,400

+400

Net = Income =

-2,400

Rent Receivable

Expenses

Advertising Expense

Retained Earnings =

5. Recognize rent revenue.

-1,140

Prepaid Insurance

4. Recognize service fees earned.

Revenues

Retained Earnings =

3. Recognize insurance expense.

Earned Capital -400

Prepaid Advertising

2. Accrue wage expense.

Totals

Liabilities

Income Statement

+1,000

Retained Earnings

Rental Income

560

3,400

2,840

*Assumes wages earned had not been accrued or recognized yet as an expense. continued next page

©Cambridge Business Publishers, 2021 3-44

Financial & Managerial Accounting for Decision Makers, 4 th Edition

a. continued Date 2018 Description Dec. 31 Advertising expense (+E, -SE) Prepaid advertising (-A)

Debit 400

Credit 400

To record advertising expense ($1,200 − $800 = $400).

Wages expense (+E, -SE) Wages payable (+L)

1,300 1,300

To record accrued wages.

Insurance expense (+E, -SE) Prepaid insurance (-A)

1,140

Performance obligations (-L) Service fee revenue (+R, +SE)

2,400

1,140

To record insurance expense ($3,420 − $2,280 = $1,140).

2,400

To recognize unearned fees as earned ($5,400 − $3,000 = $2,400).

Rent receivable (+A) Rental income (R, +SE)

1,000 1,000

To record rent earned but not yet recorded.

b. Balance Sheet Transaction

Cash Asset

Noncash Assets

= Liabilities +

1. Pay wages of $2,400.

-2,400

2. Receipt of $1,000 rent revenue.

+1,000

-1,000

Cash

Rent Receivable

Date 2019

Description Credit Wages payable (-L) Wages expense (+E, -SE) Cash (-A)

Jan.

Cash

Income Statement Contrib. Capital +

Earned Capital

-1,300

-1,100

Wages Payable

Retained Earnings

Revenues

Expenses

Net Income

+1,100

-1,100

Wages Expense -

Debit 1,300 1,100 2,400

To record payment of wages.

Cash (+A) Rent receivable (-A)

1,000 1,000

To record collection of rent.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-45

P3-47. (90 minutes) LO 2, 3 For part d, the adjusting entries are indicated by the numbers 1-5. The unadjusted trial balance required in part c is calculated before the adjusting entries are made. a., b. & d. 6/1 6/2 6/30

6/10 6/28

6/2

6/1

+ Cash (A) 24,000 4,400 6,400 875 7,800 930 3,600 1,240 520 3,600 1,500 21,535

6/1 6/2 6/2 6/12 6/15 6/18 6/26 6/30 5.

+ Accounts Receivable (A) 5,800 7,800 5,200 3,200 + Prepaid Advertising (A) 930 310 620

6/30

+ Office Supplies (A) 2,840 1,310 1,530

+ Office Equipment (A) 11,040

- Acc. Depreciation – Off. Equip (XA) + 115

+ Advertising Expense (E) 310 + Salaries Expense (E) -

6/12 6/26 2.

6/18

- Accounts Payable (L) + 9,480

6/1

- Salaries Payable (L) + 725

- Contract Liabilities (L) + 3,200 6,400 3,200 - Common Stock (SE) + 24,000

6/30

- Retained Earnings(SE) + 1,500

+ Supplies Expense (E) 1,310

6/15

+ Travel Expense (E) 1,240

+ Depreciation Expense(E) 115

6/2

+ Rent Expense (E) 875

6/1

- Service Fees Revenue (R) +

3,600 3,600 725

5,800 5,200 3,200

7,925

14,200

+ Postage Expense (E) 520

©Cambridge Business Publishers, 2021 3-46

6/2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

6/10 6/28 5.

b. Balance Sheet Transaction

Cash Asset

Noncash Assets

6/1. Investment +24,000 for common Cash stock. 6/1. Purchase of assets for cash & on account.

-4,400 Cash

6/2. Pay rent $875.

-875 Cash

6/2. Purchase $930 of advertising in advance.

-930 Cash

6/2 Signed research contract.

+6,400 Cash

6/10. Bill customers for services.

Liabilities

+ 11,040 Office Equipment +2,840 Supplies

Income Statement Contrib. Capital

Revenues -

+9,480 Accounts Payable

-875 Retained Earnings

+6,400 Contract Liabilities

+5,800 Retained Earnings

+5,800 Service Fees Revenue

Expenses

+5,800 Accounts Receivable

Earned Capital

+24,000 Common Stock

+930 Prepaid Advertising

+875 Rent Expense

Net Income

-875

+5,800

6/12. Paid salaries.

-3,600 Cash

-3,600 Retained Earnings

+3,600 Salaries Expense

-3,600

6/15. Paid travel expenses.

-1,240 Cash

-1,240 Retained Earnings

+1,240 Travel Expense

-1,240

6/18. Paid postage.

-520 Cash

-520 Retained Earnings

+520 Postage Expense

-520

6/26. Paid salaries.

-3,600 Cash

-3,600 Retained Earnings

+3,600 Salaries Expense

-3,600

+5,200 Retained Earnings

+5,200 Service Fees Revenue

+5,200

6/28. Bill customers for services.

+5,200 Accounts Receivable

6/30. Collect +7,800 service fees. Cash

-7,800 Accounts Receivable

6/30. Cash dividend paid.

-1,500 Cash

-1,500 Retained Earnings

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-47

P3-47. b. continued Date 2019 Description June 1 Cash (+A) Common stock (+SE)

Debit 24,000

Credit 24,000

Owner invested cash for common stock.

Office equipment (+A) Office supplies (+A) Cash (-A) Accounts payable (+L)

11,040 2,840 4,400 9,480

Purchased equipment and supplies; $4,400 cash paid with the remainder due in 60 days.

Rent expense (+E, -SE) Cash (-A)

875 875

Paid June rent.

Prepaid advertising (+A) Cash (-A)

930 930

Paid three months' advertising in advance.

Cash (+A) Contract liabilities (+L)

6,400 6,400

Received two months' fees in advance on six-month contract.

10 Accounts receivable (+A) Service fee revenue (+R, +SE)

5,800 5,800

Billed customers for services.

12 Salaries expense (+E, -SE) Cash (-A)

3,600 3,600

Paid two weeks' salaries to employees.

15 Travel expense (+E, -SE) Cash (-A)

1,240 1,240

Paid business travel expenses.

18 Postage expense (+E, -SE) Cash (-A)

520 520

Paid postage for questionnaire mailing.

26 Salaries expense (+E, -SE) Cash (-A)

3,600 3,600

Paid two weeks' salaries to employees. continued next page ©Cambridge Business Publishers, 2021 3-48

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-47. b. continued Date 2019 Description June 28 Accounts receivable (+A) Service fees revenue (+R, +SE)

Debit 5,200

Credit 5,200

Billed customers for services.

30 Cash (+A) Accounts receivable (-A)

7,800 7,800

Collections from customers on account.

30 Retained earnings (-SE) Cash (-A)

1,500 1,500

Declared and paid dividends.

Cash Accounts Receivable Office Supplies Prepaid Advertising Office Equipment Accounts Payable Contract Liabilities Common Stock Retained Earnings* Service Fees Revenue Salaries Expense Rent Expense Travel Expense Postage Expense

MARKET-PROBE Unadjusted Trial Balance June 30, 2019 Debit $21,535 3,200 2,840 930 11,040

Credit

$9,480 6,400 24,000 1,500 11,000 7,200 875 1,240 520 $50,880

______ $50,880

* The negative (debit) balance in Retained Earnings reflects the dividend paid.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-49

P3-47. d. Balance Sheet Transaction a. Recognize supplies expense.

Cash Asset

Noncash Assets

-1,310

= Liabilities

Income Statement Contrib. + Capital +

c. Accrue depreciatio n expense.

+115

+725

-725

Salaries Payable

Retained Earnings

-725

+115 = Depreciation Expense

-115

+310

-310

Advertising Expense

-3,200

+3,200

Contract Liabilities

Retained Earnings

Service Fees Revenue

Date 2019 Description Debit June 30 Supplies expense (+E, -SE) 1,310 Office supplies (-A) To record supplies used during June ($2,840 − $1,530 = $1,310). 30

= -1,310

+725

Retained Earnings -

+1,310

Salaries Expense

-310

Prepaid Advertising

Net = Income

Retained Earnings =

Expenses

Supplies Expense

-115

Accum. Depreciation

e. Recognize earned service fees.

Revenues

Retained Earnings -

-310

Earned Capital -1,310

Office Supplies

b. Recognize salaries expense.

d. Recognize advertising expense.

Contra Assets

Salaries expense (+E, -SE) Salaries payable (+L) To record unpaid salaries at June 30.

725

Depreciation expense—Office equipment (+E, -SE) Accum. deprec. Off. equipment (+XA, -A) To record June depreciation ($11,040/96 mo. = $115).

115

Advertising expense (+E, -SE) Prepaid advertising (-A) To record one month's advertising expense.

310

Contract liabilities (-L) Service fee revenue (+R, +SE) To record one month's fees earned, received in advance.

= +3,200

Credit 1,310

725

115

310

3,200 3,200

©Cambridge Business Publishers, 2021 3-50

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-48. (40 minutes) LO 3 a.

Cash Accounts Receivable Prepaid Advertising Supplies Equipment Notes Payable Accounts Payable Common Stock Mailing Fee Revenue Wages Expense Rent Expense Utilities Expense

DELIVERALL Unadjusted Trial Balance December 31, 2018 Debit $ 2,300 5,120 1,680 6,270 42,240

Credit

$7,500 2,700 9,530 86,000 38,800 6,300 3,020 $105,730

________ $105,730

b Balance Sheet Transaction 1. Recognize advertising expense.

Cash Asset

Noncash Assets -1,540 Prepaid Advertising

Contra Assets

Earned Capital

Revenues

Expenses

Net = Income

-1,540 Retained Earnings

+1,540 = -1,540 Advertising Expense

-5,280 Retained Earnings

+5,280 = -5,280 Depreciation Expense

2. Recognize depreciatio n expense.

3. Recognize utilities expense.

+325 Accts Payable

-325 Retained Earnings

+325 Utilities Expense

4. Accrue wages expense.

+1,200 Wages Payable

-1,200 Retained Earnings

+1,200 Wages Expense

= -1,200

-4,750 Retained Earnings

+4,750 Supplies Expense

= -4,750

6. Accrue interest expense.

+450 Interest Payable

-450 Retained Earnings

+450 Interest Expense

-450

7. Recognize rent expense*.

+430 Accts Payable

-430 Retained Earnings

+430 Rent Expense

-430

5. Recognize supplies expense.

-4,750 Supplies

+5,280 Accum. Deprec.

= Liabilities +

Income Statement Contrib. Capital

*(1/2%  $86,000 = $430). The rent for the year ($6,300 = $525 x 12) has already been recognized in the accounts. See the beginning balances given in the problem statement.

continued next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-51

-325

P3-48. b. continued Date 2018 Description Dec. 31 Advertising expense (+E, -SE) Prepaid advertising (-A)

Debit 1,540

Credit 1,540

To record 11 months' advertising expense ($1,680  11/12 = $1,540).

31 Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A)

5,280 5,280

To record depreciation for the year ($42,240/8 years = $5,280).

. 31 Utilities expense (+E, -SE) Accounts payable (+L)

325 325

To record estimated December utilities expense.

31 Wages expense (+E, -SE) Wages payable (+L)

1,200 1,200

To record unpaid wages at December 31.

31 Supplies expense (+E, -SE) Supplies (-A)

4,750 4,750

To record supplies expense for the year ($6,270 − $1,520 = $4,750).

31 Interest expense (+E, -SE) Interest payable (+L)

450 450

To record accrual of interest expense at Dec. 31.

31 Rent expense (+E, -SE) Accounts payable (+L)

430 430

To record additional rent owed under lease (1/2%  $86,000 = $430).

©Cambridge Business Publishers, 2021 3-52

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-48. c.

Only the T-accounts needed to enter the adjustments are provided. - Accounts Payable (L) + 2,700 325 430

Bal. 3. 7.

Bal.

+ Prepaid Advertising (A) 1,680 1,540

Bal.

+ Supplies (A) 6,270 4,750

- Accumulated Depreciation–Equip (XA) + 5,280

+Advertising Expense (E) 1,540

- Interest Payable (L) + 450

Bal. 7.

+ Rent Expense (E) 6,300 430

- Wages Payable (L) + 1,200

Bal. 4.

+ Wages Expense (E) 38,800 1,200

Bal. 3.

+ Utilities Expense (E) 3,020 325

+ Depreciation Expense (E) 5,280

+ Interest Expense (E) 6.

450

+ Supplies Expense (E) 5.

4,750

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-53

P3-49 (60 minutes) LO 2, 3, 4, 5, 6 a. Balance Sheet

Transaction 1. Recognize rent expense. 2. Recognize supplies expense.

Cash Asset

Noncash Assets -795

Contra Assets

= Liabilities

Income Statement

Contrib. Capital

Net Expenses = Income

+795

-795

-1,980

-335

-560

-390

+500

Debit

Credit

Retained Earnings -

Rent Expense

-1,980

Supplies

+1,980

Retained Earnings

3. Accrue depreciatio n expense.

4. Accrue wages payable.

5. Recognize utilities expense.

6. Recognize service revenue.

+335

Supplies Expense

-335

Accum. Depreciation

Retained Earnings =

+560

-560

Wages Payable

Retained Earnings

+390

-390

Accounts Payable

Retained Earnings

+560 Wages Expense

+390 Utilities Expense

-500

+500

Retained Earnings

Service Revenue

Rent expense (+E, -SE) Prepaid rent (-A)

+335 Depreciatio n Expense

Service Contract Liability

Date 2019 Description Mar. 31

Revenues

-795

Prepaid Rent -1,980

Earned Capital

795 795

To record March rent expense ($4,770/6 months = $795).

Supplies expense (+E, -SE) Supplies (-A)

1,980 1,980

To record March supplies expense ($3,700−$1,720 = $1,980).

Depreciation expense—Equipment (+E, -SE) Accumulated depreciation—Equipment (+XA, -A)

335 335

To record March depreciation ($36,180/108 months = $335).

Wages expense (+E, -SE) Wages payable (+L)

560 560

To record unpaid wages at March 31.

Utilities expense (+E, -SE) Accounts payable (+L)

390 390

To record estimated March utilities expense.

Service contract liability (-L) Service revenue (+R, +SE)

500 500

To record revenue received in advance that was earned in March.

©Cambridge Business Publishers, 2021 3-54

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-49. b. Not all the T-accounts given are needed to enter the adjustments required. Also, the closing entries required in part d are referenced by 1c, 2c etc. - Accounts Payable (L) + 2,510 390 2,900

Bal. 5. Bal.

Bal. Bal.

Bal. Bal. - Acc Depreciation - Equipment (XA) + 335

+ Prepaid Rent (A) 4,770 795 3,975

+ Supplies (A) 3,700 1,980 1,720 - Service Contract Liability (L) + 500 1,000 500

-Service Revenue(R) + 6c.

12,860

12,360 500

Bal. Bal.

+ Rent Expense (E) Bal. 6.

795

1c.

+ Supplies Expense (E) 2.

1c. 2c. 3c. 4c. 5c.

+Depreciation Expense (E) 335 335

+ Utilities Expense (E) 390 390 - Retained Earnings (SE) + 795 1,980 335 4,460 390 12,860 4,900

3c.

5c.

Bal. 4.

1,980

2c.

+Wages Expense (E) 3,900 560 4,460

4c.

- Wages Payable (L) + 560

6c.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-55

P3-49. c. WHEEL PLACE COMPANY Income Statement For Month Ended March 31, 2019 Service revenue…………………………………….……...

$12,860

Expenses: Utilities expense…………….…………………..…………

$390

Supplies expense…………..………………………………

1,980

Wages expense……………..…………………………..…

4,460

Depreciation expense………………………………….…

335

Rent expense……………………………………………...

795

Net income ………………………………………………...

7,960 $4,900

WHEEL PLACE COMPANY Balance Sheet March 31, 2019 Assets

Liabilities $ 1,900 Accounts payable

Cash

$ 2,900

Accounts receivable

3,820 Wages payable

560

Supplies

1,720 Service contract liability

500

Prepaid rent

3,975

Total Liabilities

35,845

Owners’ Equity

Equipment

3,960

$ 36,180

Less:Accumulated depreciation

Total Assets

335

Common stock

38,400

Retained earnings

4,900

$47,260 Total Liabilities and Owners’ Equity

$47,260

©Cambridge Business Publishers, 2021 3-56

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-49.

d. 1c.

2c. 3c. 4c.

5c. 6c.

Retained earnings (-SE) ...................................................... Rent expense (-E) ...........................................................

795

Retained earnings (-SE) ...................................................... Supplies expense (-E) .....................................................

1,980

Retained earnings (-SE) ...................................................... Depreciation expense (-E) ..............................................

335

Retained earnings (-SE) ...................................................... Wages expense (-E) .......................................................

4,460

Retained earnings (-SE) ...................................................... Utilities expense (-E) .......................................................

390

795

1,980 335 4,460

390

Service revenue (-R) .......................................................... 12,860 Retained earnings (+SE) .................................................

12,860

The closing journal entries are shown in the T-accounts in part b. P3-50. (30 minutes) LO 4, 5 a. TRAILS, INC. Income Statement For the Year Ended December 31, 2018 Revenues Subscription revenue Advertising revenue Total revenues Expenses Salaries expense Printing and mailing expense Rent expense Supplies expense Insurance expense Depreciation expense Income tax expense Total expenses Net income

$ 168,300 49,700 $218,000 100,230 85,600 8,800 6,100 1,860 5,500 1,600 209,690 $8,310 Continued next page ©Cambridge Business Publishers, 2021

Solutions Manual, Chapter 3

3-57

P3-50. a. continued TRAILS, INC. Statement of Stockholders’ Equity For Year Ended December 31, 2018

$25,000

$23,220

Total Stockholders’ Equity $48,220

_____ $25,000

8,310 $31,530

8,310 $56,530

Common Stock Balance at December 31, 2017 .............. Stock issuance ..................................... Dividends ............................................. Net income ........................................... Balance at December 31, 2018 ..............

Retained Earnings

TRAILS, INC. Balance Sheet December 31, 2018 Assets

Liabilities

Cash

$3,400

Accounts payable

$ 2, 100

Accounts receivable

8,600

Subscription liabilities

10,000

Supplies

4,200

Salaries payable

3,500

930

Total liabilities

15,600

Prepaid insurance Office equipment

$66,000

Less: Accum. depreciation

11,000

Stockholders' equity 55,000 Common stock

$25,000

Retained earnings

31,530

Total stockholders' equity _______ Total assets

$72,130

56,530

Total liabilities and stockholders' equity

$72,130

©Cambridge Business Publishers, 2021 3-58

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Date 2018 Description Dec. 31 Subscription revenue (-R) Advertising revenue (-R) Retained earnings (+SE)

Debit 168,300 49,700

Credit

218,000

To close the revenue accounts.

Retained earnings (-SE) Salaries expense (-E) Printing and mailing expense (-E) Rent expense (-E) Supplies expense (-E) Insurance expense (-E) Depreciation expense (-E) Income tax expense (-E)

209,690 100,230 85,600 8,800 6,100 1,860 5,500 1,600

To close the expense accounts.

P3-51. (30 minutes) LO 5 a. Date 2018 Dec. 31

Description Service fee revenue (-R) Retained earnings (+SE)

Debit 72,500

Credit 72,500

To close the revenue account.

Retained earnings (-SE) Wages expense (-E) Rent expense (-E) Insurance expense (-E) Supplies expense (-E) Advertising expense(-E) Depreciation expense—Trucks(-E) Depreciation expense—Equipment (-E)

58,800 29,800 10,200 2,900 5,100 6,000 4,000 800

To close the expense accounts.

b. The balance in Retained Earnings after closing entries are posted is $29,250 credit ($15,550 + $13,700).

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c. MAYFLOWER MOVING SERVICE Post-Closing Trial Balance December 31, 2018 Debit Cash $ 3,800 Accounts Receivable 5,250 Supplies 2,300 Prepaid Advertising 3,000 Trucks 28,300 Accumulated Depreciation—Trucks Equipment 7,600 Accumulated Depreciation—Equipment Accounts Payable Service contract liabilities Common Stock Retained Earnings ______ $50,250

Credit

$10,000 2,100 1,200 2,700 5,000 29,250 $50,250

P3-52. (20 minutes) LO 2, 3, 6 a. Balance Sheet Transaction 1. Recognize maintenance expense. 2. Recognize supplies expense.

Cash Asset

Noncash Assets

-1,800

-5,200

Earned Capital

Revenues

Expenses

Net Income

+1,800

-1,800

-5,200

+4,500

+2,800

-913

Maintenance Expense

-5,200

Retained Earnings =

-4,500

+4,500

Retained Earnings

Commission Revenue

+2,800

Retained Earnings

Commission Revenue

+913

-913

Rent Payable

Retained Earnings

+5,200 Supplies Expense

Performance Obligations

Commissions Receivable

5. Rent expense.

Contrib. Capital +

Retained Earnings

Supplies

+2,800

-1,800

Prepaid Maintenance

3. Accrue earned commissions.

4. Earned but unbilled commission fees.

Liabilities

Income Statement

+913 Rent Expense

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Balance Sheet Transaction

Cash Asset

1. Recognize maintenance expense.

Noncash Assets

Liabilities

Income Statement +

Contrib. Capital +

-2,800 = Commissions Receivable

Earned Capital

Revenues

Net Income

+1,800 Retained Earnings

+1,800 Commission Revenue

+1,800

Expenses

+4,600 Accounts Receivable 2. Recognize rent expense.

-913 Cash

-913 Rent Payable

c. Date 2018 Description Dec. 31 Maintenance expense (+E, -SE) Prepaid maintenance (-A)

Debit 1,800

Credit 1,800

To record four months' maintenance expense [($2,700/6)  4 = $1,800].

Supplies expense (+E, -SE) Supplies (-A)

5,200

Performance obligations (-L) Commission revenue (+R, +SE)

4,500

5,200

To record supplies expense ($8,400 − $3,200 = $5,200).

4,500

To transfer fees earned from unearned fees ($8,500 − $4,000 = $4,500).

Commissions receivable (+A) Commission revenue (+R, +SE)

2,800 2,800

To record fees earned but not yet billed.

Rent expense (+E, -SE) Rent payable (+L)

913 913

To record additional 2018 rent [1%  ($84,000 + $4,500 + $2,800) = $913].

2019 Jan. 10

Accounts receivable (+A) Commisions receivable (-A) Commision revenue (+R, +SE)

4,600 2,800 1,800

To record billings on Jan. 10, 2016.

Rent payable (-L) Cash (-A)

913 913

To record payment of contingent rent from 2018.

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P3-53. (60 minutes) LO 3, 4, 5, 6 a. Balance Sheet Transaction 1. Cash sales.

Cash Asset

Noncash Assets

+145,850 Cash

2. Record inventory purchased and used.

+2,500 Inventories

3. Recognize recent payments on A/P.

-77,300 Cash

4. Recognize rent paid and rent expense.

-24,000 Cash

5. Recognize wage expense and wages paid.

-12,500 Cash

+200 Prepaid Rent

6. Recognize depreciation expense.

Contra Assets

= Liabilities

+76,200 Accounts Payable

-77,300 Accounts Payable

+1,700 = Accum. Deprec.

Income Statement Contrib. + Capital +

+250 Wages Payable

Earned Capital

Revenues

+145,850 Retained Earnings

+145,850 Sales Revenue

= +145,850

+73,700 = -73,700 Cost of Goods Sold

-73,700 Retained Earnings

Expenses

-23,800 Retained Earnings

+23,800 Rent Expense

= -23,800

-12,750 Retained Earnings

+12,750 Wages Expense

= -12,750

-1,700 Retained Earnings

+1,700 Deprec. Expense

= -1,700

b. 1. Cash (+A) ............................................................................................. 145,850 Sales revenue (+R,+SE) ..................................................................... 145,850 2. Inventories (+A) ................................................................................... 2,500 Cost of goods sold (+E, -SE) .............................................................. 73,700* Accounts payable (+L) ........................................................................ 76,200 Or, make two separate entries with the same net effect:

Inventory (+A) ...................................................................................... 76,200 Accounts payable (+L) ........................................................................ 76,200 Cost of goods sold (+E, -SE) .............................................................. 73,700* Inventory (-A) ....................................................................................... 73,700 *73,700 = 12,000 +76,200 – 14,500.

continued next page

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-53. b. continued 3. Accounts payable (-L) ......................................................................... 77,300* Cash (-A) ............................................................................................. 77,300 *77,300 = 5,200 +76,200 – 4,100.

4. Prepaid rent (+A) .................................................................................. 200* Rent expense (+E, -SE) ....................................................................... 23,800* Cash (-A) .............................................................................................. 24,000 * $23,800 = $3,800 + ($24,000 ÷12) x (10) and 200 = $24,000 – $3,800 – ($24,000 ÷12) x (10). The rent expense for the first two months of the year is $3,800. But the rate for March 1, 2019 through February 29, 2020 is $2,000 per month. So, for the last ten months of 2019, the rent expense is $20,000, making the total rent expense $23,800 for 2019.

5. Wages expense (+E,-SE) ................................................................... 12,750* Cash (-A) ............................................................................................. 12,500 Wages payable (+L) ............................................................................ 250 * 12,750 = 12,500 + (350 – 100).

6. Depreciation expense (+E,-SE) .......................................................... 1,700 Acc. depreciation – Equipment (+XA, -A) ...........................................1,700

c. & e. The closing entries required in part e are also included here and indicated by the letter e before the relevent entry. + Cash (A) Bal. 1.

8,500 145,850

Bal.

40,550

Bal. Bal.

77,300 24,000 12,500

3. 4. 5.

+ Equipment (A) 7,500 7,500

Bal. 2. Bal.

+ Inventories (A) 12,000 2,500 14,500

Bal. 4. Bal.

+ Prepaid Rent (A) 3,800 200 4,000

- Accumulated Depreciation Equip.(XA) + 3,000 1,700 4,700

Bal. 6. Bal.

- Wages Payable (L) + 100 250 350

-Accounts Payable (L)+ 5,200 77,300 76,200 4,100

Bal. 2. Bal.

-Owners’ Equity (SE)+ 23,500 33,900 57,400

Bal. 5. Bal.

Bal. e. Bal.

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P3-53. c. & e. continued -Sales Revenue (R)+ 145,850 145,850 0

4. Bal.

5. Bal.

+Rent Expense (E)23,800 23,800 0 +Wages Expense (E)12,750 12,750 0

Bal.

6. e. Bal.

+Cost of Goods Sold (E)73,700 73,700 0 +Depreciation Expense(E)1,700 1,700 0

d. & e. Part d is easier to complete if the closing entries required in part e are journalized and entered in the T-accounts. The appropriate T-account entries for part e have been made earlier and indicated by the letter e. Sales revenue (-R) .............................................................................. 145,850 Cost of goods sold (-E) ....................................................................... Rent expense (-E) ............................................................................... Wages expense (-E) ........................................................................... Depreciation expense (-E) .................................................................. Owners’ equity...................................................................................... To close temporary revenue and expense accounts.

73,700 23,800 12,750 1,700 33,900

FISCHER CARD SHOP Income Statement For the Year ended December 31, 2019 Sales revenue Cost of goods sold Gross profit Other expenses: Rent expense Wages expense Depreciation expense Total other expenses Net income

$145,850 73,700 72,150 $23,800 12,750 1,700 38,250 $33,900 continued next page

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-53. d. & e. continued FISCHER CARD SHOP Balance Sheets As of December 31, Assets: Cash Inventories Prepaid rent

2018

2019

$ 8,500 12,000 3,800

$ 40,550 14,500 4,000

Total current assets Equipment Accumulated depreciation Equipment, net Total assets Liabilities and owners’ equity: Accounts payable Wages payable Total liabilities

24,300 7,500 (3,000) 4,500 $ 28,800

59,050 7,500 (4,700) 2,800 $ 61,850

$ 5,200 100 5,300

$ 4,100 350 4,450

Owners’ equity Total liabilities and owners’ equity

23,500 $ 28,800

57,400 $ 61,850

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P3-54. (120 minutes) LO 2, 3, 4, 5, 6 a. & b. The T-accounts follow the journal entries and the FSET. Balance Sheet Transaction 12/1 Investment for common stock. 12/2. Rent paid in cash.

Cash Asset + +20,000 Cash

Noncash Assets

= Liabilities =

-1,200 Cash

Income Statement Contrib. Capital +20,000 Common Stock

12/2 Purchase supplies on account.

Earned Capital

-1,200 Retained Earnings

+4,800 Accounts Payable

-1,080 Accounts Payable

-900 Cash

-900 Retained Earnings

12/20 Received cash +3,000 for consulting Cash services.

+3,000 Retained Earnings

12/28 Paid wages in cash.

-900 Retained Earnings

+7,200 = Fees Receivable

+7,200 Retained Earnings

-1,800 Retained Earnings

-900 Cash

-1,800 Cash

Balance Sheet Contra LiabiAssets = lities

2. Accrue wages expense.

3. Record depreciation expense.

4. Recognize accrued consulting fees.

+9,500 Office Equipment

12/14 Paid wages in cash.

1. Record supplies expense.

+1,200 Rent Expense

-1,080 Cash

Adjusting Entries

= =

+1,080 Accounts Payable

12/8. Paid for supplies.

Cash Asset

Expenses

-4,700 Cash

12/30 Paid cash dividends.

+1,080 Supplies

12/3 Office equipment bought for 4,700 cash and rest on account.

12/30 Bill clients for consulting.

Revenues

Noncash Assets -370 Supplies

+2,250 Fees Receivable

+3,000 Consulting Revenue

+900 Wages Expense

-1,200

-900

+3,000

-900

+7,200

+7,200 Consulting Revenue

Net Income

+900 Wages Expense

Income Statement Contrib. + Capital +

Earned Capital

Net = Income

Expenses

-370 Retained Earnings

+370 Supplies Expense

-370

-270 Retained Earnings

+270 Wages Expense

-270

+120 = Accum. Deprec.

-120 Retained Earnings

+120 = Depreciation Expense

-120

+2,250 Retained Earnings

+270 Wages Payable

Revenues

+2,250 Consulting Revenue

= +2,250

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-54. c. Transactions: Dec. 1 Cash (+A) Common stock (+SE)

20,000 20,000

Invested $20,000 cash in the business.

2 Rent expense (+E, -SE) Cash (-A)

1,200 1,200

Paid rent for December.

2 Supplies (+A) Accounts payable (+L)

1,080 1,080

Purchased various supplies on account.

Dec. 3 Office equipment (+A) Cash (-A) Accounts payable (+L)

9,500 4,700 4,800

Purchased $9,500 of office equipment, $4,700 cash down payment and balance due in 30 days.

8 Accounts payable (-L) Cash (-A)

1,080 1,080

Payment on account.

14 Wages expense (+E, -SE) Cash (-A)

900 900

Paid assistant's wages.

20 Cash (+A) Consulting revenue (+R, +SE)

3,000 3,000

Cash received for services.

28 Wages expense (+E, -SE) Cash (-A)

900 900

Paid assistant's wages.

30 Fees receivable (+A) Consulting revenue (+R, +SE) Billed customers for services.

7,200

31 Retained earnings (-SE) Cash (-A)

1,800

7,200

1,800

Issued and paid $1,800 in dividends.

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P3-54. b, c, and g. The adjusting entries requested are included and are denoted by the letter a followed by a number 1 through 5. The closing entries requested in part g are indicated by the letter g. + 12/1 12/20

Bal.

Cash (A) 20,000 1,200 3,000 4,700 1,080 900 900 1,800 12,420

12/2 12/3 12/8 12/14 12/28 12/31

12/2 Bal.

+Supplies(A)1,080 370 710

12/3

+Office Equipment (A) 9,500

-Wages Payable(L) + 2a.

270

-Accumulated Depreciation+ Office Equipment (XA)

12/8

12/31 g.

120

3a.

- Accounts Payable (L) + 1,080 1,080 4,800 4,800

12/2 12/3 Bal.

12/2 Bal.

+Rent Expense (E) 1,200 1,200 0

12/14 12/28 2a. Bal.

+ Wages Expense (E) 900 2,070 900 270 0

12/20 12/30 4a. 0

12/30 4a. Bal.

+Fees Receivable (A)7,200 2,250 9,450

1a. Bal.

+ Supplies Expense (E) 370 370 0

- Retained Earnings (SE)+ 1,800 12,450 3,760 6,890

3a. Bal.

-Common Stock(SE)+

-Consulting Revenue(R)+ 3,000 7,200 12,450 2,250 Bal. +Depreciation Expense(E)120 120 0

Bal.

20,000

12/1

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-54. d. RHOADES TAX SERVICES Unadjusted Trial Balance December 31, 2018 Debit $12,420 7,200 1,080 9,500

Cash Fees Receivable Supplies Office Equipment Accounts Payable Common Stock Retained Earnings (Dividend) Consulting Revenue Wages Expense Rent Expense

Credit

$4,800 20,000 1,800 10,200 1,800 1,200 $35,000

______ $35,000

e. Adjusting Entries: Date 2018 Description Dec. 31 Supplies expense (+E, -SE) Supplies (-A)

Debit 370

370

To record December supplies expense ($1,080 − $710).

Wages expense (+E, -SE) Wages payable (+L)

Credit

270 270

To reflect unpaid wages at December 31.

Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A)

120 120

To record December depreciation.

Fees receivable (+A) Consulting revenue (+R, +SE)

To record unbilled service revenue (30  $75).

2,250 2,250

Continued next page

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P3-54. e. continued RHOADES TAX SERVICES Adjusted Trial Balance December 31, 2018 Debit Cash $12,420 Fees Receivable 9,450 Supplies 710 Office Equipment 9,500 Accumulated Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings 1,800 Consulting Revenue Supplies Expense 370 Wages Expense 2,070 Rent Expense 1,200 Depreciation Expense 120 $37,640

Credit

$120 4,800 270 20,000 12,450

______ $37,640

f. RHOADES TAX SERVICES Income Statement For the Month of December 2018 Revenue Consulting revenue Expenses Wages expense Rent expense Supplies expense Depreciation expense Total expenses Net income

$12,450 $ 2,070 1,200 370 120 3,760 $ 8,690 Continued next page

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-54. f.

continued RHOADES TAX SERVICES Statement of Stockholders’ Equity For the Month of December 2018 Common Stock Balance at December 1, 2018 ................ $0 Stock issuance ..................................... 20,000

Retained Earnings $0

Total Stockholders’ Equity $0 20,000 (1,800) 8,690 $26,890

Dividends ............................................. Net income ...........................................

______

(1,800) 8,690

Balance at December 31, 2018 ..............

$20,000

$6,890

RHOADES TAX SERVICES Balance Sheet December 31, 2018 Assets Cash Fees receivable Supplies Total current assets Office equipment Less: Accum. depreciation

Total assets

$ 9,500 120

Liabilities and Equity $12,420 Accounts payable 9,450 Wages payable 710 Total liabilities 22,580 Stockholders’ equity 9,380 Common stock Retained earnings Total liabilities and stockholders’ $31,960 equity

$ 4,800 270 5,070

20,000 6,890 $31,960

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P3-54. g. Date 2018 Description Dec.31 Consulting revenue (-R) Retained earnings (+SE)

Debit 12,450

Credit 12,450

To close the revenue account.

31 Retained earnings (-SE) Wages expense (-E) Rent expense (-E) Supplies expense (-E) Depreciation expense (-E)

3,760 2,070 1,200 370 120

To close the expense accounts.

Cash Fees Receivable Supplies Office Equipment Accumulated Depreciation Accounts Payable Wages Payable Retained Earnings Common Stock

RHOADES TAX SERVICES Post-Closing Trial Balance December 31,2018 Debit Credit $12,420 9,450 710 9,500

$32,080

$ 120 4,800 270 6,890 20,000 $32,080

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

CASES and PROJECTS C3-55. (90 minutes) LO 2, 3, 4, 5, 6 a. 1. Entries in the FSET are first shown for the initial deposits and checks. These are entries 1- 8. Entries a - f are the adjusting entries that would be made at the end of the three months. The expenditures for rent and salaries are assumed to have been initially debited to expense accounts. Balance Sheet Noncash Assets

Transaction 1. Investment for common stock.

+50,000 Cash

2. Collections from customers.

+81,000 Cash

3. Bank borrowing. +10,000 Cash

= +10,000 Loans Payable

4. Rent expense.

-24,000 Cash

5. Purchased equipment.

-25,000 Cash

+25,000 Equipment

6. Purchased inventory.

-62,000 Cash

+62,000 Inventory

7. Paid salaries.

-6,000 Cash

-6,000 Retained Earnings

+6,000 Salaries Expense

-6,000

8. Paid other expenses.

-13,000 Cash

-13,000 Retained Earnings

+13,000 Misc. Expenses

-13,000

+9,000

Contra Assets

Liabilities

Income Statement

Cash Asset

Contrib. Capital

Earned Capital

Revenues

+50,000 Investment +81,000 Retained Earnings

+81,000 Sales Revenue

-24,000 Retained Earnings

Net = Income

= +81,000

+24,000 Rent Expense

+9,000

+9,000 Retained Earnings

b. Adjust rent expense.

+12,000 Prepaid Rent

+12,000 Retained Earnings

-12,000 Rent Expense

+12,00 0

= +3,000 Salaries Payable

-3,000 Retained Earnings

+3,000 Salaries Expense

-3,000

-41,000 Retained Earnings

+41,000 = Cost of Goods Sold

-41,000

-1,250 Retained Earnings

+1,250 Deprec.

-1,250

-300 Retained Earnings

-300

c. Accrue salaries expense. d. Recognize cost of goods sold.

-41,000 Inventory

e. Accrue depreciation expense.

f. Accrue interest expense*.

+1,250 Accumulated Depreciation

+300 Interest Payable

= -24,000

a. Recognize credit sales.

A/R

+9,000 Sales Revenue

Expenses

Expense +300 Interest Expense

*($10,000 x 1% x 3 mos.) continued next page

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a. 2. Journal entries are shown only for the adjustments a-f. a. Accounts receivable (+A) Sales revenue (+R, +SE) To recognize sales on account.

9,000 9,000

b. Prepaid rent (+A) 12,000 Rent expense (-E, +SE) To recognize remaining prepaid rent and correct rent expense.

12,000

c. Salaries expense (+E, -SE) Salaries payable (+L) To recognize unpaid salaries earned during September.

3,000 3,000

d. Cost of goods sold (+E, -SE) Merchandise inventory (-A) To recognize cost of sales; ($62,000 - $21,000).

41,000

e. Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A) To accrue depreciation on the fixtures and equipment ($25,000/60) x (3).

1,250

f. Interest expense (+E, -SE) Interest payable (+L) To accrue interest on bank loan assumed taken out 7/1/2019. ($10,000) x (0.12) x (1/4).

41,000

1,250

300 300

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

C3-55. b. T-accounts: The opening balances shown are the amounts in the accounts prior to the entry of the adjustments described in items a through f. The cash balance represents the deposits made, $141,000, less the checks drawn, $130,000. + Cash (A) 11,000

Bal.

- Accumulated Deprec.-Equip. (XA) + 1,250

+ Prepaid Rent (A) 12,000

+ Accounts Receivable (A) 9,000

- Sales Revenue (R) + 81,000 9,000

Bal.

+ Rent Expense (E) 24,000 12,000

Bal.

+ Other Expense (E) 13,000

+ Bal. c. + f.

+ Merchandise Inventory (A) 62,000 41,000

+ Equipment (A) 25,000

Bal.

Bal. a.

- Salaries Payable (L) + 3,000

- Owners’ Equity (SE) + 50,000

Bal.

+ Cost of Goods Sold (E) 41,000

+ Depreciation Expense (E) 1,250

- Bank Loan Payable (L) + 10,000

Salaries Expense (E) 6,000 3,000

Interest Expense (E) 300

Bal.

Interest Payable (L) + 300

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C3-55. c. SEASIDE SURF SHOP Income Statement July 1, 2019 to September 30 ,2019 Sales revenue Cost of goods sold Gross margin Expenses: Rent expense Salaries expense Depreciation expense Interest expense Misc. expenses Net income

$90,000 41,000 49,000 $12,000 9,000 1,250 300 13,000

35,550 $13,450

SEASIDE SURF SHOP Balance Sheet September 30, 2019 Assets Current assets Cash Accounts receivable Inventory Prepaid rent Total current assets

$11,000 9,000 21,000 12,000 53,000

Fixtures and equipment, net Total assets

23,750 $76,750

Liabilities and owners’ equity Current liabilities Salaries payable Bank loan payable Interest payable Total current liabilities

$3,000 10,000 300 13,300

Owners’ equity* Total liabilities and owners’ equity

63,450 $76,750

*$50,000 + $13,450

©Cambridge Business Publishers, 2021 3-76

Financial & Managerial Accounting for Decision Makers, 4 th Edition

C3-55. d. Chapter 1 introduced the return on equity ratio as a simple performance measure that can be used to evaluate how well this new business is doing. The return on equity is calculated as the ratio of net income to average total equity. In this case, the return on equity for the three-month period was 23.7% = $13,450 / [($50,000+ $63,450)/2]. This is a very good return for a three-month period and equates to 95% annualized. However, the favorable performance evaluation should be tempered by a few caveats: (1) Because this business appears to be a sole proprietorship, any “salary” paid to the owner is not deducted from net income. Instead, cash payments to the owner are treated as dividends (or withdrawals). As a consequence, any services provided by the owner to the business would not be reflected among the expenses reported in the income statement, and net income would be overstated. (2) No expense is reported in the income statement for income taxes. This is consistent with the business being a sole proprietorship, in which income taxes are levied against the owner as an individual taxpayer. Again, this makes “net” income appear to be larger than it otherwise might be. (3) Retail businesses are notoriously seasonal. That is, sales (and profits) fluctuate from season to season. A business such as this one would likely have its highest sales in the second and third quarters. This seasonality must be considered when we try to annualize quarterly results like these. Once the business has operated for a year or two, the owner would likely have a better idea about how seasonal fluctuations affect sales and returns and would be better able to interpret quarterly performance measures. (4) Finally, Seaside’s cash position is precarious. The firm has burned through most of the $60 thousand cash raised to begin the business and is likely to have trouble replacing its inventory as well as paying its bills. Perhaps they can convince lenders to come to its rescue. If not, the firm will not last another three months.

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C3-56. (15 minutes) LO 2, 3, 6 a. The following analysis shows how the relevant information affects total assets, liabilities, and owners’ equity of the firm:

Per original balance sheet Percentage of debt equity 1. Recognition of insurance expense ($4,500  1/2 = $2,250) 2. Depreciation correction (5%  $68,500 = $3,425) 3. (No adjustment required) 4. Unbilled services performed 5. Advance consulting fee earned ($11,300  1/2 = $5,650) 6. Recognition of supplies expense ($13,200 − $4,800 = $8,400) Revised totals Percentage of debt and equity

Assets $88,500

Liabilities $45,900 51.9%

Owners Equity $42,600 48.1%

(2,250)

3,425

6,000

(8,400) $87,275

(5,650)

5,650

______ $40,250 46.1%

(8,400) $47,025 53.9%

Revised debt-to-equity ratio: $40,250/$47,025 = 0.86 Original debt-to-equity ratio: $45,900/$42,600 = 1.08 b. Apparently, the loan agreement has not been violated.

©Cambridge Business Publishers, 2021 3-78

Financial & Managerial Accounting for Decision Makers, 4 th Edition

C3-57. (30 minutes) LO 2, 3 a. Discussion of this case may consider the following ethical considerations facing Javetz: 1. Balancing the long-run interests of the firm (securing the international contract) against the short-run requirement to present accurately the financial data of the company for the current year (recording $150,000 adjusting entry). 2. Compromising the confidentiality of the contract negotiations (by disclosing the contract negotiations to additional persons) versus compromising her professional responsibilities (by omitting a significant year-end adjusting entry). 3. Jeopardizing her position with the firm (by revealing information the president wants kept secret) versus risking possible future legal action by parties relying on the firm's financial statements (by not revealing a significant accrued expense and accrued liability in the financial statements). b. Discussion of this case should also note that outside auditors frequently access confidential data and disclosing the contract negotiations to the auditor should not represent a significant breach of confidentiality. Perhaps Javetz can achieve a reasonable solution to her dilemma by suggesting that an adjusting entry be recorded and described in very general terms (for example, labeling the liability Payable to Consultants and indicating it is for marketing research and development). Such an adjustment would permit the disclosure of the significant liability without revealing important details to anyone else within or outside the company.

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C3-58. (30 minutes) LO 2, 3, 4, 6 a. - d. FSET: Balance Sheet Transaction a1. Recognize prepaid catalog costs.

Cash Asset

Noncash Assets

-62,550

+62,550

Cash

Prepaid Catalog Costs

a2. Advertising credits received.

+ 849

Liabilities

Advertising Credits Receivable

b. Recognize advertising expense.

-62,138

-336

+849

Retained Earnings

Advertising Credits Revenue

Expenses

Net Income

+849

-62,138

-336

+62,138 Catalog Expenses

-336

Retained Earnings

Cash

d2. Recognize sales using gift certificates.

Revenues

Retained Earnings

Advertising Credits Receivable

+19,175

Earned Capital

-62,138

Prepaid Catalog Costs

c. Recognize expiration of advertising credits.

d1. Sales of gift certificates.

Income Statement Contrib. Capital

+336 Expense: Expiration of Advertising Credits

+19,175

Gift Certificate Liability

- 18,230

+18,230

Gift Certificate Liability

Retained Earnings

Gift Certificate Revenues

Continued next page

©Cambridge Business Publishers, 2021 3-80

Financial & Managerial Accounting for Decision Makers, 4 th Edition

+18,230

a. – d. continued Journal Entries: a1. Prepaid catalog costs (+A) Cash (-A) To record catalog printing costs.

62,550 62,550

a2. Advertising credits receivable (+A) Advertising credits revenue (+R, +SE) To recognize advertising credits earned. b.

849 849

Catalog expense (+E, -SE) Prepaid catalog costs (-A) To regognize catalog expense ($3,894 + $62,550 - $4,306).

62,138 62,138

Advertising credit expiration expense (+E, -SE) 336 Advertising credits receivable (-A) To record the expiration of advertising credits ($21 + $849 - $534).

336

Advertising credits expire either because they were used to advertise or, if there was a time limitation to their use, the time limit expired. d1. Cash (+A) Customer deposits (+L) To recognize gift certificates sold but not yet redeemed.

19,175

d2. Gift certificate liability (-L) Gift certificate revenues (+R, +SE) To recognize revenues based on redeemed gift certificates ($6,108 +$19,175 - $7,053).

18,230

19,175

18,230

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-81

Chapter 3 Adjusting Accounts for Financial Statements Learning Objectives – coverage by question MiniExercises

Exercises

21 - 23, 25,

33, 35,

29, 30

36, 38

23, - 25,

32 - 36,

29, 30

Problems

Cases and Projects

LO1 – Identify the major steps in the accounting cycle. LO2 – Review the process of journalizing and posting transactions.

LO3 – Describe the adjusting process and illustrate adjusting entries.

LO4 – Prepare financial statements from adjusted accounts.

40 - 42, 46, 47, 49,

55 - 58

52 - 54 40 - 43, 46 - 49,

55 - 58

52 - 54 40 - 42,

44, 47, 49,

55, 58

50, 53, 54 LO5 – Describe the process of closing temporary accounts.

LO6 – Analyzing changes in balance sheet accounts.

27, 28, 30

24, 25, 29

31, 33, 37, 39

34 - 36, 38

42, 44, 45, 49 - 51

53, 54 40, 42, 49 52 - 54

55, 56, 58

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-1

QUESTIONS Q3-1.

Q3-2.

The fiscal year is the annual accounting period adopted by a firm. A firm using a fiscal year ending on December 31 is on a calendar-year basis.

Q3-3.

Q3-4.

Q3-5.

Q3-6.

Q3-7.

©Cambridge Business Publishers, 2021 3-2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q3-8.

Q3-9.

Q3-10. Jan. 31

Insurance expense (+E, -SE) Prepaid insurance (-A) To record insurance expense for January ($1,872/24 = $78).

78 78

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-3

Q3-13. (a)

(b)

Jan. 1

Q3-14. Jan. 31

Q3-15. Jan. 31

9,720 9,720

405 405

Wages expense (+E, -SE) Wages payable (+L) To record unpaid wages for Jan. 30–31 [($475/5)  2 = $190].

190

Interest receivable (+A) Interest income (+R,+SE) To record interest earned during January.

360

190

360

©Cambridge Business Publishers, 2021 3-4

Financial & Managerial Accounting for Decision Makers, 4 th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-5

MINI EXERCISES M3-21. (45 minutes) LO 2 a. Balance Sheet Transaction

Cash Asset

June 1. Invested $12,000 cash.

+12,000

June 2. Paid $950 cash for June rent.

-950

June 3

= Liabilities +

Cash

+6,400 Office Equipment

-1,800

+3,800

Cash

Supplies

Accounts Receivable

Net Income

+950 -

Retained Earnings

Accounts Payable

Rent Expense

-950

+2,000 Accounts Payable

June 17. Collected $3,250 on accounts.

+3,250

-3,250

Cash

Accounts Receivable

June 19. Paid $3,000 on office equipment account.

-3,000

Cash

= Accounts Payable

June 25. Paid cash dividend of $900.

-900

+4,700

Retained Earnings

Service Fees Earned

+4,700

-900

Cash

Retained Earnings

-350

Cash

5,750

Expenses

+4,700

TOTALS

+6,400

-2,500

Revenues

-950

Cash

June 30. Paid $2,500 salaries.

Earned Capital

Common Stock

June 11. $4,700 billed for services.

June 30. Paid $350 utilities.

Contrib. Capital + +12,000

Purchased $6,400 of office equipment on account.

June 6. Purchased $3,800 of supplies; $1,800 cash, $2,000 on account.

Noncash Assets

Income Statement

+350 -

Utilities Expense

Salaries Expense

3,800

-2,500

Cash +

11,650

5,400

12,000

+2,500

4,700

-350

-2,500

900

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. June 1

Cash (+A) Common stock (+SE) Owner invested cash for stock.

12,000 12,000

Rent expense (+E, -SE) Cash (-A) Paid June rent.

950 950

Office equipment (+A) Accounts payable (+L) Purchased office equipment on account.

6,400

Supplies (+A) Cash (-A) Accounts payable (+L) Purchased $3,800 of supplies; paid $1,800 down with balance due in 30 days.

3,800

6,400

1,800 2,000

11 Accounts receivable (+A) Service fees earned (+R,+SE) Billed clients for services.

4,700

17 Cash (+A) Accounts receivable (-A) Collections from clients on account.

3,250

19 Accounts payable (-L) Cash (-A) Payment on account.

3,000

25 Retained earnings (-SE) Cash (-A) Issued dividends.

900

30 Utilities expense (+E, -SE) Cash (-A) Paid utilities bill for June.

350

30 Salaries expense (+E, -SE) Cash (-A) Paid salaries for June.

2,500

4,700

3,250

3,000

900

350

2,500

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-7

c. + June 1 17

+ June 11

Cash (A) 12,000 950 3,250 1,800 3,000 900 350 2,500

June 2 6 19 25 30 30

Supplies (A) 3,800

Office Equipment (A) 6,400

June 6

June 3

Accounts Receivable (A) 4,700 3,250 June 17

June 19

Accounts Payable (L) + 3,000 6,400 June 3 2,000 June 6

Common Stock (SE) 12,000

June 25

Retained Earnings (SE) 900

Rent Expense (E) 950

June 2

+ June 30

Utilities Expense (E) 350

+ June 1

Service Fees Earned (R) 4,700

+ June 11

+ June 30

Salaries Expense (E) 2,500

©Cambridge Business Publishers, 2021 3-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M3-22. (45 minutes) LO 2 a. Balance Sheet Transaction

Cash Asset

April 1

Invested $9,000 in cash.

+9,000

Paid $2,850 cash for lease.

-2,850

+2,850

Cash

Prepaid Van Lease

Borrowed $10,000.

+10,000

Purchased $5,500 equipment for $2,500 cash with rest on account.

-2,500

+5,500

Cash

Equipment

Paid $4,300 cash for supplies.

-4,300

+4,300

Cash

Supplies

Paid $350 cash for ad.

-350

April 2

April 3

April 4

April 7

Noncash Assets

= Liabilities

Income Statement Contrib. Capital +

Earned Capital

Revenues

Expenses

+9,000 =

Cash

Common Stock

+10,000 =

Cash

Note Payable +3,000

Accounts Payable

-350 =

Cash

April 21 Billed $3,500 for services

Retained Earnings

+3,500 Accounts Receivable

+350 -

+3,500

Retained Earnings

Cleaning Fees Earned

Ad. Expense

April 23 Paid $3,000 cash on account.

-3,000

Cash

= Accounts Payable

April 28 Collected $2,300 on account.

+2,300

-2,300

Cash

Accounts Receivable

April 29 Paid $1,000 cash dividend.

-1,000

April 30 Paid $1,750 cash for wages.

-1,750

April 30 Paid $995 cash for gas. TOTALS

-350

+3,500

-1,000 =

Cash

Retained Earnings -1,750

Cash

Retained Earnings

-995

+1,750 -

Wages Expense

Van Fuel Expense

3,095

-995

Cash 4,555

Net Income

13,850

10,000

9,000

-595

+995

3,500

-1,750

-995

405

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-9

b. April

Cash (+A) Common stock (+SE) Owner invested cash for stock.

9,000

Prepaid van lease (+A) Cash (-A) Paid six months' lease on van.

2,850

Cash (+A) Notes payable (+L) Borrowed money from bank for one year at 10% interest.

10,000

Equipment (+A) Cash (-A) Accounts payable (+L) Purchased $5,500 of equipment; paid $2,500 down with balance due in 30 days.

5,500

Supplies (+A) Cash (-A) Purchased supplies for cash.

4,300

Advertising expense (+E, -SE) Cash (-A) Paid for April advertising.

350

21 Accounts receivable (+A) Cleaning fees earned (+R, +SE) Billed customers for services.

3,500

23 Accounts payable (-L) Cash (-A) Payment on account.

3,000

28 Cash (+A) Accounts receivable (-A) Collections from customers on account.

2,300

29 Retained earnings (-SE) Cash (-A) Issued cash dividends.

1,000

30 Wages expense (+E, -SE) Cash (-A) Paid wages for April.

1,750

9,000

2,850

10,000

2,500 3,000

4,300

350

3,500

3,000

30 Van fuel expense (+E, -SE) Cash (-A) Paid for gasoline used in April.

2,300

1,000

1,750 995 995

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. + April 1 3 28

Cash (A) 9,000 2,850 April 2 10,000 2,500 3 2,300 4,300 4 350 7 3,000 23 1,000 29 1,750 30 995 30

April 4

Supplies (A) 4,300

April 23

Accounts Payable (L) 3,000 3,000

+ April 3

Common Stock (SE) 9,000

+ April 1

+ April 7

Advertising Expense (E) 350

+ April 30

Van Fuel Expense (E) 995

Accounts Receivable (A) 3,500 2,300 April 28

Prepaid Van Lease (A) 2,850

April 21

April 2 + April 3

April 29 -

+ April 30

Equipment (A) 5,500

Notes Payable (L) 10,000

Retained Earnings (SE) 1,000

Cleaning Fees Earned (R) 3,500

+ April 21

Wages Expense (E) 1,750

April 3

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-11

M3-23. (20 minutes) LO 2, 3 a. Balance Sheet Cash Asset

Transaction 1. Received $20,100 in advance for contract work.

Jan.

Noncash Assets

= Liabilities

+20,100

Cash

Unearned = Service Fees

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

1 Cash (+A) Unearned service fees (+L) To record fee received in advance.

Net Income

20,100 20,100

b. Balance Sheet Transaction

Cash Asset

Noncash Assets

2. Adjusting entry for work completed by Jan. 31.

Income Statement Earned Capital

Revenues

-3,350

+3,350

Unearned = Service Fees

Retained Earnings

Service Fees

= Liabilities

Contrib. Capital +

Jan. 31 Unearned service fees (-L) Service fees (+R, +SE) To reflect January service fees earned on contract ($20,100/6 = $3,350).

Expenses

Net Income

+3,350

3,350 3,350

c. Balance Sheet Transaction 3. Adjusting entry for fees earned but not billed.

Jan. 31

Cash Asset

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

+570

Fees Receivable

Retained Earnings

Service Fees

Fees receivable (+A) Service fees (+R, +SE) To record unbilled service fees earned at January 31.

Expenses

Net Income

+570

570 570

©Cambridge Business Publishers, 2021 3-12

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M3-24. (15 minutes) LO 3, 6 1. Balance Sheet Cash Asset

Transaction

1. Adjusting entry for prepaid insurance

Jan.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

-185

+185

Prepaid Insurance

Retained Earnings

Insurance Expense

Insurance expense (+E, -SE) Prepaid insurance (-A) To record January insurance expense ($6,660/36 = $185).

Net Income

-185

185 185

2. Balance Sheet Cash Asset

Transaction

2. Adjusting entry for supplies used

Jan.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

-1,080

+1,080

Supplies Inventory

Retained Earnings

Supplies Expense

Supplies expense (+E, -SE) Supplies inventory (-A) To record January supplies expense ($1,930 − $850 = $1,080).

Net Income

-1,080

1,080 1,080

3. Cash Asset

Transaction

3. Adjusting entry for depreciation of equipment.

Jan.

Noncash Assets

Balance Sheet Contra Liabil= Assets ities

Income Statement +

Contrib. + Capital

+62 Accum. Deprecn.

Earned Capital

Revenues

-62 Retained Earnings

Depreciation expense—Equipment (+E, -SE) Accumulated depreciation—Equipment (+XA, -A) To record January depreciation on office equipment ($5,952/96 = $62).

Expenses

+62 Deprec. Expense

62 62

Continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-13

Net Income -62

4. Balance Sheet Transaction

Cash Asset

Noncash Assets

4. Adjusting entry for rent

Jan.

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

+875

Retained Earnings

Rent Revenue

-875 Unearned = Rent Liability

31 Unearned rent liability (-L) Rent revenue (+R, +SE) To record portion of advance rent earned in January.

Expenses

Net Income

+875

875 875

5. Balance Sheet Transaction

Cash Asset

Noncash Assets

5. Adjusting entry for accrued salaries

Jan.

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

+490

-490

+490

Salaries Payable

Retained Earnings

Salaries Expense

31 Salaries expense (+E, -SE) Salaries payable (+L) To record accrued salaries at January 31.

Net Income

-490

490 490

M3-25. (15 minutes) LO 2, 3, 6 (All amounts in thousands of Mexican pesos.) a. Balance Sheet Transaction Inventory purchases (total)

Cash Asset

Noncash Assets

+78,023,979 Inventory

Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

+78,023,979 =

Accounts Payable

Inventories (+A)……………………………………. Accounts payable (+L)……………………… To record total purchases made at various dates.

78,023,979 78,023,979

b. Beginning AP balance + Purchases – Payments = Ending AP balance. So, $15,210,743 + $78,023,979 - Payments = $22,535,802. Thus, Payments = $70,698,920.

©Cambridge Business Publishers, 2021 3-14

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Balance Sheet Transaction

Cash Asset

Adjusting entry for cost of goods sold for 2013.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

–73,387,487

Inventory

Retained Earnings

Revenues

Expenses

Net Income

+73,387,487 -

Cost of Goods Sold

= –73,387,487

* Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv balance. So, $13,849,931 + $78,023,979 – COGS = $18,486,423. Thus, COGS = $73,387,487

Cost of goods sold (+E, -SE)…………………................... Inventories (-A)………………………………… To record cost of goods sold for the year ended 12/31/2017.

73,387,487 73,387,487

(Note: the COGS figure can be verified from the firm’s financial statements. Purchases cannot be so determined, but could be established by working backwards. See M3-29.)

Retained Earnings $18,000 (9,700) 29,900 $38,200

Total Stockholders’ Equity $48,000 6,000 (9,700) 29,900 $74,200

M3-27. (5 minutes) LO 5 Ending balance = Beginning balance + Credit from closing revenue – Debit from closing expenses: $137,600 = $99,000 + $347,400 - $308,800

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-15

M3-28. (15 minutes) LO 5 a.

Date 2018 Description

Debit

84,900

Credit 84,900

55,900 36,000 1,900 8,200 9,800

Wages Expense (E) 36,000 36,000 0

(2) Dec. 31

+ Bal. Bal.

Utilities Expense (E) 8,200 8,200 0

Insurance Expense (E) 1,900 1,900 (2) Dec. 31 0

- Commissions Revenue (R) + (1) Dec. 31 84,900 84,900 0

Depreciation Expense (E) 9,800 9,800 (2) Dec. 31 0

(2) Dec. 31

- Retained Earnings (SE) + 55,900 72,100 Bal. 84,900 (1) Dec.31 101,100 Bal. Dec.31

©Cambridge Business Publishers, 2021 3-16

Bal. Bal.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M3-29. (30 minutes) LO 2, 3, 6 (All amounts in $ millions.) a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Recognize cost of goods sold

= Liabilities

Income Statement +

Contrib. Capital +

-111,934 Merchandise Inventory

Earned Capital

Revenues

Expenses

-111,934 =

Net Income

-111,934

+111,934 -

Retained Earnings

Cost of Goods Sold

111,934

b. Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv balance. So $11,461 + Purchases - $111,934 = $16,047. Thus purchases = $116,520 Balance Sheet Transaction

Cash Asset

Recording inventory purchases.

Noncash Assets

= Liabilities

+116,520 Merchandise Inventory

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

+116,520 =

Account Payable

Merchandise inventory(+A) ...................................................... Accounts payable (+L) ........................................................

116,520 116,520

To recognize the purchases on account.

c. Beginning AP balance + Purchases – Payments = Ending AP balance So, $25,309 + $116,520 - Payments = $34,616. Thus, Payments = $107,213

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-17

M3-30 (10 minutes) LO 2, 3, 5 a. Balance Sheet Transaction

Cash Asset

a. Dec. 31 Interest earned.

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

+600 Interest Receivable

Earned Capital

Revenues

+600

Retained Earnings

Interest Income

Dec. 31 Interest receivable (+A) Interest income (+R, +SE) To record accrued interest income. b. Dec. 31

Expenses

Net Income

+600

600 600

Interest income (-R) Retained earnings (+SE) To close the Interest Income account.

2,400 2,400

c. Balance Sheet Transaction c. Jan. 31 Receipt of $900 interest

Cash Asset

Noncash Assets

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

+900

-600

+300

Cash

Interest Receivable

Retained Earnings

Interest Income

2019 Jan. 31 Cash (+A) Interest income (+R, +SE) Interest receivable (-A) To record cash receipt of interest.

Expenses

Net Income

+300

900 300 600

©Cambridge Business Publishers, 2021 3-18

Financial & Managerial Accounting for Decision Makers, 4 th Edition

EXERCISES E3-31. (30 minutes) LO 5 a. Dec. 31

Service fees earned (-R) Retained earnings (+SE) To close the revenue account.

80,300 80,300

Retained earnings (-SE) Rent expense (-E) Salaries expense (-E) Supplies expense (-E) Depreciation expense (-E) To close the expense accounts.

82,300 20,800 45,700 5,600 10,200

b. + Bal. Bal.

Rent Expense (E) 20,800 20,800 0

+ (2)

Bal. Bal. + Bal. Bal.

+ Bal. Bal.

Salaries Expense (E) 45,700 45,700 0

(2)

Retained Earnings (SE) 82,300 67,000 80,300 65,000

+ Bal. (1) Bal.

(2)

(1)

Supplies Expense (E) 5,600 5,600 0 Depreciation Expense (E) 10,200 10,200 0

Service Fees Earned (R) 80,300 80,300 0

(2) (2)

Bal. Bal.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-19

E3-32. (30 minutes) LO 3 a. Income Statement

Balance Sheet Noncash Assets -

Contra Assets

= Liabilities

1. Adjusting entry for depreciateion: equipment.

+610

2. Adjusting entry for utilities expense.

Transaction

Cash Asset

Contrib. Capital +

-700

+390

-390

Utilities Payable

Retained Earnings

5. Adjusting entry for wage expense.

-400

+610

610

Contract Liabilities

Retained Earnings

Premium Revenue

+965

-965

Wages Payable

Retained Earnings

887

+700

-610

-390

-700

+468

+965

-965

+300

-1,897

Wages Expense

+300

Retained Earnings

Interest Income

-1,897

768

b. 1. Depreciation expense—Equipment (+E,-SE) Accumulated depreciation—Equip (+XA, -A) To record depreciation for the period.

Rent Expense +468

+390

+468

Net = Income

Utilities Expense

-468

Interest Receivable 0

Expenses

Retained Earnings

4. Adjusting entry for premium revenues.

+300

Depreciation Expense

-700

Prepaid Rent

6. Adjusting entry for interest earned.

Revenues

Retained Earnings

Earned Capital -610

Accum. Depreciation

3. Adjusting entry for rent expense.

TOTALS

2,665

610 610

2. Utilities expense (+E, - SE) Utilities payable (+L) To record accrued utilities expense.

390

3. Rent expense (+E,-SE) Prepaid rent (-A) To record rent expense for the month ($2,800/4 = $700).

700

4. Contract liabilities (-L) Premium revenue (+R,+SE) To record premium revenue earned [($624/12)  9 = $468].

468

390

700

468

Continued next page

©Cambridge Business Publishers, 2021 3-20

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. continued 5. Wages expense (+E,-SE) Wages payable (+L) To record accrued wages at the end of the period.

965

6. Interest receivable (+A) Interest income (+R,+SE) To accrue interest earned but not yet received.

300

965

300

E3-33. (15 minutes) LO 2, 3, 5 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

a. Adjusting entry for salaries expense.

= Liabilities =

Income Statement +

Contrib. Capital +

Earned Capital

+4,700

-4,700

Salaries Payable

Retained Earnings

2018 Dec. 31 Salaries expense (+E,-SE) Salaries payable (+L) To record accrued salaries payable.

Revenues

Expenses

Salaries Expense

+4,700

Net Income -4,700

4,700 4,700

31 Retained earnings (-RE) Salaries expense (-E) To close the Salaries Expense account.

250,000 250,000

c. Balance Sheet Transaction c. Paid salaries.

2019 Jan.

Cash Asset

Noncash Assets

= Liabilities

-12,000 Cash

Income Statement +

Contrib. Capital +

Earned Capital

-4,700

-7,300

Salaries Payable

Retained Earnings

7 Salaries payable (-L) Salaries expense (+E,-SE) Cash (-A) To record payment of salaries.

Revenues

Expenses

Salaries Expense

+7,300

Net Income -7,300

4,700 7,300 12,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-21

Wages paid in January = $3,200 − $500 = $2,700.

d. Monthly depreciation expense = $8,700/60 months = $145. Fields has owned the truck for 18 months ($2,610/$145 = 18).

E3-35. (30 minutes) LO 2, 3, 6 a. Balance Sheet Transaction

Cash Asset

1.7/31 Adjusting entry for rent expense.

Noncash Assets

-475

Liabilities

Income Statement +

Contrib. Capital +

-210

Revenues

-475

Prepaid Rent

2. 7/31 Adjusting entry for ad. expense.

Earned Capital

+475

-475

-210

-1,900

+800

+300

-1,485

Retained Earnings -1,900

+800

Fees Receivable

Retained Earnings

Refinish. Revenue

Retained Earnings

5. 7/31 Adjusting entry for fees revenue. =

-300

+300

Retained Earnings

Refinish. Revenue

-1,485

1,100

+1,900 Supplies Expense

Performance Obligation Liability -300

+210 Advertising Expense

4. 7/31 Adjusting entry for fees revenue.

-1,785

Net Income

-1,900 Supplies Inventory

Rent Expense

- 210

Prepaid Advertising

Expenses

Retained Earnings

3. 7/31 Adjusting entry for supplies expense.

TOTALS

2,585

©Cambridge Business Publishers, 2021 3-22

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. July 31 Rent expense (+E,-SE) Prepaid rent (-A) To record July rent expense ($5,700/12 = $475).

475 475

31 Advertising expense (+E,-SE) Prepaid advertising (-A) To record July advertising expense ($630/3 = $210).

210

31 Supplies expense (+E,-SE) Supplies inventory (-A) To record supplies expense for July ($3,000 − $1,100 = $1,900).

1,900

31 Fees receivable (+A) Refinishing fees revenue (+R,+SE) To record unbilled revenue earned during July.

800

210

1,900

800

31 Performance obligation liability (-L) 300 Refinishing fees revenue (+R,+SE) To record portion of advance fees earned in July ($600/2 = $300).

300

c. + Prepaid Rent (A)

Bal.

5,700

475

Bal.

5,225

Bal. Bal.

+ Prepaid Advertising (A) 630 210 420

+ Supplies (A) (1)

(2)

Bal.

3,000

Bal.

1,100

(3)

- Performance Obligation Liability (L) + (5) 300 600 Bal. 300 Bal.

+ Fees Receivable (A) (4)

1,900

- Refinishing Fees Revenue (R) +

800

2,500 800 300 3,600 +

Supplies Expense (E)

(3)

1,900

Advertising Expense(E) -

(2)

210

+ (1)

Bal. (4) (5) Bal.

Rent Expense (E)

475

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-23

E3-36. (30 minutes) LO 2, 3, 6 (All amounts in $ thousands.) a. Balance Sheet Cash Asset

Transaction

Recognize inventory purchases

Noncash Assets +1,433,446 Inventory

= Liabilities

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

+1,433,446 = Accounts Payable

1,433,446

* Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv. So, $399,795 + Purchases $1,408,848 = $424,393. Thus, purchases = $1,433,446

E3-37. (30 minutes) LO 5 a. Dec. 31

Service fees revenue (-R) Interest income (-R) Retained earnings (+SE) To close the revenue accounts.

92,500 2,200

Retained earnings (-SE) Salaries expense (-E) Advertising expense (-E) Depreciation expense (-E) Income tax expense (-E) To close the expense accounts.

64,700

94,700

41,800 4,300 8,700 9,900

©Cambridge Business Publishers, 2021 3-24

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. - Retained Earnings (SE) + 64,700 42,700 94,700 72,700

(2)

Bal. (1) Bal.

- Service Fees Revenue (R) + 92,500 92,500 0 - Interest Income (R) + 2,200 2,200 0

(1)

+ Salaries Expense (E) 41,800 41,800 0 + Depreciation Expense (E) 8,700 8,700 0

Bal. Bal. Bal. Bal.

(2)

Bal. Bal.

(2)

Bal. Bal.

Bal. Bal. Bal. Bal.

+ Advertising Expense (E) 4,300 4,300 0 + Income Tax Expense (E) 9,900 9,900 0

(2)

E3-38. (15 minutes) LO 2, 3, 6 a. Balance Sheet Transaction (1) Collect deposits from customers. (2) Recognize income on completed customer orders.

(1)

(2)

Cash Asset +200,000 Cash

+565,387 Cash

Noncash Assets

= =

Liabilities +200,000 Customer Deposits

-197,998 Customer Deposits

Income Statement +

Contrib. Capital

Earned Capital

Revenues

+763,385 Retained Earnings

+763,385 Sales Revenue

Cash (+A) ……………………………………………… Customer deposits* (+L) ……………………… To record unearned customer deposits.

Expenses

= =

200,000

763,385

* Also sometimes called Unearned Customer Deposits ** $60,958 + $200,000 – Deposits earned = $62,960; Deposits earned = $197,998.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-25

Net Income

+763,385

b. Balance Sheet Transaction

Cash Asset

Record inventory purchases

Noncash Assets

= Liabilities

+330,822

Inventory

= Accounts Payable

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

Net Income

330,822 330,822

c. Customer Deposits are reported as a current liability.

Retained Earnings $20,600*

Total Stockholders’ Equity $63,600

(8,000) 8,900 $21,500

(8,000) 8,900 $64,500

*12,600 + 8,000 The dividend was paid and debited to retained earnings prior to the end of the period. continued next page ©Cambridge Business Publishers, 2021 3-26

Financial & Managerial Accounting for Decision Makers, 4 th Edition

$10,000 10,000

43,000 21,500 $74,500

b. 1.

Service fees revenue (-R) ....................................................... 71,000 Retained earnings (+SE) ....................................................

71,000

Retained earnings (-SE).......................................................... 18,000 Rent expense (-E)...............................................................

18,000

Retained earnings (-SE).......................................................... 37,100 Salaries expense (-E) .........................................................

37,100

Retained earnings (-SE)..........................................................7,000 Depreciation expense (-E) .................................................

7,000

The cash dividend has already been paid and is already reflected in the adjusted trial balance. c. Only the T-accounts affected by closing process are shown here.

Bal. Bal

+ Depreciation Expense (E) 7,000 7,000 0

Bal. Bal.

+ Salaries Expense (E) 37,100 37,100 0

(4)

(1)

- Service Fees Revenue (R) + 71,000 71,000 0 +

(3)

Bal. Bal

(2-4)

Bal. Bal.

Rent Expense (E) 18,000 18,000 0

- Retained Earnings (SE) + 62,100 12,600 71,000 21,500

(2)

Bal. (1) Bal.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-27

PROBLEMS P3-40. (90 minutes) LO 2, 3, 6 a., b. &d. +

Cash (A)

Apr. 1 5 18

11,500 1,800 4,900

Bal.

2,880 6,100 1,000 675

Apr. 1 2 2 29

100 2,500

30 30

4,945

+ Apr. 1 Unadj. bal. Adj bal.

Prepaid Insurance (A) 2,880 2,880 120 2,760 +

Apr. 2 Bal.

+ Apr. 30 Bal.

Bal.

5,500 4,000 4,600

+ Apr. 5 Unadj. bal. Adj. bal.

Supplies (A) 1,200 1,200 800 400 +

(d) Apr. 30

Equipment (A) 3,100 3,100

Apr. 2 Bal. -

+ Apr. 12 30 Unadj. bal. (d) 30

9,950

Apr. 30 Adj. Bal.

Apr. 12 30

4,900

Apr. 18

(d) Apr. 30

Roofing Fees Revenue (R) 5,500 4,000 9,500 450

Accounts Receivable (A)

Trucks (A) 6,100 6,100 Accounts Payable (L) 2,100 1,200 3,300

Apr. 30

+ Apr. 2 5 Bal.

Contract Liability (L) + 1,800 Apr. 5 (d) 450 1,800 Unadj. bal 1,350 Adj. Bal

Adj. Bal.

Supplies Expense (E) (d) 800 800

Advertising Expense (E) 100 100

Common Stock (SE) 11,500 11,500 +

Apr. 29 Bal.

Fuel Expense (E) 675 675

+ Apr. 1 Bal. -

continued next page

©Cambridge Business Publishers, 2021 3-28

Financial & Managerial Accounting for Decision Makers, 4 th Edition

a. continued + Apr. 30 Adj. Bal.

Insurance Expense (E) (d) 120 120

+ Apr. 30 Bal.

Wages Expense (E) 2,500 2,500

+ Depreciation Expense – Equip. (E) Apr. 30 (d) 35 Adj. Bal. 35

- Accumulated Deprec. – Equip. (XA) + 35 (d) Apr. 30 35 Adj. Bal.

+ Depreciation Expense - Trucks (E) Apr. 30 (d) 125 Adj. Bal. 125

- Accumulated Deprec. – Trucks (XA) + 125 (d) Apr. 30 125 Adj. Bal

b. Balance Sheet Transaction

Cash Asset

Noncash + Assets

4/1 Cash +11,500 received for Cash stock.

Liabilities

Income Statement Contrib. Capital +

Earned Capital

Revenues

+11,500 Common Stock

Expenses

4/1 Purchase liability insurance.

-2,880 Cash

+2,880 Prepaid Insurance

4/2 Purchase truck for cash.

-6,100 Cash

+ 6,100 Truck

4/2 Purchase equipment.

-1,000 Cash

4/5 Purchase supplies on account. 4/5 Cash in advance for roofing repairs.

+3,100 = Equipment

+2,100 Accts Payable

+ 1,200 Supplies

+1,200 Accts Payable

+1,800 Contract Liability

+5,500 Roofing Fees Revenue

+1,800 Cash

4/12 Bill customers for services.

+5,500 = Accts Receivable

+5,500 Retained Earnings

4/18 Collected cash on account.

+4,900 Cash

-4,900 = Accts Receivable

4/29 Paid cash for fuel.

-675 Cash

-675 Retained Earnings

4/30 Paid cash for ads.

-100 Cash

-100 Retained Earnings

4/30 Paid cash wages.

-2,500 Cash

-2,500 Retained Earnings

+4,000 = Accounts Receivable

+4,000 Retained Earnings

+4,000 Roofing Fees Revenue

6,225

9,500

4/30 Bill customers for services. Totals

4,945

17,880

5,100

11,500

+675 Fuel Expense

+5,500

-675

+100 = Ad. Expense

-100

+2,500 Wages Expense

3,275

-2,500

+4,000

6,225

continued next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

Net Income

3-29

b. continued Date 2019 Description Apr. 1 Cash (+A) Common stock (+SE) Owner invested cash. 1

Debit 11,500

Credit 11,500

Prepaid insurance (+A) Cash (-A) Paid two-year premium on liability insurance policy.

2,880

Trucks (+A) Cash (-A) Purchased used truck for $6,100 cash.

6,100

2,880

6,100

1,200

Cash (+A) Contract liability (+L) Received advance payment for services.

1,800

Accounts receivable (+A) Roofing fees revenue (+R,+SE) Billed customers for services.

5,500

Cash (+A) Accounts receivable (-A) Collection on account from customers.

4,900

Fuel expense (+E,-SE) Cash (-A) Paid truck fuel bill for April.

675

Advertising expense (+E,-SE) Cash (-A) Paid for April newspaper advertising.

100

1,000 2,100

1,200

1,800

5,500

4,900

675

100

Wages expense (+E, -SE) Cash (-A) Paid wages.

2,500

Accounts receivable (+A) Roofing fees revenue (+R, +SE) Billed customers for services.

4,000

2,500

4,000

©Cambridge Business Publishers, 2021 3-30

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. LOUGEE ROOFING SERVICE Unadjusted Trial Balance April 30, 2019 Debit $ 4,945 4,600 1,200 2,880 6,100 3,100

Cash Accounts Receivable Supplies Prepaid Insurance Trucks Equipment Accounts Payable Contract liability Common Stock Roofing Fees Revenue Fuel Expense Advertising Expense Wages Expense

Credit

$ 3,300 1,800 11,500 9,500 675 100 2,500 $26,100

$26,100

d. Balance Sheet Transaction

Cash Asset

1. Recognize one month of insurance expense.

Noncash Assets

-120

= Liabilities

Income Statement +

Contrib. Capital

-800

Expenses

+120

4. Recognize depreciatio n expense on equipment.

5. Recognize roofing fees earned.

+125

+35

-35

-450

+450

Retained Earnings

Roofing Fees Revenue

-630

450

+800

+125

+35

1,080

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

-800

-125

-35

+450

-630

Depreciation Expense

Contract liability -450

-120

Depreciation Expense

Retained Earnings

160

Retained Earnings

Accum. Depreciation

Supplies Expense

-125

Net = Income

Insurance Expense

-800

Accum. Depreciation

-920

Retained Earnings

3. Recognize depreciatio n expense – Trucks.

Revenues

Retained Earnings

Supplies

Earned Capital -120

Prepaid Insurance

2. Recognize supplies expense.

Totals

Contra Assets

3-31

d. continued Date 2019 Description April 30 Insurance expense (+E,-SE) Prepaid insurance (-A)

Debit 120

Credit 120

To record April insurance expense ($2,880/24 months = $120).

Supplies expense (+E,-SE) Supplies (-A)

800

Depreciation expense—Trucks (+E,-SE) Accumulated depreciation—Trucks (+XA,-A)

125

800

To record April supplies expense ($1,200 − $400 = $800).

125

To record April depreciation on trucks.

Depreciation expense—Equipment (+E,-SE) Accumulated depreciation—Equipment (+XA,-A)

35 35

To record April depreciation on equipment.

Contract liability (-L) Roofing fees revenue (+R,+SE)

450 450

To record portion of advance payment earned in April ($1,800/4 = $450).

P3-41. (40 minutes) LO 2, 3 a.

Cash Accounts Receivable Prepaid Rent Prepaid Insurance Supplies Equipment Accounts Payable Performance Obligations Common Stock Photography Fees Revenue Wages Expense Utilities Expense

SNAPSHOT COMPANY Unadjusted Trial Balance December 31, 2018 Debit $2,150 3,800 12,600 2,970 4,250 22,800

Credit

$1,910 2,600 24,000 34,480 11,000 3,420 $62,990

______ $62,990

©Cambridge Business Publishers, 2021 3-32

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Balance Sheet Transaction

Cash Asset

1. Fees earned but not received.

Noncash Assets

+925

Liabilities

Income Statement +

Contrib. Capital +

Fees Receivable

2. Recognize depreciati on expense for one year.

3. Recognize utilities expense.

+2,280

Accum. Depreciation

4. Recognize rent expense for year.

-6,300

-990

-2,730

-9,095

-2,280

+2,280 Depreciation Expense

+2,600 Retained Earnings

+2,600

2,280

-375

Wages Payable

Retained Earnings

-1,825

-9,550

+6,300

= +2,600

+990

-990

Insurance Expense -

+2,730

= -2,730

Supplies Expense -

+375

-375

Wages Expense 3,525

13,075

= -9,550

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

-400

= -6,300

-2,730

+375

+400

Photo Fees Revenue

Retained Earnings =

= -2,280

Rent Expense

-990

+925

Utilities Expense

Retained Earnings -

Net = Income =

Retained Earnings

-6,300

-2,600 Performance Obligations

Expenses

Retained Earnings

+925 Photo Fees Revenue

-400

Supplies

8. Recognize wages expense.

+925

Retained Earnings

Prepaid Insurance

7. Recognize supplies expense.

Revenues -

Retained Earnings

+400

6. Recognize insurance expense.

Earned Capital

Utilities Payable

Prepaid Rent

5. Recognize photo revenues.

Totals

Contra Assets

3-33

c. Date 2018 Description Dec. 31 Fees receivable (+A) Photography fees revenue (+R, +SE) `

Debit 925

Credit 925

To record revenue earned but not billed.

Depreciation expense (+E,-SE) Accum. depreciation—Equipment (+XA, -A)

2,280 2,280

To record depreciation for the year ($22,800/10 years = $2,280).

Utilities expense (+E, -SE) Utilities payable (+L)

400 400

To record estimated December utilities expense.

Rent expense (+E, -SE) Prepaid rent (-A)

6,300 6,300

To record rent expense for the year ($12,600/2 years = $6,300).

Performance obligations (-L) Photography fees revenue (+R, +SE)

2,600 2,600

To record advance payments earned during the year.

Insurance expense (+E, -SE) Prepaid insurance (-A)

990 990

To record insurance expense for the year ($2,970/3 years = $990).

Supplies expense (+E,-SE) Supplies (-A)

2,730 2,730

To record supplies expense for the year ($4,250 − $1,520 = $2,730).

Wages expense (+E, -SE) Wages payable(+L)

375

To record unpaid wages at December 31.

©Cambridge Business Publishers, 2021 3-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

375

d. + Cash (A) Unadj. bal. 2,150 Adj. bal. 2,150 + Accounts Receivable (A) Unadj. bal.

3,800

Adj. bal.

3,800

- Accounts Payable (L) + 1,910 Unadj. bal. 1,910 Adj. bal. - Performance Obligations (L) + Dec.31

+ Fees Receivable (A) -

(5) 2,600

2,600

Unadj. bal.

Adj. bal.

- Utilities Payable (L) +

Dec. 31

(1) 925

400

(3) Dec.31

Adj. bal.

925

400

Adj. bal.

+ Prepaid Rent (A) Unadj. bal.

12,600

Adj. bal.

6,300

- Wages Payable (L) +

6,300 (4) Dec.31

+ Prepaid Insurance (A) Unadj. bal.

2,970

Adj. bal.

1,980

Unadj. bal. Adj. bal.

+ Supplies (A) 4,250 2,730 (7) Dec.31 1,520

Unadj. bal. Adj. bal.

+ Equipment (A) 22,800 22,800

+ Supplies Expense (E) -

(8) Dec.31

375

Adj. bal.

- Common Stock (SE) +

990 (6) Dec.31

- Accum. Depreciation – Equip. (XA) + 2,280 (2) Dec.31 2,280 Adj. Bal.

375

24,000

Unadj. bal.

24,000

Adj. bal.

Dec. 31

(7) 2,730

Dec.31

(2) 2,280

Adj. bal.

2,730

Adj. Bal.

2,280

+ Insurance Expense (E) -

+ Rent Expense (E) -

Dec. 31

(6) 990

Dec.31

(4) 6,300

Adj. bal.

990

Adj. Bal.

6,300

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-35

P3-42. (90 minutes) LO 2, 3, 4, 5, 6 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Contra Assets

= Liabilities

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

1. Recognize rent expense.

-775 Prepaid Rent

-775 Retained Earnings

+775 Rent Expense

-775

2. To recognize supplies expense.

-1,700 Supplies

-1,700 Retained Earnings

+1,700 Supplies Expense

-1,700

3. To recognize depreciation expense.

+74 = Accum. Deprec.

-74 Retained Earnings

+74 = Depreciation Expense

-74

4. To recognize wages expense.

+210 Wages Payable

-210 Retained Earnings

+210 Wages Expense

-210

5. To recognize utilities expense.

+300 Utilities Payable

-300 Retained Earnings

+300 Utilities Expense

-300

+380 Accounts Receivable

+380

-2,095

-2,679

6. To recognize fees earned.

Totals

510

+380 Retained Earnings

+380 Service Fees Revenue

-2,679

380

3,059

b. Date 2019 Description June 30 Rent expense (+E, -SE) Prepaid rent (-A)

Debit 775

Credit 775

To record June rent expense ($3,100/4 months = $775).

30 Supplies expense (+E, -SE) Supplies (-A)

1,700 1,700

To record June supplies expense (2,520 − $820 = $1,700).

30 Depreciation expense—Equip (+E, -SE) Accum. depreciation—Equipment (+XA, -A)

74 74

To record June depreciation ($4,440/60 months = $74).

30 Wages expense (+E, -SE) Wages payable (+L)

210 210

To record unpaid wages at June 30.

30 Utilities expense (+E, -SE) Utilities payable (+L)

300 300

To record estimated June utilities expense.

30 Accounts receivable (+A) Service fees revenue (+R, +SE)

380 380

To record fees earned but not billed in June. ©Cambridge Business Publishers, 2021 3-36

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. + Cash (A) Unadj. bal 1,180 Adj. bal. 1,180 + Accounts Receivable (A) Unadj. bal Jun. 30 Adj. bal.

- Accounts Payable (L) + 760 760 - Wages Payable (L) +

Unadj. bal Adj. bal.

450

210

(4) Jun.30

(6) 380

210

Adj. bal.

830 - Utilities Payable (L) +

+ Prepaid Rent (A) Unadj. bal

3,100

Adj. bal.

2,325

300

(5) Jun.30

300

Adj. bal.

- Retained Earnings (SE) +

775 (1) Jun.30

5,300

+ Rent Expense (E) -

Unadj. bal.

- Common Stock (SE) +

Jun.30

(1) 775

2,000

Unadj. bal

Adj. bal.

775

2,000

Adj. bal.

Unadj. bal Adj. bal.

+ Supplies (A) 2,520 1,700 (2) Jun.30 820

Unadj. bal Adj. bal.

+ Equipment (A) 4,440 4,440

- Accum. Depreciation – Equip.(XA) + 74 (3) Jun.30 74 Adj. Bal.

+ Supplies Expense (E) Jun. 30

(2) 1,700

Jun.30

(3) 74

Adj. bal.

1,700

Adj. bal.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-37

$ 760 210 300 1,270

2,000 6,251 $9,521

©Cambridge Business Publishers, 2021 3-38

Financial & Managerial Accounting for Decision Makers, 4 th Edition

e. 1. 2. 3.

4. 5. 6.

1. 2. 3. 4. 5.

Retained earnings (-SE) ........................................................ Rent expense (-E) ..............................................................

775

Retained earnings (-SE) ......................................................... Supplies expense (-E) ........................................................

1,700

Retained earnings (-SE) ......................................................... Wages expense (-E) ..........................................................

1,230

Retained earnings (-SE) ......................................................... Utilities expense (-E ) .........................................................

300

Retained earnings (-SE) ......................................................... Depreciation expense (-E) .................................................

Service fees revenue (-R) ...................................................... Retained earnings (+SE)....................................................

5,030

- Retained Earnings (SE) + 5,300 775 1,700 1,230 300 74 5,030 6,251

Bal.

1,230 0

1,230

+ Depreciation Expense (E) 74 74 0

1,700 1,230

300 74 5,030

Bal.

+ Rent Expense (E) 775 775 0

Bal.

+ Supplies Expense (E) 1,700 1,700 0

6. Bal.

+ Wages Expense(E) Bal.

775

+ Utilities Expense (E) 3.

Bal.

300 0

300

- Service Fees Revenue (R) + 5,030 5,030 Bal. 0

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-39

P 3-43. (30 minutes) LO 3 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Contra Assets

Income Statement

= Liabilities +

Contrib. Capital +

Earned Capital

Revenues

- Expenses

Net Income

1. Accrue salary expense.

+720 Salaries Payable

-720 Retained Earnings

+720 Salaries Expense

-720

2. Accrue interest expense.

+200 Interest Payable

-200 Retained Earnings

+200 Interest Expense

-200

+900 Retained Earnings

+900

-400 Retained Earnings

+400 Maint. Expense

-400

-300

+300 Ad. Expense

-300

+160 Rent Expense

-160

+38

+2,175 = Depreciation Expense

-2,175

3. Accrue fees receivable.

+900 Fees Receivable

4. Accrue maintenance expense.

-400 Prepaid Maintenance

5. Accrue ad. Expense.

-300 Prepaid Advertising

6. Accrue rent expanse. 7. Accrue interest revenue.

+38

Totals

+238

Retained Earnings -

+160 Rent Payable

-160 Retained Earnings

+38 Retained Earnings

+2,175 = Accum. Depreciation

-2,175 Retained Earnings

2,175

Interest Receivable

8. Accrued depreciation expense.

+900 Printing Revenue

1,080

-3,017

+38 Interest Revenue

938

3,955

©Cambridge Business Publishers, 2021 3-40

Financial & Managerial Accounting for Decision Makers, 4 th Edition

-3,017

b. Date Dec 31

200

Fees receivable (+A) Printing revenue (+R, +SE) To record revenue earned but not yet billed.

900

Maintenance expense (+E ,-SE) Prepaid maintenance (-A) To record December maintenance expense. ($2,400 / 6 = $400).

400

Advertising expense (+E, -SE) Prepaid advertising (-A) To record December advertising expense ($900  1/3 = $300).

300

Rent expense (+E, -SE) Rent payable (+L) To accrue one-half month's rent expense [(400  $0.80)/2 = $160].

160

Interest receivable (+A) Interest income (+R, +SE) To accrue interest earned in December.

Credit 720

200

900

400

300

160

Depreciation expense—Equipment (+E, -SE) Accum. depreciation—Equipment (+XA) To record annual depreciation on equipment.

2,175 2,175

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-41

$58,400 $12,000 33,400 4,700 3,250 720 630 54,700 $ 3,700

TRUEMAN CONSULTING INC. Statement of Stockholders’ Equity For the Year Ended December 31, 2018 Retained Earnings $3,305

Total Stockholders’ Equity $4,305

Net income ............................................. _____

3,700

Balance at December 31, 2018 .............. $1,000

$7,005

$8,005

Common Stock Balance at December 31, 2017 .............. $1,000 Stock issuance ....................................... Dividends ................................................

TRUEMAN CONSULTING Balance Sheet December 31, 2018 Assets Cash Accounts receivable Supplies Prepaid insurance Equipment Less: Accumulated depreciation

$ 6,400 1,080

Total Assets

Liabilities $ 2,700 Accounts payable 3,270 Long-term notes payable 3,060 Total Liabilities 1,500 Owners’ Equity 5,320 Common stock

$15,850

Retained earnings Total Liabilities and Owners’ Equity

$ 845 7,000 7,845

1,000 7,005 $15,850

©Cambridge Business Publishers, 2021 3-42

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Debit 58,400

Credit 58,400

54,700 12,000 33,400 4,700 3,250 720 630

P3-45. (30 minutes) LO 5 a. Date 2018 Dec. 31

Description Service fees revenue (-R) Miscellaneous income (-R) Retained earnings (+SE) To close the revenue accounts.

Debit 97,200 4,200

Retained earnings (-SE) Salaries expense (-E) Rent expense (-E) Insurance expense (-E) Depreciation expense (-E) Income tax expense (-E) To close the expense accounts.

74,800

Credit

101,400

42,800 13,400 1,800 8,000 8,800

b. After the closing entries are posted, Retained Earnings has a $45,700 credit balance ($19,100 + $26,600 net income).

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-43

Credit

$8,500 8,000 3,600 72,000 $12,000 600 8,800 25,000 45,700 $92,100

______ $92,100

P3-46. (30 minutes) LO 2, 3 a. Balance Sheet Transaction

Cash Asset

1. Recognize Advertising expense.

Noncash Assets

-400

Contrib. Capital +

-1,140

+1,300

-1,300

Wages Payable*

Retained Earnings

+1,000

-540

-400

-1,300

-1,140

+2,400

+1,000

560

Performance Obligations

Retained Earnings

Service Fee Revenue

+1,140 Insurance Expense

+2,400

-1,100

+1,300 Wages Expense

+2,400

+400

Net = Income =

-2,400

Rent Receivable

Expenses

Advertising Expense

Retained Earnings =

5. Recognize rent revenue.

-1,140

Prepaid Insurance

4. Recognize service fees earned.

Revenues

Retained Earnings =

3. Recognize insurance expense.

Earned Capital -400

Prepaid Advertising

2. Accrue wage expense.

Totals

Liabilities

Income Statement

+1,000

Retained Earnings

Rental Income

560

3,400

2,840

*Assumes wages earned had not been accrued or recognized yet as an expense. continued next page

©Cambridge Business Publishers, 2021 3-44

Financial & Managerial Accounting for Decision Makers, 4 th Edition

a. continued Date 2018 Description Dec. 31 Advertising expense (+E, -SE) Prepaid advertising (-A)

Debit 400

Credit 400

To record advertising expense ($1,200 − $800 = $400).

Wages expense (+E, -SE) Wages payable (+L)

1,300 1,300

To record accrued wages.

Insurance expense (+E, -SE) Prepaid insurance (-A)

1,140

Performance obligations (-L) Service fee revenue (+R, +SE)

2,400

1,140

To record insurance expense ($3,420 − $2,280 = $1,140).

2,400

To recognize unearned fees as earned ($5,400 − $3,000 = $2,400).

Rent receivable (+A) Rental income (R, +SE)

1,000 1,000

To record rent earned but not yet recorded.

b. Balance Sheet Transaction

Cash Asset

Noncash Assets

= Liabilities +

1. Pay wages of $2,400.

-2,400

2. Receipt of $1,000 rent revenue.

+1,000

-1,000

Cash

Rent Receivable

Date 2019

Description Credit Wages payable (-L) Wages expense (+E, -SE) Cash (-A)

Jan.

Cash

Income Statement Contrib. Capital +

Earned Capital

-1,300

-1,100

Wages Payable

Retained Earnings

Revenues

Expenses

Net Income

+1,100

-1,100

Wages Expense -

Debit 1,300 1,100 2,400

To record payment of wages.

Cash (+A) Rent receivable (-A)

1,000 1,000

To record collection of rent.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-45

6/10 6/28

6/2

6/1

+ Cash (A) 24,000 4,400 6,400 875 7,800 930 3,600 1,240 520 3,600 1,500 21,535

6/1 6/2 6/2 6/12 6/15 6/18 6/26 6/30 5.

+ Accounts Receivable (A) 5,800 7,800 5,200 3,200 + Prepaid Advertising (A) 930 310 620

6/30

+ Office Supplies (A) 2,840 1,310 1,530

+ Office Equipment (A) 11,040

- Acc. Depreciation – Off. Equip (XA) + 115

+ Advertising Expense (E) 310 + Salaries Expense (E) -

6/12 6/26 2.

6/18

- Accounts Payable (L) + 9,480

6/1

- Salaries Payable (L) + 725

- Contract Liabilities (L) + 3,200 6,400 3,200 - Common Stock (SE) + 24,000

6/30

- Retained Earnings(SE) + 1,500

+ Supplies Expense (E) 1,310

6/15

+ Travel Expense (E) 1,240

+ Depreciation Expense(E) 115

6/2

+ Rent Expense (E) 875

6/1

- Service Fees Revenue (R) +

3,600 3,600 725

5,800 5,200 3,200

7,925

14,200

+ Postage Expense (E) 520

©Cambridge Business Publishers, 2021 3-46

6/2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

6/10 6/28 5.

b. Balance Sheet Transaction

Cash Asset

Noncash Assets

6/1. Investment +24,000 for common Cash stock. 6/1. Purchase of assets for cash & on account.

-4,400 Cash

6/2. Pay rent $875.

-875 Cash

6/2. Purchase $930 of advertising in advance.

-930 Cash

6/2 Signed research contract.

+6,400 Cash

6/10. Bill customers for services.

Liabilities

+ 11,040 Office Equipment +2,840 Supplies

Income Statement Contrib. Capital

Revenues -

+9,480 Accounts Payable

-875 Retained Earnings

+6,400 Contract Liabilities

+5,800 Retained Earnings

+5,800 Service Fees Revenue

Expenses

+5,800 Accounts Receivable

Earned Capital

+24,000 Common Stock

+930 Prepaid Advertising

+875 Rent Expense

Net Income

-875

+5,800

6/12. Paid salaries.

-3,600 Cash

-3,600 Retained Earnings

+3,600 Salaries Expense

-3,600

6/15. Paid travel expenses.

-1,240 Cash

-1,240 Retained Earnings

+1,240 Travel Expense

-1,240

6/18. Paid postage.

-520 Cash

-520 Retained Earnings

+520 Postage Expense

-520

6/26. Paid salaries.

-3,600 Cash

-3,600 Retained Earnings

+3,600 Salaries Expense

-3,600

+5,200 Retained Earnings

+5,200 Service Fees Revenue

+5,200

6/28. Bill customers for services.

+5,200 Accounts Receivable

6/30. Collect +7,800 service fees. Cash

-7,800 Accounts Receivable

6/30. Cash dividend paid.

-1,500 Cash

-1,500 Retained Earnings

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-47

P3-47. b. continued Date 2019 Description June 1 Cash (+A) Common stock (+SE)

Debit 24,000

Credit 24,000

Owner invested cash for common stock.

Office equipment (+A) Office supplies (+A) Cash (-A) Accounts payable (+L)

11,040 2,840 4,400 9,480

Purchased equipment and supplies; $4,400 cash paid with the remainder due in 60 days.

Rent expense (+E, -SE) Cash (-A)

875 875

Paid June rent.

Prepaid advertising (+A) Cash (-A)

930 930

Paid three months' advertising in advance.

Cash (+A) Contract liabilities (+L)

6,400 6,400

Received two months' fees in advance on six-month contract.

10 Accounts receivable (+A) Service fee revenue (+R, +SE)

5,800 5,800

Billed customers for services.

12 Salaries expense (+E, -SE) Cash (-A)

3,600 3,600

Paid two weeks' salaries to employees.

15 Travel expense (+E, -SE) Cash (-A)

1,240 1,240

Paid business travel expenses.

18 Postage expense (+E, -SE) Cash (-A)

520 520

Paid postage for questionnaire mailing.

26 Salaries expense (+E, -SE) Cash (-A)

3,600 3,600

Paid two weeks' salaries to employees. continued next page ©Cambridge Business Publishers, 2021 3-48

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-47. b. continued Date 2019 Description June 28 Accounts receivable (+A) Service fees revenue (+R, +SE)

Debit 5,200

Credit 5,200

Billed customers for services.

30 Cash (+A) Accounts receivable (-A)

7,800 7,800

Collections from customers on account.

30 Retained earnings (-SE) Cash (-A)

1,500 1,500

Declared and paid dividends.

MARKET-PROBE Unadjusted Trial Balance June 30, 2019 Debit $21,535 3,200 2,840 930 11,040

Credit

$9,480 6,400 24,000 1,500 11,000 7,200 875 1,240 520 $50,880

______ $50,880

* The negative (debit) balance in Retained Earnings reflects the dividend paid.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-49

P3-47. d. Balance Sheet Transaction a. Recognize supplies expense.

Cash Asset

Noncash Assets

-1,310

= Liabilities

Income Statement Contrib. + Capital +

c. Accrue depreciatio n expense.

+115

+725

-725

Salaries Payable

Retained Earnings

-725

+115 = Depreciation Expense

-115

+310

-310

Advertising Expense

-3,200

+3,200

Contract Liabilities

Retained Earnings

Service Fees Revenue

Date 2019 Description Debit June 30 Supplies expense (+E, -SE) 1,310 Office supplies (-A) To record supplies used during June ($2,840 − $1,530 = $1,310). 30

= -1,310

+725

Retained Earnings -

+1,310

Salaries Expense

-310

Prepaid Advertising

Net = Income

Retained Earnings =

Expenses

Supplies Expense

-115

Accum. Depreciation

e. Recognize earned service fees.

Revenues

Retained Earnings -

-310

Earned Capital -1,310

Office Supplies

b. Recognize salaries expense.

d. Recognize advertising expense.

Contra Assets

Salaries expense (+E, -SE) Salaries payable (+L) To record unpaid salaries at June 30.

725

Depreciation expense—Office equipment (+E, -SE) Accum. deprec. Off. equipment (+XA, -A) To record June depreciation ($11,040/96 mo. = $115).

115

Advertising expense (+E, -SE) Prepaid advertising (-A) To record one month's advertising expense.

310

Contract liabilities (-L) Service fee revenue (+R, +SE) To record one month's fees earned, received in advance.

= +3,200

Credit 1,310

725

115

310

3,200 3,200

©Cambridge Business Publishers, 2021 3-50

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-48. (40 minutes) LO 3 a.

Cash Accounts Receivable Prepaid Advertising Supplies Equipment Notes Payable Accounts Payable Common Stock Mailing Fee Revenue Wages Expense Rent Expense Utilities Expense

DELIVERALL Unadjusted Trial Balance December 31, 2018 Debit $ 2,300 5,120 1,680 6,270 42,240

Credit

$7,500 2,700 9,530 86,000 38,800 6,300 3,020 $105,730

________ $105,730

b Balance Sheet Transaction 1. Recognize advertising expense.

Cash Asset

Noncash Assets -1,540 Prepaid Advertising

Contra Assets

Earned Capital

Revenues

Expenses

Net = Income

-1,540 Retained Earnings

+1,540 = -1,540 Advertising Expense

-5,280 Retained Earnings

+5,280 = -5,280 Depreciation Expense

2. Recognize depreciatio n expense.

3. Recognize utilities expense.

+325 Accts Payable

-325 Retained Earnings

+325 Utilities Expense

4. Accrue wages expense.

+1,200 Wages Payable

-1,200 Retained Earnings

+1,200 Wages Expense

= -1,200

-4,750 Retained Earnings

+4,750 Supplies Expense

= -4,750

6. Accrue interest expense.

+450 Interest Payable

-450 Retained Earnings

+450 Interest Expense

-450

7. Recognize rent expense*.

+430 Accts Payable

-430 Retained Earnings

+430 Rent Expense

-430

5. Recognize supplies expense.

-4,750 Supplies

+5,280 Accum. Deprec.

= Liabilities +

Income Statement Contrib. Capital

*(1/2%  $86,000 = $430). The rent for the year ($6,300 = $525 x 12) has already been recognized in the accounts. See the beginning balances given in the problem statement.

continued next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-51

-325

P3-48. b. continued Date 2018 Description Dec. 31 Advertising expense (+E, -SE) Prepaid advertising (-A)

Debit 1,540

Credit 1,540

To record 11 months' advertising expense ($1,680  11/12 = $1,540).

31 Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A)

5,280 5,280

To record depreciation for the year ($42,240/8 years = $5,280).

. 31 Utilities expense (+E, -SE) Accounts payable (+L)

325 325

To record estimated December utilities expense.

31 Wages expense (+E, -SE) Wages payable (+L)

1,200 1,200

To record unpaid wages at December 31.

31 Supplies expense (+E, -SE) Supplies (-A)

4,750 4,750

To record supplies expense for the year ($6,270 − $1,520 = $4,750).

31 Interest expense (+E, -SE) Interest payable (+L)

450 450

To record accrual of interest expense at Dec. 31.

31 Rent expense (+E, -SE) Accounts payable (+L)

430 430

To record additional rent owed under lease (1/2%  $86,000 = $430).

©Cambridge Business Publishers, 2021 3-52

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-48. c.

Only the T-accounts needed to enter the adjustments are provided. - Accounts Payable (L) + 2,700 325 430

Bal. 3. 7.

Bal.

+ Prepaid Advertising (A) 1,680 1,540

Bal.

+ Supplies (A) 6,270 4,750

- Accumulated Depreciation–Equip (XA) + 5,280

+Advertising Expense (E) 1,540

- Interest Payable (L) + 450

Bal. 7.

+ Rent Expense (E) 6,300 430

- Wages Payable (L) + 1,200

Bal. 4.

+ Wages Expense (E) 38,800 1,200

Bal. 3.

+ Utilities Expense (E) 3,020 325

+ Depreciation Expense (E) 5,280

+ Interest Expense (E) 6.

450

+ Supplies Expense (E) 5.

4,750

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-53

P3-49 (60 minutes) LO 2, 3, 4, 5, 6 a. Balance Sheet

Transaction 1. Recognize rent expense. 2. Recognize supplies expense.

Cash Asset

Noncash Assets -795

Contra Assets

= Liabilities

Income Statement

Contrib. Capital

Net Expenses = Income

+795

-795

-1,980

-335

-560

-390

+500

Debit

Credit

Retained Earnings -

Rent Expense

-1,980

Supplies

+1,980

Retained Earnings

3. Accrue depreciatio n expense.

4. Accrue wages payable.

5. Recognize utilities expense.

6. Recognize service revenue.

+335

Supplies Expense

-335

Accum. Depreciation

Retained Earnings =

+560

-560

Wages Payable

Retained Earnings

+390

-390

Accounts Payable

Retained Earnings

+560 Wages Expense

+390 Utilities Expense

-500

+500

Retained Earnings

Service Revenue

Rent expense (+E, -SE) Prepaid rent (-A)

+335 Depreciatio n Expense

Service Contract Liability

Date 2019 Description Mar. 31

Revenues

-795

Prepaid Rent -1,980

Earned Capital

795 795

To record March rent expense ($4,770/6 months = $795).

Supplies expense (+E, -SE) Supplies (-A)

1,980 1,980

To record March supplies expense ($3,700−$1,720 = $1,980).

Depreciation expense—Equipment (+E, -SE) Accumulated depreciation—Equipment (+XA, -A)

335 335

To record March depreciation ($36,180/108 months = $335).

Wages expense (+E, -SE) Wages payable (+L)

560 560

To record unpaid wages at March 31.

Utilities expense (+E, -SE) Accounts payable (+L)

390 390

To record estimated March utilities expense.

Service contract liability (-L) Service revenue (+R, +SE)

500 500

To record revenue received in advance that was earned in March.

©Cambridge Business Publishers, 2021 3-54

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Bal. 5. Bal.

Bal. Bal.

Bal. Bal. - Acc Depreciation - Equipment (XA) + 335

+ Prepaid Rent (A) 4,770 795 3,975

+ Supplies (A) 3,700 1,980 1,720 - Service Contract Liability (L) + 500 1,000 500

-Service Revenue(R) + 6c.

12,860

12,360 500

Bal. Bal.

+ Rent Expense (E) Bal. 6.

795

1c.

+ Supplies Expense (E) 2.

1c. 2c. 3c. 4c. 5c.

+Depreciation Expense (E) 335 335

+ Utilities Expense (E) 390 390 - Retained Earnings (SE) + 795 1,980 335 4,460 390 12,860 4,900

3c.

5c.

Bal. 4.

1,980

2c.

+Wages Expense (E) 3,900 560 4,460

4c.

- Wages Payable (L) + 560

6c.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-55

P3-49. c. WHEEL PLACE COMPANY Income Statement For Month Ended March 31, 2019 Service revenue…………………………………….……...

$12,860

Expenses: Utilities expense…………….…………………..…………

$390

Supplies expense…………..………………………………

1,980

Wages expense……………..…………………………..…

4,460

Depreciation expense………………………………….…

335

Rent expense……………………………………………...

795

Net income ………………………………………………...

7,960 $4,900

WHEEL PLACE COMPANY Balance Sheet March 31, 2019 Assets

Liabilities $ 1,900 Accounts payable

Cash

$ 2,900

Accounts receivable

3,820 Wages payable

560

Supplies

1,720 Service contract liability

500

Prepaid rent

3,975

Total Liabilities

35,845

Owners’ Equity

Equipment

3,960

$ 36,180

Less:Accumulated depreciation

Total Assets

335

Common stock

38,400

Retained earnings

4,900

$47,260 Total Liabilities and Owners’ Equity

$47,260

©Cambridge Business Publishers, 2021 3-56

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-49.

d. 1c.

2c. 3c. 4c.

5c. 6c.

Retained earnings (-SE) ...................................................... Rent expense (-E) ...........................................................

795

Retained earnings (-SE) ...................................................... Supplies expense (-E) .....................................................

1,980

Retained earnings (-SE) ...................................................... Depreciation expense (-E) ..............................................

335

Retained earnings (-SE) ...................................................... Wages expense (-E) .......................................................

4,460

Retained earnings (-SE) ...................................................... Utilities expense (-E) .......................................................

390

795

1,980 335 4,460

390

Service revenue (-R) .......................................................... 12,860 Retained earnings (+SE) .................................................

12,860

$ 168,300 49,700 $218,000 100,230 85,600 8,800 6,100 1,860 5,500 1,600 209,690 $8,310 Continued next page ©Cambridge Business Publishers, 2021

Solutions Manual, Chapter 3

3-57

P3-50. a. continued TRAILS, INC. Statement of Stockholders’ Equity For Year Ended December 31, 2018

$25,000

$23,220

Total Stockholders’ Equity $48,220

_____ $25,000

8,310 $31,530

8,310 $56,530

Retained Earnings

TRAILS, INC. Balance Sheet December 31, 2018 Assets

Liabilities

Cash

$3,400

Accounts payable

$ 2, 100

Accounts receivable

8,600

Subscription liabilities

10,000

Supplies

4,200

Salaries payable

3,500

930

Total liabilities

15,600

Prepaid insurance Office equipment

$66,000

Less: Accum. depreciation

11,000

Stockholders' equity 55,000 Common stock

$25,000

Retained earnings

31,530

Total stockholders' equity _______ Total assets

$72,130

56,530

Total liabilities and stockholders' equity

$72,130

©Cambridge Business Publishers, 2021 3-58

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Date 2018 Description Dec. 31 Subscription revenue (-R) Advertising revenue (-R) Retained earnings (+SE)

Debit 168,300 49,700

Credit

218,000

To close the revenue accounts.

Retained earnings (-SE) Salaries expense (-E) Printing and mailing expense (-E) Rent expense (-E) Supplies expense (-E) Insurance expense (-E) Depreciation expense (-E) Income tax expense (-E)

209,690 100,230 85,600 8,800 6,100 1,860 5,500 1,600

To close the expense accounts.

P3-51. (30 minutes) LO 5 a. Date 2018 Dec. 31

Description Service fee revenue (-R) Retained earnings (+SE)

Debit 72,500

Credit 72,500

To close the revenue account.

58,800 29,800 10,200 2,900 5,100 6,000 4,000 800

To close the expense accounts.

b. The balance in Retained Earnings after closing entries are posted is $29,250 credit ($15,550 + $13,700).

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-59

Credit

$10,000 2,100 1,200 2,700 5,000 29,250 $50,250

P3-52. (20 minutes) LO 2, 3, 6 a. Balance Sheet Transaction 1. Recognize maintenance expense. 2. Recognize supplies expense.

Cash Asset

Noncash Assets

-1,800

-5,200

Earned Capital

Revenues

Expenses

Net Income

+1,800

-1,800

-5,200

+4,500

+2,800

-913

Maintenance Expense

-5,200

Retained Earnings =

-4,500

+4,500

Retained Earnings

Commission Revenue

+2,800

Retained Earnings

Commission Revenue

+913

-913

Rent Payable

Retained Earnings

+5,200 Supplies Expense

Performance Obligations

Commissions Receivable

5. Rent expense.

Contrib. Capital +

Retained Earnings

Supplies

+2,800

-1,800

Prepaid Maintenance

3. Accrue earned commissions.

4. Earned but unbilled commission fees.

Liabilities

Income Statement

+913 Rent Expense

©Cambridge Business Publishers, 2021 3-60

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Balance Sheet Transaction

Cash Asset

1. Recognize maintenance expense.

Noncash Assets

Liabilities

Income Statement +

Contrib. Capital +

-2,800 = Commissions Receivable

Earned Capital

Revenues

Net Income

+1,800 Retained Earnings

+1,800 Commission Revenue

+1,800

Expenses

+4,600 Accounts Receivable 2. Recognize rent expense.

-913 Cash

-913 Rent Payable

c. Date 2018 Description Dec. 31 Maintenance expense (+E, -SE) Prepaid maintenance (-A)

Debit 1,800

Credit 1,800

To record four months' maintenance expense [($2,700/6)  4 = $1,800].

Supplies expense (+E, -SE) Supplies (-A)

5,200

Performance obligations (-L) Commission revenue (+R, +SE)

4,500

5,200

To record supplies expense ($8,400 − $3,200 = $5,200).

4,500

To transfer fees earned from unearned fees ($8,500 − $4,000 = $4,500).

Commissions receivable (+A) Commission revenue (+R, +SE)

2,800 2,800

To record fees earned but not yet billed.

Rent expense (+E, -SE) Rent payable (+L)

913 913

To record additional 2018 rent [1%  ($84,000 + $4,500 + $2,800) = $913].

2019 Jan. 10

Accounts receivable (+A) Commisions receivable (-A) Commision revenue (+R, +SE)

4,600 2,800 1,800

To record billings on Jan. 10, 2019.

Rent payable (-L) Cash (-A)

913 913

To record payment of contingent rent from 2018.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-61

P3-53. (60 minutes) LO 3, 4, 5, 6 a. Balance Sheet Transaction 1. Cash sales.

Cash Asset

Noncash Assets

+145,850 Cash

2. Record inventory purchased and used.

+2,500 Inventories

3. Recognize recent payments on A/P.

-77,300 Cash

4. Recognize rent paid and rent expense.

-24,000 Cash

5. Recognize wage expense and wages paid.

-12,500 Cash

+200 Prepaid Rent

6. Recognize depreciation expense.

Contra Assets

= Liabilities

+76,200 Accounts Payable

-77,300 Accounts Payable

+1,700 = Accum. Deprec.

Income Statement Contrib. + Capital +

+250 Wages Payable

Earned Capital

Revenues

+145,850 Retained Earnings

+145,850 Sales Revenue

= +145,850

+73,700 = -73,700 Cost of Goods Sold

-73,700 Retained Earnings

Expenses

-23,800 Retained Earnings

+23,800 Rent Expense

= -23,800

-12,750 Retained Earnings

+12,750 Wages Expense

= -12,750

-1,700 Retained Earnings

+1,700 Deprec. Expense

= -1,700

continued next page

©Cambridge Business Publishers, 2021 3-62

Net = Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

6. Depreciation expense (+E,-SE) .......................................................... 1,700 Acc. depreciation – Equipment (+XA, -A) ...........................................1,700

c. & e. The closing entries required in part e are also included here and indicated by the letter e before the relevent entry. + Cash (A) Bal. 1.

8,500 145,850

Bal.

40,550

Bal. Bal.

77,300 24,000 12,500

3. 4. 5.

+ Equipment (A) 7,500 7,500

Bal. 2. Bal.

+ Inventories (A) 12,000 2,500 14,500

Bal. 4. Bal.

+ Prepaid Rent (A) 3,800 200 4,000

- Accumulated Depreciation Equip.(XA) + 3,000 1,700 4,700

Bal. 6. Bal.

- Wages Payable (L) + 100 250 350

-Accounts Payable (L)+ 5,200 77,300 76,200 4,100

Bal. 2. Bal.

-Owners’ Equity (SE)+ 23,500 33,900 57,400

Bal. 5. Bal.

Bal. e. Bal.

continued next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 3

3-63

P3-53. c. & e. continued -Sales Revenue (R)+ 145,850 145,850 0

4. Bal.

5. Bal.

+Rent Expense (E)23,800 23,800 0 +Wages Expense (E)12,750 12,750 0

Bal.

6. e. Bal.

+Cost of Goods Sold (E)73,700 73,700 0 +Depreciation Expense(E)1,700 1,700 0

73,700 23,800 12,750 1,700 33,900

$145,850 73,700 72,150 $23,800 12,750 1,700 38,250 $33,900 continued next page

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P3-53. d. & e. continued FISCHER CARD SHOP Balance Sheets As of December 31, Assets: Cash Inventories Prepaid rent

2018

2019

$ 8,500 12,000 3,800

$ 40,550 14,500 4,000

Total current assets Equipment Accumulated depreciation Equipment, net Total assets Liabilities and owners’ equity: Accounts payable Wages payable Total liabilities

24,300 7,500 (3,000) 4,500 $ 28,800

59,050 7,500 (4,700) 2,800 $ 61,850

$ 5,200 100 5,300

$ 4,100 350 4,450

Owners’ equity Total liabilities and owners’ equity

23,500 $ 28,800

57,400 $ 61,850

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P3-54. (120 minutes) LO 2, 3, 4, 5, 6 a. & b. The T-accounts follow the journal entries and the FSET. Balance Sheet Transaction 12/1 Investment for common stock. 12/2. Rent paid in cash.

Cash Asset + +20,000 Cash

Noncash Assets

= Liabilities =

-1,200 Cash

Income Statement Contrib. Capital +20,000 Common Stock

12/2 Purchase supplies on account.

Earned Capital

-1,200 Retained Earnings

+4,800 Accounts Payable

-1,080 Accounts Payable

-900 Cash

-900 Retained Earnings

12/20 Received cash +3,000 for consulting Cash services.

+3,000 Retained Earnings

12/28 Paid wages in cash.

-900 Retained Earnings

+7,200 = Fees Receivable

+7,200 Retained Earnings

-1,800 Retained Earnings

-900 Cash

-1,800 Cash

Balance Sheet Contra LiabiAssets = lities

2. Accrue wages expense.

3. Record depreciation expense.

4. Recognize accrued consulting fees.

+9,500 Office Equipment

12/14 Paid wages in cash.

1. Record supplies expense.

+1,200 Rent Expense

-1,080 Cash

Adjusting Entries

= =

+1,080 Accounts Payable

12/8. Paid for supplies.

Cash Asset

Expenses

-4,700 Cash

12/30 Paid cash dividends.

+1,080 Supplies

12/3 Office equipment bought for 4,700 cash and rest on account.

12/30 Bill clients for consulting.

Revenues

Noncash Assets -370 Supplies

+2,250 Fees Receivable

+3,000 Consulting Revenue

+900 Wages Expense

-1,200

-900

+3,000

-900

+7,200

+7,200 Consulting Revenue

Net Income

+900 Wages Expense

Income Statement Contrib. + Capital +

Earned Capital

Net = Income

Expenses

-370 Retained Earnings

+370 Supplies Expense

-370

-270 Retained Earnings

+270 Wages Expense

-270

+120 = Accum. Deprec.

-120 Retained Earnings

+120 = Depreciation Expense

-120

+2,250 Retained Earnings

+270 Wages Payable

Revenues

+2,250 Consulting Revenue

= +2,250

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P3-54. c. Transactions: Dec. 1 Cash (+A) Common stock (+SE)

20,000 20,000

Invested $20,000 cash in the business.

2 Rent expense (+E, -SE) Cash (-A)

1,200 1,200

Paid rent for December.

2 Supplies (+A) Accounts payable (+L)

1,080 1,080

Purchased various supplies on account.

Dec. 3 Office equipment (+A) Cash (-A) Accounts payable (+L)

9,500 4,700 4,800

Purchased $9,500 of office equipment, $4,700 cash down payment and balance due in 30 days.

8 Accounts payable (-L) Cash (-A)

1,080 1,080

Payment on account.

14 Wages expense (+E, -SE) Cash (-A)

900 900

Paid assistant's wages.

20 Cash (+A) Consulting revenue (+R, +SE)

3,000 3,000

Cash received for services.

28 Wages expense (+E, -SE) Cash (-A)

900 900

Paid assistant's wages.

30 Fees receivable (+A) Consulting revenue (+R, +SE) Billed customers for services.

7,200

31 Retained earnings (-SE) Cash (-A)

1,800

7,200

1,800

Issued and paid $1,800 in dividends.

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Bal.

Cash (A) 20,000 1,200 3,000 4,700 1,080 900 900 1,800 12,420

12/2 12/3 12/8 12/14 12/28 12/31

12/2 Bal.

+Supplies(A)1,080 370 710

12/3

+Office Equipment (A) 9,500

-Wages Payable(L) + 2a.

270

-Accumulated Depreciation+ Office Equipment (XA)

12/8

12/31 g.

120

3a.

- Accounts Payable (L) + 1,080 1,080 4,800 4,800

12/2 12/3 Bal.

12/2 Bal.

+Rent Expense (E) 1,200 1,200 0

12/14 12/28 2a. Bal.

+ Wages Expense (E) 900 2,070 900 270 0

12/20 12/30 4a. 0

12/30 4a. Bal.

+Fees Receivable (A)7,200 2,250 9,450

1a. Bal.

+ Supplies Expense (E) 370 370 0

- Retained Earnings (SE)+ 1,800 12,450 3,760 6,890

3a. Bal.

-Common Stock(SE)+

-Consulting Revenue(R)+ 3,000 7,200 12,450 2,250 Bal. +Depreciation Expense(E)120 120 0

Bal.

20,000

12/1

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P3-54. d. RHOADES TAX SERVICES Unadjusted Trial Balance December 31, 2018 Debit $12,420 7,200 1,080 9,500

Cash Fees Receivable Supplies Office Equipment Accounts Payable Common Stock Retained Earnings (Dividend) Consulting Revenue Wages Expense Rent Expense

Credit

$4,800 20,000 1,800 10,200 1,800 1,200 $35,000

______ $35,000

e. Adjusting Entries: Date 2018 Description Dec. 31 Supplies expense (+E, -SE) Supplies (-A)

Debit 370

370

To record December supplies expense ($1,080 − $710).

Wages expense (+E, -SE) Wages payable (+L)

Credit

270 270

To reflect unpaid wages at December 31.

Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A)

120 120

To record December depreciation.

Fees receivable (+A) Consulting revenue (+R, +SE)

To record unbilled service revenue (30  $75).

2,250 2,250

Continued next page

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Credit

$120 4,800 270 20,000 12,450

______ $37,640

f. RHOADES TAX SERVICES Income Statement For the Month of December 2018 Revenue Consulting revenue Expenses Wages expense Rent expense Supplies expense Depreciation expense Total expenses Net income

$12,450 $ 2,070 1,200 370 120 3,760 $ 8,690 Continued next page

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P3-54. f.

Retained Earnings $0

Total Stockholders’ Equity $0 20,000 (1,800) 8,690 $26,890

Dividends ............................................. Net income ...........................................

______

(1,800) 8,690

Balance at December 31, 2018 ..............

$20,000

$6,890

RHOADES TAX SERVICES Balance Sheet December 31, 2018 Assets Cash Fees receivable Supplies Total current assets Office equipment Less: Accum. depreciation

Total assets

$ 9,500 120

$ 4,800 270 5,070

20,000 6,890 $31,960

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P3-54. g. Date 2018 Description Dec.31 Consulting revenue (-R) Retained earnings (+SE)

Debit 12,450

Credit 12,450

To close the revenue account.

31 Retained earnings (-SE) Wages expense (-E) Rent expense (-E) Supplies expense (-E) Depreciation expense (-E)

3,760 2,070 1,200 370 120

To close the expense accounts.

Cash Fees Receivable Supplies Office Equipment Accumulated Depreciation Accounts Payable Wages Payable Retained Earnings Common Stock

RHOADES TAX SERVICES Post-Closing Trial Balance December 31,2018 Debit Credit $12,420 9,450 710 9,500

$32,080

$ 120 4,800 270 6,890 20,000 $32,080

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Transaction 1. Investment for common stock.

+50,000 Cash

2. Collections from customers.

+81,000 Cash

3. Bank borrowing. +10,000 Cash

= +10,000 Loans Payable

4. Rent expense.

-24,000 Cash

5. Purchased equipment.

-25,000 Cash

+25,000 Equipment

6. Purchased inventory.

-62,000 Cash

+62,000 Inventory

7. Paid salaries.

-6,000 Cash

-6,000 Retained Earnings

+6,000 Salaries Expense

-6,000

8. Paid other expenses.

-13,000 Cash

-13,000 Retained Earnings

+13,000 Misc. Expenses

-13,000

+9,000

Contra Assets

Liabilities

Income Statement

Cash Asset

Contrib. Capital

Earned Capital

Revenues

+50,000 Investment +81,000 Retained Earnings

+81,000 Sales Revenue

-24,000 Retained Earnings

Net = Income

= +81,000

+24,000 Rent Expense

+9,000

+9,000 Retained Earnings

b. Adjust rent expense.

+12,000 Prepaid Rent

+12,000 Retained Earnings

-12,000 Rent Expense

+12,00 0

= +3,000 Salaries Payable

-3,000 Retained Earnings

+3,000 Salaries Expense

-3,000

-41,000 Retained Earnings

+41,000 = Cost of Goods Sold

-41,000

-1,250 Retained Earnings

+1,250 Deprec.

-1,250

-300 Retained Earnings

-300

c. Accrue salaries expense. d. Recognize cost of goods sold.

-41,000 Inventory

e. Accrue depreciation expense.

f. Accrue interest expense*.

+1,250 Accumulated Depreciation

+300 Interest Payable

= -24,000

a. Recognize credit sales.

A/R

+9,000 Sales Revenue

Expenses

Expense +300 Interest Expense

*($10,000 x 1% x 3 mos.) continued next page

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a. 2. Journal entries are shown only for the adjustments a-f. a. Accounts receivable (+A) Sales revenue (+R, +SE) To recognize sales on account.

9,000 9,000

b. Prepaid rent (+A) 12,000 Rent expense (-E, +SE) To recognize remaining prepaid rent and correct rent expense.

12,000

c. Salaries expense (+E, -SE) Salaries payable (+L) To recognize unpaid salaries earned during September.

3,000 3,000

d. Cost of goods sold (+E, -SE) Merchandise inventory (-A) To recognize cost of sales; ($62,000 - $21,000).

41,000

e. Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A) To accrue depreciation on the fixtures and equipment ($25,000/60) x (3).

1,250

f. Interest expense (+E, -SE) Interest payable (+L) To accrue interest on bank loan assumed taken out 7/1/2019. ($10,000) x (0.12) x (1/4).

41,000

1,250

300 300

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Bal.

- Accumulated Deprec.-Equip. (XA) + 1,250

+ Prepaid Rent (A) 12,000

+ Accounts Receivable (A) 9,000

- Sales Revenue (R) + 81,000 9,000

Bal.

+ Rent Expense (E) 24,000 12,000

Bal.

+ Other Expense (E) 13,000

+ Bal. c. + f.

+ Merchandise Inventory (A) 62,000 41,000

+ Equipment (A) 25,000

Bal.

Bal. a.

- Salaries Payable (L) + 3,000

- Owners’ Equity (SE) + 50,000

Bal.

+ Cost of Goods Sold (E) 41,000

+ Depreciation Expense (E) 1,250

- Bank Loan Payable (L) + 10,000

Salaries Expense (E) 6,000 3,000

Interest Expense (E) 300

Bal.

Interest Payable (L) + 300

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$90,000 41,000 49,000 $12,000 9,000 1,250 300 13,000

35,550 $13,450

SEASIDE SURF SHOP Balance Sheet September 30, 2019 Assets Current assets Cash Accounts receivable Inventory Prepaid rent Total current assets

$11,000 9,000 21,000 12,000 53,000

Fixtures and equipment, net Total assets

23,750 $76,750

Liabilities and owners’ equity Current liabilities Salaries payable Bank loan payable Interest payable Total current liabilities

$3,000 10,000 300 13,300

Owners’ equity* Total liabilities and owners’ equity

63,450 $76,750

*$50,000 + $13,450

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C3-56. (15 minutes) LO 2, 3, 6 a. The following analysis shows how the relevant information affects total assets, liabilities, and owners’ equity of the firm:

Assets $88,500

Liabilities $45,900 51.9%

Owners Equity $42,600 48.1%

(2,250)

3,425

6,000

(8,400) $87,275

(5,650)

5,650

______ $40,250 46.1%

(8,400) $47,025 53.9%

Revised debt-to-equity ratio: $40,250/$47,025 = 0.86 Original debt-to-equity ratio: $45,900/$42,600 = 1.08 b. Apparently, the loan agreement has not been violated.

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C3-58. (30 minutes) LO 2, 3, 4, 6 a. - d. FSET: Balance Sheet Transaction a1. Recognize prepaid catalog costs.

Cash Asset

Noncash Assets

-62,550

+62,550

Cash

Prepaid Catalog Costs

a2. Advertising credits received.

+ 849

Liabilities

Advertising Credits Receivable

b. Recognize advertising expense.

-62,138

-336

+849

Retained Earnings

Advertising Credits Revenue

Expenses

Net Income

+849

-62,138

-336

+62,138 Catalog Expenses

-336

Retained Earnings

Cash

d2. Recognize sales using gift certificates.

Revenues

Retained Earnings

Advertising Credits Receivable

+19,175

Earned Capital

-62,138

Prepaid Catalog Costs

c. Recognize expiration of advertising credits.

d1. Sales of gift certificates.

Income Statement Contrib. Capital

+336 Expense: Expiration of Advertising Credits

+19,175

Gift Certificate Liability

- 18,230

+18,230

Gift Certificate Liability

Retained Earnings

Gift Certificate Revenues

Continued next page

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+18,230

a. – d. continued Journal Entries: a1. Prepaid catalog costs (+A) Cash (-A) To record catalog printing costs.

62,550 62,550

a2. Advertising credits receivable (+A) Advertising credits revenue (+R, +SE) To recognize advertising credits earned. b.

849 849

Catalog expense (+E, -SE) Prepaid catalog costs (-A) To regognize catalog expense ($3,894 + $62,550 - $4,306).

62,138 62,138

Advertising credit expiration expense (+E, -SE) 336 Advertising credits receivable (-A) To record the expiration of advertising credits ($21 + $849 - $534).

336

19,175

d2. Gift certificate liability (-L) Gift certificate revenues (+R, +SE) To recognize revenues based on redeemed gift certificates ($6,108 +$19,175 - $7,053).

18,230

19,175

18,230

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Chapter 4 Reporting and Analyzing Cash Flows Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Explain the purpose of the statement of cash flows and classify cash transactions by type of business activity: operating, investing and financing

21 - 24, 29

LO2 – Construct the operating activities section of the statement of cash flows using the direct method.

25, 27, 30, 31

34, 38, 41, 43, 44

47, 49, 51, 53

LO3 – Reconcile cash flows from operations to net income and use the indirect method to compute operating cash flows.

21, 23, 25 - 29

35, 42, 44

45, 46, 48, 50 - 56

57, 58, 59

LO4 – Construct the investing and financing activities sections of the statement of cash flows.

21, 24

36 - 40, 42

46, 48, 50 - 56

57, 58, 59

32, 33, 35, 43

46, 48, 50, 52, 55, 56

LO5 – Compute and interpret ratios that reflect a company’s liquidity and solvency using information reported in the statement of cash flows. LO6 – Appendix 4A: Use a spreadsheet to construct the statement of cash flows.

58, 59

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QUESTIONS Q4-1.

Cash equivalents are short-term, highly liquid investments that firms acquire with temporarily idle cash to earn interest on these excess funds. To qualify as a cash equivalent, an investment must (1) be easily convertible into a known cash amount and (2) be close enough to maturity so that its market value is not sensitive to interest rate changes (generally, investments with initial maturities of three months or less). Three examples of cash equivalents are treasury bills, commercial paper, and money market funds.

Q4-2.

Cash equivalents are included with cash in a statement of cash flows because the purchase and sale of such investments are considered to be part of a firm's overall management of cash rather than a source or use of cash. Similarly, as statement users evaluate cash flows, it may matter very little to them whether the cash is on hand, deposited in a bank account, or invested in cash equivalents.

Q4-3.

Operating activities Inflow: Cash received from customers Outflow: Cash paid to suppliers Investing activities Inflow: Sale of equipment Outflow: Purchase of stocks and bonds Financing activities Inflow: Issuance of common stock Outflow: Payment of dividends

Q4-4.

a. Investing; outflow. b. Investing; inflow. c. Financing; outflow. d. Operating (direct method, not shown separately under indirect method); inflow. e. Financing; inflow. f. Operating (direct method, not shown separately under indirect method); inflow. g. Operating (direct method, not shown separately under indirect method); outflow. h. Operating (direct method, not shown separately under indirect method); inflow.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

Q4-5.

This is a noncash investing and financing event. It must be reported in a supplementary schedule to the statement of cash flows.

Q4-6.

Noncash investing and financing transactions are disclosed as supplemental information to a statement of cash flows because a secondary objective of cash flow reporting is to present information about investing and financing activities. Noncash investing and financing transactions, generally, affect future cash flows. Issuing bonds payable to acquire equipment, for example, requires future cash payments for interest and principal on the bonds. On the other hand, converting bonds payable into common stock eliminates future cash payments related to the bonds. Knowledge of these types of events, therefore, should be helpful to users of cash flow data who wish to assess a firm's future cash flows.

Q4-7.

A statement of cash flows helps external users assess the amount, timing, and uncertainty of future cash flows to the enterprise. These assessments help users evaluate their own future cash receipts from their investments in, or loans to, the firm. A statement of cash flows shows the periodic cash effects of a firm's operating, investing, and financing activities. Distinguishing among these different categories of cash flows helps users compare, evaluate, and predict cash flows. With cash flow information, creditors and investors are better able to assess a firm's ability to settle its liabilities and pay its dividends. Over time, the statement of cash flows permits users to observe and analyze management's investing and financing policies. A statement of cash flows also provides information useful in evaluating a firm's financial flexibility (which is its ability to generate cash to respond to unanticipated needs and opportunities).

Q4-8.

The direct method presents the net cash flow from operating activities by showing the major categories of operating cash receipts and cash payments (such as cash received from customers, cash paid to employees and suppliers, cash paid for interest, and cash paid for income taxes). The indirect (or reconciliation) method, in contrast, presents the net cash flow from operating activities by applying a series of adjustments to the accrual net income to convert it to a cash basis.

Q4-9.

Under the indirect method, depreciation is added to net income because, as a noncash expense, it was deducted in computing net income. Adding depreciation to net income, therefore, eliminates it from the cash-basis income amount. Amortization and depletion expenses are handled the same way.

Q4-10. Under the indirect method, the $98,000 cash received from the sale of the land will appear in the cash flows from investing activities section of the statement of cash flows. In addition, the $28,000 gain from the sale will be deducted from net income as one of the adjustments made to determine the net cash flow from operating activities.

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Q4-11. Net income Add (deduct) items to convert net income to cash basis Depreciation expense Subtract change in accounts receivable Subtract change in inventory Add change in accounts payable Add change in income tax payable Net cash provided by operating activities

$ 88,000 6,000 13,000 (9,000) (3,500) 1,500 $ 96,000

Q4-12. The separate disclosures required for a company using the indirect method in the statement of cash flows are (1) cash paid during the year for interest (net of amount capitalized) and for income taxes, (2) all noncash investing and financing transactions, and (3) the policy for determining which highly liquid, short-term investments are treated as cash equivalents. Q4-13. The statement of cash flows will show a positive net cash flow from operating activities if operating cash receipts exceed operating cash payments. This could happen, for example, if noncash expenses (such as depreciation and amortization) exceed the net loss. It would also happen if operating cash receipts exceed sales by more than the loss or if operating cash payments are less than accrual expenses by more than the loss (or some combination of these events). Q4-14. Sales + Accounts receivable decrease = Cash received from customers

$925,000 14,000 $939,000

Q4-15. Wages expense + Wages payable decrease = Cash paid to employees

$ 86,000 1,100 $ 87,100

Q4-16.

$ 43,000 1,600 $ 44,600

Advertising expense + Prepaid advertising increase = Cash paid for advertising

Q4-17. Under the direct method, the $5,100 cash received from the sale of equipment will appear in the cash flows from investing activities section of the statement of cash flows. Q4-18. The separate disclosures required for a company using the direct method in the statement of cash flows are (1) a reconciliation of net income to net cash flow from operating activities, (2) all noncash investing and financing transactions, and (3) the policy for determining which highly liquid, short-term investments are treated as cash equivalents.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

Q4-19. The operating cash flow to current liabilities ratio is calculated by dividing net cash flow from operating activities by average current liabilities. This ratio is a measure of a firm's ability to liquidate its current liabilities. Q4-20. The operating cash flow to capital expenditures ratio is calculated by dividing a firm's cash flow from operating activities by its annual capital expenditures. A ratio below 1.00 means that the firm's current operating activities are not providing enough cash to cover the capital expenditures. A ratio above 1.0 is normally considered a sign of financial strength.

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MINI EXERCISES M4-21. (5 minutes) LO 1, 3, 4 a. Positive adjustment b. Negative adjustment c. Positive adjustment d. Positive adjustment e. Negative adjustment

M4-22. (10 minutes) LO 1 a. Cash flow from an operating activity. b. Cash flow from an investing activity. c. Cash flow from an investing activity. d. Cash flow from an operating activity. e. Cash flow from a financing activity. f. Cash flow from a financing activity. g. Cash flow from an investing activity.

M4-23. (15 minutes) LO 1, 3

1 2 3 4 5 6 7 8 9 10 11

GENERAL MILLS, INC. Selected Items from the Cash Flow Statement Long-term debt repayments Change in receivables Depreciation and amortization Change in prepaid expenses Dividends paid Stock-based compensation Cash received from sales of assets and businesses Net earnings Change in accounts payable Proceeds from common stock issued Purchases of land, buildings and equipment

Financing Operating Operating Operating Financing Operating Investing Operating Operating Financing Investing

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M4-24. (10 minutes) LO 1, 4 a. (3) Cash flow from a financing activity. b. (1) Cash flow from an operating activity. c. (4) Noncash investing and financing activity. d. (1) Cash flow from an operating activity. e. (1) Cash flow from an operating activity. f. (5) None of the above (a change in the composition of cash and cash equivalents).

M4-25. (30 minutes) LO 2, 3 a. Income Statement

Balance Sheet

Accts. Receivable

+507,400 +

(2)

+91,500 +

(3)

Transaction (1)

Cash Asset

Contrib. Capital +

Earned Capital

Revenue

+507,400

+507,400 -

+507,400

+91,500

+91,500 -

+91,500

+–320,100 =

–320,100

+320,100 =

–320,100

(4)

+ –63,400 =

–63,400

+63,400 =

–63,400

(5)

++351,600 =

+351,600 +

(6)

-47,700 +

+ +47,700 =

(7)

+483,400 +

–483,400 +

(8)

–340,200 +

(9)

-172,300 +

-172,300

+172,300 =

-172,300

Total

+14,700 +

+24,000 + +15,800 =

+11,400 +

+43,100

+555,800 =

+43,100

Inven+ tories

Accts. Payable

+598,900

- Expenses =

Net Income

Net income was €43,100 (from the net income column), and cash flow from operating activities was €14,700 (from the cash column).

c. 1. Accounts receivable increased by €24,000, 2. Inventories increased by €15,800, and 3. Accounts payable increased by €11,400.

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d. The accounting equation is kept with every entry, so it is kept for the totals over the period. Cash flow + change in accounts receivable + change in inventory = Change in accounts payable + net income. This relationship can be presented in the following indirect method cash flow from operating activities. Net income € 43,100 - Change in accounts receivable –24,000 - Change in inventories –15,800 + Change in accounts payable +11,400 Cash flow from operating activities € 14,700 M4-26. (15 minutes –INDIRECT METHOD) LO 3 Net income Add (deduct) items to convert net income to cash basis Add back depreciation Subtract gain on sale of investments Subtract change in operating assets: Accounts receivable Inventory Prepaid rent Add change in operating liabilities: Accounts payable Income tax payable Net cash provided by operating activities

$ 45,000 8,000 (9,000) (9,000) (6,000) 2,000 4,000 (2,000) $ 33,000

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M4-27. (30 minutes) LO 2, 3 a. Balance Sheet Transaction

Cash Asset

(1) (2)

+46,200

(3)

Accts. Receivable

+ +769,200

(4)

–149,100

(5)

–521,600

(6)

Prepaid Rent

+149,100

–117,900

Contr. + Capital

Earned Capital

Revenue

+769,200

+769,200 -

+769,200

+46,200

+46,200 -

+46,200

–526,700

+526,700 =

–526,700

+117,900 =

Accum. Deprec.

Income Statement

Wages Payable

+526,700

–521,600

–117,900

- Expenses =

Net Income

–117,900

(7)

+724,100

+ –724,100

(8)

–122,800

+122,800 =

–122,800

+23,000

-23,000

+23,000 =

-23,000

+23,000

+25,000

+815,400 -

+790,400 =

+25,000

(9) Total

–23,200

+45,100

+31,200

+5,100

b. Net income was $25,000 (from the net income column), and cash flow from operating activities was –$23,200 (from the cash column). c. 1. Accounts receivable increased by $45,100, 2. Prepaid rent increased by $31,200, 3. Accumulated depreciation (a contra-asset) increased by $23,000 due to depreciation expense and 4. Wages payable increased by $5,100. d. The accounting equation is kept with every entry, so it is kept for the totals over the period. Cash flow + change in accounts receivable + change in prepaid rent – change in accumulated depreciation = Change in wages payable + net income. This relationship can be presented in the following indirect method cash flow from operating activities. Net income $ 25,000 + Depreciation expense 23,000 – Change in accounts receivable –45,100 – Change in prepaid rent –31,200 + Change in wages payable +5,100 Cash flow from (used in) operating activities ($ 23,200)

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M4-28. (15 minutes—INDIRECT METHOD) LO 3 Net loss Add (deduct) items to convert net loss to cash basis Add back depreciation Subtract change in operating assets: Accounts receivable Inventory Prepaid expenses Add change in operating liabilities: Accounts payable Accrued liabilities Net cash provided by operating activities

$(21,000) 8,600 (9,000) (3,000) (3,000) 4,000 (2,600) $ 4,000

Weber Company's 2018 operating activities provided $4,000 cash. The dividend paid to shareholders affects cash flows from financing activities.

M4-29. (20 minutes) LO 1, 3 A “+” indicates that the amount is added and a “-“ indicates that it is subtracted when preparing the cash flow statement using the indirect method.

1 2 3 4 5 6 7 8 9 10 11 12 13 14

NORDSTROM, INC. Consolidated Statement of Cash Flows – Selected Items Decrease in accounts receivable Operating Capital expenditures Investing Proceeds from long-term borrowings Financing Increase in deferred income tax net liability Operating Principal payments on long-term borrowings Financing Increase in merchandise inventories Operating Increase in prepaid expenses and other assets Operating Proceeds from issuances under stock compensation plans Financing Increase in accounts payable Operating Net earnings Operating Payments for repurchase of common stock Financing Increase in accrued salaries, wages and related benefits Operating Cash dividends paid Financing Depreciation and amortization expenses Operating

++ + + + + + +

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Financial & Managerial Accounting for Decision Makers, 4th Edition

M4-30. (15 minutes—DIRECT METHOD) LO 2 a.

Rent expense – Prepaid rent decrease = Cash paid for rent

$ 60,000 (2,000) $ 58,000 Balance Sheet

Transaction

Cash

Begin Balance Make rent payment

+ +

-X

Noncash Assets

10,000 Prepaid Rent +X Prepaid Rent

Income Statement

= Liabilities +

Contr. + Capital

Earned Surplus

Revenue

- Expenses =

Record rent expense

-60,000 Prepaid Rent

End Balance

8,000

-60,000 Retained Earnings

+60,000 Rent Expense

Net Income

-60,000

X must equal $58,000 to make the FSET balance. b.

Interest income – Interest receivable increase = Cash received as interest

$ 16,000 (700) $ 15,300

Balance Sheet Transaction

Cash

Begin Balance Record interest income Receive interest payment End Balance

+ +

Noncash Assets

3,000 Interest Receivable +16,000 Interest Receivable

Income Statement

= Liabilities +

Contr. + Capital

Earned Surplus

+16,000 Retained Earnings

Revenue -

Expenses

+16,000 Interest income

-X

3,700

Net Income

+16,000

X must equal $15,300 to make the FSET balance.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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c. Cost of goods sold + Inventory increase + Accounts payable decrease = Cash paid for merchandise purchased

$ 98,000 3,000 4,000 $105,000

Balance Sheet

Income Statement

Noncash Assets

= Liabilities

Contr. + Capital

Begin Balance

19,000 Inventory

11,000 Accounts Payable

Purchase inventory

-Y Accounts Payable

Transaction

Pay supplier Recognize Cost of Goods Sold End Balance

Cash

-Y

-98,000 Inventory

22,000

7,000

Earned Surplus

Revenue -

-98,000 Retained Earnings

Expenses

98,000 Cost of Goods Sold

Net Income

-98,000

To make the inventory account work properly, X (purchases) must equal $101,000. If purchases were $101,000, then Y (payments to suppliers) must equal $105,000.

M4-31. (15 minutes—DIRECT METHOD) LO 2 Operating cash flow + change in operating assets = net income + change in operating liabilities or Net income - change in operating assets + change in operating liabilities = operating cash flow Effect of sales on net income – Change in accounts receivable = Effect of customers on cash

$825,000 (11,000) $814,000

Effect of cost of goods sold on net income - Change in inventory + Change in accounts payable = Effect of merchandise purchases on cash

($550,000) (13,000) (6,000) ($569,000)

Chakravarthy Company received $814,000 in cash from its customers and paid $569,000 in cash to its suppliers. ©Cambridge Business Publishers, 2021 4-12

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E4-32. (20 minutes) LO 5 (All dollar amounts in millions) a. Merck: $6,447/$17,909 = 0.360 Pfizer: $16,470/$30,771 = 0.535 Abbott Labs: $5,570/$7,786 = 0.715 Johnson & Johnson: $21,056/$28,412 = 0.741 b. Merck: $6,447 – $1,888 = $4,559 Pfizer: $16,470 – $1,956 = $14,514 Abbott Labs: $5,570 – $1,135 = $4,435 Johnson & Johnson: $21,056 – $3,279 = $17,777 c. None of the firms has sufficient cash flow to cover their current liabilities although none of the ratios is alarmingly low. The industry ratios shown in Chapter 5, show that only Merck is below median. Pfizer and Johnson & Johnson are the larger of these companies and have relatively more cash left over after capital expenditures to consider using on other activities that could strengthen the firm’s operating or financial position. But all four have significant free cash flow that could be invested or returned to shareholders in the form of dividends or stock repurchases. Given that these firms are of different sizes and have different research program success, it is difficult to generalize further.

E4-33. (20 minutes) LO 5 (All dollar amounts in millions) a. Wal-Mart: $28,337/$72,725 = 0.390 Coca-Cola: $6,995/$26,863 = 0.260 ExxonMobil: $30,066/$52,705 = 0.570 b. Wal-Mart: $28,337 – ($10,051 – $378) = $18,664 Coca-Cola: $6,995 – ($1,675 – $104) = $5,424 ExxonMobil: $30,066 – ($15,402 – $3,103) = $17,767 c. All three companies are producing much more cash than needed for capital expenditures. All of them are returning substantial amounts of cash to shareholders through dividends and share repurchases. ExxonMobil appears to be in the best position with respect to OCFCL, but it is lower than the industry average reported in Chapter 5. Wal-Mart and Coca-Cola have lower ratios, and are also below the average ratio for their industries. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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E4-34. (30 minutes—INDIRECT METHOD) LO 2 MASON CORPORATION Statement of Cash Flows For Year Ended December 31, 2018 Cash flows from operating activities Cash received from customers Cash received as interest Cash paid to employees and suppliers Cash paid as income taxes Net cash provided by operating activities Cash flows from investing activities Sale of land Purchase of equipment Net cash used by investing activities Cash flows from financing activities Issuance of bonds payable Acquisition of treasury stock Payment of dividends Net cash provided by financing activities Net decrease in cash Cash at beginning of year Cash at end of year

$194,000 6,000 (148,000) (11,000) $ 41,000 40,000 (89,000) (49,000) 30,000 (10,000) (16,000) 4,000 (4,000) 16,000 $ 12,000

E4-35. (15 minutes—INDIRECT METHOD) LO 3, 5 a. Net income Add (deduct) items to convert net income to cash basis Accounts receivable increase Inventory decrease Prepaid insurance increase Accounts payable increase Wages payable decrease Net cash provided by operating activities

$113,000 (5,000) 6,000 (1,000) 4,000 (2,000) $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83

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Financial & Managerial Accounting for Decision Makers, 4th Edition

E4-36. (15 minutes–INVESTING ACTIVITIES) LO 4 The basic approach here is to use the beginning and ending balances and the additional information to reconstruct what must have happened during 2018. Begin by setting up the T-accounts for property, plant and equipment with the beginning and ending balances. + Beg. balance

Property, plant and equipment at cost (A) 1,000

Ending balance

- Accumulated depreciation (XA) 350

Beg. balance

390

Ending balance

1,200

At this point in the book, we know four entries that can affect these two accounts – (1) acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals, and (4) depreciation expense. The journal entries for these entries are given below, with amounts given in the problem filled in. (1)

(2)

(3)

(4)

Property, plant and equipment at cost (+A) 300 Cash (-A) To record purchase of property, plant and equipment with cash.

300

Property, plant and equipment at cost (+A) 100 Mortgage payable (+L) To record purchase of property, plant and equipment with financing.

100

Cash (+A) Accumulated depreciation (-XA, +A) Property, plant and equipment at cost (-A) Gain on equipment disposal (+R, +SE) To record sale of used equipment. Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A) To record depreciation expense.

100 Y X 20

Z Z

continued next page

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The three unknowns in the journal entries correspond to the three questions in the problem. We begin by putting the journal entry amounts into the T-accounts. + Beg. balance (1) (2) (3) Ending balance

Property, plant and equipment at cost (A) 1,000 300 100 X 1,200

- Accumulated depreciation (XA) 350

Y Z 390

+ Beg. balance

(3) (4) Ending balance

a. The PPE at cost account will only balance if the value X equals 200. So, the original cost of the used equipment that was sold is €200. We can put that amount in the Taccount (so it balances) and also in Journal entry (3). b. Now, looking at journal entry (3), we see that there is only one unknown left – the depreciation that had accumulated on the used equipment. In order for the entry to balance (with debits equal to credits), the accumulated depreciation must have been 120 (= Y). Cost of 200 and accumulated depreciation of 120 would produce a net book value of 80, so when Meubles Fischer sold it for 100, they recorded a gain of 20 on the disposal. c. Back at the Accumulated depreciation T-account, we can fill in the entry for (3), leaving only the depreciation expense to determine for entry (4). Knowing that the disposal reduced the contra-asset by 120, and that the contra-asset increased by 40 over the year, we can infer than the depreciation expense must have been €160 (= Z).

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Financial & Managerial Accounting for Decision Makers, 4th Edition

E4-37. (15 minutes—INVESTING ACTIVITIES) LO 4 The basic approach here is to use the beginning and ending balances and the additional information to reconstruct what must have happened during 2018. Begin by setting up the T-accounts for property, plant and equipment with the beginning and ending balances. + Beg. balance

Property, plant and equipment at cost (A) 175

Ending balance

- Accumulated depreciation (XA) 78

Beg. balance

Ending balance

183

At this point in the course, we know four entries that can affect these two accounts – (1) acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals, and (4) depreciation expense. The journal entries for these entries are given below, with amounts given in the problem filled in. (1)

(2)

(3)

(4)

Property, plant and equipment at cost (+A) 28 Cash (-A) To record purchase of property, plant and equipment with cash.

Property, plant and equipment at cost (+A) 0 Mortgage payable (+L) To record purchase of property, plant and equipment with financing.

Cash (+A) Accumulated depreciation (-XA, +A) Loss on equipment disposal (+E, -SE) Property, plant and equipment at cost (-A) To record sale of used equipment.

Z Y 5

Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A) To record depreciation expense.

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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Property, plant and equipment at cost (A) 175 28 0 X 183

- Accumulated depreciation (XA) 78

Y 17 83

+ Beg. balance

(3) (4) Ending balance

a. The PPE at cost account will only balance if the value X equals 20. So, the original cost of the used equipment that was sold is £20. We can put that amount in the Taccount (so it balances) and also in Journal entry (3). b. The accumulated depreciation account will only balance if the value Y equals 12. So, the accumulated depreciation on the used equipment sold must be £12, and that amount can be entered into transaction (3) above. c. Now, looking at journal entry (3), we see that there is only one unknown left – the amount of cash received from disposal of the used equipment. In order for the entry to balance (with debits equal to credits), the cash amount must have been £3 million (= Z). Cost of 20 and accumulated depreciation of 12 would produce a net book value of 8, so when Kasznik Ltd. sold it for 3, they recorded a loss of 5 on the disposal.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

E4-38. (30 minutes) LO 2, 4 a. The analysis from the chapter shows that Cash flow (payments)

Change in inventory

Change in accounts payable

Net income (COGS expense)

-57 (=8,899-8,956)

+1,484 (=12,484-11,000)

-89,052

The solution to this is that X = -$89,052 + 57 + 1,484 = -$87,511. So, the payments to suppliers reduced cash by $87,511 million in fiscal year 2017. b. The net property and equipment account decreased by $693 million (=$13,642 – $14,335). Depreciation expense would have decreased this balance by $1,545 million in fiscal year 2017, so the net investment must have been $852 million (=-$693 + $1,545) to result in the ending balance of $13,642 million. c. With the beginning balance of $27,684 million in retained earnings, net earnings of $4,078 would have increased retained earnings to $31,762 million. But the ending balance in retained earnings is $30,137 million, so Walgreens Boots must have paid $1,625 million in dividends (=$31,762 - $30,137).

E4-39. (15 minutes) LO 4 a.

Cash flows from investing activities will show: Purchase of stock investments Sale of stock investments

$ (80,000) 59,000

Cash flows from financing activities will show: Issuance of bonds Retirement of bonds

$130,000 (131,000)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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E4-40. (20 minutes) LO 4 a. The net increase in property and equipment, cost was $821,989 (= $98,190,992 $97,369,003). Expenditures should have increased this by $1,182,854, and the noncash transaction another $239,382. Therefore, the original cost of the property and equipment sold must have been $600,247 (= $1,182,854 + $239,382 - $821,989). Depreciation expense should have increased the accumulated depreciation account by $3,876,111, but the account increased by only $3,275,864. The accumulated depreciation on the property and equipment sold must account for the difference, making it $600,247 (=$3,876,111 - $3,275,864). b. The book value of the property and equipment sold was zero (=$600,247 – $600,247), and the reported gain on sale of the property and equipment was $56,446. Therefore, the cash proceeds on the sale of these fully-depreciated assets must have been $56,446! c. Cash (+A) Accumulated depreciation (-XA, +A) Property and equipment, cost (-A) Gain on sale of property and equipment (+R, +SE)

$ 56,446 600,247 $ 600,247 56,446

d. Retained earnings increased by $1,688,643 (= $20,738,143 – 19,049,500), and net income was $3,184,803, which would increase retained earnings. The difference would be accounted for by cash dividends paid to shareholders, and the amount is $1,496,160 ($3,184,803 - $1,688,643). The dividends paid are approximately equal to previous years even though earnings are considerably higher, demonstrating that companies are reluctant to change dividends as earnings fluctuate up and down..

E4-41. (20 minutes—DIRECT METHOD) LO 2 a.

Advertising expense + Prepaid advertising increase = Cash paid for advertising

$ 62,000 4,000 $ 66,000

Income tax expense + Income tax payable decrease = Cash paid for income taxes

$ 29,000 2,200 $ 31,200

Cost of goods sold – Inventory decrease – Accounts payable increase = Cash paid for merchandise purchased

$180,000 (5,000) (2,000) $173,000

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Financial & Managerial Accounting for Decision Makers, 4th Edition

E4-42. LO 3, 4 HOSKINS CORPORATION Statement of Cash Flows Year ended December 31, 2018 Cash Flows from Operations: Net income $ 700 Adjustments: Add back Depreciation 350 – Change in Accounts Receivable (900) – Change in Inventory (100) – Change in Prepaid Expenses 250 + Change in Accounts Payable 400 + Change in Income Taxes Payable (100) Cash Flows from Operating Activities

$ 600

Cash Flows from Investing: Purchases of Equipment Proceeds from Disposal of Equipment Cash Flows from Investing Activities

(1,200) 600 (600)

Cash Flows from Financing: Dividends Paid Increase in Short-term Debt Decrease in Long-term Debt Cash Flows from Financing Activities

(250) 1,500 (1,000)

Net Change in Cash Beginning Cash Balance Ending Cash Balance

250 250 300 $ 550

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E4-43. (30 minutes—DIRECT METHOD) LO 2, 5 a. Sales – Accounts Receivable Increase = Cash Received from Customers

$750,000 (5,000) $745,000

Cost of Goods Sold – Inventory Decrease – Accounts Payable Increase = Cash Paid for Merchandise Purchased

$470,000 (6,000) (4,000) $460,000

Wages Expense + Wages Payable Decrease = Cash Paid to Employees

$110,000 2,000 $112,000

Insurance Expense + Prepaid Insurance Increase = Cash Paid for Insurance

$ 15,000 1,000 $ 16,000

Cash Flows from Operating Activities Cash Received from Customers Cash Paid for Merchandise Purchased Cash Paid to Employees Cash Paid for Rent Cash Paid for Insurance Net Cash Provided by Operating Activities b.

$745,000 $460,000 112,000 42,000 16,000

630,000 $115,000

$115,000/[($31,000 + $29,000)/2] =3.83

E4-44. (15 minutes) LO 2, 3 1.

True

---

False

$25

3. 4.

False False

$10 $0

Changing financial reporting depreciation will change net income, but not cash flows. Changing tax depreciation will change cash flows, but not net income. This issue is examined later in Chapter 10.

©Cambridge Business Publishers, 2021 4-22

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P4-45. (20 minutes) LO 3 Cash flows from operating activities Net income ..........................................................................................

$135,000

Adjustments to reconcile net income to operating cash flows Add back depreciation expense ..................................................... $25,000 Gain on sale of assets

(5,000)

Subtract changes in: Accounts receivable ....................................................................... (10,000) Prepaid expenses...........................................................................3,000 Add changes in: Accounts payable ...........................................................................6,000 Wages payable...............................................................................(4,000)

Net cash provided from operating activities .........................................

15,000

$150,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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P4-46. (45 minutes—INDIRECT METHOD) LO 3, 4, 5 a. Cash, December 31, 2018........................................................ $11,000 Cash, December 31, 2017........................................................ 5,000 Cash increase during 2018....................................................... $ 6,000 b. STATEMENT OF CASH FLOWS (INDIRECT METHOD) WOLFF COMPANY Statement of Cash Flows For Year Ended December 31, 2018 Net Cash Flow from Operating Activities Net Income Add (Deduct) Items to Convert Net Income to Cash Basis Depreciation Accounts Receivable Increase Inventory Increase Prepaid Insurance Decrease Accounts Payable Decrease Wages Payable Increase Income Tax Payable Decrease Net Cash Provided by Operating Activities Cash Flows from Investing Activities Purchase of Plant Assets Cash Flows from Financing Activities Issuance of Bonds Payable Payment of Dividends Net Cash Provided by Financing Activities Net Increase in Cash Cash at Beginning of Year Cash at End of Year

$56,000 17,000 (9,000) (30,000) 2,000 (3,000) 3,000 (1,000) $35,000 (55,000) 55,000 (29,000) 26,000 6,000 5,000 $11,000

c. (1) $35,000/(($23,000 + $24,000)/2) = 1.49 (2) $35,000/$55,000 = 0.64 Wolff’s cash flow ratios indicate that, while the company has sufficient cash flow to cover its current obligations, it must rely on external financing to pay for capital expenditures.

©Cambridge Business Publishers, 2021 4-24

Financial & Managerial Accounting for Decision Makers, 4th Edition

P4-47. (30 minutes) LO 2 a. Adjustments to Convert Income Statement Items to Operating Activity Cash Flows Net income

$ 56,000

Sales revenue

–Cost of goods sold

–Wage expenses

–Insurance expense

–Depreciation expense

–Interest expense

+Gains

–Losses

–Income tax expense

$635,000

–430,000

–86,000

–8,000

–17,000

–9,000

–0

–29,000

Adjustments: +Depreciation expense

Add back depreciation expense

+17,000 –Gains 0

Subtract (add) non-operating gains (losses)

+Losses 0

Subtract the change in operating assets (operating investments)

–Change in accounts receivable

–Change in inventory

–Change in prepaid insurance

-9,000

-30,000

-(-2,000)

Add the change in operating liabilities (operating financing) Cash from operations $ 35,000

+Change in accounts payable

+Change in wages payable

+Change in income tax payable

+(-3,000)

+3,000

+(-1,000)

Receipts from customers

–Payments for merchandise

–Payments for Wages

–Payments for insurance

(zero)

–Payments for interest

(zero)

–Payments for income tax

$626,000

-463,000

-83,000

-6,000

-9,000

–0

–30,000

b. Computing cash flows from operating activities using the direct method provides additional detail about the specific cash flows that occurred during the period. For example, the indirect method does not reveal that Wolff paid $463,000 for merchandise during 2018, or $83,000 for wages. Because this detail is missing, the FASB requires supplemental disclosure of two specific (and important) cash payments – interest and taxes – if the indirect method is used.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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P4-48. (45 minutes—INDIRECT METHOD) LO 3, 4, 5 a. Cash, December 31, 2018 Cash, December 31, 2017 Cash increase during 2018

$49,000 28,000 $21,000

b. Statement of Cash Flows (Indirect Method) ARCTIC COMPANY Statement of Cash Flows For Year Ended December 31, 2018 Net Cash Flow from Operating Activities Net Loss Add (Deduct) Items to Convert Net Loss to Cash Basis Depreciation Gain on Sale of Land Accounts Receivable Decrease Inventory Decrease Prepaid Advertising Decrease Accounts Payable Decrease Interest Payable Increase Net Cash Used by Operating Activities Cash Flows from Investing Activities Sale of Land Purchase of Equipment Net Cash Used by Investing Activities Cash Flows from Financing Activities Issuance of Bonds Payable Purchase of Treasury Stock Net Cash Provided by Financing Activities Net Increase in Cash Cash at Beginning of Year Cash at End of Year

$ (42,000)

22,000 (25,000) 8,000 6,000 3,000 (14,000) 6,000 $ (36,000) 70,000 (183,000)* (113,000) 200,000 (30,000) 170,000 21,000 28,000 $ 49,000

* The sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000).

c. - $36,000/(($23,000 + $31,000)/2) = -1.33 - $36,000/$183,000 = -0.20 Arctic’s operating cash flows are negative, primarily because the firm reported a net loss for the year. As a consequence, its cash flow ratios indicate insufficient cash flows to fund operations and capital expenditures.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

P4-49. (30 minutes) LO 2 a. Adjustments to Convert Income Statement Items to Operating Activity Cash Flows Net income (loss) –$ 42,000

Sales revenue $728,000

–Cost of goods sold –534,000

–Wage expenses –190,000

–Advertising expense –31,000

–Depreciation expense –22,000

–Interest expense –18,000

+Gains

–Losses

+25,000

–0

Income tax expense –0

Adjustments:

Add back depreciation expense

+Depreciation expense +22,000 –Gains –25,000

Subtract (add) nonoperating gains (losses)

+Losses 0

Subtract the change in operating assets (operating investments)

–Change in accounts receivable -(-8,000)

Add the change in operating liabilities (operating financing) Cash from operations –$ 36,000

Receipts from customers $736,000

–Change in prepaid advertising -(-3,000)

–Change in inventory -(-6,000)

+Change in accounts payable +(-14,000)

+change in wages payable +0

–Payments for merchandise –542,000

–Payments for Wages –190,000

+Change in interest payable +6,000 –Payments for advertising –28,000

(zero) 0

–Payments for interest –12,000

+Change in income tax payable +0

(zero)

–0

–Payments for income tax –0

b. Computing cash flows from operating activities using the direct method provides additional detail about the specific cash flows that occurred during the period. For example, the indirect method does not reveal that Arctic paid $542,000 for merchandise during 2018, or $28,000 for advertising. Because this detail is missing, the FASB requires supplemental disclosure of two specific (and important) cash payments – interest and taxes – if the indirect method is used.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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P4-50. (50 minutes—INDIRECT METHOD) LO 3, 4, 5 a. Cash, December 31, 2018................................................ Cash, December 31, 2017................................................ Cash increase during 2018...............................................

$27,000 18,000 $ 9,000

b. STATEMENT OF CASH FLOWS (INDIRECT METHOD) DAIR COMPANY Statement of Cash Flows For Year Ended December 31, 2017 Net Cash Flow from Operating Activities Net Income Add (deduct) items to convert net income to cash basis Depreciation Amortization of intangible assets Loss on bond retirement Accounts receivable increase Inventory decrease Prepaid expenses increase Accounts payable increase Interest payable decrease Income tax payable decrease Net cash provided by operating activities Cash flows from investing activities Sale of equipment Cash flows from financing activities Retirement of bonds payable Issuance of common stock Payment of dividends Net cash used by financing activities Net increase in cash Cash at beginning of year Cash at end of year

$ 85,000

22,000 7,000 5,000 (5,000) 6,000 (2,000) 6,000 (3,000) (2,000) $119,000 17,000 (125,000) 24,000 (26,000) (127,000) 9,000 18,000 $ 27,000

©Cambridge Business Publishers, 2021 4-28

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. (1) Supplemental cash flow disclosures Cash paid for interest ............................................................................ Cash paid for income taxes................................................................... *

Interest expense + Interest payable decrease Cash paid for interest

$10,000 3,000 $13,000

†

Income tax expense + Income tax payable decrease Cash paid for income taxes

$36,000 2,000 $38,000

(2) Schedule of noncash investing and financing activities Issuance of bonds payable to acquire equipment................................. d. (1) (2) (3)

$ 13,000* $ 38,000†

$ 60,000

$119,000/[($42,000 + $41,000)/2] = 2.87. The firm did not spend any cash on capital investments. The firm did issue debt for equipment, but this is not a capital expenditure. $119,000 + $17,000 = $136,000

P4-51. (45 minutes) LO 2, 3, 4 a. Cash received from customers was $176,594. They report an increase in accounts receivable, net of $941. So, based on the information in the statement of cash flows, total revenues would be $176,594 + $941 = $177,535 b. Add net income and subtract dividends as follows: $38,983 + $6,623 - $2,049 = $43,557. c. Stock-based compensation is deducted as an expense when computing net income. However, it is compensation paid in the form of common stock, not cash. Since it doesn’t decrease cash, it is added back to net income when reconciling net income to cash flow from operations. d. Some of CVS’ operations occur in Canada and some of its cash transactions are transacted in Canadian dollars. When the financial statements are prepared, the Canadian dollars must be translated into U.S. dollars so that the statements are presented in a common unit of currency. The amount listed in the cash flow statement reflects the small effect that this conversion had on the cash flows and cash balances of CVS. e. CVS used its cash flow from operating activities as follows: • It invested over $2.9 billion, mostly in new property, plant and equipment and acquisitions; • It spent over 6.7 billion on financing transactions, mostly to repurchase stock and pay dividends, net of amounts borrowed; • It decreased its cash balance by almost 1.7 billion. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

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P4-52. (50 minutes—INDIRECT METHOD) LO 3, 4, 5 a. Cash and cash equivalents, December 31, 2018............................ $19,000 Cash and cash equivalents, December 31, 2017............................ 25,000 Cash and cash equivalents decrease during 2018.......................... $ 6,000 b. RAINBOW COMPANY Statement of Cash Flows For Year Ended December 31, 2018 Cash flow from operating activities Net income Add (deduct) items to convert net income to cash basis Depreciation Patent amortization Loss on sale of equipment Gain on sale of investments Accounts receivable increase Inventory increase Prepaid expenses increase Accounts payable increase Interest payable increase Income tax payable decrease Net cash provided by operating activities ……… Cash flows from investing activities Sale of investments Purchase of land Improvements to building Sale of equipment Net cash used by investing activities Cash flows from financing activities Issuance of bonds payable Issuance of common stock Payment of dividends Net cash provided by financing activities ……… Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year …. Cash and cash equivalents at end of year

$ 90,000 39,000 7,000 5,000 (3,000) (10,000) (26,000) (4,000) 4,000 1,000 (2,000) $101,000 60,000 (90,000) (95,000) 14,000 (111,000) 30,000 24,000 (50,000) 4,000 (6,000) 25,000 $ 19,000

©Cambridge Business Publishers, 2021 4-30

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. (1)

(2)

Supplemental Cash Flow Disclosures Cash paid for interest Cash paid for income taxes

$ 12,000* $ 46,000†

* Interest expense - Interest payable increase Cash paid for interest

$13,000 (1,000) $12,000

† Income tax expense + Income tax payable decrease Cash paid for income taxes

$44,000 2,000 $46,000

Schedule of noncash investing and financing activities Issuance of preferred stock to acquire patent

$ 25,000

d. (1) $101,000/[($34,000 + $31,000)/2] = 3.11. (2) $101,000/$185,000 = 0.55. (3): $101,000 – ($90,000 + $95,000 - $14,000) = -$70,000

P4-53. (35 minutes) LO 2, 3, 4 a. Cash and cash equivalents, December 31, 2018 ……….. Cash and cash equivalents, December 31, 2017 ……….. Cash and cash equivalents decrease during 2018 ……..

$19,000 25,000 $ 6,000

b. RAINBOW COMPANY Statement of Cash Flows (Direct Method) For Year Ended December 31, 2018 Cash flows from operating activities Cash received from customers ………………………… Cash received as dividends …………………………….. Cash paid for merchandise purchased ……………….. Cash paid for wages and other operating expenses … Cash paid for interest …………………………………….. Cash paid for income taxes ……………………………… Net cash provided by operating activities ……………..

$740,000 15,000 462,000 134,000 12,000 46,000

Cash flows from investing activities Sale of investments ……………………………………….. Purchase of land …………………………………………… Improvements to building ………………………………… Sale of equipment ………………………………………….. Net cash used by investing activities …………………...

60,000 (90,000) (95,000) 14,000

$755,000

(654,000) 101,000

(111,000)

Table continued on next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-31

b. Table continued RAINBOW COMPANY Statement of Cash Flows (Direct Method) For Year Ended December 31, 2018 Cash flows from financing activities Issuance of bonds payable ………………………………. Issuance of common stock ………………………………. Payment of dividends ……………………………………… Net cash provided by financing activities ………………

30,000 24,000 (50,000) 4,000

Net decrease in cash and cash equivalents ……………….. Cash and cash equivalents at beginning of year …………. Cash and cash equivalents at end of year ………………….

(6,000) 25,000 $ 19,000

c. (1) Reconciliation of net income to net cash flow from operating activities Net income Add (deduct) items to convert net income to cash basis Depreciation Patent amortization Loss on sale of equipment Gain on sale of investments Accounts receivable increase Inventory increase Prepaid expenses increase Accounts payable increase Interest payable increase Income tax payable decrease Net cash provided by operating activities

$ 90,000 39,000 7,000 5,000 (3,000) (10,000) (26,000) (4,000) 4,000 1,000 (2,000) $101,000

(2) Schedule of noncash investing and financing activities Issuance of preferred stock to acquire patent

$ 25,000

©Cambridge Business Publishers, 2021 4-32

Financial & Managerial Accounting for Decision Makers, 4th Edition

P4-54. (30 minutes) LO 3, 4 Operating cash flow + change in operating assets = net income + change in operating liabilities, or Net income - change in operating assets + change in operating liabilities = operating cash flow a. Apple’s adjustment for accounts receivable is ($2,093) million. This adjustment represents minus the change in receivables, so Apple’s operations would have caused accounts receivable to go up by $2,093 million. ($ millions) Net sales ………………………………………………………………… - Change in accounts receivable …………………………………… + Change in deferred revenue Cash collected from customers ……………………………………..

$229,234 -2,093 -626 $226,515

b. ($ millions) - Cost of goods sold ……………………………………………………. - Change in inventories …………………………………………….. + Change in accounts payable ………………………………………

($141,048) -2,723 +9,618

- Cash paid for purchases of inventories ……………………………

($134,153)

c. ($ billions) Property, plant and equipment, ending balance ………………… - Purchases of property, plant and equipment ………………… + Book value of PPE assets sold …………………………………... + Depreciation of property, plant and equipment ……………… Property, plant and equipment, beginning balance ……………

$33.8 (12.5) none 8.2 $29.5

d. Stock-based compensation expense is deducted when calculating net income similar to cash compensation. The only difference is that the compensation is paid in shares of stock (or stock options) instead of cash. Because stock-based compensation does not require the payment of cash, it is treated as a noncash expense, much like depreciation, and added back to net income when the indirect method is used in the cash flow statement. Generally speaking, compensation cost is classified as part of operating activities whether or not the compensation is paid in cash.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-33

P4-55.A (75 minutes) LO 3, 4, 5, 6 a. A

Effect of change on cash flow

2016

2015

Change

Operating

Investing

Financing

No effect

Total

on cash

(F+G+H+I)

Assets

Cash and cash equivalents

1,993,854

1,159,449

834,405

Receivables, net

10,666,986

11,085,689

(418,703)

418,703

Inventories

5,735,110

5,242,197

492,913

(492,913)

Prepaid expenses

1,275,918

1,350,201

(74,283)

74,283

Income tax receivable

22,473

476,154

(453,681)

453,681

Property, plant and equipment, net

O,I

22,034,603

24,488,478

(2,453,875)

Depreciation expense

PPE purchased

PPE sold

3,876,111 (1,182,854) (56,446)

PPE acuired w/o cash

Cash surrender value of life insurance

Other

2,453,875

56,446 (239,382)

438,429

630,259

(191,830)

191,830

917,533

973,195

(55,662)

55,662

1,068,745

(1,068,745)

186,155

16 17

LIABILITIES

Checks outstanding in excess of bank balances

Accounts payable

4,235,488

4,049,333

186,155

Current portion of long-term debt

837,225

799,204

38,021

Line of credit outstanding

2,823,477

(2,823,477)

Other accrued expenses

5,158,236

5,021,286

136,950

Salary continuation plan

114,958

106,148

8,810

38,021

(2,823,477)

Table continued next page

4-34

th Edition

a. Table continued A

Note payable to bank, non-current

5,351,057

6,213,513

(862,456)

Capital lease obligation

208,412

(862,456)

(862,456) 239,382

208,412

Repayment of lease principal

Salary continuation plan

920,440

921,882

(1,442)

(30,970) (1,442)

Deferred income taxes, net

2,632,762

2,717,360

(84,598)

29 30

STOCKHOLDERS’ EQUITY

Common stock at par value

9,219,195

Additional paid-in capital

6,805,984

6,552,973

253,011

O, F

20,738,143

19,049,500

1,688,643

Stock-based compensation

Retained earnings

Net income

253,011

253,011 -

3,184,803

Dividends Treasury shares – at cost (2,537,036 shares in 2016 and 2015)

(1,496,160) F

(13,136,994)

7,135,855

Solutions Manual, Chapter 4

(1,496,160)

(1,126,408)

(5,175,042)

834,405

4-35

b. The following statement of cash flows from operations combines the effects of the income tax asset and liability and combines the effects of the deferred tax asset and liability. In addition, the effects of changes in current and noncurrent salary continuation plan liabilities have been combined in the operating cash flow. GOLDEN ENTERPRISES, INC. Consolidated Statement of Cash Flows Year ended June 3, 2016 CASH FLOWS FROM OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Deferred income taxes Stock based compensation Gain on sale of property and equipment - Change in receivables, net - Change in inventories - Change in prepaid expenses - Change in cash surrender value of insurance - Change in other assets + Change in accounts payable + Change in checks outstanding in excess of bank balances + Change in accrued expenses + Change in salary continuation plan(both current and noncurrent) + Change in accrued income taxes Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment Proceeds from sale of property, plant and equipment Net cash used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Debt repayments (line of credit and long-term debt) Principal payments under capital lease obligations Cash dividends paid Net cash used by financing activities NET INCREASE IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR CASH AND CASH EQUIVALENTS AT END OF YEAR

$ 3,184,803

3,876,111 (84,598) 253,011 (56,446) 418,703 (492,913) 74,283 191,830 55,662 186,155 (1,068,745) 136,950 7,368 453,681 7,135,855

(1,182,854) 56,446 (1,126,408)

(3,647,912) (30,970) (1,496,160) (5,175,042) 834,405 1,159,449 $ 1,993,854

c. OCFCL = $7,135,855 ÷ [(10,345,907 + 13,868,193) ÷ 2] = 0.589 OCFCX = $7,135,855 ÷ 1,182,854 = 6.03 ©Cambridge Business Publishers, 2020 4-36

Financial Accounting, 6th Edition

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-37

P4-56. (30 minutes) LO 3, 4, 5 The problem demonstrates the effect of payment terms on cash flows. A young, growing organization is particularly susceptible to cash shortages, even when reporting profits. Many of the decisions that might foster growth also use cash. In this simple case, Amazin, Inc. could eliminate the dividend for the present time. Sometimes a company’s business model will facilitate the generation of cash flows. For example, at the time it went public, Groupon was collecting cash as customers bought coupons, but then they didn’t pay the vendors until a few weeks went by. With that arrangement, faster growth meant that Groupon generated more cash, not less. a. Base case

Beginning

Quarter 1

Amazin, Inc

Balance sheets

Cash Accts receivable PPE, net Accts payable Shareholders’ equity

Income statement

Statement of cash flows

400.0 600.0

-95.0 1000.0 675

1,000.0

400.0 1,180

Revenue COGS Depreciation SG&A Net income

1,000.0 400.0 75.0 300.0 225.0

Net income + Depreciation - Δ Accts receivable + Δ Accts payable Cash from opns

225.0 75.0 -1,000.0 +400.0 -300.0

Capital expenditures

-150.0

Dividends

-45.0

Change in cash

-495.0

©Cambridge Business Publishers, 2020 4-38

Financial Accounting, 6th Edition

b. Aggressive growth Amazin, Inc

Balance sheets

Beginning

Cash Accts receivable PPE, net Accts payable Shareholders’ equity

Income statement

Statement of cash flows

400.0

Quarter 1

600.0

-195.8 1,200 675

1,000.0

480 1,199.2

Revenue COGS Depreciation SG&A Net income

1,200.0 480.0 75.0 396.0 249.0

Net income + Depreciation - Δ Accts receivable + Δ Accts payable Cash from opns

249.0 75.0 -1,200.0 480.0 -396.0

Capital expenditures

-150

Dividends

-49.8

Change in cash

-595.8

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-39

c. Happy suppliers Amazin, Inc

Balance sheets

Beginning Cash Accts receivable PPE, net Accts payable Shareholders’ equity

Income statement

Statement of cash flows

400.0

Quarter 1

600.0

-463.0 1,000.0 675.0

1,000.0

̶ 1,212.0

Revenue COGS Depreciation SG&A Net income

1000.0 360.0 75.0 300.0 265.0

Net income + Depreciation - Δ Accts receivable + Δ Accts payable Cash from opns

265.0 75.0 -1000 ̶ -660.0

Capital expenditures

-150.0

Dividends

-53.0

Change in cash

-863.0

©Cambridge Business Publishers, 2020 4-40

Financial Accounting, 6th Edition

CASES AND PROJECTS C4-57. (30 minutes) LO 3, 4 The required debt to equity ratio allows for total liabilities to be up to $477 million. That is $477 / ($125+$148) =1.747 < 1.75. This implies total short-term borrowing of $107 million and an ending cash balance of $70 million. LAMBERT CO. Statement of Cash Flows (projected) Cash from operations Net income …………………………………………………… Depreciation expense ……………………………………… Increase in accounts receivable …………………………. Decrease in inventory ……………………………………… Increase accounts payable ……………………………….. Decrease in income taxes payable ………………………. Cash provided by (used in) operations ……………….. Cash from investing Acquisitions of property, plant and equipment ………… Disposal proceeds ………………………………………….. Cash provided by (used in) investing …………………. Cash from financing Issue long-term debt ……………………………………….. Repay long-term debt ……………………………………….. Common stock issue ……………………………………….. Shareholder dividends ……………………………………… Increase (decrease) in short-term borrowing …………… Cash provided by (used in) financing ………………….. Net change in cash …………………………………………….. Beginning cash balance ………………………………………. Ending cash balance …………………………………………..

18 120 (40) 20 30 (10) $ 138

(225) 75 (150)

80 (100) 25 (30) 57

32 20 50 70

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-41

C4-58. (45 minutes) LO 1, 3, 4 a. see following page b. 1 2 3 4 5 6 7 8 9 10 11

12 13

Accounts receivable (+A) …………………………… Sales revenue (+R,+SE)…………………………

3,800

Cash (+A) ……………………………………………… Accounts receivable (-A) ………………………

3,500

Cost of goods sold (+E,-SE) ………………………… Inventory (-A) …………………………………….

1,800

Inventory (+A) ………………………………………… Accounts payable (+L) …………..……………..

1,200

Accounts payable (-L) …..…………………………… Cash (-A) …….…………………………………..

1,100

Salaries and wages expense (+E,-SE) ……………. Salaries and wages payable (+L) …………….

700

Salaries and wages payable (-L) …………………… Cash (-A) ……..…………………………………..

730

Rent expense (+E,-SE)……………………….……… Prepaid rent (-A) ………………………………..

200

Prepaid rent (+A) ……………………..……………… Cash (-A) …….…………………………………..

600

Depreciation expense (+E,-SE) ……………………. Accumulated depreciation (+XA,-A) ………….

150

Cash (+A) ………………………………………………. Accumulated depreciation (-XA,+A) ………………… Fixtures and equipment (-A) ……………………

10 70

Fixtures and equipment (+A) ……………………….. Cash (-A) …………………………………………..

800

Interest expense (+E,-SE) …..……………………….. Cash (-A) …………………………………………..

3,800 3,500 1,800 1,200 1,100 700 730 200 600 150

80 800 16

continued next page

©Cambridge Business Publishers, 2020 4-42

Financial Accounting, 6th Edition

b. continued 14 15

16 17 18

Bank loan payable (-L) ……….……………………….. Cash (-A) …………………………………………..

1,600

Cash (+A) ……………………………………………….. Long-term loan payable (+L) ……………………

2,000

Income tax expense (+E,-SE) …………………………. Taxes payable (+L) ………………………………..

374

Retained earnings (-SE) ………………………………. Cash (-A) ……………………………………………

Revenue (-R) ……………………………………………. Cost of goods sold (-E) …………………………. Salaries and wages expense (-E) ……………… Rent expense (-E) ………………………………… Depreciation expense (-E) ……………………… Interest expense (-E) …………………………….. Income tax expense (-E) ………………………… Retained earnings (+SE) …………………………

3,800

1,600 2,000

374 80 1,800 700 200 150 16 374 560

Entry 18 closes revenue and expense accounts to retained earnings. a. & c. + 2

15 Bal

Cash (A) 600 3,500 1,100 5 730 7 600 9 10 800 12 16 13 1,600 14 2,000 80 17 1,184

- Accounts Payable (L) + 3,000 5 1,100 1,200 4 3,100 Bal

- Salaries and Wages + Payable (L) 100 7 730 700 6 70 Bal

- Retained Earnings (SE)+ 1,300 17 80 560 18 1,780 Bal

+ Accounts Rec. (A) 6,500 1 3,800 3,500 2 Bal 6,800

- Common Stock (SE) + 4,600 4,600 Bal

Taxes Payable (L) 0 374 374

16 Bal

- Bank Loan Payable (L) + 1,600 14 1,600 0 Bal

Revenue (R) + 3,800 1 3,800 0 Bal

+ Cost of Goods Sold (E) 3 1,800 1,800 18 Bal 0

continued next page ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-43

a. & c. continued + 4 Bal

Inventory (A) 2,400 1,200 1,800 1,800

+ Prepaid Rent (A) 0 9 600 200 Bal 400

12 Bal

- Long-term Loan (L) + 0 2,000 15 2,000 Bal

+ Salaries & Wages (E) 6 700 700 18 Bal 0

+ 8 8

Fixtures and Equipment (A) 1,900 800 80 11 2,620

- Accum. Deprec. (XA) + 800 11 70 150 10 880 Bal

Bal

Rent Expense (E) 200 200 0

+ Depreciation Exp. (E) 10 150 150 18 Bal 0 + Interest Expense (E) 13 16 16 18 Bal 0 + Income Tax Exp (E) 16 374 374 18 Bal 0

©Cambridge Business Publishers, 2020 4-44

Financial Accounting, 6th Edition

C4-59. (30 minutes) LO 1, 2, 3, 4, 5 a. Depreciation and amortization are noncash expenses that are deducted in the computation of net income. The depreciation and amortization add-back effectively zeros these expenses out of the income statement to focus on operating cash flow. The positive amount for depreciation and amortization does not mean that the company is generating cash from depreciation and amortization, a common misconception. It is merely an adjustment to remove these expenses from net income to convert profit to cash flow. b. Gains and losses on disposals of asset are the result of investing activity, not operating activity, but they are recognized in net income. When we start with net income in an indirect method cash from operations, subtracting the gain removes this investing item from the determination of cash from operations. Daimler reports cash proceeds from disposals of PPE and intangible assets of €812 million. If the recognized gain is €453 million, then the book value of the assets disposed would be €359 million (= €812 million - €453 million). c. It does not. The adjustments can only be interpreted relative to the amounts that are included in net income. The negative €1,455 million inventory adjustment means that Daimler’s cost to acquire inventory for the year exceeded its cost of goods sold for the year by €1,455 million. d. Free cash flow (€ millions): ̶€1,652 – €(6,744 + 3,414 - 812) = -€10,998. Daimler’s operating cash flow is slightly negative, but its free cash flow is significantly negative due to the large investment in PPE and intangible assets. Daimler financed its investing activities and dividends by €16 billion in net additions to long-term financing. e. The primary sources of difference between net income and cash from operating activities are a net increase in operating assets, income taxes, and large increases in financial receivables and vehicles on operating leases. These last two items are related to their customer finance operation. In its financial statements, Daimler reports that “Customized financing and leasing products accelerate our automotive business.” One of the most important factors behind our success is our attractive and innovative range of services around vehicle financing and insurance. Daimler Financial Services has posted record figures for many years. We aim to systematically pursue our strategy of profitable growth at high speed in the future. Daimler Financial Services finances or leases half of all the new vehicles sold worldwide by the Daimler Group.

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-45

f. Daimler is a global corporation and transacts business in many different currencies. When the financial statements are prepared, these various currencies must be translated into one common currency (Euros in this case) for reporting purposes. Because exchange rates fluctuate, this translation process results in some changes in the cash value of some transactions and cash balances. The -€868 million listed in the cash flow statement reflects the net impact on Euros of the translation of foreign currencies.

©Cambridge Business Publishers, 2020 4-46

Financial Accounting, 6th Edition

Chapter 4 Reporting and Analyzing Cash Flows Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Explain the purpose of the statement of cash flows and classify cash transactions by type of business activity: operating, investing and financing

21 - 24, 29

LO2 – Construct the operating activities section of the statement of cash flows using the direct method.

25, 27, 30, 31

34, 38, 41, 43, 44

47, 49, 51, 53

LO3 – Reconcile cash flows from operations to net income and use the indirect method to compute operating cash flows.

21, 23, 25 - 29

35, 42, 44

45, 46, 48, 50 - 56

57, 58, 59

LO4 – Construct the investing and financing activities sections of the statement of cash flows.

21, 24

36 - 40, 42

46, 48, 50 - 56

57, 58, 59

32, 33, 35, 43

46, 48, 50, 52, 55, 56

58, 59

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-1

QUESTIONS Q4-1.

Q4-2.

Q4-3.

Q4-4.

©Cambridge Business Publishers, 2021 4-2

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q4-5.

This is a noncash investing and financing event. It must be reported in a supplementary schedule to the statement of cash flows.

Q4-6.

Q4-7.

Q4-8.

Q4-9.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-3

$ 88,000 6,000 13,000 (9,000) (3,500) 1,500 $ 96,000

$925,000 14,000 $939,000

Q4-15. Wages expense + Wages payable decrease = Cash paid to employees

$ 86,000 1,100 $ 87,100

Q4-16.

$ 43,000 1,600 $ 44,600

Advertising expense + Prepaid advertising increase = Cash paid for advertising

©Cambridge Business Publishers, 2021 4-4

Financial & Managerial Accounting for Decision Makers, 4th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-5

MINI EXERCISES M4-21. (5 minutes) LO 1, 3, 4 a. Positive adjustment b. Negative adjustment c. Positive adjustment d. Positive adjustment e. Negative adjustment

M4-23. (15 minutes) LO 1, 3

1 2 3 4 5 6 7 8 9 10 11

Financing Operating Operating Operating Financing Operating Investing Operating Operating Financing Investing

©Cambridge Business Publishers, 2021 4-6

Financial & Managerial Accounting for Decision Makers, 4th Edition

M4-25. (30 minutes) LO 2, 3 a. Income Statement

Balance Sheet Transaction (1)

Cash Asset

Accts. Receivable

+ +507,400 + +

Inventories

Contrib. Capital +

Earned Capital

Revenue

+507,400

+507,400 -

+507,400

+91,500

+91,500 -

+91,500

Accts. Payable

- Expenses =

Net Income

(2)

+91,500 +

(3)

+–--320,100 =

–320,100

+320,100 =

–320,100

(4)

–63,400 =

–63,400

+63,400 =

–63,400

(5)

+ +351,600 =

+351,600 +

(6)

-47,700 +

+47,700 =

(7)

+483,400 + –483,400 +

(8)

–340,200 +

(9)

-172,300 +

-172,300

+172,300 =

-172,300

Total

+14,700 +

+24,000 +

+15,800 =

+11,400 +

+43,100

+555,800 =

+43,100

+598,900

Net income was €43,100 (from the net income column), and cash flow from operating activities was €14,700 (from the cash column).

c. 1. Accounts receivable increased by €24,000, 2. Inventories increased by €15,800, and 3. Accounts payable increased by €11,400.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-7

$ 45,000 8,000 (9,000) (9,000) (6,000) 2,000 4,000 (2,000) $ 33,000

©Cambridge Business Publishers, 2021 4-8

Financial & Managerial Accounting for Decision Makers, 4th Edition

M4-27. (30 minutes) LO 2, 3 a. Balance Sheet Transaction

Cash Asset

(1) (2)

+46,200

(3)

Accts. Receivable

+ +769,200

(4)

–149,100

(5)

–521,600

(6)

Prepaid Rent

+149,100

–117,900

Contr. + Capital

Earned Capital

Revenue

+769,200

+769,200 -

+769,200

+46,200

+46,200 -

+46,200

–526,700

+526,700 =

–526,700

+117,900 =

Accum. Deprec.

Income Statement

Wages Payable

+526,700

–521,600

–117,900

- Expenses =

Net Income

–117,900

(7)

+724,100

+ –724,100

(8)

–122,800

+122,800 =

–122,800

+23,000

-23,000

+23,000 =

-23,000

+23,000

+25,000

+815,400 -

+790,400 =

+25,000

(9) Total

–23,200

+45,100

+31,200

+5,100

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-9

$(21,000) 8,600 (9,000) (3,000) (3,000) 4,000 (2,600) $ 4,000

Weber Company's 2018 operating activities provided $4,000 cash. The dividend paid to shareholders affects cash flows from financing activities.

M4-29. (20 minutes) LO 1, 3 A “+” indicates that the amount is added and a “-“ indicates that it is subtracted when preparing the cash flow statement using the indirect method.

1 2 3 4 5 6 7 8 9 10 11 12 13 14

++ + + + + + +

©Cambridge Business Publishers, 2021 4-10

Financial & Managerial Accounting for Decision Makers, 4th Edition

M4-30. (15 minutes—DIRECT METHOD) LO 2 a.

Rent expense – Prepaid rent decrease = Cash paid for rent

$ 60,000 (2,000) $ 58,000 Balance Sheet

Transaction

Cash

Begin Balance Make rent payment

+ +

-X

Noncash Assets

10,000 Prepaid Rent +X Prepaid Rent

Income Statement

= Liabilities +

Contr. + Capital

Earned Surplus

Revenue

- Expenses =

Record rent expense

-60,000 Prepaid Rent

End Balance

8,000

-60,000 Retained Earnings

+60,000 Rent Expense

Net Income

-60,000

X must equal $58,000 to make the FSET balance. b.

Interest income – Interest receivable increase = Cash received as interest

$ 16,000 (700) $ 15,300

Balance Sheet Transaction

Cash

Begin Balance Record interest income Receive interest payment End Balance

+ +

Noncash Assets

3,000 Interest Receivable +16,000 Interest Receivable

Income Statement

= Liabilities +

Contr. + Capital

Earned Surplus

+16,000 Retained Earnings

Revenue -

Expenses

+16,000 Interest income

-X

3,700

Net Income

+16,000

X must equal $15,300 to make the FSET balance.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-11

c. Cost of goods sold + Inventory increase + Accounts payable decrease = Cash paid for merchandise purchased

$ 98,000 3,000 4,000 $105,000

Balance Sheet

Income Statement

Noncash Assets

= Liabilities

Contr. + Capital

Begin Balance

19,000 Inventory

11,000 Accounts Payable

Purchase inventory

-Y Accounts Payable

Transaction

Pay supplier Recognize Cost of Goods Sold End Balance

Cash

-Y

-98,000 Inventory

22,000

7,000

Earned Surplus

Revenue -

-98,000 Retained Earnings

Expenses

98,000 Cost of Goods Sold

Net Income

-98,000

To make the inventory account work properly, X (purchases) must equal $101,000. If purchases were $101,000, then Y (payments to suppliers) must equal $105,000.

$825,000 (11,000) $814,000

Effect of cost of goods sold on net income - Change in inventory + Change in accounts payable = Effect of merchandise purchases on cash

($550,000) (13,000) (6,000) ($569,000)

Chakravarthy Company received $814,000 in cash from its customers and paid $569,000 in cash to its suppliers. ©Cambridge Business Publishers, 2021 4-12

Financial & Managerial Accounting for Decision Makers, 4th Edition

4-13

$194,000 6,000 (148,000) (11,000) $ 41,000 40,000 (89,000) (49,000) 30,000 (10,000) (16,000) 4,000 (4,000) 16,000 $ 12,000

$113,000 (5,000) 6,000 (1,000) 4,000 (2,000) $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83

©Cambridge Business Publishers, 2021 4-14

Financial & Managerial Accounting for Decision Makers, 4th Edition

Property, plant and equipment at cost (A) 1,000

Ending balance

- Accumulated depreciation (XA) 350

Beg. balance

390

Ending balance

1,200

(2)

(3)

(4)

Property, plant and equipment at cost (+A) 300 Cash (-A) To record purchase of property, plant and equipment with cash.

300

Property, plant and equipment at cost (+A) 100 Mortgage payable (+L) To record purchase of property, plant and equipment with financing.

100

100 Y X 20

Z Z

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-15

Property, plant and equipment at cost (A) 1,000 300 100 X 1,200

- Accumulated depreciation (XA) 350

Y Z 390

+ Beg. balance

(3) (4) Ending balance

©Cambridge Business Publishers, 2021 4-16

Financial & Managerial Accounting for Decision Makers, 4th Edition

Property, plant and equipment at cost (A) 175

Ending balance

- Accumulated depreciation (XA) 78

Beg. balance

Ending balance

183

(2)

(3)

(4)

Property, plant and equipment at cost (+A) 28 Cash (-A) To record purchase of property, plant and equipment with cash.

Property, plant and equipment at cost (+A) 0 Mortgage payable (+L) To record purchase of property, plant and equipment with financing.

Cash (+A) Accumulated depreciation (-XA, +A) Loss on equipment disposal (+E, -SE) Property, plant and equipment at cost (-A) To record sale of used equipment.

Z Y 5

Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A) To record depreciation expense.

continued next page

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-17

Property, plant and equipment at cost (A) 175 28 0 X 183

- Accumulated depreciation (XA) 78

Y 17 83

+ Beg. balance

(3) (4) Ending balance

©Cambridge Business Publishers, 2021 4-18

Financial & Managerial Accounting for Decision Makers, 4th Edition

E4-38. (30 minutes) LO 2, 4 a. The analysis from the chapter shows that Cash flow (payments)

Change in inventory

Change in accounts payable

Net income (COGS expense)

-57 (=8,899-8,956)

+1,484 (=12,484-11,000)

-89,052

E4-39. (15 minutes) LO 4 a.

Cash flows from investing activities will show: Purchase of stock investments Sale of stock investments

$ (80,000) 59,000

Cash flows from financing activities will show: Issuance of bonds Retirement of bonds

$130,000 (131,000)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-19

$ 56,446 600,247 $ 600,247 56,446

E4-41. (20 minutes—DIRECT METHOD) LO 2 a.

Advertising expense + Prepaid advertising increase = Cash paid for advertising

$ 62,000 4,000 $ 66,000

Income tax expense + Income tax payable decrease = Cash paid for income taxes

$ 29,000 2,200 $ 31,200

Cost of goods sold – Inventory decrease – Accounts payable increase = Cash paid for merchandise purchased

$180,000 (5,000) (2,000) $173,000

©Cambridge Business Publishers, 2021 4-20

Financial & Managerial Accounting for Decision Makers, 4th Edition

$ 600

Cash Flows from Investing: Purchases of Equipment Proceeds from Disposal of Equipment Cash Flows from Investing Activities

(1,200) 600 (600)

Cash Flows from Financing: Dividends Paid Increase in Short-term Debt Decrease in Long-term Debt Cash Flows from Financing Activities

(250) 1,500 (1,000)

Net Change in Cash Beginning Cash Balance Ending Cash Balance

250 250 300 $ 550

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-21

E4-43. (30 minutes—DIRECT METHOD) LO 2, 5 a. Sales – Accounts Receivable Increase = Cash Received from Customers

$750,000 (5,000) $745,000

Cost of Goods Sold – Inventory Decrease – Accounts Payable Increase = Cash Paid for Merchandise Purchased

$470,000 (6,000) (4,000) $460,000

Wages Expense + Wages Payable Decrease = Cash Paid to Employees

$110,000 2,000 $112,000

Insurance Expense + Prepaid Insurance Increase = Cash Paid for Insurance

$ 15,000 1,000 $ 16,000

$745,000 $460,000 112,000 42,000 16,000

630,000 $115,000

$115,000/[($31,000 + $29,000)/2] =3.83

E4-44. (15 minutes) LO 2, 3 1.

True

---

False

$25

3. 4.

False False

$10 $0

Changing financial reporting depreciation will change net income, but not cash flows. Changing tax depreciation will change cash flows, but not net income. This issue is examined later in Chapter 10.

©Cambridge Business Publishers, 2021 4-22

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P4-45. (20 minutes) LO 3 Cash flows from operating activities Net income ..........................................................................................

$135,000

Adjustments to reconcile net income to operating cash flows Add back depreciation expense ..................................................... $25,000 Gain on sale of assets

(5,000)

Net cash provided from operating activities .........................................

15,000

$150,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-23

$56,000 17,000 (9,000) (30,000) 2,000 (3,000) 3,000 (1,000) $35,000 (55,000) 55,000 (29,000) 26,000 6,000 5,000 $11,000

©Cambridge Business Publishers, 2021 4-24

Financial & Managerial Accounting for Decision Makers, 4th Edition

P4-47. (30 minutes) LO 2 a. Adjustments to Convert Income Statement Items to Operating Activity Cash Flows Net income

$ 56,000

Sales revenue

–Cost of goods sold

–Wage expenses

–Insurance expense

–Depreciation expense

–Interest expense

+Gains

–Losses

–Income tax expense

$635,000

–430,000

–86,000

–8,000

–17,000

–9,000

–0

–29,000

Adjustments: +Depreciation expense

Add back depreciation expense

+17,000 –Gains 0

Subtract (add) non-operating gains (losses)

+Losses 0

Subtract the change in operating assets (operating investments)

–Change in accounts receivable

–Change in inventory

–Change in prepaid insurance

-9,000

-30,000

-(-2,000)

Add the change in operating liabilities (operating financing) Cash from operations $ 35,000

+Change in accounts payable

+Change in wages payable

+Change in income tax payable

+(-3,000)

+3,000

+(-1,000)

Receipts from customers

–Payments for merchandise

–Payments for Wages

–Payments for insurance

(zero)

–Payments for interest

(zero)

–Payments for income tax

$626,000

-463,000

-83,000

-6,000

-9,000

–0

–30,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-25

P4-48. (45 minutes—INDIRECT METHOD) LO 3, 4, 5 a. Cash, December 31, 2018 Cash, December 31, 2017 Cash increase during 2018

$49,000 28,000 $21,000

$ (42,000)

22,000 (25,000) 8,000 6,000 3,000 (14,000) 6,000 $ (36,000) 70,000 (183,000)* (113,000) 200,000 (30,000) 170,000 21,000 28,000 $ 49,000

* The sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000).

©Cambridge Business Publishers, 2021 4-26

Financial & Managerial Accounting for Decision Makers, 4th Edition

P4-49. (30 minutes) LO 2 a. Adjustments to Convert Income Statement Items to Operating Activity Cash Flows Net income (loss) –$ 42,000

Sales revenue $728,000

–Cost of goods sold –534,000

–Wage expenses –190,000

–Advertising expense –31,000

–Depreciation expense –22,000

–Interest expense –18,000

+Gains

–Losses

+25,000

–0

Income tax expense –0

Adjustments:

Add back depreciation expense

+Depreciation expense +22,000 –Gains –25,000

Subtract (add) nonoperating gains (losses)

+Losses 0

Subtract the change in operating assets (operating investments)

–Change in accounts receivable -(-8,000)

Add the change in operating liabilities (operating financing) Cash from operations –$ 36,000

Receipts from customers $736,000

–Change in prepaid advertising -(-3,000)

–Change in inventory -(-6,000)

+Change in accounts payable +(-14,000)

+change in wages payable +0

–Payments for merchandise –542,000

–Payments for Wages –190,000

+Change in interest payable +6,000 –Payments for advertising –28,000

(zero) 0

–Payments for interest –12,000

+Change in income tax payable +0

(zero)

–0

–Payments for income tax –0

b. Computing cash flows from operating activities using the direct method provides additional detail about the specific cash flows that occurred during the period. For example, the indirect method does not reveal that Arctic paid $542,000 for merchandise during 2018, or $28,000 for advertising. Because this detail is missing, the FASB requires supplemental disclosure of two specific (and important) cash payments – interest and taxes – if the indirect method is used.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-27

$27,000 18,000 $ 9,000

b. STATEMENT OF CASH FLOWS (INDIRECT METHOD) DAIR COMPANY Statement of Cash Flows For Year Ended December 31, 2018 Net Cash Flow from Operating Activities Net Income Add (deduct) items to convert net income to cash basis Depreciation Amortization of intangible assets Loss on bond retirement Accounts receivable increase Inventory decrease Prepaid expenses increase Accounts payable increase Interest payable decrease Income tax payable decrease Net cash provided by operating activities Cash flows from investing activities Sale of equipment Cash flows from financing activities Retirement of bonds payable Issuance of common stock Payment of dividends Net cash used by financing activities Net increase in cash Cash at beginning of year Cash at end of year

$ 85,000

22,000 7,000 5,000 (5,000) 6,000 (2,000) 6,000 (3,000) (2,000) $119,000 17,000 (125,000) 24,000 (26,000) (127,000) 9,000 18,000 $ 27,000

©Cambridge Business Publishers, 2021 4-28

Financial & Managerial Accounting for Decision Makers, 4th Edition

Interest expense + Interest payable decrease Cash paid for interest

$10,000 3,000 $13,000

†

Income tax expense + Income tax payable decrease Cash paid for income taxes

$36,000 2,000 $38,000

(2) Schedule of noncash investing and financing activities Issuance of bonds payable to acquire equipment................................. d. (1) (2) (3)

$ 13,000* $ 38,000†

$ 60,000

4-29

$ 90,000 39,000 7,000 5,000 (3,000) (10,000) (26,000) (4,000) 4,000 1,000 (2,000) $101,000 60,000 (90,000) (95,000) 14,000 (111,000) 30,000 24,000 (50,000) 4,000 (6,000) 25,000 $ 19,000

©Cambridge Business Publishers, 2021 4-30

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. (1)

(2)

Supplemental Cash Flow Disclosures Cash paid for interest Cash paid for income taxes

$ 12,000* $ 46,000†

* Interest expense - Interest payable increase Cash paid for interest

$13,000 (1,000) $12,000

† Income tax expense + Income tax payable decrease Cash paid for income taxes

$44,000 2,000 $46,000

Schedule of noncash investing and financing activities Issuance of preferred stock to acquire patent

$ 25,000

d. (1) $101,000/[($34,000 + $31,000)/2] = 3.11. (2) $101,000/$185,000 = 0.55. (3): $101,000 – ($90,000 + $95,000 - $14,000) = -$70,000

$19,000 25,000 $ 6,000

$740,000 15,000 462,000 134,000 12,000 46,000

60,000 (90,000) (95,000) 14,000

$755,000

(654,000) 101,000

(111,000)

Table continued on next page ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-31

30,000 24,000 (50,000) 4,000

Net decrease in cash and cash equivalents ……………….. Cash and cash equivalents at beginning of year …………. Cash and cash equivalents at end of year ………………….

(6,000) 25,000 $ 19,000

$ 90,000 39,000 7,000 5,000 (3,000) (10,000) (26,000) (4,000) 4,000 1,000 (2,000) $101,000

(2) Schedule of noncash investing and financing activities Issuance of preferred stock to acquire patent

$ 25,000

©Cambridge Business Publishers, 2021 4-32

Financial & Managerial Accounting for Decision Makers, 4th Edition

$229,234 -2,093 -626 $226,515

($141,048) -2,723 +9,618

- Cash paid for purchases of inventories ……………………………

($134,153)

$33.8 (12.5) none 8.2 $29.5

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 4

4-33

P4-55.A (75 minutes) LO 3, 4, 5, 6 a. A

Effect of change on cash flow

2016

2015

Change

Operating

Investing

Financing

No effect

Total

on cash

(F+G+H+I)

Assets

Cash and cash equivalents

1,993,854

1,159,449

834,405

Receivables, net

10,666,986

11,085,689

(418,703)

418,703

Inventories

5,735,110

5,242,197

492,913

(492,913)

Prepaid expenses

1,275,918

1,350,201

(74,283)

74,283

Income tax receivable

22,473

476,154

(453,681)

453,681

Property, plant and equipment, net

O,I

22,034,603

24,488,478

(2,453,875)

Depreciation expense

PPE purchased

PPE sold

3,876,111 (1,182,854) (56,446)

PPE acuired w/o cash

Cash surrender value of life insurance

Other

2,453,875

56,446 (239,382)

438,429

630,259

(191,830)

191,830

917,533

973,195

(55,662)

55,662

1,068,745

(1,068,745)

186,155

16 17

LIABILITIES

Checks outstanding in excess of bank balances

Accounts payable

4,235,488

4,049,333

186,155

Current portion of long-term debt

837,225

799,204

38,021

Line of credit outstanding

2,823,477

(2,823,477)

Other accrued expenses

5,158,236

5,021,286

136,950

Salary continuation plan

114,958

106,148

8,810

38,021

(2,823,477)

Table continued next page

4-34

th Edition

a. Table continued A

Note payable to bank, non-current

5,351,057

6,213,513

(862,456)

Capital lease obligation

208,412

(862,456)

(862,456) 239,382

208,412

Repayment of lease principal

Salary continuation plan

920,440

921,882

(1,442)

(30,970) (1,442)

Deferred income taxes, net

2,632,762

2,717,360

(84,598)

29 30

STOCKHOLDERS’ EQUITY

Common stock at par value

9,219,195

Additional paid-in capital

6,805,984

6,552,973

253,011

O, F

20,738,143

19,049,500

1,688,643

Stock-based compensation

Retained earnings

Net income

253,011

253,011 -

3,184,803

Dividends Treasury shares – at cost (2,537,036 shares in 2016 and 2015)

(1,496,160) F

(13,136,994)

7,135,855

Solutions Manual, Chapter 4

(1,496,160)

(1,126,408)

(5,175,042)

834,405

4-35

$ 3,184,803

3,876,111 (84,598) 253,011 (56,446) 418,703 (492,913) 74,283 191,830 55,662 186,155 (1,068,745) 136,950 7,368 453,681 7,135,855

(1,182,854) 56,446 (1,126,408)

(3,647,912) (30,970) (1,496,160) (5,175,042) 834,405 1,159,449 $ 1,993,854

c. OCFCL = $7,135,855 ÷ [(10,345,907 + 13,868,193) ÷ 2] = 0.589 OCFCX = $7,135,855 ÷ 1,182,854 = 6.03 ©Cambridge Business Publishers, 2020 4-36

Financial Accounting, 6th Edition

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-37

Beginning

Quarter 1

Amazin, Inc

Balance sheets

Cash Accts receivable PPE, net Accts payable Shareholders’ equity

Income statement

Statement of cash flows

400.0 600.0

-95.0 1000.0 675

1,000.0

400.0 1,180

Revenue COGS Depreciation SG&A Net income

1,000.0 400.0 75.0 300.0 225.0

Net income + Depreciation - Δ Accts receivable + Δ Accts payable Cash from opns

225.0 75.0 -1,000.0 +400.0 -300.0

Capital expenditures

-150.0

Dividends

-45.0

Change in cash

-495.0

©Cambridge Business Publishers, 2020 4-38

Financial Accounting, 6th Edition

b. Aggressive growth Amazin, Inc

Balance sheets

Beginning

Cash Accts receivable PPE, net Accts payable Shareholders’ equity

Income statement

Statement of cash flows

400.0

Quarter 1

600.0

-195.8 1,200 675

1,000.0

480 1,199.2

Revenue COGS Depreciation SG&A Net income

1,200.0 480.0 75.0 396.0 249.0

Net income + Depreciation - Δ Accts receivable + Δ Accts payable Cash from opns

249.0 75.0 -1,200.0 480.0 -396.0

Capital expenditures

-150

Dividends

-49.8

Change in cash

-595.8

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-39

c. Happy suppliers Amazin, Inc

Balance sheets

Beginning Cash Accts receivable PPE, net Accts payable Shareholders’ equity

Income statement

Statement of cash flows

400.0

Quarter 1

600.0

-463.0 1,000.0 675.0

1,000.0

̶ 1,212.0

Revenue COGS Depreciation SG&A Net income

1000.0 360.0 75.0 300.0 265.0

Net income + Depreciation - Δ Accts receivable + Δ Accts payable Cash from opns

265.0 75.0 -1000 ̶ -660.0

Capital expenditures

-150.0

Dividends

-53.0

Change in cash

-863.0

©Cambridge Business Publishers, 2020 4-40

Financial Accounting, 6th Edition

18 120 (40) 20 30 (10) $ 138

(225) 75 (150)

80 (100) 25 (30) 57

32 20 50 70

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-41

C4-58. (45 minutes) LO 1, 3, 4 a. see following page b. 1 2 3 4 5 6 7 8 9 10 11

12 13

Accounts receivable (+A) …………………………… Sales revenue (+R,+SE)…………………………

3,800

Cash (+A) ……………………………………………… Accounts receivable (-A) ………………………

3,500

Cost of goods sold (+E,-SE) ………………………… Inventory (-A) …………………………………….

1,800

Inventory (+A) ………………………………………… Accounts payable (+L) …………..……………..

1,200

Accounts payable (-L) …..…………………………… Cash (-A) …….…………………………………..

1,100

Salaries and wages expense (+E,-SE) ……………. Salaries and wages payable (+L) …………….

700

Salaries and wages payable (-L) …………………… Cash (-A) ……..…………………………………..

730

Rent expense (+E,-SE)……………………….……… Prepaid rent (-A) ………………………………..

200

Prepaid rent (+A) ……………………..……………… Cash (-A) …….…………………………………..

600

Depreciation expense (+E,-SE) ……………………. Accumulated depreciation (+XA,-A) ………….

150

Cash (+A) ………………………………………………. Accumulated depreciation (-XA,+A) ………………… Fixtures and equipment (-A) ……………………

10 70

Fixtures and equipment (+A) ……………………….. Cash (-A) …………………………………………..

800

Interest expense (+E,-SE) …..……………………….. Cash (-A) …………………………………………..

3,800 3,500 1,800 1,200 1,100 700 730 200 600 150

80 800 16

continued next page

©Cambridge Business Publishers, 2020 4-42

Financial Accounting, 6th Edition

b. continued 14 15

16 17 18

Bank loan payable (-L) ……….……………………….. Cash (-A) …………………………………………..

1,600

Cash (+A) ……………………………………………….. Long-term loan payable (+L) ……………………

2,000

Income tax expense (+E,-SE) …………………………. Taxes payable (+L) ………………………………..

374

Retained earnings (-SE) ………………………………. Cash (-A) ……………………………………………

3,800

1,600 2,000

374 80 1,800 700 200 150 16 374 560

Entry 18 closes revenue and expense accounts to retained earnings. a. & c. + 2

15 Bal

Cash (A) 600 3,500 1,100 5 730 7 600 9 10 800 12 16 13 1,600 14 2,000 80 17 1,184

- Accounts Payable (L) + 3,000 5 1,100 1,200 4 3,100 Bal

- Salaries and Wages + Payable (L) 100 7 730 700 6 70 Bal

- Retained Earnings (SE)+ 1,300 17 80 560 18 1,780 Bal

+ Accounts Rec. (A) 6,500 1 3,800 3,500 2 Bal 6,800

- Common Stock (SE) + 4,600 4,600 Bal

Taxes Payable (L) 0 374 374

16 Bal

- Bank Loan Payable (L) + 1,600 14 1,600 0 Bal

Revenue (R) + 3,800 1 3,800 0 Bal

+ Cost of Goods Sold (E) 3 1,800 1,800 18 Bal 0

continued next page ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-43

a. & c. continued + 4 Bal

Inventory (A) 2,400 1,200 1,800 1,800

+ Prepaid Rent (A) 0 9 600 200 Bal 400

12 Bal

- Long-term Loan (L) + 0 2,000 15 2,000 Bal

+ Salaries & Wages (E) 6 700 700 18 Bal 0

+ 8 8

Fixtures and Equipment (A) 1,900 800 80 11 2,620

- Accum. Deprec. (XA) + 800 11 70 150 10 880 Bal

Bal

Rent Expense (E) 200 200 0

+ Depreciation Exp. (E) 10 150 150 18 Bal 0 + Interest Expense (E) 13 16 16 18 Bal 0 + Income Tax Exp (E) 16 374 374 18 Bal 0

©Cambridge Business Publishers, 2020 4-44

Financial Accounting, 6th Edition

©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 4

4-45

©Cambridge Business Publishers, 2020 4-46

Financial Accounting, 6th Edition

Chapter 5 Analyzing and Interpreting Financial Statements Learning Objectives – coverage by question MiniExercises

Exercises

LO1 – Prepare and analyze common-size financial statements.

15, 16, 19, 20

LO2 – Compute and interpret measures of return on investment, including return on equity (ROE), return on assets (ROA), and return on financial leverage (ROFL).

14, 17, 21, 22

LO3 – Disaggregate ROA into profitability (profit margin) and efficiency (asset turnover) components. LO4 – Compute and interpret measures of liquidity and solvency.

Problems

Cases and Projects

25 - 31, 34

36, 38, 41

14, 17, 21, 22, 24

25, 27 - 31, 34

36, 38, 41, 45, 46

47 - 49

18, 23

32, 33

37, 39, 42

LO5 – Appendix 5A: Measure and analyze the effect of operating activities on ROE. LO6 – Appendix 5B: Prepare financial statement forecasts.

40, 43

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 5

5-1

QUESTIONS Q5-1.

Return on investment measures profitability in relation to the amount of investment that has been made in the business. A company can always increase dollar profit by increasing the amount of investment (assuming it is a profitable investment). So, dollar profits are not necessarily a meaningful way to look at financial performance. Using return on investment in our analysis, whether as investors or business managers, requires us to focus not only on the income statement, but also on the balance sheet.

Q5-2.

ROE is the sum of return on assets (ROA) and the return that results from the effective use of financial leverage (ROFL). Increasing leverage increases ROE as long as ROA exceeds the after-tax interest rate. Financial leverage is also related to risk: the risk of potential bankruptcy and the risk of increased variability of profits. Companies must, therefore, balance the positive effects of financial leverage against their potential negative consequences. It is for this reason that we do not witness companies entirely financed with debt.

Q5-3.

Gross profit margins can decline because 1) the industry has become more competitive, and/or the firm’s products have lost their competitive advantage so that the company has had to reduce prices or is selling fewer units or 2) product costs have increased, or 3) the sales mix has changed from highermargin/slowly-turning products to lower-margin/higher-turning products. Declining gross profit margins are usually viewed negatively. On the other hand, cost increases that reflect broader economic events or certain strategic product mix changes might not be viewed negatively.

Q5-4.

Reducing advertising or R&D expenditures can increase current operating profit at the expense of the long-term competitive position of the firm. Expenditures on advertising or R&D are more asset-like and create long-term economic benefits even though they are not reported as assets on the balance sheet.

Q5-5.

Asset turnover measures the amount of revenue volume compared with the investment in an asset. Generally speaking, we want turnover to be higher rather than lower. Turnover measures productivity, and an important company objective is to make assets as productive as possible. Since turnover is one of the components of ROE (via ROA), increasing turnover increases shareholder value. Turnover is, therefore, viewed as a value driver.

Q5-6.

ROE>ROA implies a positive return on financial leverage. This results from borrowed funds being invested in operating assets whose return (ROA) exceeds the cost of borrowing. In this case, borrowing money increases ROE.

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Q5-7.

Common-size financial statements express balance sheet and income statement items in ratio form. Common-size balance sheets express each asset, liability and equity item as a percentage of total assets and common-size income statements express each line item as a percentage of sales. The ratio form facilitates comparison among firms of different sizes as well as across time for the same firm.

Q5-8.

The asset turnover ratio (AT) is the ratio of sales revenue to average total assets. The ratio is increased by increasing sales while holding assets constant, or by reducing assets without reducing sales. The most effective means of improving the ratio is to increase the efficient utilization of operating assets. This is done by improving inventory management practices, improving accounts receivable collection, and improving the efficient use of PP&E.

Q5-9.

The “net” in net operating assets, means operating assets “net” of operating liabilities. This netting recognizes that a portion of the costs of operating assets is financed by parties other than the company. For example, payables and accrued expenses help fund inventories, wages, utilities, and other operating costs. Similarly, long-term operating liabilities also help finance the cost of longterm operating assets. Thus, these long-term operating liabilities are deducted from long-term operating assets.

Q5-10. Companies must manage both the income statement and the balance sheet in order to maximize ROA. This is important, as many managers look only to the income statement and do not fully appreciate the value added by effective balance sheet management. The disaggregation of ROA into its profit margin and turnover components facilitates analysis of these two areas of focus. Q5-11. There are an infinite number of possible combinations of margin and turnover that will yield a given level of ROA. The relative weighting of profit margin and asset turnover is driven in large part by the company’s business model. As a result, since companies in an industry tend to adopt similar business models, industries will generally trend toward points along the margin/turnover continuum. Q5-12. Liquidity refers to how much cash a company has, how much cash is coming in, and how much cash can be raised quickly. Companies must generate cash in order to pay their debts, pay their employees and provide their shareholders a return on investment. Cash is, therefore, critical to a company’s survival. Q5-13. Ratio analysis relies on the data presented in the financial statements and is, therefore, dependent on the quality of those statements. Differences in the application of GAAP across companies or within the same company across time can affect the reliability of the analysis. Limitations of GAAP itself and differences in the make-up of the company (e.g., types of products or industries in which the company competes) can also affect the usefulness of ratio analysis.

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MINI EXERCISES M5-14. (15 minutes) LO 2, 3 a. ROE = $5,000/$500,000 = 1% ROA = $20,000/$1,000,000 = 2% ROFL = 1% - 2% = -1% b. Net profit margin = $5,000/$1,000,000 = 0.5% Asset turnover = $1,000,000/$1,000,000 = 1.0 Financial leverage = $1,000,000/$500,000 = 2.0 c. ROFL is negative for Sunder Company, indicating that financial leverage is hurting this company. The return on assets is insufficient to cover the interest cost of the debt. DuPont analysis masks this problem. The financial leverage ratio of 2.0 suggests (incorrectly) that leverage doubled the return.

M5-15. (20 minutes) LO 1 TARGET CORPORATION Common-size Balance Sheets Cash and cash equivalents……………………………………. Inventory…………………………………………………………. Other current assets……………………………………………. Total current assets…………………………………………….. Property and equipment, net………………………………….. Other noncurrent assets……………………………………….. Total assets………………………………………………………

2018 6.8% 22.2% 3.2% 32.2% 64.2% 3.6% 100.0%

2017 6.7% 22.2% 3.1% 32.0% 65.9% 2.1% 100.0%

Accounts payable………………………………………………. Accrued and other current liabilities………………………….. Current portion of long-term debt and other borrowings....... Total current liabilities…………………………………………. Long-term debt and other borrowings……………………….. Deferred income taxes…………………………………………. Other noncurrent liabilities……………………………………. Total shareholders' investment………………………………. Total liabilities and shareholders' investment………………..

22.2% 10.9% 0.7% 33.8% 29.0% 1.8% 5.3% 30.0% 100.0%

19.4% 10.0% 4.6% 33.9% 29.5% 2.3% 5.0% 29.3% 100.0%

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M5-16 (20 minutes) LO 1 TARGET CORPORATION Common-size Income Statement Year ended: February 3, 2018 Sales revenue………………..………………………………………………. 100.0% Cost of sales…………………………………………………………………. 71.1% Selling, general and administrative expenses……………………………. 19.8% Depreciation and amortization……………………………………………… 3.1% Earnings from continuing operations before interest and income taxes 6.0% Net interest expense………………………………………………………… 0.9% Earnings from continuing operations before income taxes……………… 5.1% Provision for income taxes…………………………………………………. 1.0% Net earnings from continuing operations ………………………………… 4.1% Discontinued operations, net of tax ……………………………………….. 0.0% Net earnings (loss) ………………………………………………………….. 4.1%

M5-17. (15 minutes) LO 2, 3 ($ millions) a. EWI = $2,928 + $666 x (1 - 0.25) = $3,427.5 (using net earnings from continuing operations)

Average total assets = ($38,999 + $37,431)/2 = $38,215 ROA = $3,427.5/$38,215 = 8.97% (using net earnings from continuing operations)

Using net earnings, ROA = ($2,934 + (1 - 0.25) × 666)/(($38,999 + $37,431)/2) = 8.98% b. Using earnings from continuing operations: PM = $3,427.5/$71,879 = 4.77% AT = $71,879 /$38,215= 1.88 4.77% X 1.88 = 8.97%

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M5-18. (20 minutes) LO 4 a. 2018 Current ratio = $12,564 / $13,201 = 0.95 2017 Current ratio = $11,990 / $12,707 = 0.94 2018 Quick ratio = $2,643 / $13,201 = 0.20 2017 Quick ratio = $2,512 / $12,707 = 0.20 Both of these ratios held steady over the year. Target’s current assets increased modestly, as did its current liabilities. The make-up of the current liabilities changes somewhat over the year, with operating liabilities increasing and current debt repayments decreasing. Both of these ratios are lower than the retail industry medians, though Target’s scale of operation seems to reassure its creditors. b. 2018 Times interest earned = $4,312 / $666 = 6.47 2018 Debt-to-equity = ($38,999 - $11,709) / $11,709= 2.33 2017 Debt-to-equity = ($37,431 - $10,953) / $10,953 = 2.42 Target’s debt-to-equity decreased slightly and is lower than the retail industry median. The times-interest-earned ratio is calculated without including the income from discontinued operations. c. Target is liquid and not excessively financially leveraged. Its times interest earned ratio indicates that earnings before interest and taxes is just about 6.5 times interest expense. Because the company generates significant operating profits and operating cash flow ($6.8 billion), we have no solvency concerns about Target.

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M5-19. (20 minutes) LO 1 3M COMPANY Common-size Balance Sheets 2017

2016

Assets Current assets Cash, cash equivalents and marketable securities Accounts receivable - net of allowances of $103 and $88 Total inventories Prepaids Other current assets Total current assets

10.9% 12.9% 10.6% 2.5% 0.7% 37.6%

8.1% 13.3% 10.3% 2.5% 1.4% 35.6%

Property, plant and equipment - net Goodwill Intangible assets - net Other assets Total assets

23.3% 27.7% 7.7% 3.7% 100.0%

25.9% 27.9% 7.1% 3.6% 100.0%

Liabilities and Shareholders’ Equity Current liabilities Short-term borrowings and current portion of long-term debt Accounts payable Accrued payroll Accrued income taxes Other current liabilities Total current liabilities

4.9% 5.1% 2.3% 0.8% 7.1% 20.2%

3.0% 5.5% 2.1% 0.9% 7.5% 18.9%

Long-term debt Pension and postretirement benefits Other liabilities Total liabilities Total equity Total liabilities and equity

31.8% 9.5% 7.8% 69.4% 30.6% 100.0%

32.5% 12.2% 5.0% 68.6% 31.4% 100.0%

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M5-20. (15 minutes) LO 1 3M COMPANY Common-size Income Statements Net sales Operating expenses Cost of sales Selling, general and administrative expenses Research, development and related expenses Gain on sale of businesses Total operating expenses Operating income Interest expense Interest income Income before income taxes Provision for income taxes Net income including noncontrolling interest

2017 100.0%

2016 100.0%

50.5% 20.8% 5.8% -1.9% 75.3% 24.7% 1.0% -0.2%

50.0% 20.7% 5.8% -0.4% 76.0% 24.0% 0.7% -0.1%

23.8% 8.5% 15.4%

23.4% 6.6% 16.8%

M5-21. (20 minutes) LO 2, 3 ($ millions) a. 2017 EWI = $4,869 + $322 x (1 - 0.35) = $5,078.3 2017 Average total assets = ($37,987 + $32,906)/2 = $35,446.5 ROA = $5,078.3/$35,446.5 = 14.33% b. PM = $5,078.3/$31,657 = 16.04% AT = $31,657/$35,446.5 = 0.893 16.04% X 0.893 = 14.32% (0.01 difference due to rounding)

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M5-22. (15 minutes) LO 2, 3 ($ millions) a. URBN:

TJX:

Average total assets = ($1,953 + $1,903)/2 = $1,928 ROA = $108 / $1,928 = 5.60% Average total assets = ($14,058 + $12,884)/2 = $13,471 ROA = $2,653 / $13,471 = 19.69%

b. URBN:

PM = $108 / $3.616 = 2.99% AT = $3,616 / $1,928 = 1.88 2.99% X 1.88 = 5.62% (0.02 difference due to rounding)

TJX:

PM = $2,653 / $35,865 = 7.40% AT = $35,865 / $13,471 = 2.66 7.40% X 2.66 = 19.68% (0.01 difference due to rounding)

c. URBN’s ROA is quite a bit lower than TJX’s. TJX has a higher PM and AT. As is typical of value-priced retailers, TJX’s asset turnover is high – its AT is 41% higher than that of URBN. On balance, TJX’s business model appears to be more successful in 2017 as it is able to maintain both a high AT and a high PM, resulting in higher ROA.

M5-23. (20 minutes) LO 4 ($ millions) a. Verizon’s current ratio for the two years presented is as follows: 2017 current ratio: $29,913 / $33,037 = 0.91 2016 current ratio: $26,395 / $30,340 = 0.87 In 2017, Verizon’s current ratio was below 1.0 which is below the industry median current ratio of 1.19. We might want to know, however, whether Verizon’s current assets are concentrated in cash or relatively illiquid inventories, as well as the maturity schedule of its current liabilities. Its CR in 2016 is in the same range as 2017. From 2016 to 2017, Verizon reports a significant increase in accounts receivable and a significant increase in debt due within the next year.

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b. Verizon’s times interest earned ratio for the two years is as follows: 2017 times interest earned = $25,327 / $4,733 = 5.35 2016 times interest earned = $25,362 / $4,376 = 5.80 Verizon’s times interest earned ratio has decreased, but remains higher than the industry median (2.57). 2017 debt-to-equity = $212,456 / $43,096 = 4.93 2016 debt-to-equity = $220,148 / $22,524 = 9.77 Verizon’s 2016 debt-to-equity ratio is significantly above the 1.83 median for companies in the telecommunications industry. The ratio decreased dramatically to 4.93 in 2017 due to increased shareholders’ equity. Verizon’s operating cash flow to current liabilities ratio is as follows: 2017 OCFCL = $25,305 / [($33,037 + $30,340)/2] = 0.80 2016 OCFCL = $22,810 / [($30,340 + $35,052)/2] = 0.70 c. Verizon is carrying a significant amount of debt. Although its profitability and operating cash flow are fairly strong, neither is particularly high in relation to the company’s liabilities and interest costs. Verizon’s liquidity appears below that of others in its industry, and its debt-to-equity is now very high. Given its significant capital expenditure requirements and its current debt load, Verizon may have to fund future capital expenditures with higher-cost equity. And, to the extent that its competitors are not as highly leveraged, this may negatively impact Verizon’s competitive position.

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M5-24. (30 minutes) LO 3 a. $ millions

Asset Turnover

Procter & Gamble .............................. $66,832/$66,119 = 1.01 CVS ...................................................$184,765/$94,797 = 1.95 Valero Energy ...................................$88,407/ $48,166 = 1.84 b. $ millions

ART

Procter & Gamble .............................. $66,832/$4,640 = 14.40 CVS ...................................................$184,765/$12,673 = 14.58 Valero Energy ...................................$88,407/ $6,296 = 14.04 $ millions

INVT

Procter & Gamble .............................. $33,449/$4,681 = 7.15 CVS ...................................................$156,208/$15,028 = 10.39 Valero Energy ...................................$81,926/ $6,047 = 13.55 $ millions

PPET

Procter & Gamble .............................. $66,832/$20,247 = 3.30 CVS ...................................................$184,765/$10,234 = 18.05 Valero Energy ...................................$88,407/ $26,976 = 3.28 c. For all three companies, these ratios reflect differences in their businesses, and the overall AT ratio is related to the three individual ratios as seen in Exhibit 5.8 in the chapter. The three companies collect from their customers relative quickly, as seen in the similar values of ART. Valero carries the smallest amount of inventory relative to its cost of goods sold. Procter & Gamble’s ratios are influenced by the relative strength of its largest customer (Walmart), resulting in higher inventory levels and slower collections. In addition, P&G has a large level of intangible assets, as we will see in Chapter 8, so its PPET is relatively high, but its AT is the lowest of the three. CVS’s inventory turnover is higher than P&G. CVS leases most of its store space, so PP&E is low relative to sales (though that practice will change in the near future as we will see in Chapter 10).

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EXERCISES E5-25. (30 minutes) LO 2, 3 a. ($ millions) McDonald’s

[$5,192 + $921 x (1 - 0.35)] / $32,414 = 17.9%

Yum! Brands

[($1,340 + $440 x (1 - 0.35)] / $5,382 = 30.2%

b. ($ millions)

PM = EWI / Sales

AT = Sales / Avg. Assets

McDonald’s

[$5,192 + $921 x (1 - 0.35)] / $22,820 = 25.4%

$22,820 / $32,414 = 0.70

Yum! Brands

[($1,340 + $440 x (1 - 0.35)] / $5,878 = 27.7%

$5,878 / $5,382 = 1.09

c. McDonald’s ROA is lower than Yum! Brands’ in fiscal 2017. The companies’ profit margins (PM) are similar, but Yum! Brands has a significantly higher asset turnover (AT). For both firms, asset turnover is influenced by franchising and leasing of retail stores.

E5-26. (20 minutes) LO 2 a. Case Assets Non-interest-bearing liabilities Interest-bearing liabilities Shareholders’ equity

A 1,000 0 0 1,000

B 1,000 0 250 750

C 1,000 0 500 500

D 1,000 0 500 500

E 1,000 200 0 800

F 1,000 200 300 500

Earnings before interest and taxes Interest expense Earnings before taxes Tax expense (40%) Net income

120 0 120 48 72

120 25 95 38 57

120 50 70 28 42

80 50 30 12 18

100 0 100 40 60

80 30 50 20 30

ROE ROA ROFL

7.2% 7.2% 0.0%

7.6% 7.2% 0.4%

8.4% 7.2% 1.2%

3.6% 4.8% -1.2%

7.5% 6.0% 1.5%

6.0% 4.8% 1.2%

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b. These three cases differ only in the amount of interest-bearing liabilities used to finance the firm. As leverage increases, the return to shareholders’ equity (ROE) increases. However, the return on assets (ROA) does not change, because the ROA is independent of the way that the business was financed. c. However, financial leverage (the use of liabilities to finance the firm) does not always work in favor of shareholders. The liability holders require a fixed return (6% aftertax = 10% x (1 – 40%)), and in order for leverage to work in favor of shareholders, the overall return on assets must exceed this fixed return. In case C, the return on assets is 7.2% > 6%, so ROFL is positive. In case D, the return on assets is 4.8% < 6%, so ROFL is negative. In case E, the return on assets equals the after-tax return required on interestbearing liabilities, but the company has only non-interest-bearing liabilities. The ROA is greater than zero, so ROFL is positive. In essence, the rate required on liabilities is the “break-even” ROA in order for ROFL to be positive. d. In case F, there is a mixture of liability types. Even though ROA is less than the amount needed for interest-bearing liabilities, ROFL is positive because some of Company F’s liabilities require no interest. The general relationship among these variables is the following: ROE = ROA + ROA*(NL/SE) + [ROA – (1 – t)*i]*(IL/SE) where

A = Assets, NL = non-interest-bearing liabilities, IL = interest-bearing liabilities, SE = shareholders’ equity, t = tax rate, i = pre-tax interest rate on interest-bearing liabilities, ROE = return on shareholders’ equity, and ROA = return on assets.

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E5-27. (20 minutes) LO 2, 3 ($ millions)

CVS

Walgreens

EWI Avg. Assets ROA

$6,623 + $1,062 x (1 - 0.35) = $7,313.3 ($95,131 + $94,462)/2 = $94,796.5 $7,313.3/ $94,796.5 = 7.71%

$4,101 + $728 x (1 - 0.35) = $4,574.2 ($66,009 + $72,688) /2 = $69,348.5 $4,574.2/ $69,348.5 = 6.60%

PM AT

$7,3313.3/$184,765 = 3.96% $184,765 /$94,796.5 = 1.95

$4,574.2/$118,214 = 3.87% $118,214/$69,348.5 = 1.70

Avg. Equity ROE ROFL

($37,695 + $36,834)/2 = $37,264.5 $6,623 / $37,264.5 = 17.77% 17.77% - 7.71% = 10.06%

($28,274 + $30,281)/2 = $29,277.5 $4,101 / $29,277.5 = 14.01% 14.01% - 6.60% = 7.41%

d. Walgreen’s ROE and ROA are lower than CVS’s. CVS’s PM is slightly higher than Walgreen’s, but its AT is considerably higher than Walgreen’s. The low PMs for both companies reflect the highly competitive retail pharmaceutical industry. Both companies are using financial leverage, but to a larger degree for CVS. Asset turnover and ROA differences would have to be examined further, because both companies use operating leases that do not show up on the balance sheet. (Though, that is scheduled to change in the near future. Chapter 10 looks at this important topic.)

E5-28. (30 minutes) LO 2, 3 ($ millions) a. ROE

2017: $9,601 / [($69,019 + $66,226) / 2] = 14.20% 2016: $10,316 / [($66,226 + $61,085) / 2] = 16.21%

b. ROA

2017: [$9,601 + $637x(1 - 0.35)] / [($123,249 + $113,327) / 2] = 8.47% 2016: [$10,316 + $725x(1 - 0.35)] / [($113,327 + $101,459) / 2] = 10.04%

ROFL

2017: 14.20% - 8.47% = 5.73% 2016: 16.21% - 10.04% = 6.17%

ROFL is positive, so leverage is working in favor of Intel’s shareholders.

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c. Net Profit Margin 2017: $9,601 / $62,761 = 15.30% 2016: $10,316 / $59,387 = 17.37% Asset Turnover

2017: $62,761 / [($123,249 + $113,327) / 2] = 0.531 2016: $59,387 / [($113,327 + $101,459) / 2] = 0.553

Financial Leverage

2017: [($123,249 + $113,327) / 2] / [($69,019 + $66,226) / 2] = 1.749 2016: [($113,327 + $101,459) / 2] / [($66,226 + $61,085) / 2] = 1.687

Intel’s financial leverage increased slightly from 2016 to 2017. Both ROA and ROE decreased. Based on ROFL, leverage increased ROE by about 70% over ROA each year. These increases correspond to the DuPont financial leverage measure in this case because Intel’s borrowing costs are so low. In general, there is a bias in DuPont analysis in that it tends to overstate the benefits of financial leverage. Offsetting this bias, DuPont analysis calculates the net profit margin, which is lower than PM because the numerator is net of interest costs. For comparison purposes, Intel’s PM ratios are presented below. PM ratio

2017: [$9,601 + $637 x (1 - 0.35)] / $62,761 = 15.96% 2016: [$10,316 + $725 x (1 - 0.35)] / $59,387 = 18.16%

E5-29. (30 minutes) LO 2, 3 ($ millions) a. ROE

2019: 2018: 2017:

€850 / [(€138+€1,477) / 2] = 105.26% €805 / [(€1,477+€2,184) / 2] = 43.98% €448 / [(€2,184+$€1,875) / 2] = 22.07%

b. ROA

2019: 2018: 2017:

[€850+€246x(1 - 0.25)] / [(€6,108+€6,451) / 2] = 16.47% [€805+€208x(1 - 0.25)] / [(€6,451+€7,173) / 2] = 14.11% [€448+€237x(1 - 0.25)] / [(€7,173+€6,972) / 2] = 8.85%

ROFL

2019: 2018: 2017:

105.26% - 16.47% = 88.79% 43.98% - 14.11% = 29.87% 22.07% - 8.85% = 13.22%

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c. Net Profit Margin

2019: 2018: 2017:

€850 / €10,364 = 8.20% €805 / €9,613 = 8.37% €448 / €8,632 = 5.19%

Asset Turnover

2019: 2018: 2017:

€10,364 / [(€6,108+€6,451) / 2] = 1.650 €9,613 / [(€6,451+€7,173) / 2] = 1.411 €8,632 / [(€7,173+€6,972) / 2] = 1.221

Financial Leverage

2019: 2018: 2017:

[(€6,108+€6,451) / 2] / [(€138+€1,477) / 2] = 7.776 [(€6,451+€7,173) / 2] / [(€1,477+€2,184) / 2] = 3.721 [(€7,173+€6,972) / 2] / [(€2,184+€1,875) / 2] = 3.485

HD Rinker’s ROA increased slightly from 2018 to 2019 (mostly due to better asset turnover), but its ROE skyrocketed! During both 2018 and 2019, Rinker increased its liabilities, and significantly reduced its equity. Its debt-to-equity ratio is 43.3 at the end of fiscal year 2019, so the ROE is greater than 100%. This level of returns is exceptional for shareholders, but the company’s condition could be precarious if its performance were to deteriorate. The DuPont analysis shows that the net profit margin decreased from 2018 to 2019, but the asset turnover improved significantly. Based on ROFL, leverage increased ROA by 2.5 times in 2017 (22.07%/8.85%) while in 2019, leverage increased ROA by a factor of 6.4 (105.26%/16.47%). DuPont analysis suggests that leverage had a slightly larger impact (3.485 in 2017 and 7.776 in 2019) but the trend is the same. This is consistent with the bias in DuPont analysis in that it tends to overstate the effects of financial leverage. Offsetting this bias, DuPont analysis calculates the net profit margin, which is lower than PM because the numerator is net of interest costs. For comparison purposes, HD Rinker’s PM ratios are presented below: PM ratio

2019: [€850+€246x (1-.25)] / €10,364 = 9.98% 2018: [€805+€208x (1-.25)] / €9,613 = 10.00% 2017: [€448+€237x(1-.25)] / €8,632 = 7.25%

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E5-30. (20 minutes) LO 2, 3 ($ millions) a. EWI Avg. Equity Avg. Assets ROE ROA ROFL

$181 + $62 x (1 - 0.35) = $221.3 ($2,120 + $1,852)/2 = $1,986.0 ($6,323 + $5,540)/2 = $5,931.5 $181 / $1,986.0 = 9.11% $221.3 / $5,931.5 = 3.73% 9.11% - 3.73% = 5.38%

b. PM AT

$221.3 / $10,240 = 2.16% $10,240 / $5,931.5 = 1.73

c. Office Depot has a very low profit margin and an asset turnover that is a little less than 2.0. This ratio combination is consistent with a low-price, high-volume business model. However, compared to the retail industry, Office Depot is doing poorly. Both its AT and its PM are below the median. As a result, its ROA and ROE are well below the industry medians.

E5-31. (20 minutes) LO 2, 3 ($ millions) a.

EWI Avg. Equity Avg. Assets ROE ROA

$1,211 + $20 x (1-.35) = $1,224.0 ($2,354 + $1,354) / 2 = $1,854.0 ($5,178 + $4,068) / 2 = $4,623.0 $1,211 / $1,854.0 = 65.32% $1,224.0 / $4,623.0 = 26.48%

ROFL

65.32% - 26.48% = 38.84%

PM AT

$1,224.0 / $5,964 = 20.52% $5,964 / $4,623.0 = 1.29

c. Intuit has a relatively high PM ratio and a low AT ratio. These numbers are consistent with the business model employed in the software industry. Contrast these numbers with those of Office Depot (E5-30). Intuit uses financial leverage effectively; leverage increased its ROA by a factor of almost 2.5 (65.32%/26.48%). ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 5

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E5-32. (30 minutes) LO 4 a. 2017

2016

Current ratio

$6,570,520/$7,674,670 = 0.86

$6,259,796/$5,827,005 = 1.07

Quick ratio

($3,367,914+$155,323+$515,381) /$7,674,670 = 0.53

($3,393,216+$105,519+$499,142)/$5,827,005 = 0.69

2017

2016

Debt-toequity ratio

$23,022,980/$5,632,392 = 4.09

$16,750,167/$5,913,909 = 2.83

Timesinterestearned ratio

(-2,209,032 + $471,259)/$471,259 = -3.69

c. Cash burn rate = (-60,654 - $3,414,814)/365 days = -$9,522 thousand per day. Tesla’s financial condition has been a topic of considerable discussion in the recent past. Its current and quick ratios have dropped from 2016 to 2017, and they are among the lowest in Exhibit 5.13. (The restricted cash should not be considered an available resource for paying obligations, but the amount is not very significant.) The same is true of its debt-to-equity ratio. The times-interest-earned ratio doesn’t tell us much because it’s negative. Tesla is not earning income from which interest cash be paid; rather it is earning losses that are increased by interest expense. As of 2017, Tesla is using up cash for operations and capital expenditures at the rate of about $10 million per day. With $3.3 billion in cash as of the end of 2017, that means that if Tesla continues to spend at the same rate, it will run out of cash in late 2018. But that’s a very big “if,” and it is the source of disagreement among investors. Almost every new company starts its life with negative free cash flow. But every successful new company must reach a point where it stops consuming cash and begins to generate cash. The 2018 quarterly reports for Tesla appear to show that point may have been reached.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E5-33. (30 minutes) LO 4 a. ($ millions)

Current Ratio

OCFCL

2015

€51,442 / €39,562 = 1.30

€6,612 / [(€36,598 + €39,562) / 2] = 0.174

2016

€55,329 / €42,916 = 1.29

€7,611 / [(€39,562 + €42,916) / 2] = 0.185

2017

€58,429 / €43,394 = 1.35

€7,176 / [(€42,916 + €43,394) / 2] = 0.166

Siemens has a current ratio that is above 1.0 and has been steady around 1.3 over these years. Moreover, its OCFCL ratio stayed in the same range around 0.175. While the current ratio provides a useful point estimate of liquidity, the OCFCL ratio suggests that operations are not generating sufficient net cash flow to cover shortterm obligations, but it would be useful to also get a sense of the volume of resource flows relative to the current liabilities. Siemens’ revenues for 2017 exceeded €83 billion. b.

($ millions)

Times interest earned

Debt-to-equity

2015

€(7,218 + 818) / €818 = 9.82

€85,293 / €34,474 = 2.47

2016

€(7,404 + 989) / €989 = 8.49

€90,901 / €34,211 = 2.66

2017

€(8,306 + 1,051) / €1,051 = 8.90

€89,277 / €43,089 = 2.07

The times interest earned ratio decreased in 2016 but rebounded in 2017. Siemens’ debt-to-equity ratio has been quite high around 2.50, but decreased in 2017. c. It’s always a good idea to look into the numbers that make up the ratios before coming to conclusions. For instance, Siemens’ current liabilities include about €10.3 billion in unearned revenue, representing more than a quarter of its current liabilities. In the normal course of business, deferred performance liabilities like these aren’t paid off with cash – rather Siemens must provide the agreed-upon services and products to the customers. It’s not easy to place Siemens into one of the industry groups in Exhibit 5.13, but its DE ratio appears to be higher than any industry median except utilities. However, its TIE appears to be in a satisfactory range. And, the company’s size and diversified businesses give it a stability that can reassure lenders.

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E5-34. (30 minutes) LO 2, 3 ($ millions) a.

EWI Avg. Equity Avg. Assets ROE ROA ROFL

$848 + $74 x (1 - 0.35) = $896.1 ($3,144 + $2,904) / 2 = $3,024.0 ($7,989 + $7,610) / 2 = $7,799.5 $848 / $3,024.0 = 28.04% $896.10 / $7,799.5 = 11.49% 28.04% - 11.49% = 16.55%

PM AT

$896.10 / $15,855 = 5.65% $15,855 / $7,799.5 = 2.033

GPM INVT

$6,066 / $15,855 = 38.26% $9,789 / [($1,997 + $1,830) / 2] = 5.116

d. The Gap showed strong performance in the year ended February 3, 2018 (hereafter, 2017), with modest improvements over 2016. Its ROA was 11.5%, which is high for the retail industry. ROE was almost 30% indicating the effective use of financial leverage. Interest costs were low, suggesting that most of The Gap’s debt is from operating liabilities (accounts payable and accrued expenses). Its profit margin and asset turnover ratios place The Gap in a strong position for this industry. The GPM and INVT ratios are two important performance measures for retail companies such as The Gap. GPM measures the ability of the firm to sell its merchandise at reasonable margins while INVT provides evidence on inventory management and the popularity of its product line. Both measures are near the median for retailers in 2017.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E5-35.B (20 minutes) LO 1, 6 a. & b. THE GAP, INC. Common-size and Income Statement Forecasts Net sales Cost of goods sold and occupancy expenses Gross profit Operating expenses Operating income Interest expense Interest income Income before income taxes Income taxes Net income

100.0%

$15,800

$16,300

$16,800

63.7% 36.3% 28.7% 7.7% 0.5% -0.1% 7.2% 2.9% 4.4%

61.7% 38.3% 28.9% 9.3% 0.5% -0.1% 9.0% 3.6% 5.3%

9,796 6,004 4,582 1,422 74 (19) 1,367 342 $ 1,025

10,106 6,194 4,727 1,467 74 (19) 1,412 353 $ 1,059

10,416 6,384 4,872 1,512 74 (19) 1,457 364 $ 1,093

c. Note: 2016 and 2017 common size statements are reversed (2016 on the left). Forecasted statements are presented for three different sales levels. The Gap’s statement forecasts are based on (1) projected sales and (2) a set of assumptions that determine the relationship between various expense items and sales revenue. The accuracy of the projection depends on the reliability of these estimates, which depends on management’s ability to maintain a stable GPM ratio, maintain INVT ratio, and control operating expense ETS ratios. It also depends on which costs are variable and which are fixed. If SG&A expenses were fixed at the 2017 level regardless of 2018 sales, then the forecasted statements would show a greater variation in profits as sales change.

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PROBLEMS P5-36. (45 minutes) LO 2, 3 ($ millions) Nike

Adidas

EWI

$1,933 + $54 x (1 - 0.25) = $1,973.5

€1,100 + €93 x (1 - 0.30) = €1,165.10

Avg. Equity

($9,812 + $12,407) / 2 = $11,109.5

(€6,435 + €6,455) / 2 = €6,445

Avg. Assets

($22,536 + $23,259) / 2 = $22,897.5

(€14,522 + €15,176) / 2 = €14,849

ROE

$1,933 / $11,109.5 = 17.40%

€1,100 / €6,445 = 17.07%

ROA

$1,973.5 / $22,897.5 = 8.62%

€1,165.1 / €14,849 = 7.85%

ROFL

17.40% - 8.62% = 8.78%

17.07% - 7.85% = 9.22%

Nike’s performance on both measures of profitability exceeded that of Adidas, though not by a wide margin. We can examine possible reasons for that difference by looking at the ratios below. b.

PM AT

$1,973.5 / $36,397 = 5.42% $36,397 / $22,897.5 = 1.59

€1,165.1 / €21,218 = 5.49% €21,218 / €14,849 = 1.43

Nike’s PM ratio is very slightly lower than Adidas’s, but its AT ratio is 11% higher. So, Nike’s higher ROA appears to be driven by more efficient use of assets. c.

GPM Operating ETS

$15,956 / $36,397 = 43.8% $11,511 / $36,397 = 31.6%

€10,703 / €21,218 = 50.4% €8,634 / €21,218 = 40.7%

Adidas reports a higher GPM ratio than Nike by about 7%. However, that is more than offset by much higher operating expenses as a percentage of sales. d.

ART INVT PPET

$36,397 / $[(3,498 + 3,677) / 2] = 10.15 $20,441 / $[(5,261 + 5,055) / 2] = 3.96 $36,397 / $[(4,454 + 3,989) / 2] = 8.62

€21,218 / €[(2,315 + 2,200) / 2] = 9.40 €10,514 / €[(3,693 + 3,764) / 2] = 2.82 €21,218 / €[(2,000 + 1,915) / 2] = 10.84

Nike’s INVT is significantly higher than Adidas’s, suggesting that Nike may be managing inventory more efficiently. Both companies’ PPET ratios are high. These are consistent with a business model that outsources most of the production.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

e. The two companies’ fiscal years overlap by seven months. Nike’s income statement includes January through May 2018 while Adidas’ statements cover January through May 2017. (Both cover June through December 2017.) Economic conditions were not materially different in 2018 than 2017, so the comparisons involving income statement accounts shouldn’t be affected too much. However, companies that experience seasonality will have balance sheets that look different at different points in time. For instance, a company might have lower inventory levels just after a busy season, and choosing that point for the end of its fiscal year would produce a higher value for ROA or INVT than a fiscal year just prior to its busy season. f. Normally, we would want to identify any major differences in the valuation of assets and the measurement of income between these two companies. For example, some assets are more likely to be valued at current value (rather than historical cost) under IFRS reporting. Such a difference would affect ratios such as ROA, AT, INVT and PPET.

P5-37. (20 minutes) LO 4 ($ millions) a. Current Ratio Quick Ratio

Nike

Adidas

2017: $15,134 / $6,040 = 2.51

€8,645 / €6,291 = 1.37

2016: $16,061 / $5,474 = 2.93

€8,886 / €6,765 = 1.31

2017: $(4,249+996+3,498) / $6,040 = 1.45

€(1,598+398+2,315) / €6,291 = 0.69

2016: $(3,808+2,371+3,677) / $5,474 = 1.80

€(1,510+734+2,200) / €6,765 = 0.66

Nike is more liquid than Adidas. Its current ratio is around 2.5 and its quick ratio is near 1.5 – both values close to the medians for the apparel industry. In fact, Nike’s quick ratio is higher than Adidas’s current ratio.

b. TIE Debt-to-Equity

2017: ($4,325 + $54) / $54 = 81.09

(€2,022 + €93) / €93 = 22.74

2016: ($4,886 + $59) / $59 = 83.81

(€1,536 + €74) / €74 = 21.76

2017: $12,724 / $9,812 = 1.30

€8,087 / €6,435 = 1.26

2016: $10,852 / $12,407 = 0.87

€8,721 / €6,455 = 1.35

Nike’s debt-to-equity ratio is very low with values close to the apparel industry average. But the ratio increased significantly in 2017 when liabilities increased by $1.9 billion and equity decreased by about $2.6 billion. Adidas’s debt-to-equity ratio is higher, and also went up in 2017. Nike’s TIE ratio decreased while Adidas’ ratio increased slightly.

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Historically, Adidas relies on greater amounts of debt financing than does Nike, but their DE ratios are essentially equivalent in this latest year. The TIE ratio for Nike is much higher than for Adidas. Although Adidas’s TIE ratio is not too low, Nike’s small amount of interest expense produces a very high TIE. Neither company should have difficulty meeting its debt obligations, but Adidas may not be able to borrow as much in the future (if needed).

P5-38. (45 minutes) LO 2, 3 Home Depot

Lowe’s

EWI

$8,630 + $1,057 x (1 - 0.35) = $9,317.05

$3,447 + $649 x (1 - 0.35) = $3,868.85

Avg. Equity

($1,454 + $4,333) / 2 = $2,893.5

($5,873 + $6,434) / 2 = $6,153.5

Avg. Assets

($44,529 + $42,966) / 2 = $43,747.5

($35,291 + $34,408) / 2 = $34,849.5

ROE

$8,630 / $2,893.50 = 298.3%

$3,447 / $6,153.5 = 56.0%

ROA

$9,317.05 / $43,747.5 = 21.3%

$3,868.85 / $34,849.5 = 11.1%

ROFL

298.3% - 21.3% = 277.0%

56.0% - 11.1% = 44.9%

($ millions) a.

In 2017, Home Depot’s profitability exceeded that of Lowe’s, both in return to shareholders and in return on assets. Home Depot also had a much larger proportional effect from the use of leverage. It has shareholders’ equity that is only 17% of its current earnings – the result of large dividends and share buybacks. b.

$9,317.05 / $100,904 = 9.2%

$3,868.85 / $68,619 = 5.6%

$100,904 / $43,747.5 = 2.31

$68,619 / $34,849.5 = 1.97

Home Depot has a higher PM ratio, so it makes more money for every dollar of sales, and it also generates more sales for every dollar of resources, suggesting that it is managing assets more efficiently. c.

GPM

$34,356 / $100,904 = 34.0%

$23,409 / $68,619 = 34.1%

Operating ETS

($17,864 + $1,811) / $100,904 = 19.5%

($15,376 + $1,447) / $68,619 = 24.5%

These two companies have identical gross profit margins, but The Home Depot’s operating ETS ratio is lower by a significant amount (5% of sales, or $5 billion). Overall, Home Depot performed slightly better with respect to these two profitability measures.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

($ millions)

Lowe’s

Home Depot

ART

$100,904 / $[(1,952 + 2,029)/2] = 50.69

$68,619 / 0 = N/A

INVT

$66,548 / $[(12,748 + 12,549)/2] = 5.26

$45,210 / $[(11,393 + 10,458)/2] = 4.14

PPET

$100,904 / $[(22,075 + 21,914)/2] = 4.59

$68,619 / $[(19,721 + 19,949)/2] = 3.46

Lowe’s reports no accounts receivable and Home Depot reports very small amounts of receivables. Neither company relies on customer credit to generate sales, so the ART ratio is not very informative. More important is the INVT ratio. Home Depot’s INVT is higher than Lowe’s ratio. The same is true for the PPET ratio. These differences are consistent with the difference in the AT ratios noted earlier. Overall, the numbers suggest that Home Depot is managing inventories and PPE assets more efficiently. e. Overall, It appears that Home Depot performed better than Lowe’s in 2017. Its ratio values are either equal to or better than Lowe’s in almost every category.

P5-39. (30 minutes) LO 4 ($ millions) a.

Home Depot

Lowe’s

Current Ratio

2017: 2016:

$18,933 / $16,194 = 1.17 $17,724 / $14,133 = 1.25

$12,772 / $12,096 = 1.06 $12,000 / $11,974 = 1.00

Quick Ratio

2017: 2016:

($3,595 + $1,952) / $16,194 = 0.343 ($2,538 + $2,029) / $14,133 = 0.323

($588 + $102) / $12,096 = 0.057 ($558 + $100) / $11,974 = 0.055

Both companies’ current ratios are above one, though Home Depot’s is a bit higher. Quick ratios are very low due to the lack of receivables and low cash balances. Both companies rely on operating cash flow to cover liquidity needs. Given the lack of receivables, the INVT ratio becomes doubly important (see P5-38). Failure to turn inventories quickly would result in lower operating cash flow and liquidity problems. Hence, both companies emphasize inventory management.

TIE Debt-to-Equity

2017: 2016:

($13,698 + $1,057)/$1,057 = 13.96 ($12,491 + $972)/$972 = 13.85

($5,489 + $649)/$649 = 9.46 ($5,201 + $657)/$657 = 8.92

2017: 2016:

$43,075 / $1,454 = 29.63 $38,633 / $4,333 = 8.92

$29,418 / $5,873 = 5.01 $27,974 / $6,434 = 4.35

For both companies, the debt-to-equity ratio increased from 2016 to 2017 indicating more reliance on debt financing. In fact, The Home Depot had free cash flow over $10 billion in 2017, and it returned $12.2 billion to shareholders in dividends and repurchases of common stock. Both companies’ DEs are higher than the median for the retail industry. Despite this trend, both companies’ TIE ratios increased.

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The Home Depot utilizes more debt financing than does Lowe’s though both are higher than the median retail firm. This results in a higher ROFL (see P5-38), as well as higher debt-to-equity. Both firms have TIE ratios that are above the median for the retail industry.

P5-40.A (30 minutes) LO 5 Lowe’s

($millions) Home Depot $8,630 – [($74 - $1,057) x (1 - 0.35)] = $9,268.95

$3,447 – [($16 - $649) x (1 - 0.35)] = $3,858.45

NOA 2017:

$44,529 - $(43,075 – 2,761 – 24,267) = $28,482

$(35,291 - 102 - 408) - $(29,418 – 1,431 – 15,564) = $22,358

NOA 2016:

$42,966 - $(38,633 - 1,252– 22,349) = $27,934

$(34,408 - 100 - 366) - $(27,974 – 1,305 – 14,394) = $21,667

Avg. NOA

($28,482 + $27,934) / 2 = $28,208

($22,358 + $21,667) / 2 = $22,012.5

b. RNOA

$9,268.95 / $28,208 = 32.9%

$3,858.45 / $22,012.5 = 17.5%

c. NOPM

$9,268.95 / $100,904 = 9.19%

$3,858.45 / $68,619 = 5.62%

$100,904 / $28,208 = 3.58

$68,619 / $22,012.5 = 3.12

a. NOPAT

NOAT

d. The Home Depot reports a higher RNOA than does Lowe’s, and the pattern in the operating results parallels that in the total-firm results in P5-38. This is consistent with the ROA numbers computed in P5-38 (ROA=21.3% for Home Depot and 11.1% for Lowe’s). Overall, we would expect operating companies to have higher RNOA than ROA, because their core business is the operations of the company, not investing in financial assets. And, if management seeks to earn a favorable return for shareholders, they must expect a higher return on their operations than they have to pay for borrowed funds.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P5-41. (30 minutes) LO 2, 3 ($ millions) a.

2017

2016

EWI

$4,910 + $453 x (1 - 0.35) = $5,204.45

$3,431 + $381 x (1 - 0.35) = $3,678.65

Avg. Assets

($45,403 + $40,377) / 2 = $42,890.0

($40,377 + $38,311) / 2 = $39,344.0

ROA

$5,204.45/ $42,890.0= 12.1%

$3,678.65/ $39,344.0= 9.3%

$5,204.45/ $65,872 = 7.9%

$3,678.65/ $60,906 = 6.0%

$65,872 / $42,890.0 = 1.54

$60,906 / $39,344.0= 1.55

UPS’ ROA appears healthy in both years. Although AT decreased slightly in 2017, PM increased, which caused a corresponding increase in ROA. b.

Compensation ETS

$34,588 / $65,872 = 52.5%

$34,770 / $60,906 = 57.1%

The largest single expense on UPS’s income statement is compensation. The decrease in this ETS ratio from 57.1% to 52.5% of sales explains the rise in PM in 2017. c.

Avg. Equity

($1,030 + $429) / 2 = $729.5

($429 + $2,491) / 2 = $1,460.0

ROE

$4,910 / $729.5 = 673.1%

$3,431 / $1,460 = 235.0%

ROFL

673.1% - 12.1% = 661.0%

235.0% - 9.3% = 225.7%

UPS relies very heavily on debt financing. In 2017 and 2016, when ROA was at an acceptable level, ROFL produced an ROE 25 to 55 times as large as ROA.

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P5-42. (30 minutes) LO 4 ($ millions) a.

2017

2016

Current Ratio

$15,548 / $12,708 = 1.22

$13,849 / $11,730 = 1.18

Quick Ratio

$(3,320 + 749 + 8,773) / $12,708 = 1.01

$(3,476 + 1,091 + 7,695) / $11,730 = 1.05

UPS current and quick ratios changed little in 2017. The quick ratio is only slightly lower than the current ratio because UPS does not carry inventory balances. b.

TIE

($7,148 + $453) / $453 = 16.78

($5,136 + $381) / $381 = 14.48

Debt-to-Equity

$44,373 / $1,030 = 43.08

$39,948 / $429 = 93.12

The debt-to-equity ratio decreased dramatically in 2017 due to percentage change in shareholders’ equity exceeding that of liabilities. Nevertheless, a debt-to-equity ratio in the 40s is extremely high. At the same time, the TIE ratio increased due to an increase in pre-tax earnings. c.

UPS relies heavily on liability financing. The company’s current ratio and quick ratio are quite a bit lower than the medians of the Business Services industry. Being a capital-intensive business, their debt-to-equity ratio is significantly higher than the median. Although the company appears liquid, its ability to meet its obligations depends heavily on operating cash flow. The high debt-to-equity ratio suggests that UPS may have difficulty borrowing additional funds if needed.

P5-43.A (30 minutes) LO 5 ($ millions) a. NOPAT

United Parcel Service (UPS) $4,910 – [($72 – $453) x (1 – 0.35)] = $5,157.65

NOA

2017: $(45,403 – 749 - 483) - $(44,373 – 4,011 – 20,278) = $24,087 2016: $(40,377 – 1,091 - 476) - $(39,948 – 3,681 – 12,394) = $14,937

Avg. NOA

($24,087 + $14,937) / 2 = $19,512

b. RNOA

$5,157.65 / $19,512 = 26.4%

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. NOPM NOAT

$5,157.65 / $65,872 = 7.8% $65,872 / $19,512.0 = 3.38

d. UPS invests only small amounts in non-operating assets (less than 3% of total assets). So, when UPS invests borrowed funds in its operations, it earns a return above 20%, at least in 2017. Because its borrowing costs are significantly less than 20%, the financial leverage works in favor of the shareholders. P5-44.B (45 minutes) LO 6 a. UNITED PARCEL SERVICE, INC. Income Statements ($ millions) Revenue……………………………………………… Compensation and benefits……………………….. Other………………………………………………….. Operating profit……………………………………… Investment income………………………………….. Interest expense……………………………………… Income before income taxes……………………….. Income taxes………………………………………….. Net income……………………………………………..

2017 Actual

2018 Forecast

$65,872 34,588 23,755 7,529 72 453 7,148 2,238 $ 4,910

$70,000 36,756 25,244 8,000 72 453 7,619 1,905 $ 5,714

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b. UNITED PARCEL SERVICE, INC. Balance Sheets ($ millions) Cash and equivalents…………………………………. Marketable securities………………………………….. Accounts receivable, net……………………………… Other current assets………………………………….. Total current assets…………………………………… Property, plant and equipment………………………. Goodwill ……………………………………………… Intangible assets, net ……………………………… Non-current investments and restricted cash ……… Deferred income tax assets………………………… Other assets…………………………….……………… Total assets……………………….……………………. Current maturities of long-term debt………………… Accounts payable………………………………………. Accrued wages and withholdings……………………. Hedge margin liabilities Self-insurance reserves, current portion…………….. Accrued group welfare and retirement plan contributions ………………………………………. Other current liabilities………………………………… Total current liabilities………………………………… Long-term debt………………………….……………… Pension and postretirement obligation……………… Deferred taxes liabilities……………………………….. Self-insurance reserves ………………………………. Other noncurrent liabilities…………………………….. Total liabilities…………………………………………... Shareowners' equity…………………………………… Total liabilities and shareowners' equity……………..

2017 Actual

2018 Forecast

$ 3,320 749 8,773 2,706 15,548 22,118 3,872 1,964 483 265 1,153 $45,403

$ 4,874 749 9,323 2,876 17,822 23,504 4,115 2,087 483 282 1,225 $49,518

4,011 3,872 2,521 17 705 677 905 12,708 20,278 7,061 757 1,765 1,804 44,373 1,030 $45,403

4,011 4,115 2,679 18 749 719 962 13,253 20,278 7,503 804 1,876 1,917 45,631 3,887 $49,518

Students’ forecast calculations may vary. An unrounded forecast factor was used in the calculations presented in the solution. ©Cambridge Business Publishers, 2021 5-30

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P5-45. (45 minutes) LO 3 a. A summary of the ratios for these five companies appears in the following table. Calculations are provided below for each company. ABT

BMY

JNJ

GSK

PFE

3.89%

5.72%

2.49%

9.15%

42.21%

GPM

54.96%

68.50%

66.84%

65.74%

78.61%

b. A summary of the ratios for these five companies appears in the following table. Calculations are provided below for each company. ABT

BMY

JNJ

GSK

PFE

R&D ETS

8.16%

33.29%

13.81%

14.83%

14.57%

SG&A ETS

33.29%

24.34%

28.02%

32.04%

28.14%

c. What is perhaps most remarkable is how similar these five companies are. For example, the SG&A ETS ratio ranges between 24% and 34%, with three of the five between 28% and just over 32%. GPM ranges from a low of 55% (ABT) to 79% (PFE), but the other three firms are between 65% and 69%. This suggests that the business models employed by these companies are very similar. The PM ratio shows a fairly wide variation, ranging from a low of 2.5% (JNJ) to 42.2% (PFE). Interestingly, ABT appears to be one of the least profitable, with a 3.9% PM and a 55.0% GPM, yet it spends the least on R&D. That pattern could be caused by the fact that ABT spun off its research-oriented pharmaceuticals into a separate company (AbbVie). As an example, calculations of ratios for Abbott Laboratories follow: ($ millions)

Abbott Laboratories (ABT)

$477 + $904 x (1 - 0.35) / $27,390 = 3.89%

GPM

($27,390 - $12,337) / $27,390 = 54.96%

R&D ETS

$2,235 / $27,390 = 8.16%

SG&A ETS

$9,117 / $27,390 = 33.29%

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P5-46. (45 minutes) LO 3 a. Office Depot

Walgreens Boots

Best Buy

Kroger

Nordstrom

Return on assets (ROA)

7.85%

6.35%

3.52%

3.84%

8.20%

Profit margin (PM)

2.51%

1.91%

3.64%

2.22%

4.18%

Asset turnover (AT)

3.13

3.33

0.97

1.73

1.96

Best Buy

Kroger

Nordstrom

Office Depot

Walgreens Boots

AR turnover (ART)

35.18

74.66

89.99

12.66

20.08

Inventory turnover (INVT)

6.41

14.61

5.04

6.56

10.91

PP&E turnover (PPET)

17.88

5.83

3.95

15.44

9.55

Best Buy

Kroger

Nordstrom

Office Depot

Walgreens Boots

23.4%

22.0%

36.1%

24.0%

23.4%

Gross profit margin (GPM)

Nordstrom has the highest GPM (36.1%), but WBA has the highest ROA (8.20%) and PM (4.18%). Nordstrom has the lowest AT (0.97), reflecting its “higher margin, lower volume” position. On the other end of the spectrum, Kroger has the lowest PM (1.91%) and the highest AT and INVT, Inventory management is critical for a grocery chain. All of these companies have high ART, reflecting the fact that most of their customers pay at the time of purchase. Retail companies have the choice to report inventory and cost of sales using last-in, first-out (LIFO) or first-in, first-out (FIFO), which can affect margins and turnover ratios. We will look into this more closely in Chapter 7. In addition, retail companies lease much of their store space. As a result, the PPET ratio depends on how these store leases are reported in the balance sheet. Lease accounting is discussed in Chapter 10. continued next page

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. continued Calculations follow for Best Buy as an example ($ millions): Best Buy (BBY) EWI

$1,000 + $75 x (1-.25) = $1,056.25

ROA

$1,056.25 / $13,452.5 = 7.85%

$1,056.25 / $42,151 = 2.51%

$42,151 / $13,452.5 = 3.13

ART

$42,151 / $1,198 = 35.18

INVT

$32,275 / $5,036.5 = 6.41

PPET

$42,151 / $2,357 = 17.88

GPM

($42,151 - $32,275) / $42,151 = 23.4%

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CASES and PROJECTS C5-47. (30 minutes) LO 3 a. Raising prices and/or reducing manufacturing costs are not necessarily independent solutions and are likely related to other factors. The effect of a price increase on gross profit is a function of the demand curve for the company’s product. If the demand curve is relatively elastic, a price increase will likely significantly reduce demand, thereby decreasing, rather than increasing, gross profit (an example is a 10% increase in price and a 20% decrease in demand). A price increase will have a more desired effect if the demand curve is relatively inelastic (a 10% price increase with a 3% decrease in demand). Cutting manufacturing costs will positively affect gross profit (via reduction of COGS) if the more inexpensively made product is not perceived to be of lesser quality, thereby reducing demand. b. Raising prices is difficult in competitive markets. As the number of product substitutes increases, companies are less able to raise prices. Rather, they must be able to effectively differentiate their products in some manner in order to reduce consumers’ substitution. This can be accomplished, for example, by product design and/or advertising. These efforts, however, likely entail additional cost, and, while gross profit might be increased as a result, SG&A expense may also increase with little effect on the bottom line. Manufacturing costs consist of raw materials, labor and overhead. Each can be targeted for cost reduction. A reduction of raw materials costs generally implies some reduction in product quality, but not necessarily. It might be the case that the product contains features that are not in demand by consumers. Eliminating those features will reduce product costs with little effect on selling price. Similarly, companies can utilize less expensive sources of labor (off-shore production, for example), that can significantly reduce product costs and increase gross profit provided that product quality is maintained. Finally, manufacturing overhead can be reduced by more efficient production. Wages and depreciation expense are two significant components of manufacturing overhead. These are largely fixed costs, and the per-unit product cost can often be reduced by increasing capacity utilization of manufacturing facilities (provided, of course, that the increased inventory produced can be sold). The bottom line is that increasing gross profit is a difficult process than can only be accomplished by effective management and innovation. ©Cambridge Business Publishers, 2021 5-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

C5-48. (30 minutes) LO 3 a. Working capital management is an important component of the management of a company. By reducing the level of working capital, companies reduce the costs of carrying excess assets. This can have a significantly positive effect on financial performance. Some common approaches to reducing working capital via reductions in receivables and inventories, and increases in payables, include the following: •

Reduce receivables o Constricting the payment terms on product sales o Better credit policies that limit credit to high-risk customers o Better reporting to identify delinquencies o Automated notices to delinquent accounts o Increased collection efforts o Prepayment of orders or billing as milestones are reached o Use of electronic (ACH) payment o Use of third-party guarantors, including bank letters of credit

•

Reduce inventories o Reduce inventory costs via less costly components (of equal quality), produce with lower wage rates, eliminate product features (costs) not valued by customers o Outsource production to reduce product cost and/or inventories the company must carry on its balance sheet o Reduce raw materials inventories via just-in-time deliveries o Eliminate bottlenecks in manufacturing to reduce work-in-process inventories o Reduce finished goods inventories by producing to order rather than producing to estimated demand

•

Increase payables o Extend the time for payment of low or no-cost payables—so long as the relationship with suppliers is not harmed.

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b. The terms of payment that a company offers to its customers is a marketing tool, similar to product price and advertising programs. Many companies promote payment terms separately from other promotions (no payment for six months or interest-free financing, for example). As companies restrict credit terms, the level of receivables will likely decrease, thereby reducing working capital. The restriction of credit terms may also have the undesirable effect of reducing demand for the company’s products. The cost of credit terms must be weighed against the benefits, and credit terms must be managed with care so as to optimize costs rather than minimize them. Credit policy is as much art as it is science. Likewise, the depth and breadth of the inventories that companies carry impact customer perception. At the extreme, inventory stock-outs result in not only the loss of current sales, but also the potential loss of future sales as customers are introduced to competitors and may develop an impression of the company as “thinly stocked.” Inventories are costly to maintain, as they must be financed, insured, stocked, moved, and so forth. Reduction in inventory levels can reduce these costs. On the other hand, the amount and type of inventories carried is a marketing decision and must be managed with care so as to optimize the level inventories, not necessarily to minimize them. One company’s account payable is another’s account receivable. So, just as one company seeks to extend the time of payment, so as to reduce its working capital, so does the other company seek to reduce the average collection period so as to accomplish the same objective. Capable, dependable suppliers are a valuable resource for the company, and the supplier relation must be handled with care. All companies take as long to pay their accounts payable as the supplier allows in its credit terms. Extending the payment terms beyond that point begins to negatively impact the supplier relation, ultimately resulting in the loss of the supplier. The supplier relation must be managed with care so as to optimize the terms of payment, rather than necessarily to minimize them.

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C5-49. (30 minutes) LO 2, 3 a. The list of parties that are affected by schemes to manage earnings is often much broader than first thought. It includes the following affected parties: 1. employees above and below the level at which the scheme is implemented 2. stockholders and elected members of the board of directors 3. creditors of the company (suppliers and lenders) and their employees, stockholders, and boards of directors 4. competitors of the company 5. the company’s independent auditors 6. regulators and taxing authorities b. Managers often believe that earnings management activities will be short-lived, and will be curtailed once its operations “turn around.” Often, this does not prove to be the case. Interviews with managers and employees who have engaged in these activities often reveal that they started rather innocuously (just managing earnings to “make the numbers” in one quarter), but, quickly, earnings management became a slippery slope. Ultimately, the parties the company was trying to protect (shareholders, for example) are hurt more than they would have been had the company reported its results correctly, exposing problems early so that corrective action could be taken (possibly by removing managers) to protect the broader stakeholders in the company. c. Company managers are just ordinary people. They desire to improve their compensation, which is often linked to financial performance. Managers may act to maximize their current compensation at the expense of long-term growth in shareholder value. The reduction in the average employment period at all levels of the company has exacerbated the problem. d. Unfortunately, the separation of ownership and control often leads to less informed shareholders who are unable to effectively monitor the actions of the managers they have hired. To the extent that compensation programs are linked to financial measures, managers can use the flexibility given to them under GAAP to their benefit, even without violating GAAP per se. These actions can only be uncovered by effective auditing and enforced by an effective audit committee of the board. Corporate governance has grown considerably in importance following the accounting scandals of the early 2000s. The Sarbanes-Oxley Act mandates new levels of corporate governance. The stock market and the courts are helping to enforce this mandate.

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Chapter 6 Reporting and Analyzing Revenues, Receivables, and Operating Income Learning Objectives – coverage by question MiniExercises

Exercises

LO1 – Describe and apply the criteria for determining when revenue is recognized.

14, 15, 17

27, 28, 33, 40

LO2 – Illustrate revenue and expense recognition when the transaction involves future deliverables and/or multiple elements.

17, 24, 25

27, 28, 31, 40, 41

LO3 – Illustrate revenue and expense recognition for long-term projects.

13, 16

27 - 30

18 - 21, 23

34 - 38

45, 46

LO5 – Calculate return on net operating assets, net operating profit after taxes, net operating profit margin, accounts receivable turnover, and average collection period.

20, 22

32, 35, 39

42, 45

LO6 –Discuss earnings management and explain how it affects analysis and interpretation of financial statements.

48, 49

LO4 – Estimate and account for uncollectible accounts receivable.

LO7 Appendix 6A – Describe and illustrate the reporting for nonrecurring items.

Problems

Cases and Projects

48, 49

48 - 50

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QUESTIONS Q6-1.

Revenue should be the amount of consideration that a firm expects to receive for the performance obligations to the customer that it fulfilled during the period. The revenue rules describe a five-step process. First, the contract (i.e., agreement) with the customer must be identified. Then the firm’s distinct performance obligations under the contract must be determined. Next, the amount of consideration the firm expects to receive must be estimated. If there are multiple performance obligations, then the consideration must be allocated to them based on their stand-alone selling prices. These steps are completed at the commencement of the contract with the customer. Then, as the firm fulfills a performance obligation, it should recognize as revenue the amount that was allocated to the performance obligation.. For retailers, like Abercrombie & Fitch, revenue is generally earned when title to the merchandise passes to the buyer (e.g., when the buyer takes possession of the merchandise), because returns can be estimated. For companies operating under long-term contracts, the performance obligation (e.g., to construct an office building) is usually fulfilled over the period of construction. Many such companies use the amount of cost incurred as a measure of the fulfillment of the performance obligation. See the examples of The Gap and Fluor in the chapter.

Q6-2.

Financial statement analysis is usually conducted for purposes of forecasting future financial performance of the company. Discontinued operations are, by definition, not expected to continue to affect the profits and cash flows of the company. Accordingly, the financial statements separately report discontinued operations from continuing operations to provide more useful measures of financial performance and financial income. For example, yielding an income measure that is more likely to persist into the future, and a net assets measure absent discontinued items.

Q6-3.

Restructuring costs typically consist of two general categories: asset writedowns and accruals of liabilities. Asset write-downs reduce assets and are recognized in the income statement as an expense that reduces income and, thus, equity. Liability accruals create a liability, such as for anticipated severance costs and exit costs, and yield a corresponding expense that reduces income and equity.

Q6-4.

Big bath refers to an event in which a company records a nonrecurring loss in a period of already depressed income. By deliberately reducing current period earnings, the company removes future costs from the balance sheet or creates ‘reserves’ that can be used to increase future period earnings.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

Q6-5.

Earnings management may be motivated by a desire to reach or exceed previously stated earnings targets, to meet analysts’ expectations, or to maintain steady growth in earnings from year to year. This desire to achieve income goals may be motivated by the need to avoid violating covenants in loan indentures or to maximize incentive-based compensation. The tactics used to manage income involve transaction timing (recognizing a gain or loss) and estimations that increase (or decrease) income to achieve a target.

Q6-6.

Non-GAAP or Pro forma income adjusts GAAP income to eliminate (and sometimes add) various items that the company believes do not (or do) reflect its core operations. The SEC requires that GAAP income be reported together with pro forma income. Yet, companies often report their GAAP income at the very end of the earnings or press release, thus obfuscating their comparison and focusing attention on the pro forma income. It is because of this potential to confuse the reader about the true financial performance of the company that the SEC has become concerned. Also, pro forma numbers are not subject to accepted standards (and, thus, we observe differing definitions over time and across companies), are not subject to usual audit tests, and are subject to management latitude in what is and is not included and how items are measured.

Q6-7.

Estimates are necessary in order to accurately measure and report income on a timely basis. For example, in order to record periodic depreciation of longlived assets, one must estimate the useful life of the asset. Estimates allow accountants to match revenues and expenses incurred in different periods. For example, accountants estimate warranty costs so that the warranty expense is matched against the corresponding sales revenue. If the accounting process waited until no estimates were necessary, there would be a significant delay in the reporting of financial results.

Q6-8.

When analysts publish earnings forecasts, these forecasts become a benchmark against which some investors evaluate the company’s performance. A company that fails to meet analysts’ forecasts may suffer a stock price decline, even though earnings are higher than previous years’ earnings and overall performance is good. Consequently, management may feel pressure to meet or slightly exceed analysts’ forecasts of earnings.

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Q6-9.

Bad debts expense is recorded in the income statement when the allowance for uncollectible accounts is increased. If a company overestimates the allowance account, net income will be understated on the income statement and accounts receivable (net of the allowance account) will be underestimated on the balance sheet. In future periods, such a company will not need to add as much to its allowance account since it is already overestimated from that prior period (or, it can reverse the existing excess allowance balance). As a result, future net income will be higher. On the other hand, if a company underestimates its allowance account, then current net income will be overstated. In future periods, however, net income will be understated as the company must add to the allowance account and report higher bad debts expense.

Q6-10. There are several possible explanations for a decrease in the allowance account. First, after an aging of accounts receivable, Wallace Company may have determined that a smaller percentage of its receivables are past due. Wallace Company may have changed its credit policy such that it is attracting lower-risk customers than in the past. Second, experience may have indicated that the percentages used to estimate uncollectibles was too high in previous years. By correcting the estimated percentage of defaults, the estimated uncollectibles would end up lower than in past years. Third, Wallace Company may be managing earnings. By lowering estimated uncollectibles, the company can increase current earnings, but may end up reporting a loss in a future year when write-offs exceed the balance in the allowance account. Q6-11. Minimizing uncollectible accounts is not necessarily the best objective for managing accounts receivable. That objective could be accomplished by not offering to sell to customers on credit. The purpose of offering credit to customers is to increase sales and profits. Losses from uncollectible accounts are a cost of doing business. As long as the benefit (greater contribution to profits due to increased sales) exceeds the cost (increased losses due to uncollectibles) then a higher-risk credit policy which increases the amount of uncollectible accounts would be a more profitable policy. Q6-12. The number of defaults tends to rise and fall with the economy. For example, in a recession, customers are more likely to default and companies take longer, on average, to pay their bills than during a healthy economy. This would result in higher estimated uncollectibles if the estimates are based on an aging of accounts receivable. For many companies, sales revenue also tends to decline during a recession. If estimated uncollectibles are estimated as a percentage of sales, then the estimate would tend to fall in a recession. This is contrary to the increase in the number of defaults that occurs during a recession. Therefore, the percentage of sales approach is not as sensitive to changing economic conditions as is accounts receivable aging.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

MINI EXERCISES M6-13. (15 minutes) LO 3

Year 2019 2020 2021 Total

Costs Incurred $ 400,000 1,000,000 500,000 $1,900,000

Performance Obligation Fulfilled Over Time Revenue Recognized Percent of Total (percentage of costs Income Expected costs incurred  total (revenue – (rounded)

21%a 53%b 26%c

contract amount)

costs incurred)

$ 525,000 1,325,000 650,000 $2,500,000

$125,000 325,000 150,000 $600,000

$400,000 / $1,900,000 $1,000,000/ $1,900,000 c $500,000 / $1,900,000 b

M6-14. (20 minutes) LO 1 Company GAP

Revenue recognition When merchandise is given to the customer and returns can be estimated (or the right of return period has expired).

Merck

When merchandise is transferred to the customer and returns can be estimated (or the right of return period has expired). The company will also establish a reserve and recognize expense relating to uncollectible accounts receivable at the time the sale is recorded. When merchandise is transferred to the customer and the right of return period, if any, has expired. The company will also establish a reserve and recognize expense for uncollectible accounts receivable and anticipated warranty costs at the time the sale is recorded. Interest is earned by the passage of time. Each period, Bank of America accrues income on each of its loans and establishes a receivable on its balance sheet.

Deere

Bank of America

Johnson Controls

Revenue is recognized under long-term contracts under the cost-to-cost method as a measure of the fulfillment of performance obligation over time. ©Cambridge Business Publishers, 2021

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M6-15. (15 minutes) LO 1 The Unlimited can only recognize revenues once they have transferred the products to the customer and the amount of returns can be estimated with sufficient accuracy. Assuming that happens at the time of sale, it must estimate the proportion of product that is likely to be returned and deduct that amount from gross sales for the period. In this case, it would report $4.9 million in net revenue (98% of $5 million) for the period. If The Unlimited does not have sufficient experience to estimate returns, then one would question whether there is a substantive contract with the customer, and it should wait to recognize revenue until the right of return period has elapsed.

M6-16. (20 minutes) LO 3 a. Performance Obligation Fulfilled Over Time: Year

2019

2020

2021

Total

Percent completed Revenue Expense: Construction costs

30% $12,000,000

50% $20,000,000

20% $8,000,000

$40,000,000

9,000,000

15,000,000

6,000,000

30,000,000

Gross profit

$3,000,000

$5,000,000

$2,000,000

$10,000,000

2021 $40,000,000

Total $40,000,000

30,000,000 $10,000,000

b. Performance Obligation Fulfilled At Delivery: Year Revenue Expense: Construction costs Gross profit

2019

2020

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M6-17. (20 minutes) LO 1, 2 a. A.J. Smith should recognize the warranty revenue as it is earned. Since the warranties provide coverage for three years beginning in 2020, one-third of the revenue should be recognized in 2020, one-third in 2021, and the remaining third in 2022. b. Year Revenue Warranty expenses Gross profit

2020 $566,666 166,666 $400,000

2021 $566,667 166,667 $400,000

2022 $566,667 166,667 $400,000

Total $1,700,000 500,000 $1,200,000

c. Total revenue from sales of the camera packages is $79,800 ($399 x 200). The revenue is allocated among the three elements of the sale (camera, printer and warranty) as follows: Element Camera Printer Warranty Total

Retail Price $300 125 75 $500

Proportion of Total 60% ($300/$500) 25% ($125/$500) 15% ($75/$500) 100%

Using these proportions, the revenue is allocated among the three elements and recognized for each element as it is earned. In this case, the portion of the revenue allocated to the camera and printer are recognized immediately, while the revenue allocated to the warranty is deferred and recognized over the three-year warranty coverage period. Year 2020 2021 2022 2023 Total

Revenue $67,830 3,990 3,990 3,990 $79,800

($79,800 x 0.6) + ($79,800 x 0.25) ($79,800 x 0.15) / 3

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M6-18. (15 minutes) LO 4 a. To bring the allowance to the desired balance of $2,100, the company will need to increase the allowance account by $1,600, resulting in bad debts expense of that same amount. b. The net amount of Accounts Receivable is calculated as follows: $98,000 − $2,100 = $95,900. c. - Allowance for Doubtful Accounts (XA) + 500 Balance 1,600 (a) 2,100 Balance

(a)

+ Bad Debts Expense (E) 1,600

Balance

1,600

M6-19. (15 minutes) LO 4 a. Credit losses are incurred in the process of generating sales revenue. Specific losses may not be known until many months after the sale. A company sets up an allowance for uncollectible accounts to place the expense of uncollectible accounts in the same accounting period as the sale and to report accounts receivable at its estimated realizable value at the end of the accounting period. b. The balance sheet presentation shows the gross amount of accounts receivable, the allowance amount, and the difference between the two, the estimated net realizable value. The balance sheet, thus, reports the net amount that we expect to collect. That is the amount that is the most relevant to financial statement users. c. The rule for expense recognition is that expenses are recognized when assets are diminished (or liabilities increased) as a result of earning revenue or supporting operations, even if there is no immediate decrease in cash. This dictates the use of the allowance method. Recognition of expense only upon the write-off of the account would delay the reporting of our knowledge that losses are likely and, thereby, reduce the informativeness of the income statement. Accountants believe that providing more timely information justifies the use of estimates that may not be as precise as we would like.

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M6-20. (20 minutes) LO 4, 5 a. ($ millions)

2018

2017

Accounts receivable (net) .............................................$421.4

$450.2

Allowance for returns and uncollectible 222.2 accounts ....................................................................

214.4

Gross accounts receivable ...........................................$643.6

$664.6

Percentage of uncollectible accounts to gross accounts receivable ................................................... 3.1% ($19.7/$643.6 )

1.7% ($11.6/$664.6)

b. In general, an increase in the allowance for uncollectible accounts as a percentage of gross accounts receivable may indicate that the quality of the accounts receivable has declined, perhaps because the economy has declined, the company is selling to a less creditworthy class of customers, or the company’s management of accounts receivable is less effective. Ralph Lauren’s three biggest wholesale customers accounted for 19% of sales in 2018 and 29% of receivables at the end of March 2018. The declining fortunes of traditional retailers may account for the increase in the allowance for uncollectibles. It may also indicate, however, that the receivables were under-reserved (e.g., allowance account was too low in 2017). This would result in lower reported profits in 2018 because past profits were too high. It is also possible that credit quality has not changed and that the amount recorded in prior years is correct, but that management has incentives to record less income in 2018. c. $6,182.3/[($421.4+$450.2)/2] = 14.19 times 365/14.19 = 25.73 days

M6-21. (10 minutes) LO 4 Bad debts expense of $2,400 ($120,000 × 0.02) would cause the allowance for uncollectibles to increase by the same amount. If the allowance increased by only $2,100 for the period, Sloan Company must have written off accounts totaling $300. In computing accounts receivable, sales revenue increased the account by $120,000, and the write-offs would decrease it by $300. If there was a net increase of $15,000 for the period, Sloan Company must have collected $104,700 in cash. ($104,700 = $120,000 $300 - $15,000.)

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M6-22. (20 minutes) LO 5 a. Accounts Receivable Turnover

Average Collection Period

Procter & Gamble

$66,832/ [($4,686 +$4,594)/2]

365 / 14.4 = 25.3 days

ColgatePalmolive

$15,454 / [($1,480+$1,411)/2]

= 14.4 times 365 / 10.7 = 34.1 days

= 10.7 times

b. P&G turns its accounts receivable faster than Colgate-Palmolive. Receivable turns typically evolve to an equilibrium level for each industry that arises from the general business models used by industry competitors. Differences can arise due to variations in the product mix of competitors, the types of customers they sell to, their willingness to offer discounts for early payment, and their relative strength vis-à-vis the companies or individuals owing them money. Also, the size of the firm may affect the ability of a company to exert bargaining power over major suppliers or customers. For instance, both of these companies sell a significant amount of their product to Walmart. P&G is a sizable company, and may have greater bargaining power over Walmart than does the smaller ColgatePalmolive. One other possibility is that the difference is due to the companies’ differing fiscal year-ends. If the receivable balance is not constant during the year due to some seasonality, then the receivable turnover ratio will depend on the choice of fiscal year.

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M6-23. (20 minutes) LO 4 a. i.

ii.

Accounts receivable (+A) ……………………………………… Sales revenue (+R, +SE) …………………………..…… Bad debts expense (+E, -SE)

3,200,000 3,200,000 42,000

…………………………………

Allowance for uncollectible accounts (+XA, -A)……. iii.

iv.

42,000

Allowance for uncollectible accounts (-XA, +A) ………. Accounts receivable (-A) …………………………………..

39,000

Accounts receivable (+A) ……………………………………… Allowance for uncollectible accounts (+XA, -A)

12,000

Cash (+A) …..……………………………………………………… Accounts receivable (-A) …………………………………

12,000

39,000

12,000

The recovered receivable is reinstated, so that its payment may be properly recorded.

b. Besides the $12,000 in recovery, the collections from customers can be summarized in the following entry: vi.

Cash (+A) Accounts receivable (-A)

2,926,000 2,926,000

(This amount includes payment of the recovered receivable for $12,000. The allowance increases by $15,000 over the period, so the fact that net receivables increased by $220,000 means that gross receivables must have increased by $235,000. That fact allows us to “back out” the cash received.)

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c. +

(v) (vi)

(i) (iv)

(iii)

Cash (A) 12,000 2,926,000 2,938,000 + Accounts Receivable (A) 3,200,000 12,000 39,000 12,000 2,926,000 235,000 Allowance for Uncollectibles (XA) 42,000 39,000 12,000 15,000

+ (ii)

Sales Revenue (R) + 3,200,000

Bad Debts Expense (E) 42,000

(i)

(iii) (v) (vi) + (ii) (iv)

d. Balance Sheet Transaction

Cash Asset

i. Sales on account.

Noncash Assets

+3,200,000 Accounts Receivable

ii. Bad debts expense.

Contra Assets

+42,000

= =

Allowance for Uncollectible Accounts

iii. Write-off of uncollectibl e accounts.

-39,000

Accounts Receivable

iv. Reinstate account previously written off.

+12,000

+12,000 Cash

vi. Collect cash on sales.

+2,926,000 Cash

-12,000

Contrib. Capital

Earned Capital +3,200,000 Retained Earnings -42,000

Revenues

- Expenses =

+3,200,000

Retained Earnings =

+12,000

= +3,200,000

+42,000

Bad Debts Expense -

Allowance for Uncollectible Accounts -

Accounts Receivable -2,926,000 -

Accounts Receivable

©Cambridge Business Publishers, 2021 6-12

Net Income

Sales Revenue

Allowance for Uncollectible Accounts

Accounts Receivable

v. Collect reinstated account.

-39,000

Liabilities

Income Statement

Financial & Managerial Accounting for Decision Makers, 4th Edition

-42,000

M6-24. (20 minutes) LO 2 a. Fiscal Year 2018 2019 2020 2021

Revenue $48,000 55,000 62,000 62,000

Revenue Growth 14.6% 12.7% 0.0%

b. Fiscal Year Revenue 2018 $48,000 2019 55,000 2020 62,000 2021 62,000

(end of year)

Customer Purchases = Revenue + Change in Unearned Revenue Liability

Growth in Customer Purchases

$20,000 24,000 26,000 25,000

55,000 + 4,000 = 59,000 62,000 + 2,000 = 64,000 62,000 - 1,000 = 61,000

8.5% -4.7%

Unearned Revenue Liability

c. In both fiscal year 2020 and 2021, the growth in customer purchases is lower than the growth in reported revenues. The practice of deferring revenue recognition implies that reported revenues in a given period are the result of customer purchases over many periods, resulting in a smoothing of revenues. In the case of Finn Publishing, revenues in any given year are the result of newsstand and bookstore purchases during that year, plus part of the subscriptions from that year, plus part of the subscriptions from the previous year. That means that growth in annual revenues is a composite of growth in customer purchases over an even longer period of time. For 2020 and 2021, Finn’s growth in revenues exceeds the growth in customer purchases because the revenues are still reflecting growth from prior periods. Purchases are a “leading indicator” of revenues, and thus, calculating customer purchase behavior can be useful in forecasting future revenue and identifying changes in customers’ attitudes about a company’s current offerings.

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M6-25. (15 minutes) LO 2 This question is based on an actual situation, in which the accounting rules were influencing the product decisions. The rules for revenue deferral when there are multiple deliverables (i.e., multiple performance obligations) deterred the company from providing enhancements and upgrades that were available. If Commtech’s customers (the wireless companies) had been willing to pay for the upgrades to their customers’ phones, that would have been allowed. (It’s not clear what the wireless companies’ incentives would be, because they may want to encourage users to purchase new phones – with a new service contract – rather than improving their existing phones.) The question can generate a discussion about whether accounting should drive decisions. Whether it should or not, it does, so the question should evolve into what top management should do about this type of situation. Does the situation described in the problem require some managerial action, or not. Is the company foregoing sales because of its accounting? Within Commtech, the finance staff was skeptical of marketing’s predictions that the upgrades and enhancements would increase the sales of existing phone models. If the upgrades and enhancements are delivered, Commtech will have to change its accounting for revenue, with a resulting decrease in near-term profitability. How might the company communicate that change in a way that the investing public will understand as a net benefit to the company?

M6-26 (20 minutes) LO 6 a. Verdi Co. would report stable sales because extending sales to lower credit quality customers broadens the customer pool and thus Verdi Co. can sell the same number of computers year over year. b. Verdi Co. should have disclosed that is was selling to higher credit risk customers. At a minimum, Verdi Co. should have estimated a larger expected bad debts expense related to these customers. (If the credit quality was so poor, Verdi Co. may even consider not reporting the revenue on the grounds that the agreement with the customer lacked commercial substance). c. In future periods when it is revealed that customers cannot pay for the computers, Verdi Co. will have to write off the related accounts receivable. If these bad debts were not reserved for early via the bad debts expense and allowance for doubtful accounts, then Verdi Co. will have to record bad debts expense when the debt goes bad. This will result in an expense in a year different than the reported revenue and will suppress future earnings, potentially significantly.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E6-27. (20 minutes) LO 1, 2, 3 Company

Revenue Recognition

a. L Brands

When merchandise is given to the customer and returns can be estimated (or the right of return period has expired).

b. Boeing Corporation

Revenue is recognized under long-term government contracts under the cost-to-cost (percentage-of-completion) method.

c. SUPERVALU

When merchandise is given to the customer and cash is received.

d. Real estate developer

When title to a house is transferred to the buyers.

e. Wells Fargo

Interest is earned by the passage of time. Each period, Wells Fargo accrues income on each of its loans and establishes an account receivable on its balance sheet.

f. Harley-Davidson When title to the motorcycles is transferred to the buyer. Harley will also set up a reserve for anticipated warranty costs and recognize the expected warranty cost expense when it recognizes the sales revenue. g. Gannett Co.

When the publications are sent to subscribers.

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E6-28. (15 minutes) LO 1, 2, 3 April 6

May 31

June 15

July 15

July 31

DR Cash (+A) CR Contract liability (+L)

$40,000

DR Contract liability (-L) DR Accounts receivable (+A) DR Contract asset (+A) CR Revenue (+R, +SE)

$40,000 $50,000 $30,000

DR Cash (+A) CR Accounts receivable (-A)

$50,000

DR Accounts receivable (+A) CR Contract asset (-A) CR Revenue (+R, +SE)

$110,000

DR Cash (+A) CR Accounts receivable (-A)

$110,000

$40,000

$120,000

$50,000

$30,000 $80,000

$110,000

On May 31, Haskins is entitled to payment of $50,000, but it has earned revenue of $120,000. That is, it expects to receive consideration of $120,000 for the 120 units that it has delivered to Skaife. The contract asset represents consideration that Haskins has earned, but which is contingent on future events (i.e., delivery of the remaining 80 units).

E6-29. (20 minutes) LO 3 ($ millions)

a. Performance obligation fulfilled over time with cost-to-cost method Revenue recognized (percentage of costs incurred  total contract amount)

b. Performance obligation fulfilled at a point in time.

Year

Costs incurred

Percent of total expected costs

Income (revenue – costs incurred)

Revenue recognized

Income

2019

$100

25%

$125

$ 25

2020

300

75%

375

500

100

$400

100%

$500

$100

$500

$100

c. Any ratios involving revenues (Profit margin or Accounts receivable turnover would be affected. Ratios based on any measure of profit would show more variation in the method in part (b), The cumulative effect on net income would cause retained earnings to be higher (or at least never lower) under the method in part (a), affecting the debt-to-equity ratio and the return on shareholders’ equity. ©Cambridge Business Publishers, 2021 6-16

Financial & Managerial Accounting for Decision Makers, 4th Edition

E6-30. (30 minutes) LO 3 a. Design/Engineering

Year Cost incurred % Completed Revenue Margin 1 7.00 70.0% 10.50 3.50 2 2.00 20.0% 3.00 1.00 3 1.00 10.0% 1.50 0.50 10.00 100.0% 15.00 5.00

Margin % 33.3% 33.3% 33.3%

Construction

Year Cost incurred % Completed Revenue Margin 1 0.00 0.0% 0.00 0.00 2 15.00 60.0% 18.00 3.00 3 10.00 40.0% 12.00 2.00 25.00 100.0% 30.00 5.00

Margin % NA 16.7% 16.7%

Sum

Year 1 2 3

b. Combined

Year 1 2 3 Total

7.00 17.00 11.00 35.00

20.0% 48.6% 31.4% 100.0%

10.50 21.00 13.50 45.00

3.50 4.00 2.50 10.00

33.3% 19.0% 18.5%

9.00 21.87 14.13 45.00

2.00 4.87 3.13 10.00

22.2% 22.3% 22.2%

c. Treating the two activities as distinct performance obligations causes the design/engineering activities to report a margin of 33.3%, while the construction activities have a margin of 16.7%. When the design/engineering activities are greater than the construction activities, the margin will be higher. When the activities are viewed as a single performance obligation, the margins are “homogenized” into a combined rate of 22.2%. Treating the two activities as separate performance obligations results in more variation in the margin reported. In addition, it would lower the debt-to-equity ratio. Earlier recognition of revenue and profit would cause shareholders’ equity to be higher earlier in the contract, with no impact on the liabilities, resulting in lower debtto-equity.

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E6-31. (15 minutes) LO 2 a. Multiple element arrangements are sales transactions in which two or more performance obligations (deliverables) are “bundled” together and sold for one price. The revenue should be recognized on each performance obligation as it is fulfilled. This involves first assigning a portion of the sales revenue to each performance obligation and then recognizing each portion of the revenue only when that obligation has been fulfilled. i.e., delivered to the customer. b. The total revenue for the “bundle” is $200. However the Fire, if sold alone sells for $110 and the Amazon Prime membership sells for $120, which brings the total “value” to $230. Thus, the Fire tablet represents 47.83% of the total value of the bundle ($110/$230). Amazon should recognize $95.65 at the time of the sale (47.83% of the $200 sale price) and defer the remaining $104.35. Over the remainder of the quarter, Amazon would recognize one-fourth of this amount as revenue from the Amazon Prime membership. c. Transaction To record bundled sale transaction on July 1

Cash Asset

Balance Sheet Noncash Contrib. + = Liabilities + + Assets Capital

Earned Capital

+200

+95.65

+95.62

Retained earnings

Sales revenue

-$26.09

+$26.09

Unearned revenue

Retained earnings

Sales revenue

To recognize Prime revenue at end of quarter

+104.35 Unearned revenue

Cash (+A) Sales revenue (+R, +SE) Unearned revenue (+L)

Income Statement Revenues - Expenses = -

Net Income

+95.65

+$26.09

200.00 95.65 104.35

Unearned revenue (-L) Sales revenue (+R, +SE)

26.09 26.09

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Financial & Managerial Accounting for Decision Makers, 4th Edition

E6-32. (15 minutes) LO 5 a. 2016: €4,363 – [€0 – €432 x (1- 0.30)] = $4,665.40 2017: €5,616 – [€0 – €179 x (1- 0.30)] = $5,741.30 b. 2016: €4,665.40/€37,600 = .1241 or 12.41% 2017: €5,741.30/€42,636 = .1347 or 13.47% c. €5,741.30/ [(€67,246 - €26,714 + €58,504 - €24,340) / 2] = .1537 or 15.37%

E6-33. (15 minutes) LO 1, 6 a. There is not yet a contract with the customer that meets the company’s normal business practice,” so revenue would not be recognized. b. The performance obligation – to deliver customized units to the customer – has not yet been fulfilled. The product has been shipped, but not to the customer and not with the specified customizations that are required by the customer. c. The company could recognize revenue using the expected amount of “consideration” that it will receive from the customer. (Prior to ASC 606, the revenue could not be recognized because the price is not yet fixed or determinable.) d. The distributor does not have the means to pay for the items delivered, so collectability cannot be reasonably assured (until the distributor sells the product to an end customer). Again, there would be a question as to whether a contract exists with the distributor.

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E6-34. (20 minutes) LO 4 a. Prior to the aging of accounts, the balance in the Allowance for Uncollectible Accounts would be a credit of $520 (the opening balance of $4,350 less the amounts written off of $3,830). 2019 bad debts expense computation $250,000  0.5% $ 90,000  1% 20,000  2% 11,000  5% 6,000  10% 4,000  25%

Less: Unused balance before adjustment Bad debts expense for 2019

= = = = = =

$1,250 900 400 550 600 1,000 4,700 520 $4,180

b. Accounts receivable, net = $381,000 - $4,700 = $376,300 Reported in the balance sheet as follows: Accounts receivable, net of $4,700 in allowances ...................................

$376,300

c. + (a)

Bad Debts Expense (E) 4,180

- Allowance for Uncollectible Accounts (XA) + 4,350 Balance Write-offs 3,830 4,180 (a) 4,700

Balance

d. If the write-offs had been $1000 higher, so too would be the bad debt expense. And, if the write-offs had been $1000 lower, the bad debt expense would have been $1000 lower. The aging of accounts determines the end-of-period balance sheet value, which is combined with the beginning-of-period value and the write-offs during the period to determine the bad debt expense. Any difference between the bad debt expectations and the actual bad debt experience is corrected in this process.

©Cambridge Business Publishers, 2021 6-20

Financial & Managerial Accounting for Decision Makers, 4th Edition

E6-35. (25 minutes) LO 4, 5 a. Allowance for doubtful accounts (-XA) Accounts receivable (-A)

2.6 2.6

Provision for doubtful accounts (+E,-SE) Allowance for doubtful accounts (+XA)

2.5 2.5

The provision for doubtful accounts (bad debts expense) has the effect of decreasing Steelcase’s reported income by $2.5 million for the year. The write-off of $2.6 million of uncollectible accounts has no direct effect on income. b. Accounts receivable, net Allowance for doubtful accounts

2018 300.3 11.1

2017 307.6 11.2

Gross receivables (net plus allowance)

$311.4

$318.8

Allowance as a % of gross receivables

3.56%

3.51%

c. $3,055.5 / [($300.3 + $307.6) / 2] = 10.1 times. d. $3,055.5 + ($28.2 - $15.9) – ($300.3 - $307.6) – $2.5 = $3,072.6.

E6-36. (15 minutes) LO 4 Accounts receivable Less Allowance for uncollectible accounts

$138,100 10,384

$127,716

Computations Accounts Receivable Beginning balance Sales Collections Write-offs ($3,600 + $2,400 +$900) Provision for uncollectibles ($1,173,000  0.8%)

122,000 1,173,000 (1,150,000) (6,900) _________ $ 138,100

Allowance for Uncollectible Accounts $ 7,900

(6,900) 9,384 $ 10,384

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E6-37. (20 minutes) LO 4 a. Aging schedule at December 31, 2016 Current $304,000  1% = $ 3,040 0–60 days past due 44,000  5% = 2,200 61–180 days past due 18,000  15% = 2,700 Over 180 days past due 9,000  40% = 3,600 Amount required 11,540 Balance of allowance 4,200 Provision $ 7,340 = 2019 bad debts expense b. Current Assets Accounts receivable Less: Allowance for uncollectible accounts

$375,000 11,540 $363,460

c. + (a)

Bad Debts Expense (E) 7,340

- Allowance for Uncollectible Accounts (XA) + 4,200 Balance 7,340 (a) 11,540

Balance

E6-38. (30 minutes) LO 4 a. Year 2018 2019 2020 Total

Sales $ 751,000 876,000 972,000 $2,599,000

Collections $ 733,000 864,000 938,000 $2,535,000

Accounts Written Off $ 5,300 5,800 6,500 $17,600

Accounts Receivable at the end of 2020 is $46,400, computed as: ($2,599,000 - $2,535,000 - $17,600). Bad Debts Expense is: 2018 2019 2020 208-2020

$ 7,510 computed as 1%  $751,000 8,760 computed as 1%  $876,000 9,720 computed as 1%  $972,000 $25,990 computed as 1%  $2,599,000

Allowance for Uncollectible Accounts is $8,390 computed as: $25,990 total bad debts expense less $17,600 in total write-offs. ©Cambridge Business Publishers, 2021 6-22

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. Beg Bal Sales 2018 Bal Sales 2019 Bal Sales 2020 Bal

Accounts Receivable (A) 0 751,000 5,300 Write offs 733,000 Collections 12,700 876,000 5,800 Write offs 864,000 Collections 18,900 972,000 6,500 Write offs 938,000 Collections 46,400

Allowance for Uncollectibles (XA) 0 Beg Bal Write offs 5,300 7,510 Bad debts exp.

Write offs

5,800

2,210 8,760

2018 Bal Bad debts exp.

Write offs

6,500

5,170 9,720

2019 Bal Bad debts exp.

8,390

2020 Bal

There isn’t any indication that the 1% rate is incorrect. If the rate is too high, we would expect the allowance to grow at a faster rate than receivables. If the rate is too low, the opposite would occur. In this case, the allowance percentage of receivables is 17%, 27% and 18% at the end of 2018, 2019 and 2020, respectively. So, there is no clear direction that would indicate an inappropriate estimate.

E6-39. (20 minutes) LO 5, 7 a.

Personal Systems Printing

Corporate Investments

Earnings from Operations $1,213 3,161

End. Assets $12,156 10,548

(87)

Beg. Avg. Assets Assets $ 10,686 $11,421.0 9,959 10,253.5

Return on Capital Employed 10.6% 30.8%

(4,350.0)%

b. The most profitable group is Printing, which represents HP’s traditional strength. However, it is not growing (based on a small sales percentage increase in 2017). The Personal Systems (commercial and personal PCs, workstations, calculators, etc.) also has a good return on capital employed. Corporate Investments is described by the company as including HP Labs and cloud-related business incubation projects. The negative return makes sense as this sounds like new businesses and R&D within HP. c. The activities in Corporate Investments are reducing profits in the present, but they are vital to the long-run competitive health of the company. An operating manager might have a short-term horizon and be tempted to reduce the resources devoted to these activities. Keeping it separate allows top management (which should have the longestrun horizon) to keep a close eye on it. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 6

6-23

E6-40. (20 minutes) LO 1, 2 a. Just like for-profit organizations, not-for-profit organizations cannot recognize revenue until it has been earned. In the case of The Metropolitan Opera, it cannot recognize the ticket revenue until the performances occur. (The Metropolitan Opera does not issue quarterly reports, so we cannot observe how much of the revenue has been earned part way through its fiscal year.) b. This entry is simplified by the fact the fiscal year-end is after the end of the current season and by assuming that all of The Metropolitan Opera’s deferred revenue relates to the following season (and none to any years after the following season). To record revenue for the fiscal year 2017 season: Deferred revenue (-L) Cash or Accounts receivable (+A) Revenues (+R, +NA)

46,609 41,905 88,514

(As a not-for-profit, The Metropolitan Opera does not have shareholders’ equity, but rather “net assets.” Therefore, the recognition of revenue increases net assets (NA) on the balance sheet.) To record advance purchases for the fiscal year 2018 season: Cash or Accounts receivable (+A) 42,649 Deferred revenue (+L) 42,649 c. The Metropolitan Opera usually operates close to seating capacity. And, in a typical year, more than one-half of its seats are sold before the season. The quantity of unsold seats will affect The Metropolitan Opera’s marketing efforts for subscribers who have not yet renewed, outreach to new potential subscribers and promotions for individual tickets which go on sale shortly before the season. Those efforts can be scaled up or down depending on the experience with advance sales.

©Cambridge Business Publishers, 2021 6-24

Financial & Managerial Accounting for Decision Makers, 4th Edition

E6-41. (20 minutes) LO 2 a. Membership fees are initially recorded as a liability (deferred revenue) and recognized on a straight-line basis over the membership term (12 months). BJ’s obligation is to provide access to its clubs, its website, and its gas stations over the membership period, so the value transferred to the member is provided on a straight-line basis. b. Cash (+A) Deferred membership fees (+L)

142.1

Deferred membership fees (-L) Membership fee revenue (+R, +SE)

138.4

142.1

138.4

The latter entry can be inferred from the information on membership fee revenue in the income statement. The former entry can be inferred by noting that the Deferred membership fee liability increased by $3.7 million over the period. Therefore, the sales of memberships exceeded the revenue from memberships by $3.7 million. c. When a customer spends $100 in the rewards program, they are entitled to $2 in cash back. This reduces the value of the consideration that BJ’s receives from the customer’s purchase from $100 to $98. The $2 would be provided to the member in electronic awards in $20 increments. So, the entry would be the following: Cash

100 Revenue Payable to member

98 2

Once the member reaches the $20 mark, the payable would be debited and cash would be credited.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 6

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PROBLEMS P6-42.A (20 minutes) LO 5, 7 a. The following items might be considered to be operating: 1. Net Sales, cost of sales, R&D expenses, and SG&A expenses are typically designated as operating. 2. Amortization of intangible assets, integration and separation costs, and restructuring charges would usually be considered to be operating under the assumptions that the acquisition that gave rise to the intangible assets is included as part of operations, and that the restructuring did not involve discontinuation of distinct parts of the business. 3. The asbestos-related charge, restructuring charges and goodwill impairment losses would be considered to be operating since they are related to DowDuPont’s operating activities. (These items are both operating and nonrecurring – see b.) 4. Equity in earnings of nonconsolidated affiliates would be considered operating under the assumption that the affiliates are related to DowDuPont’s core operations, which is typically the case. 5. Sundry income would generally be considered nonoperating in the absence of a footnote clearly indicating its connection to the operating activities of the company. 6. Interest expense and amortization of debt discount is nonoperating. b. The following items might be identified as nonrecurring items: 1. Asbestos-related charges – this is an accrual of an expense due to increased asbestos-related liability related to Union Carbide Corporation, a wholly-owned subsidiary of the company. More specifically, it is primarily due to higher mesothelioma claim activity relative to forecasts of such activity. GAAP requires such an accrual if the loss is probable and can be reasonably estimated. Since it is a one-time occurrence, it can be considered to be a transitory item. 2. Goodwill and other asset impairment losses – this loss results from changes in expectations of the performance of past acquisitions. It would be considered operating, but transitory. 3. Restructuring charges (credits) – The $3,280 million restructuring charge for 2017 reflects the actions following the Dow/DuPont merger, a goodwill impairment charge of $1,491 million and $939 million impairment relating to a facility in Brazil. Restructuring costs are considered “special items,” meaning that individually they are transitory, but as a category, they happen frequently.

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Financial & Managerial Accounting for Decision Makers, 4th Edition

c. 2017 NOPAT: $1,592 – [($966 - $1,082) x (1-0.25)] = $1,679.00 NOPM: $1,679.00 / $62,484 = 2.69% 2016 NOPAT: $4,404 – [($1,452 - $858) x (1-0.25)] = $3,958.50 NOPM: $3,958.50 / $48,158 = 8.22%

P6-43. (20 minutes) LO 3 a. 1. Performance obligation fulfilled based on number of employees trained Year Number of employees trained Revenues (# trained x $1,200) Expenses (# trained x $437.50)* Gross Profit

2019 125 $150,000.00 54,687.50 $95,312.50

2020 200 $240,000.00 87,500.00 $152,500.00

2021 75 $90,000.00 32,812.50 $57,187.50

Total 400 $480,000.00 175,000.00 $305,000.00

2021 $30,000.00 17.14% $82,285.71 30,000.00 $52,285.71

Total $175,000.00 100.00%* $480,000.00* 175,000.00 $305,000.00

* $437.50 = $175,000 / 400

2. Performance obligation fulfilled based on costs incurred Year Cost incurred Percentage completed Revenues (% x $480,000) Expenses Gross profit

2019 $65,000.00 37.14% $178,285.71 65,000.00 $113,285.71

2020 $80,000.00 45.71% $219,428.57 80,000.00 $139,428.57

* Answers may vary due to rounding of percentage completed.

b. The question depends on what measure best reflects the value delivered to the customer as the contract progresses. Using the number of employees trained would reflect Elliot Company’s value from a more effective salesforce. The cost of developing the materials is spread across the 400 employees as they are trained. But the cost incurred to develop the materials also creates value for the customer. The accounting standard says “An output method would not provide a faithful depiction of the entity’s performance if the output selected would fail to measure some of the goods or services for which control has transferred to the customer. For example, output methods based on units produced or units delivered would not faithfully depict an entity’s performance in satisfying a performance obligation if, at the end of the reporting period, the entity’s performance has produced work in process or finished goods controlled by the customer that are not included in the measurement of the output.” (ASC 606-10-55-17)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 6

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P6-44. (15 minutes) LO 6 a. Management would have an incentive to shift $1 million of income from the current period into next. This might be accomplished by delaying revenue recognition or accelerating expenses. This would increase their bonus by $100,000 next year without decreasing the current bonus. b. Management would have an incentive to shift $3 million of income from next year into income reported this year. This would increase the current year bonus by $300,000 without reducing next year’s bonus. c. Management would have an incentive to shift income from the current year into next year. Even though this would reduce earnings this year, earnings are already so low that management does not expect to receive a bonus. Shifting earnings into a future period increases the bonus in that period. d. These incentives for earnings management would be mitigated if the “kinks” in the bonus formula were removed. Alternatively, some companies pay bonuses based on a three-year moving average of earnings to minimize the impact of earnings management. This problem can provide an opportunity to discuss the “slippery slope” of earnings management. For example, management’s optimism about next year in part b may not turn out to be warranted. Suppose next year’s “natural” earnings turns out to be $20 million instead of $24 million. Management’s action in the first year will have reduced next year’s $20 million to $17 million, and earnings management would again be required to meet the target. And, if meeting the target in one year causes the next year’s target to increase, things can get out of control very quickly.

©Cambridge Business Publishers, 2021 6-28

Financial & Managerial Accounting for Decision Makers, 4th Edition

P6-45. (40 minutes) LO 4, 5 ($ millions)

a. Net receivables as of December 31, 2017 were $1,128,610 thousand. b. ($ thousands) Bad debts expense (+E, -SE) Allowance for doubtful accounts (+XA) Allowance for doubtful accounts (-XA) Accounts receivable (-A) +

Bad Debts Expense (E) 17,568

17,568 17,568 13,566 13,566

- Allowance for Doubtful Accounts (XA) + 21,376 Balance 13,566 17,568 25,378

Balance

+ Accounts Receivable (A) 1,136,593 13,566

The $350 thousand recovery of a written-off account would be accounted for in the following way: Accounts receivable (+A) Allowance for doubtful accounts (+XA)

350

Cash (+A) Accounts receivable (-A)

350

The first entry reestablishes the customer’s account, and the second entry recognizes the cash payment that discharges that account. c. Allowance for doubtful accounts to gross accounts receivables are: 2.2% ($25,378/$1,153,988) in fiscal 2017 1.9% ($21,376/$1,136,593) in fiscal 2016

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d. The 2017 receivables turnover rate is $4,881,951 / [($1,128,610 + $1,115,217)/2] = 4.35. In 2016, the ART was $5,456,650/[($1,115,217 + $1,145,099)/2] = 4.83. The Average Collection Period (ACP) is 365/4.35 = 83.9 days in 2017 and 365/4.83 = 75.6 days in 2016. e. The increase in the allowance as a percentage of receivables and the slowdown in collections both indicate that Mattel is having a little more trouble in collecting from its customers. It’s possible that this change is due to the retail sector’s financial difficulties (e.g., the bankruptcy of Toys R Us). Or, Mattel’s decline in sales may mean that its products are less important to its distribution channel, and therefore less of a priority for payment. More generally, it’s also possible that the changes reflect a general decline in economic conditions or a relaxing of Mattel’s credit policies, including collection practices.

P6-46. (25 minutes) LO 4 a. The gross margin for the first quarter is 37.7% = $1,427/$3,783. The items sold in the first quarter, but expected to be returned in the second quarter, had a gross margin of 59.1% = $93 - $38)/$93. The Gap expects that the returns will be those items that have a higher-than-average margin. b. Sale and expected returns: (1) Record revenue. Cash (+A) Revenue (+R,+SE) (2) Record COGS. Cost of goods sold (+E,-SE) Inventory (-A) (3) Recognize Revenue contra, returns (+XR, -SE) expected returns. Sales returns allowance liability (+L) Right-of-return asset (+A) Cost of goods sold (-E, +SE)

5,000 5,000 3,000 3,000 500 500

300 300

continued next page

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Financial & Managerial Accounting for Decision Makers, 4th Edition

b. continued Returns: (4) Process return transactions.

Inventory (+A)

300

Right-of-return asset (-A) Sales return allowance liability (-L) Cash (-A)

300 500 500

At the conclusion of this transaction, the customers have their cash, the inventory costs have been adjusted to include the returned items, and the sales returns allowance liability has a balance of zero because the actual returns coincided with the expected returns

P6-47. (25 minutes) LO 2 a. The deferred net revenue liability goes up when customers purchase game software from TTWO, and it goes down when TTWO recognized revenue for the post-sale service. So, TTWO must have recognized more in revenue than it sold during the quarter. This phenomenon could be due to a seasonality effect. For example, TTWO’s revenues are greatest in the last calendar quarter. b. Purchases equal revenues plus the change in the deferred net revenue liability. Therefore, the first quarter purchases were $387,982 thousand + ($466,429 thousand - $566,141 = $288,270 thousand. Purchases were less than revenue recognized in the income statement. Changes in the deferred net revenue liability provide a leading indicator of the company’s revenues. One must be careful, though, to account for seasonality in purchases.

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CASES and PROJECTS C6-48. (40 minutes) LO 1, 2, 6 a. Cash or Accounts receivable (+A) Sales revenue (+R, +SE)

Cost of sales (+E, -SE) Inventory (-A)

Cash or Accounts receivable (+A) Sales revenue (+R, +SE) Payable to restaurant merchant (+L)

b. 40 40

The revenue recognized differs between parts a and b because in part a, Groupon is acting as a principal in the transaction. In part b, Groupon is acting as an agent for the restaurant, and its revenue is limited to its commission. c. In this case, Groupon must account for “variable consideration.” There is a 90% chance that Groupon will earn $40 in revenue and a 10% chance that it will earn $80 in revenue. Therefore, its expected revenue is $44 = 0.9*40 + 0.1*80. The payable to the merchant is $36 = 0.9*40 + 0.1*0. Cash or Accounts receivable (+A) Sales revenue (+R, +SE) Payable to restaurant merchant (+L)

80 44 36

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C6-49. (30 minutes) LO 1, 2, 6 a. When Dell sells other companies’ software products, it is often as part of a multipleelement sales agreement. For example, the customer may purchase hardware, software, and customer support for one price. This is an example of a bundled sale. Dell must allocate the sales price based on the relative fair market value of each element. Revenue is recognized for each specific element when it is clear that the element has been delivered and the revenue is earned. There are at least two possibilities for earnings management here. First, Dell could misallocate the sales price. By allocating more of the price to hardware and less to software, Dell may be able to manage when earnings are reported. Second, Dell may be aggressive in applying the “earned and realizable” criteria to each element, thereby prematurely recognizing revenue. From the information provided, it appears that Dell was recognizing revenue on software “resales” at the time of sale. However, most software is not truly sold. Instead, the customer purchases a license to use the software. As a result, Dell should have deferred part of the revenue and recognized it ratably over the license period. b. Extended warranties are typically sold separately from other products. Therefore, the revenue should be deferred and recognized ratably over the warranty contract period. Dell employees were apparently recording revenue at the time of sale, or were recognizing the revenue over a shorter time period than the contract period. As a result, revenues and income were overstated. c. It is common for managers to have performance targets based on revenues and earnings. This provides an incentive for these employees to take actions to accelerate revenue recognition when it appears that targets may not be met. On the other hand, in periods when revenues and earnings exceed the targets, managers may delay revenue recognition until a future period. In this way, they can “store up” revenues and earnings to meet future targets. The key to preventing this type of abuse is the periodic audit of divisional revenues and earnings. In addition, businesses spend a large amount of resources trying to design incentive compensation plans that do not encourage this type of abuse. Note: Dell Inc. was publicly traded under the ticker symbol DELL until it was taken private in October of 2013 by Michael Dell, the company’s founder, and Silver Lake Partners.

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C6-50. (45 minutes) LO 2, 4, 5 a. 2017: i. Bad debts expense (+E, -SE) Allowance for doubtful accounts (+XA, -A) ii.

Allowance for doubtful accounts (-XA, +A) Accounts receivable (-A)

2,913 2,913 2,981 2,981

2018: iii. Bad debts expense (+E, -SE) Allowance for doubtful accounts (+XA, -A)

5,439

iv.

2,518

Allowance for doubtful accounts (-XA, +A) Accounts receivable (-A)

5,439

2,518

- Allowance for Doubtful Accounts (XA) ($000) + Balance 7,254 2016 Balance 2,913 (i) (ii) 2,981 Balance 7,186 2017 Balance 5,439 (iii) (iv) 2,518 10,107 2018 Balance

b. 2017: $7,186 / ($188,679 + $7,186 + $24,300) = 3.3% 2018: $10,107 / ($212,377 + $10,107 + $18,628) = 4.2% The increase in allowance relative to receivables could be due to the difficult environment that many retail companies (Wiley’s customers) are experiencing. c. If sales returns are material in amount and can be estimated with a reasonable degree of accuracy, they should be estimated just as bad debts are estimated. Sales revenue is debited for the estimated returns in the amount of the revenue while an allowance for returns is credited an equal amount. In addition, the Cost of goods sold is credited for the cost of the expected returns, and a right-of-return asset is debited. One important difference is that with sales returns (unlike bad debts) the customer returns the product to the company and it is often returned to inventory. Hence, the amount of allowance for returns is a net amount equal to the estimated gross profit on expected returns. d. Accounts receivable turnover: $1,796,103 / [($212,377 + $188,679)/2] = 8.96 times. Average collection period: 365 / 8.96 = 40.74 days.

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C6-51 (20 minutes) LO 7 a. Restructuring charges are reported as part of operating income though 3M has allocated the restructuring costs to various operating categories in the income statement rather than reporting a single line item for restructuring. A liability is recorded on the balance sheet for the restructuring costs (e.g., severance) that have not been paid. Reporting the gain on sale of businesses as part of operating income implies that these were peripheral transactions and did not qualify as discontinued operations. b. A financial analyst generally should treat these costs as nonrecurring in nature. Thus, when forecasting future earnings the analyst would generally not expect another restructuring. c. Management may have incentives to overstate restructuring charges in some cases. If the charges are overstated, the manager will expense more as restructuring costs (and record a larger liability) than they really expect. If the company does not actually have cash outlays in future periods equivalent to the accrued liability related to the restructuring charge, the liability that was recorded will need to be reversed. In the period in which that occurs, recorded income will be higher than it otherwise would be, perhaps helping managers meet an earnings target. On the other hand, management may have incentives to understate restructuring charges in some cases. If they do not want the current period earnings to be too low (relative to some target, or if the managers are nearing the end of their working horizon) then they may record too low a cost for restructuring. However, this will make it harder to reach future targets because if the actual cash outlays turn out to be higher than the costs they accrue, additional expenses will need to be recorded in future years.

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Chapter 7 Reporting and Analyzing Inventory Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

33, 34, 36

37, 38

LO1 – Interpret disclosures of information concerning operating expenses, including manufacturing and retail inventory costs.

13 - 15, 17

LO2 – Account for inventory and cost of goods sold using different costing methods.

18 - 21, 23

26, 27, 29 - 31

LO3 – Apply the lower of cost or net realizable value rule to value inventory.

LO4 – Evaluate how inventory costing affects management decisions and outsiders’ interpretations of financial statements.

26, 29 - 31

33, 34, 36

37, 38

LO5 – Define and interpret gross profit margin and inventory turnover ratios. Use inventory footnote information to make appropriate adjustments to ratios.

16, 22

25, 31, 32

33 - 35

26, 29, 30

LO6 – Appendix 7A: Analyze LIFO liquidations and the impact they have on the financial statements.

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QUESTIONS Q7-1.

When company A purchases inventory from company B, the buyer and seller must agree on which firm is responsible for the transportation costs. The terminology “freight on board shipping point” or FOB is used to indicate the buyer assumes responsibility for the transportation cost once notice of delivery to the shipper is received. In addition, the buyer assumes responsibility for any delay or damage during transit. When goods are shipped FOB, the seller normally can recognize revenue unless the seller has not fulfilled all requirements of the purchase agreement. An example is when an equipment installation and/or up-and-running properly is part of that agreement.

Q7-2.

If stable purchase prices prevail, the dollar amount of inventories (beginning or ending) tends to be approximately the same under different inventory costing methods and the choice of method does not materially affect net income. To see this, remember that FIFO profits include holding gains on inventories. If the inflation rate is low (or inventories turn quickly), there will be less holding (inflationary) profit in inventory.

Q7-3.

FIFO holding gains occur when the costs of earlier inventory acquisitions are matched against current selling prices. Holding gains on inventories increase with an increase in the inflation rate and a decrease in the inventory turnover rate. Conversely, if the inflation rate is low or inventories turn quickly, there will be less holding (inflationary) profit in inventory.

Q7-4.

(a) Last-in, first-out, (b) Last-in, first-out, (c) First-in, first-out, (d) First-in, first-out, (e) Last-in, first-out.

Q7-5.

A significant tax benefit results from using LIFO when costs are consistently rising. LIFO results in lower pretax income and, therefore, lower taxes payable, than other inventory costing methods.

Q7-6.

Kaiser Aluminum Corporation is using the lower of cost or market (LCM) rule. When the replacement cost for inventory falls below its (FIFO or LIFO) historical cost, the inventory must be written down to the lower replacement costs (market value).

Q7-7.

The various inventory costing methods would produce the same results (inventory values and cost of goods sold) if prices were stable. The inventory costing methods produce differing results when prices are changing.

Q7-8.

Inventory “shrink” refers to the loss of inventory due to theft, spoilage, damage, etc. Shrink costs are part of cost of goods sold but do not represent goods that were actually sold.

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Q7-9.

The “LIFO reserve” is the difference between the cost of inventory determined using the last-in, first-out (LIFO) method and the cost determined using another method (either FIFO or average cost). Companies that report inventory cost using the LIFO method must also report the LIFO reserve. This allows the financial statement reader to convert from LIFO to another method for comparison purposes. The LIFO reserve represents the difference between the historical, LIFO cost of inventory and its current cost. This disparity between the book value and the current value represents a gain from holding the inventory that has not yet been recognized in income or in equity ̶ an unrealized holding gain.

Q7-10. Because LIFO assigns the last units purchased during the year to cost of goods sold (COGS), changing prices can make it difficult to forecast earnings. Companies have discretion as to when and how much inventory they purchase during an accounting period. LIFO is always applied on a periodic, annual basis, so a purchase made during the final days of the year will end up in COGS and affect current earnings. However, if that purchase is delayed until the first week of the next year, it could be several years before those units are transferred to COGS. Unlike other inventory methods, LIFO requires that the quantity and price of inventory purchases be predicted to make accurate earnings forecasts. Q7-11A. LIFO liquidation is involuntary when it is caused by events that are beyond management’s control. Examples of such events include labor strikes, natural disasters, or wars which could interrupt the delivery of inventory by suppliers or shut down production facilities. Q7-12A. In periods of rising prices, LIFO liquidation results in older, lower-cost goods being expensed as cost of goods sold, yielding higher profits. This may be the result of a management decision to reduce inventory levels for efficiency purposes. However, it may also be an earnings management tactic. Management may be trying to avoid violating bond covenants, or it may be trying to manipulate management compensation. In any case, this practice is costly, in that the additional profits lead to higher income taxes.

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MINI EXERCISES M7-13. (15 minutes) LO 1 The cost to be assigned to the inventory is $535 ($500 + $30 + $5). + (a) (b) (d) -

Inventory (A) 500 30 5

Notes Payable (L) 500

+ (a)

(c)

Accounts Payable (L) 30 10 5

+ Interest Expense, Discounts Lost (E) 10

(b) (c) (d) -

M7-14. (15 minutes) LO 1 The only cost that should be included in inventory is the cost of merchandise to be sold.

M7-15. (20 minutes) LO 1 RAW MATERIALS INVENTORY Beginning inventory Purchases Materials used Ending inventory WORK IN PROCESS INVENTORY Beginning inventory Materials used Labor costs Overhead costs Cost of goods produced Ending inventory FINISHED GOODS INVENTORY Beginning inventory Cost of goods produced Cost of goods sold Ending inventory

$ + -

0 84,000 63,000 $ 21,000

+ + + -

0 63,000 58,000 28,000 130,000 $ 19,000

+ -

$ 0 130,000 95,000 $ 35,000

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M7-16. (10 minutes) LO 5 2017:

$76,450 - 25,354 $76,450

= 0.668

2016:

$71,890 - 21,685 $71,890

= 0.698

2015:

$70,074 - 21,536 $70,074

= 0.693

M7-17. (15 minutes) LO 1 a. Purchases are understated. If ending inventory is correctly valued, cost of goods sold will also be understated and current income will be overstated. There would be no effect in the following year. If, however, ending inventory is understated (due to the mistakenly recorded purchase) then there is no effect on income in either period. b. Purchases are overstated. The effect on income, assuming normal inventory levels, depends on the inventory costing system being used by the company. Assuming rising prices, income would be reduced in the current year under LIFO or average costing but unaffected under FIFO costing. Income in the following year would not be affected. (The solution assumes the error is not discovered and corrected in the current year.) c. Shrink (part of cost of goods sold) is overstated and ending inventory is understated. Consequently, current period income is understated. If the inventory is counted correctly the following year, the error will reverse itself and income will be overstated. This is an example of a “self-correcting” inventory error.

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M7-18. (20 minutes) LO 2, 4 a. Balance Sheet, December 2019 Assets Cash Inventory

$12,000 50,000

Shareholders’ equity Contributed capital

$62,000

b. All monetary amounts in $ thousands. Year Income statement: Revenue COGS-FIFO Earnings before tax Tax expense Net income Cash flows: Receipts Inventory purchases Tax payments Cash from operations

2020

2021

2022

75 50 25 10 15

85 60 25 10 15

95 70 25 10 15

75 -60 -10 5

85 -70 -10 5

95 -80 -10 5

Dividends Cash from financing Net change in cash

-9 -9 -4

Balance sheet: Assets Cash Inventory Total

8 60 68

4 70 74

0 80 80

Shareholders’ equity Contributed capital Retained earnings Total

62 6 68

62 12 74

62 18 80

Clearly there is a problem with this business model. The company is showing profits, and assets and retained earnings are increasing. However, there is a cash flow problem. The net change in cash every year is -$4 thousand and, by the end of 2022, the company would have a cash balance of zero. In 2023, it would not be possible to replenish the inventory and to pay the dividend.

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c. All monetary amounts in $ thousands. Year Income statement: Revenue COGS-LIFO Earnings before tax Tax expense Net income

2020

2021

2022

75 60 15 6 9

85 70 15 6 9

95 80 15 6 9

Cash flows: Receipts Inventory purchases Tax payments Cash from operations

75 -60 -6 9

85 -70 -6 9

95 -80 -6 9

Dividends Cash from financing Net change in cash

-9 -9 0

Balance sheet: Assets Cash Inventory Total

12 50 62

Shareholders’ equity Contributed capital Retained earnings Total

62 0 62

Interestingly, the use of LIFO reduces profits, and the company’s reported assets (and net assets) are not growing like the FIFO case above. However, the cash flow situation is improved. The company can pay the desired dividends and continue to replace its inventory at the end of every year. The difference between LIFO and FIFO is that FIFO profits include a gain from holding inventory while prices are rising. When the company is taxed on that gain, it has less cash available to maintain its physical assets (inventory). In essence, paying taxes based on FIFO (when inventory costs are increasing) can cause a firm’s ability to stay in business to be taxed away. LIFO profits exclude holding gains, so the company could continue to stay in business. (The tax authorities will “catch up” when the business decides to stop investing in inventory, and the LIFO liquidation profits get taxed.)

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M7-19. (20 minutes) LO 2 a. FIFO cost of goods sold = 1,000 @ $100 + 700 @ $150 = $205,000 FIFO ending inventories = $400,000 - $205,000 = $195,000

b. LIFO cost of goods sold = 1,700 @ $150 = $255,000 LIFO ending inventories = $400,000 - $255,000 = $145,000

c. AC cost of goods sold = 1,700 @ $400,000/3,000 = $226,667 AC ending inventories = $400,000 – $226,667 = $173,333

M7-20. (15 minutes) LO 2 a. $1,320,000 + purchases - $6,980,000 = $1,460,000; purchases = $7,120,000. b. 1.

Inventory (+A) Cash or Accounts payable (-A or +L)

7,120,000

Cost of goods sold (+E, -SE) Inventory (-A)

6,980,000

7,120,000

6,980,000

c. +

+ Balance (1) Balance

Cash (A) 7,120,000

Inventory (A) 1,320,000 7,120,000 6,980,000 1,460,000

+ (1)

(2)

Cost of Goods Sold (E) 6,980,000

(2)

d. Transaction

Cash Asset

a. Purchase inventory.

-7,120,000 Cash

c. Cost of inventory sold.

Balance Sheet Noncash LiabiContrib. + = + + Assets lities Capital +7,120,000 Inventory

-6,980,000 Inventory

Income Statement Earned Capital

Revenues - Expenses = -

-6,980,000 Retained Earnings

Net Income

= +6,980,000 Cost of Goods Sold

-6,980,000 =

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M7-21. (10 minutes) LO 2 a. FIFO cost of goods sold = 400 @ $10 + 200 @ $12 = $6,400 FIFO ending inventories = $12,400 - $6,400 = $6,000

b. LIFO cost of goods sold = 600 @ $12 = $7,200 LIFO ending inventories = $12,400 - $7,200 = $5,200

c. AC cost of goods sold = 600 @ $12,400/1,100 = $6,764 AC ending inventories = $12,400 – $6,764 = $5,636

M7-22. (20 minutes) LO 5 a. Wal-Mart Target

Inventory Turnover-2017 373/[(43.8+43.0)/2] = 8.59 51.1/[(8.66+8.31)/2] = 6.07

Inventory Turnover-2016 361/[(43.0+44.5)/2] = 8.25 49.1/[(8.31+8.60)/2] = 5.81

b. Wal-Mart’s inventory turnover rate is higher than Target’s. There can be several reasons for this. Wal-Mart’s product lines may be oriented toward lowermargin/higher-turnover goods (Wal-Mart does report a lower gross profit margin than Target). Both companies had slight increases in turnover rates from 2016 to 2017. At the end of 2017, both companies hold roughly the same, or slightly more, inventory than in the prior year, possibly in anticipation of increased sales in 2018 (or the addition of new products). c. Inventory turns improve as the dollar volume of goods sold increases relative to the dollar volume of goods on hand. Inventory reductions can be realized by reducing the depth and breadth of product lines carried (e.g., not every style, size and color), eliminating slow-moving product lines, working with suppliers to arrange for delivery when needed rather than inventorying for a longer holding period, and marking down goods for sale at the end of product seasons. Retailers must balance the cost savings from inventory reductions against the marketing implications of lower inventory levels on hand. It would be possible to stock only those items that turn over very quickly, but those items may have low margins. Or, there may be items that turn over slowly, but have sufficient margins to make offering them attractive, even though it reduces inventory turnover. Whenever ratios are used as incentive measures, it is important to recognize that they may cause “cherry-picking” of only those activities that provide the highest ratio outcome.

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M7-23. (15 minutes) LO 2 a. Cost of goods sold (+E, -SE) Inventory (-A)

142,790,000 142,790,000

b. Balance (c) Balance

+ Inventory 25,790,000 142,790,000 140,560,000 23,560,000

+ (a)

Cost of Goods Sold 142,790,000

(a)

Inventory (+A) Cash or Accounts payable (-A or +L)

140,560,000 140,560,000

d. ($000) Transaction

Cash Asset

c. Purchase inventory

-140,560 Cash

a. Cost of inventory sold

Balance Sheet Noncash LiabilContrib. + = + + Assets ities Capital +140,560 Inventory -142,790 Inventory

Income Statement Earned Capital

Revenues - Expenses =

-142,790 Retained Earnings

Net Income

= +142,790 Cost of Goods Sold

-142,790 =

M7-24. (10 minutes) LO 3 a. (60 x $45) + (210 x $34) + (300 x $20) + (100 x $27) = $18,540 b. Cost: (60 x $45) + (210 x $38) + (300 x $22) + (100 x $27) = $19,980 Market: (60 x $48) + (210 x $34) + (300 x $20) + (100 x $32) = $19,220 Therefore, the ending inventory balance should be $19,220.

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EXERCISES E7-25. (45 minutes) LO 5 a. Fiscal year 2015: Gross profit margin = ($705 – $503) ÷ $705 = 28.7% Inventory turnover ratio = $503 ÷ [($214 + $223) ÷ 2] = 2.30 times Fiscal year 2016: Gross profit margin = ($703 – $497) ÷ $703 = 29.3% Inventory turnover ratio = $497 ÷ [($223 + $212) ÷ 2] = 2.29 times b. Fiscal Year 2015

2016

Quarter 1 2 3 4 1 2 3 4

Gross Profit $ 27 91 56 28 32 90 55 29

Gross Profit Margin 21.3% 36.0% 28.9% 21.5% 24.6% 35.7% 28.7% 22.3%

The gross profit and gross profit margin numbers show that West Marine is significantly more profitable in the second and third quarters. The revenues from these quarters are 50% - 100% higher than the other quarters and the gross profit from quarters two and three is sometimes more than three times that of quarters one and four. Unlike many retailers, who make most of their sales and profits in the fourth calendar quarter, West Marine must discount its prices and run promotions in order to generate sales in the first and fourth quarters.

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c. Inventory is lowest at the end of the fiscal year. At the end of the first quarter (end of March), inventory has increased in anticipation of the busy second quarter, and inventory stays high through the second quarter (end of June). By the end of September (third quarter), inventory has declined, and it continues to decline through the fourth quarter. It is common for seasonal businesses to choose fiscal year-ends when inventories (and other balances like receivables) are lower. But it can mean that annual ratios (like those calculated in part a) do not reflect the inventory investment that was necessary to generate the sales reported for the year. Understanding these seasonal effects can be important for cash management over the year. d. One approach to calculating an inventory turnover ratio is to use an “average of averages” approach. For the first quarter of 2015, the average inventory was ($214 + $257) / 2 = $235.5. Follow the same process to determine the average inventory for quarters two, three and four. Then average the averages. The effect of this process is the following: 2015: Weighted average inventory = [214 + 2x(257 + 258 + 237) + 223)] / 8 = $242.6 2016: Weighted average inventory = [223 + 2x(269 + 254 + 232) + 212)] / 8 = $243.1 The weighted average inventory levels are greater than the simple annual averages for both years because the fiscal year-end is set when inventory is predictably low. When these inventory values are divided into annual cost of goods sold, the inventory turnover ratios are lower than those calculated in part a. Weighted average inventory turnover ratio: 2015: $503 / $242.6 = 2.07 times 2016: $497 / $243.1 = 2.04 times

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E7-26.A (30 minutes) LO 2, 4 6 Units 1,000 1,800 800 1,200 4,800

Beginning Inventory Purchases: #1 #2 #3 Goods available for sale

Cost $ 20,000 39,600 20,800 34,800 $115,200

Units in ending inventory = 4,800 – 2,800 = 2,000

a. First-in, first-out

Ending Inventory

Units 1,200 800 2,000

@ @

Cost of goods available for sale Less: Ending inventory Cost of goods sold

Cost $29 = $26 =

Total $34,800 20,800 $55,600

$115,200 55,600 $ 59,600

b. Last-in, first-out

Ending inventory

Units 1,000 @ 1,000 @ 2,000

Cost of goods available for sale Less: Ending inventory Cost of goods sold

Cost $20 $22

Total = $20,000 = 22,000 $42,000

$115,200 42,000 $ 73,200

c. Average cost $115,200/4,800 = $24 average unit cost 2,000 x $24 = $48,000 ending inventory $115,200 - $48,000 = $67,200 cost of goods sold (or 2,800x$24)

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d. 1. The first-in, first-out method in most circumstances represents physical flow. This inventory system applies to perishables or to situations in which the earliest items acquired are moved out first because of risk of deterioration or obsolescence. 2. Last-in, first-out results in the lowest inventory amount during periods of rising unit costs, which in turn results in the lowest net income and the lowest income tax. 3. The first-in, first-out results in the lowest cost of goods sold in periods of rising prices. This is the inventory method Chen should use to report the largest amount of income. Of course, this assumes that prices will continue to rise. Companies cannot change inventory costing methods without justification, and the change may be prohibited by tax laws as well.

E7-27. (25 minutes) LO 2 Units 100 650 550 200 1,500

Beginning inventory Purchases: Purchase #1 Purchase #2 Purchase #3 Cost of goods available for sale

@ @ @ @

Cost $46 42 38 36

@ @

Cost $36 38

= = = =

Total $ 4,600 27,300 20,900 7,200 $60,000

= =

Total $ 7,200 5,700 $12,900

a. First-in, first-out

Ending inventory .................................

Units 200 150 350

Cost of goods available for sale.......... Less: Ending inventory ....................... Cost of goods sold ..............................

$60,000 12,900 $47,100

b. Average cost Cost of Goods Available for Sale/Total Units Available for Sale = $60,000/1,500 = $40 Average Unit Cost Ending Inventory = 350 units x $40 =

$14,000

Cost of goods available for sale Less: Ending inventory Cost of goods sold

$60,000 14,000 $46,000

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c. Last-in, first-out

Ending inventory

Units 100 @ 250 @ 350

Cost $46 42

Cost of goods available for sale Less: Ending inventory Cost of goods sold

= =

Total $ 4,600 10,500 $15,100 $60,000 15,100 $44,900

E7-28. (20 minutes) LO 3 a. 1. (70 x $190) + (45 x $268) + (20 x $350) + (120 x $60) + (80 x $88) + (50 x $126) = $52,900. 2. Desks: (70 x $190) + (45 x $280) + (20 x $350) = $32,900 (70 x $210) + (45 x $268) + (20 x $360) = $33,960 Chairs: (120 x $60) + (80 x $95) + (50 x $130) = $21,300 (120 x $64) + (80 x $88) + (50 x $126) = $21,020 Therefore, inventory would be reported at $32,900 + $21,020 = $53,920. 3. (70 x $190) + (45 x $280) + (20 x $350) + (120 x $60) + (80 x $95) + (50 x $130) = $54,200 (70 x $210) + (45 x $268) + (20 x $360) + (120 x $64) + (80 x $88) + (50 x $126) = $54,980 Therefore, inventory would be reported at $54,200. b. Applying the lower of cost or net realizable value (NRV) rule to individual items in inventory results in the lowest inventory amount, the highest cost of goods sold and the lowest net income. Under either of the other two methods, the inventory may be valued at the higher of cost or NRV for some items in inventory.

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E7-29.A (20 minutes) LO 2, 4, 6 a. $13,042 million b. $14,275 million c. Pretax income has been reduced by $1,233 million cumulatively since GM adopted LIFO inventory costing. This is because it has matched current inventory costs against current selling prices, thus avoiding the recognition of holding gains that would have resulted had FIFO inventory costing been used. If LIFO has put $1,233 million less into ending inventory than FIFO, it must have put $1,233 more into cost of goods sold than FIFO. d. Pretax income has been reduced by $1,233 million (see part c). Assuming a 35% tax rate, taxes have been reduced by $1,233 x 0.35 = $431.6 million. Cumulative taxes were decreased by the use of LIFO inventory costing. e. During this period GM was experiencing declining earnings while inventory costs were not keeping pace. Under these conditions, FIFO reporting mitigates the effect on income. E7-30.A (25 minutes) LO 2, 4, 6 a. $6,149 million b. $7,786 million. The FIFO inventory carrying amount is greater than the LIFO carrying amount, which is common. It implies Deere’s current inventory costs are rising. We cannot blindly assume that inventory costs always rise, however. When costs decline as is true in the computer chip industry (generally not on LIFO) or in the past year in the oil and gas industry (generally on LIFO), a lower FIFO carrying amount can occur. However, if prices fall for so long and to such an extent that the FIFO carrying amount is lower than the LIFO carrying amount the company would have to consider switching off of LIFO onto FIFO. c. Pretax income has been decreased by $1,637 million cumulatively since Deere adopted LIFO inventory costing. This result occurs because higher current inventory costs are matched against current selling prices, thus avoiding the recognition of holding gains that would have resulted had FIFO inventory costing been used. d. Pretax income has been decreased by $1,637 million (see part c). Assuming a 25% tax rate, taxes have been decreased by $1,637 x 0.25 = $409.25 million. Cumulative taxes have been decreased by use of LIFO inventory costing.

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e. For 2018, the change in the LIFO reserve is an increase of $176 million. Pretax income has been decreased by this amount, thus decreasing taxes by $176 million x 0.25 = $44 million. Observation: If Deere’s inventory were at some future date to be more highly valued under LIFO than under FIFO, the company could reduce its tax expense by switching to FIFO costing. This is, however, unlikely for Deere or other industries facing continued price increases or even essentially constant prices. f. In 2016 and 2015, Deere liquidated some LIFO layers, meaning that it sold more inventory than it bought (of a certain type) and thus older costs assigned previously assigned to inventory are now assigned to cost of goods sold as that inventory is sold. In periods of rising costs that means old, lower costs are assigned to cost of goods sold and matched with revenues from the current period. As a result, higher profits are recorded than would have been recorded if new inventory (purchased at higher prices) would have been bought and assumed to have been sold. Companies are required to disclose this when it happens because it shows a higher profit merely for depleting inventory layers. Deere states that they recorded $4 million in pretax profit attributable to such LIFO liquidations in 2016 ($22 million in 2015).

E7-31. (20 minutes) LO 2, 4, 5 a. ($ millions) $517 + Purchases - $10,633 = $471. Purchases = $10,587. b. ($ millions) Sales revenue Cost of goods sold Gross profit

As reported (LIFO) $16,030 10,633 $ 5,397

Pro forma (FIFO) $16,030 10,628 $ 5,402

$10,633 - ($47 - $42) = $10,628 c. As reported (LIFO): $5,397 / $16,030 = 33.67% Pro forma (FIFO): $5,402 / $16,030 = 33.70% The small differences between LIFO and FIFO reflect both the rate of price change for Whole Foods’ inventories and the fact that its inventory moves through very quickly (about 21 times per year).

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E7-32. (30 minutes) LO 5 a.

Revenue COGS Gross profit Gross profit margin (GPM)

Tiffany 2017 2016 $4,170 $4,002 1,565 1,512 2,605 2,490 62.5% 62.2%

Best Buy RH 2017 2016 2017 2016 $42,151 $39,403 $2,440 $2,135 32,275 29,963 1,591 1,455 9,876 9,440 849 680 23.4% 24.0% 34.8% 31.9%

COGS Average inventory Inventory turnover Average inventory Average daily COGS AIDO

Tiffany 2017 1,565 2,206 0.71 2,206 4.29 514.2

Best Buy 2017 32,275 5,036.5 6.41 5,036.5 88.42 57.0

b. RH 2017 1,591 639.5 2.49 639.5 4.36 146.7

c. These three retailers offer very different products (jewelry, consumer electronics, and furniture) and thus have different gross profit margins and inventory turnover ratios. All three have seen their gross profit margins improve slightly from 2016 to 2017. Comparing the three retailers, each has ratios that are consistent with the type of product they sell. Tiffany’s GPM is quite high, but its inventory turnover is very low. This is representative of jewelry retailers. Best Buy, a “big box” store chain, illustrates a more typical retail GPM and turnover. RH, which sells furniture, has ratios between the jewelry retailer, Tiffany, and Best Buy. The comparison illustrates that retailers of “big ticket” items tend to have inventory that turns slower but has higher gross profit per dollar of sales.

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PROBLEMS P7-33. (25 Minutes) LO 2, 4, 5 a. Caterpillar: INVT: $31,049 / [($8,614 + $10,018) / 2] = 3.33 AIDO: [($8,614 + $10,018) / 2] / ($31,049 / 365) =109.52 Komatsu: INVT: ¥1,765,832 / [(¥533,897 + ¥730,288) / 2] = 2.79 AIDO: [(¥533,897 + ¥730,288) / 2] / ¥1,765,832 / 365) =130.65 As calculated, Caterpillar’s turnover is about 0.54 times faster than Komatsu’s, and there is a 21-day difference in the companies’ average inventory days outstanding. This difference could be attributed to differential production efficiencies or to differential component sourcing strategies. Perhaps, Caterpillar purchased more components from outside suppliers. b. When there are no LIFO liquidation effects, decreases in the LIFO reserve can be attributed to changes in the company’s costs. Caterpillar’s LIFO reserve decreased in 2017, implying that its costs probably decreased. c. Pretax income has been reduced by $1,934 million cumulatively since CAT adopted LIFO inventory costing. This is because it has matched current inventory costs against current selling prices, thus avoiding the recognition of holding gains that would have resulted had FIFO inventory costing been used. Each year, the difference between FIFO cost of goods sold and LIFO cost of goods sold is added to the LIFO reserve. Assuming a 25% tax rate, cumulative taxes have been reduced by $1,934 x 0.25 = $483.5 million by the use of LIFO inventory costing. d. For 2017, the change in the LIFO reserve is a decrease of $205 million ($1,934 million - $2,139 million). Pretax income has been increased by this amount (relative to FIFO), thus increasing taxes by $205 million x 0.25 = $51.25 million. e. Komatsu’s use of specific identification probably approximates a FIFO inventory costing method. As a result, the comparison in part a above is not valid because Caterpillar’s use of LIFO produces distortions. We should use the LIFO reserve information to construct Caterpillar’s inventory turnover based on FIFO. FIFO 2017 cost of goods sold = $31,049 – ($1,934 – $2,139) = $31,254 FIFO 2017 average inventory = [($8,614 + $2,139) + ($10,018+$1,934)]÷2 = $11,352.5 FIFO 2017 inventory turnover = $31,254 ÷ $11,352.5 = 2.75 times So, Caterpillar’s inventory turnover is 0.04 slower than Komatsu’s once we take into account the differences in their inventory cost flow assumptions. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 7

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P7-34. (20 minutes) LO 2, 4, 5 a. $7,781 million - $1,248 million = $6,533 million b. $1,248 million c. $1,248 million x 0.25 = $ 312 million d. $1,907 million + [($1,248 million - $1,291 million) x (1 - 0.25)] = $1,874.75 million e. $95,662 / [($6,533 + $6,561) / 2] = 14.61 f. [$95,662 - ($1,248 - $1,291)] / [($7,781 + $7,852) / 2] = 12.24

P7-35. (30 minutes) LO 5 a. ($ millions) Samsung 2017

2016

Hewlett-Packard 2015

Apple

2017

2016

2015

2017

2016

2015

Revenue

239,575,376 201,866,745 200,653,482

58,472

52,056

48,238

265,395

229,234

215,639

COGS

129,290,661 120,277,715 123,482,118

47,803

42,478

39,240

163,756

141,048

131,376

Gross profit

110,284,715

81,859,030

77,171,364

10,669

9,578

8,998

101,639

88,186

84,263

Gross profit margin (GPM)

40.4%

38.8%

38.5%

18.2%

18.4%

18.7%

38.3%

38.5%

39.1%

b. COGS Average ending inventory Inventory turnover

Samsung 2017 2016 129,290,661 120,277,715 21,668,429 18,582,648.5 5.97 6.47

Hewlett-Packard 2017 2016 47,803 42,478 5,924 5,135 8.07 8.27

Apple 2017 2016 163,756 141,048 4,405.5 3,493.5 37.17 40.37

Average ending inventory Average daily COGS AIDO

Samsung 2017 2016 21,668,429 18,582,648.5 354,221 329,528 61 56

Hewlett-Packard 2017 2016 5,924 5,135 131 116 45 44

Apple 2017 2016 4,405.5 3,493.5 449 386 10 9

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c. Gross profit margins reflect the companies’ cost control, their product mix, and their relative ability to create differentiated products. Inventory turnover is much higher at Apple. This may be tied to Apple’s practice of outsourcing a great deal of its production to third party manufacturers in Asia. In fact, Apple reports “The Company’s inventories consist primarily of finished goods for all periods presented.” In addition, Apple seems willing to be out of stock following new product releases meaning they do not hold as much inventory at any particular time. P7-36.A (45 minutes) LO 2, 4, 6 ($ thousands) a. Inventories as a percent of current assets follow: 87.5% ($680,828/$778,012) of current assets in 2017 As long as Seneca has sufficient product to meet demand, a reduction of inventories represents efficient manufacturing processes, while an increase in inventories might reflect slowing demand, rising input prices, or production inefficiencies. b. The inventory turnover rate follows: 2018: $1,240,178/[($680,828+$628,935)/2]=1.89 2017: $1,150,194/[($628,935+$609,481)/2]=1.86 The inventory turnover rate has increased very slightly from 2017 to 2018. This increase, though very small, is positive because it represents increased manufacturing/retailing efficiency. c. Seneca uses the LIFO inventory costing method. The effect of LIFO was to reduce net earnings by $11.2 million relative to if the firm had used FIFO in 2018 and increased earnings by $6.6 million in 2017. This is because LIFO records newer (higher in 2018 and lower in 2017) costs in cost of goods sold which makes income lower in 2018 and higher in 2017. d. Seneca’s use of LIFO has led to a reduction of its taxes as indicated by the $158.8 million amount in the LIFO reserve. Seneca’s cash savings due to the use of assuming a constant tax rate of 25% amount to $39.7 million = $158.8M X (0.25).

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CASES and PROJECTS C7-37.A (30 minutes) LO 2, 4, 5, 6 a. In the year 2017, Exxon’s pretax earnings would be higher by the change in the LIFO reserve because the reserve increased. In 2017, the LIFO reserve increased from $8.1 billion to $10.8 billion, for an increase of $2.7 billion. The 2017 pretax income that would have been reported if FIFO had been used would thus be $18.7 billion + $2.7 billion = $21.4 billion. Note: The increase in the LIFO reserve is likely due to rising oil (and oil product) prices in the last year. b. The inventory turnover would be as follows: $128,217 [($12,871+$4,121) + ($10,877+$4,203)] / 2

= 8.0

c. BP’s inventory turnover is calculated as follows: $179,716 = 9.8 ($19,011+$17,655) /2 d. Based on calculations from their financial statements, it appears that BP’s inventory turns over more quickly than Exxon Mobil’s. However, Exxon Mobil’s use of LIFO makes such a comparison invalid, because BP is not allowed to use LIFO under IFRS. To make a better comparison, we adjust Exxon Mobil’s inventory turnover ratio to FIFO. In 2017 there was an increase in the LIFO reserve, so we need to decrease the cost of goods sold by the increase in the LIFO reserve and increase the value of the inventories by the balance in the LIFO reserve each year: $128,217 + $10,800 [($12,871 + $4,121 + $10,800)+($10,817 + $4,203 + $8,100)]/2

= 5.5

This ratio shows that Exxon Mobil’s inventory is turning over more slowly than the original calculation implied. e. The statement refers to the impact of LIFO liquidation on Exxon-Mobil’s profits.

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C7-38. (40 minutes) LO 2, 4 a. GAAP requires that LIFO abandonment decisions be presented using the retrospective method. That is, all of the financial statements that are presented must be restated using the new accounting method (FIFO). As a result, all of Virco’s statements – income statement and balance sheets - that are presented in the January 31, 2011 10-K are restated to reflect the switch to FIFO. Virco’s 10-K reveals that inventories increased by $7.6 million for the year ended January 31, 2011. This represents the LIFO reserve that is added to LIFO inventory value to get to the inventory valued at FIFO. The company states that $4.7 is added to equity. This adjustment reflects that LIFO reduces reported earnings by allocating higher cost goods (most recently purchased) in cost of goods sold and lower cost goods (earlier purchases). These lower earnings over time cause retained earnings to be lower. Thus, to adjust to FIFO retained earnings needs to be increased to get to what retained earnings would have been had the company been on the FIFO method of accounting for inventory all along. Finally, the increase to inventory and the increase to equity are not the same because of taxes. If the company would have been on FIFO they would have paid extra taxes over time. Upon the switch to FIFO the company has to pay tax on the LIFO reserve amount (but can spread the payments over time). Thus, the effect on equity will be net of tax on the earnings but the effect on inventory is not net of tax. b. Virco argues (correctly) that the FIFO method is better because all inventory will be on the same method of accounting for inventory, it results in a balance sheet that reflects current acquisition costs, and it increases comparability with companies on IFRS because IFRS does not allow LIFO. c. Note that Virco justified the use of LIFO in prior annual reports by saying it provided a better matching of current costs to current revenues in the income statement. This is a correct statement but in some contrast to the statements made in the year the company decided to switch to FIFO? Do they not care about matching anymore? One explanation is that the arguments in favor of FIFO outweighed the matching benefit of LIFO. The IFRS is potentially an explanation (although financial statement users should be able to adjust the inferences from the statements to use “as if FIFO” numbers). The company’s statement about the line of credit is interesting. It potentially suggests that the covenants in their debt agreement are affected adversely if the company uses LIFO (e.g., income is lower so the covenant more easily violated). Other potential explanations are that 1) the company may not expect prices to rise in the future which would negate the tax savings of LIFO, or 2) perhaps corporate performance is declining and management is switching off LIFO so stated results look better.

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Chapter 8 Reporting and Analyzing Long-Term Operating Assets Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Describe and distinguish between tangible and intangible assets.

LO2 – Determine which costs to capitalize and report as assets and which costs to expense.

11,17

LO3 – Apply different depreciation methods to allocate the cost of assets over time.

12, 13, 16, 18, 19

22 - 28, 32

LO4 – Determine the effects of asset sales and impairments on financial statements.

14, 15

22, 24, 26, 35

36, 38, 39

40, 42, 43

LO5 – Describe the accounting and reporting for intangible assets.

17, 21

31, 34

LO6 – Analyze the effects of tangible and intangible assets on key performance measures.

20, 21

29, 30, 33

40 – 42

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QUESTIONS Q8-1.

Routine maintenance costs that are necessary to realize the full benefits of ownership of the asset should be expensed. However, betterment or improvement costs should be capitalized if the outlay enhances the usefulness of the asset or extends the asset’s useful life beyond original expectations. As would be the case with any cost, an immaterial amount should be expensed as incurred.

Q8-2.

Capitalizing interest costs as part of the cost of constructing an asset reduces interest expense, and increases net income during the construction period. In subsequent periods, the interest costs that were capitalized as part of the cost of the asset will increase the periodic depreciation expense and reduce net income.

Q8-3.

As any asset is used up, its cost is removed from the balance sheet and transferred into the income statement as an expense. Capitalization of costs onto the balance sheet and subsequent removal as expense is the essence of accrual accounting. If the cost of a depreciable asset is recognized in full upon purchase, profit would be inaccurately measured: it would be too low in the year of purchase when the asset is expensed and too high in later years as revenues earned by the asset are not matched with a corresponding cost. In other words, expenses would not be recognized as assets are used up or as a result of earning revenue.

Q8-4.

The primary benefit of accelerated depreciation for tax reporting is that the higher depreciation deductions in early periods reduce taxable income and income taxes. Cash flow is, therefore, increased, and this additional cash can be invested to yield additional cash inflows (e.g., an "interest-free loan" that can be used to generate additional income). We would generally prefer to receive cash inflows sooner rather than later in order to maximize this investment potential.

Q8-5.

When a change occurs in the estimate of an asset's useful life or its salvage value, the revision of depreciation expense is handled by depreciating the current undepreciated cost of the asset (original cost – accumulated depreciation) using the revised assumptions of remaining useful life and salvage value. Present and future periods are affected by such revisions. Depreciation expense calculated and reported in past periods is not revised.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q8-6.

The gain or loss on the sale of a PPE asset is determined by the difference between the asset's book value and the sale proceeds. Sales proceeds in excess of book values create gains; sales proceeds less than book values cause losses. The relevant factors, then, are the depreciation rate and salvage values used to compute depreciation expense, accumulated depreciation and the net book value of the asset, as well as the selling price of the asset.

Q8-7.

A PPE asset is considered to be impaired when the sum of the undiscounted expected cash flows to be derived from the asset is less than its current book value. An impairment loss is calculated as the difference between the asset's book value and its current fair market value.

Q8-8.

Research and development costs must be expensed under GAAP unless they have alternative future uses. Equipment relating to a specific research project with no alternative use would, therefore, be expensed rather than capitalized and subsequently depreciated. Accounting standard-setters have justified this ‘expense as incurred’ treatment for R&D costs since the outputs from research and development activities are uncertain and thus there is not a way to know when the asset is used up or whether revenue will be earned from the R&D spending.

Q8-9.

The difficulty with amortizing intangible assets is estimating the useful life. For some intangibles, the useful life is limited and can be easily estimated. However, some intangibles have an indefinite life. This means that the useful life of the intangible is long and cannot be determined with any reasonable degree of accuracy. Under these circumstances, it is not appropriate to amortize the asset until the useful life can be determined.

Q8-10. Goodwill arises whenever a company acquires another company and the purchase price is greater than the fair value of the identifiable assets acquired. The amount of goodwill is the difference between the purchase price and the value assigned to the net assets of the acquired company. It is recorded as a long-term asset in the balance sheet. Since goodwill is assumed to have an indefinite life, it is not amortized. The only time that goodwill will affect the income statement is if it is determined that its value is impaired. In that case, an impairment loss is recorded in the income statement and the value of the goodwill asset on the balance sheet is reduced.

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MINI EXERCISES M8-11. (10 minutes) LO 2 a. Expense b. Capitalize c. Capitalize (the new equipment enhances the assembly line) d. Expense – this is routine maintenance of the building, unless it extends the building’s useful life e. Capitalize – the useful life is extended f. Capitalize – this is a purchased intangible asset

M8-12. (15 minutes) LO 3 a. Straight-line: ($18,000 - $1,500)/ 5 years = $3,300 for both 2019 and 2020. b. Double-declining-balance: Twice straight-line rate = 2 x 1/5 = 40% 2018: $18,000 x 0.40 = $7,200 2019: ($18,000 - $7,200) x 0.40 = $4,320 Notice that, over the first two years, the company reports $6,600 of depreciation expense under the straight-line method and $11,520 of depreciation expense under the double-declining-balance method.

M8-13. (15 minutes) LO 3 a. Straight-line: ($130,000 - $10,000)/ 6 years = $20,000 for both 2019 and 2020. b. Double-declining-balance: Twice straight-line rate = 2 x 1/6 = 1/3 2018: $130,000 x 1/3 = $43,333 2019: ($130,000 - $43,333) x 1/3 = $28,889 c. Units of production: ($130,000 - $10,000) / 1,000,000 = $0.12 per unit 2018: 180,000 units x $0.12 = $21,600 2019: 140,000 units x $0.12 = $16,800

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M8-14. (15 minutes) LO 4 Straight-line depreciation: $40,000/10 = $4,000; 8 years x $4,000 = $32,000. a. Cash (+A) .......................................................................................... 3,500 Accumulated depreciation (-XA, +A) ................................................. 32,000 Loss on sale of furniture and fixtures (+E, -SE) ................................. 4,500 Furniture and fixtures (-A) ................................................................40,000 b. Balance Sheet Transaction Sold furniture and fixtures for cash.

Cash Asset

Noncash + Assets

Contra Assets

+3,500 Cash

-40,000 Furniture and Fixtures

-32,000 Accum. Deprec.

Liabi= lities

Income Statement Contrib. + + Capital

Earned Capital

Net Income

Revenues - Expenses =

-4,500 Retained Earnings

+4,500 -4,500 Loss on Sale = of Furniture and Fixtures

M8-15. (15 minutes) LO 4 Twice the straight-line rate = 1/5 x 2 = 40% Year 1: $75,000 x .4 = Year 2: ($75,000 - $30,000) x .4 = Year 3: ($75,000 - $30,000 - $18,000) x .4 = Total accumulated depreciation

$30,000 18,000 10,800 $58,800

a. Cash (+A) ........................................................................................... 25,000 Accumulated depreciation (-XA, +A) .................................................. 58,800 Machinery (-A) .................................................................................. Gain on sale of machinery (+R, +SE) ...............................................

75,000 8,800

b. Balance Sheet Transaction Sold machinery for cash.

Cash Asset

Noncash + Assets

+25,000 Cash

-75,000 Machinery

Contra Assets

-58,800 Accum. Deprec.

Liabi= lities

Income Statement Contrib. + + Capital

Earned Capital +8,800 Retained Earnings

Revenues +8,800 Gain on Sale of Machinery

- Expenses =

Net Income +8,800

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8-5

M8-16. (15 minutes) LO 3 a. Straight-line depreciation 2018: ($145,800 - $5,400)/3 = $46,800; (8/12) x $46,800 = $31,200 (Note: 8/12 is the fraction of the year, May through December) 2019: $46,800 b. Double-declining-balance depreciation Preliminary computation: Twice straight-line rate = 2 x 1/3 = 66⅔% ($145,800 x 66⅔%) = $97,200 2018: (8/12) x $97,200 = $64,800 2019: ($145,800 - $64,800) x 66⅔% = $54,000

M8-17. (20 minutes) LO 1, 2, 5 a. Under U.S. GAAP, capitalization of development costs is not allowed and all R&D costs must be expensed. Under IFRS, development costs are capitalized if there is the intention, feasibility and resources to bring the asset to completion, there exists the ability to use or sell the asset to generate an economic benefit. Otherwise the costs must be expensed. b. Yes, impairment should be tested for annually (or sooner if there is an indication that goodwill is impaired).

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M8-18. (20 minutes) LO 3 a. Year 1 2 3 4

Book Value $50,000 25,000 12,500 8,000

Depreciation Rate 2 x ¼ = 0.5 2 x ¼ = 0.5

Depreciation Expense $25,000 12,500 4,500 0*

*No depreciation is recorded in Year 4 because the asset is depreciated to its residual value of $8,000.

b. Year 1 2 3 4 5

Book Value $50,000 30,000 18,000 10,800 6,480

Depreciation Rate 2 x 1/5 = 0.4 2 x 1/5 = 0.4 2 x 1/5 = 0.4 2 x 1/5 = 0.4

Depreciation Expense $20,000 12,000 7,200 4,320 3,480*

*$3,480 of depreciation is required in Year 5 to depreciate the asset to its residual value of $3,000.

Year 1 2 3 4 5 6 7 8 9 10

Book Value $50,000 40,000 32,000 25,600 20,480 16,384 13,107 10,486 8,389 6,711

Depreciation Rate 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2 2 x 1/10 = 0.2

Depreciation Expense $10,000 8,000 6,400 5,120 4,096 3,277 2,621 2,097 1,678 5,711*

* $5,711 of depreciation is required in Year 10 to depreciate the remaining value of the asset. Alternatively, DeFond could switch to straight-line depreciation in Year 7, recording $3,027 of depreciation in Years 7 through 10.

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M8-19. (15 minutes) LO 3 a. Year 2019 2020 2021

Barrels Extracted 300,000 500,000 600,000

Depletion per Barrel $32,000,000 / 4,000,000 = $8 $32,000,000 / 4,000,000 = $8 $32,000,000 / 4,000,000 = $8

Depletion $2,400,000 $4,000,000 $4,800,000

b. i.

Oil reserve (+A) ......................................................... 32,000,000 Cash (-A) ..............................................................

ii. Oil inventory (+A) ...................................................... Oil reserve (-A) ......................................................

32,000,000

2,400,000 2,400,000

c. + i. Balance +

Oil Reserve (A) 32,000,000 2,400,000 29,600,000 Cash (A) 32,000,000

Balance

+ ii.

Oil Inventory (A) 2,400,000

Balance

2,400,000

ii.

32,000,000

M8-20. (15 minutes) LO 6 a. Texas Instruments Intel Corp.

PPE Turnover Rates for 2018 $15,784 / [($3,183 + $2,664) / 2] = 5.40 $70,848 / [($48,976 + $41,109) / 2] = 1.57

Texas Instruments turns its PPE more quickly than does Intel. b. PPE turnover rates increase with increases in sales volume relative to the dollar amount of PPE on the balance sheet. The PPE turnover rate is often a very difficult turnover rate to change, and typically requires creative thinking. Many companies are outsourcing the manufacturing process in whole or in part to others in the supply chain. This is beneficial so long as the savings realized by the reduction of manufacturing assets more than offset the higher cost of the goods as these are now purchased rather than manufactured. Another approach is to utilize long-term operating assets in partnership with another firm, say in a joint venture. ©Cambridge Business Publishers, 2021 8-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M8-21. (15 minutes) LO 5, 6 a. $2,300 / $30,578 = 7.52%. Abbott’s R&D expenditure level could be compared to the R&D expenditure level for its competitors to gain a sense of the appropriateness of its R&D expenditures. Roche Holding AG has historically spent 20% of its revenues on R&D while Teva Pharmaceutical Industries Limited has a research and development intensity ratio of about 7% (note both of these companies are listed as primary competitors on Yahoo Finance). b. R&D costs must be expensed when incurred unless they are expenditures for depreciable assets that have alternative future uses (in which case the depreciation is expensed as recognized). As a result, the balance sheet does not reflect the costs incurred for long-term R&D assets. In addition, operating expenses are increased, thus reducing retained earnings. ($ millions)

Balance Sheet

Transaction

Cash Asset

R&D expenditures

-2,300 Cash

Noncash Liabi+ Assets = lities =

Contrib. + Capital +

Income Statement Earned Capital -2,300 Retained Earnings

Revenues

Net - Expenses = Income -

+2,300 R&D Expense

-2,300

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8-9

EXERCISES E8-22. (15 minutes) LO 2, 3, 4 a. Machine (+A) ..................................................................................... 89,500 Cash (-A) ($85,000 + $2,000 + $2,500) ............................................ 89,500 b. ($89,500 - $7,000) / 5 = $16,500 per year. Depreciation expense (+E, -SE) ........................................................ 16,500 Accumulated depreciation (+XA, -A) ................................................. 16,500 c. Cash (+A) ........................................................................................... 12,000 Accumulated depreciation (-XA, +A) ($16,500 x 4) ............................ 66,000 Loss on sale of machine (+E, -SE) .................................................... 11,500 Machine (-A) ..................................................................................

89,500

E8-23. (20 minutes) LO 3 a. Straight line: ($80,000 - $5,000)/5 years = $15,000 per year b. Double declining balance: Twice straight-line rate = 2 x 1/5 = 40% Year

Book Value x Rate

1 2 3 4 5 Total

$80,000 x 0.40 = ($80,000 - $32,000) x 0.40 = ($80,000 - $51,200) x 0.40 = ($80,000 - $62,720) x 0.40 =

Depreciation Expense $32,000 19,200 11,520 6,912 5,368 (plug) $75,000

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E8-24. (25 minutes) LO 3, 4 a. 1. Accumulated depreciation on the date of sale: [($800,000-$80,000)/10 years] x 6 years = $432,000 2. Net book value of the plane at date of sale: $800,000 - $432,000 = $368,000 b. 1. Cash (+A) ........................................................................................ 368,000 Accumulated depreciation (-XA, +A) ............................................... 432,000 Plane (-A) .....................................................................................

800,000

2. Loss on sale of: $195,000 - $368,000 = $173,000 Cash (+A) ....................................................................................... 195,000 Accumulated depreciation (-XA, +A) ............................................... 432,000 Loss on sale of plane (+E, -SE) ...................................................... 173,000 Plane (-A) ....................................................................................

800,000

3. Gain on sale of: $600,000 - $368,000 = $232,000 Cash (+A) ....................................................................................... 600,000 Accumulated depreciation (-XA, +A) ............................................... 432,000 Gain on sale of plane (+R, +SE) .................................................. Plane (-A) ....................................................................................

232,000 800,000

E8-25. (15 minutes) LO 3 a. Straight-line: 2019 and 2020 ($218,700 - $23,400)/6 years = $32,550 b. Double-declining-balance: twice straight-line rate = 2 x 1/6 = 33⅓% 2019 $218,700 x 33⅓% = $72,900 2020 ($218,700 - $ 72,900) x 33⅓% = $48,600

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E8-26. (15 minutes) LO 3, 4 a. Depreciation expense to date of sale is [($27,200 - $2,000)/6] x 3 = $12,600. The net book value of the van is, therefore, $27,200 - $12,600 = $14,600. b. 1. $0 2. $400 gain ($15,000 - $14,600) 3. $2,600 loss ($12,000 - $14,600)

E8-27. (20 minutes) LO 3 a. Straight line: ($110,000 - $15,000) / 6 = $15,833 each year. b. Double-declining-balance: rate = 2 x 1/6 = 1/3 2019: $110,000 x 1/3 = $36,667 2020: ($110,000 – $36,667) x 1/3 = $24,444 2021: ($110,000 – $36,667 – $24,444) x 1/3 = $16,296 c. Straight line: [$110,000 – ($15,833 x 2) – $10,000] / 5 = $13,667 in 2021 and each subsequent year. Double-declining balance: rate = 2 x 1/5 = 40%. ($110,000 – $36,667 – $24,444) x 40% = $19,556 in 2021

E8-28. (20 minutes) LO 3 a. Straight-line: $6,000,000 / 30 = $200,000 per year each year. b. Double-declining balance: rate = 2 x 1/30 = 1/15. 2019: $6,000,000 x 1/15 = $400,000 2020: ($6,000,000 – $400,000) x 1/15 = $373,333 c. The revised depreciation rate = 2 x 1/23 = 8.7% 2021: ($6,000,000 – $400,000 – $373,333) x 8.7% = $454,720* *$454,493 (using unrounded depreciation rate)

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E8-29. (10 minutes) LO 6 Percent depreciated = Accumulated depreciation / Asset cost = $7,095 million / ($12,916 - $283 - $619) million = 59% Note: We eliminate land and construction in progress from the computation because these assets are not depreciated. Assuming that assets are replaced evenly as they are used up, we would expect assets to be 50% depreciated, on average. Deere’s 59% is slightly higher than this level. If the percentage depreciation were high, one possible concern is that it often requires higher capital expenditures in the near future to replace aging assets.

E8-30. (25 minute) LO 6 a. 2017

2018

Receivable Turnover Rate $31,657 = 6.81 $4,911+$4,392 2 $32,765 $5,020+$4,911 2

=6.60

Inventory Turnover Rate $16,055 = 4.33 $4,034+$3,385 2

PPE Turnover Rate $31,657 = 3.64 $8,866+$8,516 2

$16,682 $4,366+$4,034 2

$32,765 $8,738+$8,866 2

= 3.97

= 3.72

b. 3M’s Receivable and Inventory turnover ratios have declined from 2017 to 2018, while its PPET improved. 3M’s revenues increased in 2018, and that increase is likely to account for the increase in the PPET. PPE turns can also be improved by off-loading manufacturing to other companies in the supply chain and acquiring longterm operating assets in partnership with other companies, for example, in a joint venture. Receivable turnover decline indicates that receivables have increased faster than sales. This could indicate a need to monitor more closely the quality of customers to which credit is granted, implement better collection procedures, or offering discounts as an incentive for early payment. Inventory turnover rates can be improved by weeding out slowly moving product lines, by reducing the depth and breadth of products carried, and by implementing just-in-time deliveries.

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E8-31. (10 minutes) LO 1, 5 a. Fair Value (Capitalized)

Useful Life

b. Amortization Expense for 2019

Patent

$200,000

3 years

$66,667

Trademark Noncompetition agreement

$500,000 $300,000

Indefinite 5 years

$60,000 $126,667

E8-32. (15 minutes) LO 3 a. Cost of resource property: $7,200,000 + $420,000 + $50,000 + $800,000 = $8,470,000 Residual value: $1,200,000 Depletion base: $8,470,000 – $1,200,000 = $7,270,000 Depletion rate: $7,270,000 / 500,000 tons = $14.54 per ton 2019: 60,000 x $14.54 = $872,400 2020: 85,000 x $14.54 = $1,235,900 b. 2019: Inventory (+A) ................................................................................... 872,400 Resource property (-A) ..................................................................... 872,400 2020: Inventory (+A) ................................................................................... 1,235,900 Resource property (-A) ..................................................................... 1,235,900

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E8-33. (15 minutes) LO 6 a. PPET: $21,461,268 / [($11,330,077 + $10,027,522)/2] = 2.0 times b. Percent depreciated: $2,699,098 / ($14,029,175 - $807,297) = 20.4% The cost of construction in progress is subtracted in the denominator because this amount represents PPE assets that are not currently in the base of depreciable assets. The cost of land should also be subtracted, but because Tesla lumps land and buildings together, this is not possible. Therefore, the actual percent depreciated ratio should be a little higher than the 20.4% we calculated. c. Tesla’s assets are about one fifth depreciated at the end of 2018. This results in an extremely low percent depreciated ratio and PPE turnover ratio (PPET). Tesla’s useful life assumptions could affect these ratios. For example, Tesla uses a units-of-production approach to depreciate tooling. In the auto industry, companies retool each time they make major design changes to a model. Years ago, this would happen annually, but in more recent years, automakers may retool only every three to five years. Tesla’s depreciation for tooling costs depend on its assumptions about sales of each model. So, it assumes 325,000 units for the expensive Models S and X while the (relatively) less expensive Model 3 has a projected demand of 1,000,000 units. Ultimately, the accuracy of these sales estimates will have an effect on depreciation expenses and, in turn, Tesla’s ratios.

E8-34. (15 minutes) LO 5 a. The list illustrates the wide range in expenditures for R&D (as a percent of sales) across firms. Note the large amount spent by Intel (19.11%) and pharmaceutical companies Pfizer (14.92%) and Merck (23.06%), compared to the amount spent by Apple (5.36%), Deere (4.97%) or Callaway Golf (3.28%). The companies in the list are to some extent paired by industry. It is interesting to see how similar some firms in the same industry are. For example, Apple and Samsung spend almost the same percentage of sales on R&D. b. Beside industry affiliation, the differences in R&D expenditures as a percent of sales is due to differences in markets, product mix, and other strategic considerations. As suppliers of technology (hardware and software), Intel and Microsoft depend very heavily on their intellectual property. As a result, their expenditures on research and development are among the highest of established firms. Apple has established itself as an innovator in technology and design and has spent billions of dollars developing unique products such as the iPad®. Apple’s research intensity looks relatively low but the company has tremendous sales revenue (the denominator in the R&D intensity ratio). In addition, the company has increased their spending on R&D. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 8

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E8-35. (20 minutes) LO 4 a. Yes, the equipment is impaired at July 1, 2020 because its book value is not recoverable through future cash flows. Specifically, on July 1, 2020, its book value is $145,000 ($225,000 initial cost less $80,000 accumulated depreciation*) and the estimated future (undiscounted) cash flows are only $125,000. *4 years of [($225,000-$25,000)/10 years].

b. The impairment loss in a is computed as the equipment's book value minus its current fair value: $145,000 − $90,000 = $55,000 Impairment loss (+E, -SE) .................................................................. 55,000 Equipment* (-A) ................................................................................

55,000

*Accumulated depreciation is sometimes credited for the loss. c. Assuming that the salvage value remains the same after the impairment (this is not likely given the decline in market value of the asset), the annual depreciation expense would be ($90,000 - $25,000) / 6 = $10,833 per year. Depreciation expense (+E, -SE) ....................................................... 10,833 Accumulated depreciation (+XA, -A) ................................................

10,833

d. ($000) Transaction b. Impairment charge.

Income Statement

Balance Sheet Cash Asset

Noncash Assets -55,000 Equipment

c. Depreciation expense.

Contra Assets

Liabilities

Contrib. Capital +

Earned Capital -55,000 Retained Earnings

+10,833 Accum. Deprec.

-10,833 Retained Earnings

Revenues

Net - Expenses = Income +55,000 -55,000 - Impairment = Loss

+10,833 Deprec. Expense

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

-10,833

PROBLEMS P8-36. (20 minutes) LO 4 In order to determine the entries for the sale of property, plant and equipment, we need to “fill in the blanks” for the PPE and accumulated depreciation accounts. Once we record the purchases and the depreciation expense, we can determine the cost and accumulated depreciation for the assets sold. (i)

Property, plant and equipment (+A) ................................................. 72 Cash (-A) ......................................................................................

Depreciation expense (+E, -SE) ....................................................... 54 Accumulated depreciation (+XA, -A) ............................................

(iii) Cash (+A) ......................................................................................... 4 Accumulated depreciation (-XA, +A) ................................................ 23 Property, plant and equipment (-A) .............................................

(ii)

+ Property, Plant and Equipment (A) Balance 803 (i) 72 27 Balance 848

(iii)

Accumulated Depreciation (XA) + 450 Balance 54 (ii) 23 481 Balance

The net book value of the assets that were sold was $4 million. If Hilton sold the assets for more (less) than $4 million a gain (loss) would have resulted equal to the difference between the sale price and the net book value. A gain would be recorded as a credit entry in the journal entry (iii) and a loss would be recorded as a debit entry.

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P8-37. (20 minutes) LO 5 a. $385 million / $4,914 million = 7.8% b. R&D costs are expensed in the income statement except for the portion relating to depreciable assets that have alternate uses. Expensing (rather than capitalizing and depreciating) reduces assets, and the additional expense reduces profit and equity (via the reduction in retained earnings). In addition, expensing R&D as incurred means that potentially valuable intangible assets are omitted from the balance sheet. c. Agilent has reduced its R&D spending as a percent of revenues in recent years and, as a result, increased its earnings. This has turned operating losses into an operating profit for the company. However, Agilent is dependent upon technology in order to maintain its market position, and R&D is critical to its very existence. Agilent divested itself of some high-intensity R&D businesses between 2003 and 2011. Changes in R&D spending, as a percent of revenues, is affected by R&D spending and also by revenues. Agilent’s revenues have decreased from 2014 to 2018 but its R&D expenditures have decreased at a faster rate. A company can maintain its investment in intellectual capital and reduce expenses by outsourcing the activity to other countries where the intellectual resources are less expensive.

P8-38. (20 minutes) LO 4 ($ millions) a. i. Depreciation expense (+E, -SE) ...................................................... 2,460 Accumulated depreciation (+XA, -A) ................................................ ii.

2,460

Property and equipment (+A) ........................................................... 3,516 Cash (-A) ..........................................................................................

3,516

iii. Cash (+A) ......................................................................................... 85 Accumulated depreciation (-XA, +A) (see T-account) ...................... 2,171 Property and equipment (-A) (see T-account) ..................................

2,256

iv. Impairment and writedown charges (+E, -SE) Property and equipment (-A) + Property and Equipment (A) Balance 42,934 (ii) 3,516 2,256 92 (b) 118 Balance 44,220

(iii) (iv)

(iii)

92 92 Accumulated Depreciation (XA) + 18,398 Balance 2,460 (i) 2,171

18,687

Balance

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

The problem provides information directly to make entries (i), (ii), (iii) and (iv) in part a. For part (iii), we can infer the accumulated depreciation on disposed property and equipment as being the amount ($2,171) that makes that account balance. Since no gain or loss was reported on these disposals, the credit to property and equipment in part (iii) is the amount that balances the disposal transaction ($2,256). However, this leaves the property and equipment T-account unbalanced. A likely reason is that Target acquires some property and equipment without an expenditure of cash. (Chapter 10 will cover capital lease transactions, which play a role in Target’s operations.) Based on the information in the problem, we would estimate that $118 million of property and equipment was acquired through such transactions, because that amount balances the property and equipment T-account.

P8-39. (20 minutes) LO 4 The process used in this question is to fill in the entries for property and equipment and for accumulated depreciation in parts a, b and c, and then to use the “plug” figures in the T-accounts to determine the values in part d. ($ thousands) a. Depreciation expense (+E, -SE) ....................................................... 182,533 Accumulated depreciation (+XA, -A) ................................................

182,533

b. Property and equipment (+A) ............................................................ 190,102 Cash (-A) ..........................................................................................

190,102

c. Loss on impairment of property and equipment (+E) ........................9,639 Property and equipment (-A) ............................................................

9,639

d. Cash (+A) ......................................................................................... 8 Loss on disposal of property and equipment 570 Accumulated depreciation (-XA, +A) (see T-account) ....................... 56,595 Property and equipment (-A) (see T-account) ..................................

57,173

+ Property and Equipment (A) Balance 2,619,112 (b) 190,102 9,639 57,173 Balance 2,742,402

(d)

Accumulated Depreciation (XA) + 1,686,829 Balance 182,533 (a) 56,595 1,812,767

Balance

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CASES and PROJECTS C8-40. (90 min) LO 4, 6 a. PPE Turnover: $15,740.4/[($4,047.2 + $3,687.7)/2] = 4.07 The firm appears to be as capital intensive as others in the industry based on a similar PPE turnover ratio to its closest competitors. However, if the assets are older (more depreciation) the denominator will be smaller and could cause the PPE turnover to be higher. Thus, the age of the assets can affect the ratio as well. b. Accumulated depreciation / Depreciable asset cost $5,596.0/ ($10,003.2 - $77.7*- $692.9*) = 0.606 or 61%

*Note: We eliminate land from the computation because land is never depreciated. We eliminate construction in progress because these represent assets that the company is building. These assets are not yet in service and are consequently not yet depreciable. This elimination is also used in part c.

If plant assets are replaced at a constant rate, we would expect those assets to be about 50% “used up,” on average. A substantially higher percentage “used up” indicates that the assets are closer to the end of their useful lives and will require replacement (and usually higher maintenance costs near the end of their useful lives). Such a situation would negatively affect future cash flows. c. Average depreciable assets = [($10,003.2 – 77.7 – 692.9) + ($9,526.6 – 79.8 – 553.0)] / 2 = $9,063.2 Average depreciable assets/ Depreciation expense = $9,063.2 / $589.0 per year = 15.4 years. d. Depreciation expense (+E, -SE) ....................................................... 589.0 PPE accumulated depreciation (+XA, -A) .........................................

589.0

PPE (+A) ........................................................................................... 622.7 Cash (-A) ..........................................................................................

622.7

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

C8-41. (40 minutes) LO 6 Reducing operating assets is an important means of increasing performance measures including the return on net operating assets. Most companies focus first on reducing receivables and inventories. This is the so-called low-hanging fruit that can lead to quick results. Some possible actions include those listed. Students will think of additional possibilities. a. Reducing receivables through: 1. Better underwriting of credit quality 2. Better controls to identify delinquencies, automated over-due notices, and better collection procedures 3. Increased attention to accuracy in invoicing 4. Offering early payment incentives b. Reducing inventories and inventory costs through essentially eliminating nonproductive activities including inspection, moving activities, waiting setup time: 1. Use of less costly components (of equal quality) and production with lower wage rates 2. Elimination of product features not valued by customers 3. Outsourcing to reduce product cost 4. Just-in-time deliveries of raw materials 5. Elimination of manufacturing bottlenecks to reduce work-in-process inventories 6. Producing to order rather than to estimated demand to reduce finished goods inventories 7. Eliminating defects c. Reducing PPE assets is much more difficult. The benefits, however, can be substantial. Some suggestions are the following: 1. Sale of unused and unnecessary assets 2. Acquisition of production and administrative assets in partnership with other companies for greater throughput 3. Acquisition of finished or semi-finished goods (sub-components) from suppliers to reduce manufacturing assets d. Reducing unnecessary intangible assets that are reported on the balance sheet is the most difficult. 1. Sale of assets no longer relevant to company plans 2. License intangibles to other companies ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 8

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C8-42. (30 minutes) LO 4, 5, 6 a. Take-Two (TTWO) spent $326,909 in 2018 on software development. TTWO’s amortization and write-downs were $77,887 in 2018. Using EA’s method, the money spent on additions would be expensed, and the amortization and write-downs would disappear. The result is that if TTWO used EA’s approach, 2018 expenses would increase by $249,022 ($326,909 – 77,887). Net income would decrease by $186,766.5 [$249,022 X (1-0.25)] in 2018.

C8-43. (20 minutes) LO 4 a. DreamWorks would have recorded a pretax profit of $10.6 million for 2014. [($86.26 million) + $66.5 million + $30.3 million] = $10.6 million. b. DreamWorks capitalizes film production costs and amortizes them over the life of the film, meaning over the time period of the expected revenue stream. The unamortized asset (that is, the unamortized capitalized costs) have to be tested for impairment each reporting period. c. Loss due to impairment (+E, -RE) Mr. Peabody and Sherman (-A) The Penguins of Madagascar (-A)

96.8 million 66.5 million 30.3 million

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Chapter 9 Reporting and Analyzing Liabilities Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Identify and account for current operating liabilities.

18, 19, 21, 25, 33

38 - 40, 43

51, 59

LO2 – Describe and account for current nonoperating (financial) liabilities.

20, 21

LO3 – Explain and illustrate the pricing of long-term nonoperating liabilities.

22, 31, 32, 34 - 37

41, 42, 44 - 48, 50

52 - 58

60, 61

LO4 – Analyze and account for financial statement effects of longterm nonoperating liabilities.

20, 23, 24, 26 - 29, 34 - 36

41, 44 - 50

51 - 58

60, 61

LO5 – Explain how solvency ratios and debt ratings are determined and how they impact the cost of debt.

22, 30

60, 61

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-1

QUESTIONS Q9-1.

Current liabilities are obligations that require payment within the coming year or operating cycle, whichever is longer. Generally, current liabilities are normally settled with use of existing current assets or operating cash flows.

Q9-2.

If a company fails to take a cash discount that is offered by a supplier, it is effectively paying a penalty for taking additional time to pay the account payable. Depending on the size of the discount, this penalty (an implicit interest rate) can be quite high. The net-of-discount method records the inventory at the purchase cost less the discount. If the discount is lost, the extra cost is treated as part of interest expense for the period. This has two benefits: (1) the lost discount is not capitalized as part of the cost of inventory, and (2) the lost discount is highlighted, which is useful information that may be helpful in managing accounts payable.

Q9-3.

An accrual is the recognition of an event in the financial statements even though no actual transaction has occurred. Accruals can involve both liabilities (and expenses) and assets (and revenues). Accruals are vital to the fair presentation of the financial condition of a company as they impact both the recognition of revenue and the matching of expense.

Q9-4.

The coupon rate is the rate specified on the face of the bond. It is used to compute the amount of cash interest paid to the bond holder. The market rate is the rate of return expected by investors that purchase the bonds. The market rate determines the market price of the bond. It incorporates expectations about the relative riskiness of the borrower and the rate of inflation. In general, there is an inverse relation between the bond’s market rate and the bond’s market price.

Q9-5.

Bonds sold at face (par) value earn an effective interest rate equal to the bonds’ coupon rate. Bonds are sold at a discount when the effective interest rate is higher than the coupon rate. Bonds are sold at a premium when the effective interest rate is lower than the coupon rate.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q9-6.

Bonds are reported at historical cost, that is, the face amount plus (minus) unamortized premium (discount). The market price of the bonds varies inversely with the level of interest rates and fluctuates continuously. Differences between the market price of a bond and its carrying amount represent unrealized gains and losses. These unrealized gains (losses) are not reflected in the financial statements (although they are disclosed in the footnotes). They must be recognized upon repurchase of the bonds, the point at which they become “realized.” If the bonds are refunded (that is, replaced with new bonds reflecting current market values and interest rates), the gain (or loss) that is recognized in the current period will be offset by correspondingly higher (lower) interest payments in the future. The present value of the future interest payments, along with the present value of the difference between the face amount of the new bond and the former face amount, exactly offset the reported gain (loss).

Q9-7.

Debt ratings reflect the relative riskiness of the borrowing company. This riskiness relates to the probability of default (e.g., not repaying the principal and interest when due). Higher (greater quality) debt ratings result in higher market prices for the bonds and a correspondingly lower effective interest rate for the issuer. Lower (lesser quality) debt ratings result in lower market prices for the bonds and a correspondingly higher effective interest rate for the issuer.

Q9-8.

Reported gains or losses on bond redemption result from changes in the market price of the bonds and the use of historical cost accounting. Because bonds are typically reported at historical cost, fluctuations in bond prices are not recognized until they are realized when the bonds are redeemed or refunded. If the bonds are refunded (new bonds are issued), the gain or loss is offset by the present value of lower (higher) future interest payments on the new bond issue. (If the liabilities are reported at fair value, the gain or loss is the difference between the last reported fair value and the sales price (assuming all the fair value changes were recorded in income – meaning were not due to instrument-specific credit risk changes.)

Q9-9.

(a) Bonds payable – the liability account used to record the face value of bonds issued by a company (b) Call provision – the right for the bond issuer to repurchase the debt, before it matures, at a predetermined price. (c) Face value – the predetermined amount (typically $1,000) that must be repaid when a bond matures (d) Coupon rate – the rate specified on the face of the bond that determines the periodic interest (coupon) payment (e) Bond discount – the difference between the face value of the bond and the market price when the price is lower than the face value; recorded as a contra-liability

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

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(f) Bond premium – the difference between the market price of a bond and the face value when the market price is higher than the face value; recorded as an adjunct-liability (g) Amortization of premium or discount – the periodic reduction of the balance in the premium or discount account recorded each time interest expense is accrued; equal to the difference between the accrued interest and the coupon payment (or payable) Q9-10. The advantages of issuing bonds are (1) the interest payments are limited to the predetermined amount specified on the bond; (2) the interest is tax deductible; (3) bondholders do not have a vote when it comes to electing directors and managing the company; (4) the additional financial leverage created when bonds are issued increases profits in good years. The disadvantages of bonds include (1) bonds must be repaid while common stock is issued with an indefinite life; (2) bondholders can impose restrictive covenants in the loan indenture; (3) the additional financial leverage created when bonds are issued decreases profits in lean years. Q9-11. $3,000,000 x [.98 + (.09 x 3/12)] = $3,007,500 Q9-12. The contract rate (or stated rate or coupon rate) determines the periodic coupon payment. If this rate is not equal to the rate required by the market, the bond price is adjusted to the present value of the cash payments from the bond discounted at the applicable market rate of interest. If the market rate is higher than the coupon rate, then the periodic coupon payments are insufficient and the bond will be priced lower than the face value (a discount). If the market rate is lower than the coupon rate, then the periodic coupon payments will be higher than required by the market, and the bond will sell for a premium. Q9-13. When the bonds mature, the book value of the bonds will be equal to the face value. Over the life of the bonds, the change in the book value of the bonds will be equal to face value less the market value at the time that the bonds are issued. Q9-14. When the effective interest method is used to amortize a bond discount or premium, the effective rate is multiplied by the net balance in bonds payable (bonds payable plus/minus the premium or discount). If the bond is issued at a discount, the balance increases over the life of the bond; the interest expense will increase as the balance increases. If the bond is issued at a premium, the balance decreases over the life of the bond; the interest expense will decrease as the balance decreases.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q9-15. Bonds payable is presented in the balance sheet net of any discount or plus any premium. Q9-16. The loss is the difference between the retirement value and the book value of the bond: (101% x $200,000) – $197,600 = $4,400. Q9-17. Each payment includes both interest on the outstanding balance and repayment of the principal. As each payment is made, the principal balance is reduced. As a consequence, the interest component of the payment is smaller each period.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

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MINI EXERCISES M9-18. (15 minutes) LO 1 a. 11/15

11/23

Inventory (+A) Accounts payable (+L)

6,076

Accounts payable (-L) Cash (-A)

6,076

$6,076 = $6,200 x 0.98

b. + 11/15

Inventory (A) 6,076

11/23

Cash (A)

Accounts Payable (L) 6,076 6,076

+ 11/15

6,076

11/23

c. [($6,200 - $6,076)/$6,076] x [365/(30-10)] = 37.25%. (With interest compounding, the annual rate of interest r can be solved from (1+r)(20/365)=1.02. The value that solves this relationship is r = 43.5%.)

M9-19. (15 minutes) LO 1 a. 1/20

2/15

Inventory (+A) Accounts payable (+L)

12,250

Accounts payable (-L) Interest expense, discounts lost (+E, -SE) Cash (-A)

12,250 250

12,250

12,500

$12,250 = $12,500 x 0.98

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. +

Inventory (A) 12,250

1/20

2/15

Cash (A)

12,500

Accounts Payable (L) 12,250 12,250

+ 1/20

+ Interest Expense, Discounts Lost (E) 2/15 250

2/15

c. [($12,500- $12,250)/$12,250] x [365/(60-15)] = 16.55%. (With interest compounding, the annual rate of interest r can be solved from (1+r)(45/365)=1.02. The value that solves this relationship is r = 17.4%.)

M9-20. (10 minutes) LO 2 a. Interest expense (+E,-SE)…………………… Interest payable (+L)…………………….

24 24

$7,200 × 8% × (15/365) = $24

b. -

Interest Payable (L)

Interest Expense (E)

c. Balance Sheet Transaction Accrued $24 interest on note payable

Cash Asset

Noncash Assets

Liabilities +24 = Interest Payable =

Income Statement Contrib. Capital +

Earned capital -24 Retained Earnings

Revenues

- Expenses +24 Interest Expense

Net = Income -24 =

M9-21. (15 minutes) LO 1, 2 a. Accounts Payable, $110,000 (current liability). b. Not recorded as a liability; an accountable transaction has not yet occurred. c. Estimated liability for product warranty, $2,200 (current liability). d. Bonuses Payable, $30,000 (current liability)—computed as $600,000  5%. This liability must be reported since its payment is “probable” and can be “estimated.”

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M9-22. (10 minutes) LO 3, 5 a. Microsoft is offering bonds with a coupon (stated) rate of 3.3%% when the market rate (yield) is higher (3.383%). In order to obtain this expected rate of return, the bonds sell at a discount price of 99.31 (99.31% of par). b. The first bond matures in 2027 while the second matures in 2057. There is, generally, a higher rate (yield) expected for a longer maturity.

M9-23. (10 minutes) LO 4 Amount paid to retire bonds ($400,000 x 102%).............................................. Book value of retired bonds, net of $3,000 unamortized discount ................... Loss on bond retirement ..................................................................................

$408,000 397,000 $ 11,000

M9-24. (10 minutes) LO 4 a. The $3,546 million of debt that is due in 2018 is already listed as the current portion of long-term debt in Pfizer’s current liabilities. b. Pfizer will need to pay off the bonds when they mature. This will result in a cash outflow that must come from operating activities if the bonds cannot be refinanced prior to maturity. However, most of Pfizer’s long-term debt matures more than 5 years after the financial statement date (December 31, 2017). Thus, Pfizer’s nearterm cash needs for covering long-term debt should not place a significant burden on the company’s operations.

M9-25 (10 minutes) LO 1 a. Gain on Bond Retirement: In the other (nonoperating) income and expenses section of the income statement. b. Discount on Bonds Payable: Deduction from Bonds Payable; thus, a (contra) long-term liability in the balance sheet (e.g., it is netted in the presentation of long-term liabilities). c. Mortgage Notes Payable: Long-term liability in the balance sheet. d. Bonds Payable: Long-term liability in the balance sheet.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

e. Bond Interest Expense: In other (nonoperating) income and expenses section of the income statement. f. Bond Interest Payable: Current liability in the balance sheet. g. Premium on Bonds Payable: Addition to Bonds Payable; thus, part of a long-term liability in the balance sheet (e.g., it is included in the presentation of long-term liabilities). h. Loss on Bond Retirement: In the other (nonoperating) income and expenses section of the income statement.

M9-26. (10 minutes) LO 4 a. Restrictive loan covenants are typically designed to protect the bond holders against actions by management that they feel would be detrimental to their interests. These covenants might include restrictions against the impairment of liquidity, restrictions on the amount of financial leverage the company can employ, and restrictions on the payment of dividends. In addition, bond holders usually impose various covenants prohibiting the acquisition of other companies or the divestiture of business segments without their consent. All of these covenants, by design, restrict management in its actions. b. Management, facing imminent violation of one or more of its bond covenants, may be pressured into taking actions in order to avoid default. These may include, for example, foregoing profitable investments, reduction of discretionary spending such as R&D or advertising in order to improve profitability, missing opportunities to take cash discounts and other methods of “leaning on the trade,” or reduction of receivables (via early payment incentives) and inventories (by marketing promotions or delaying restocking) in order to boost cash balances. Actions may also include questionable accounting measures, such as improper recognition of revenues or delayed recognition of expenses. c. When evaluating solvency, analysts should compare a company’s position relative to its restrictive covenants. A company may appear solvent, but in fact may be in close proximity to a restrictive covenant. Also, analysts should be aware of the potential effect that restrictive covenants can have on management decisions (see the answer to requirement b). Restricted assets, such as cash or securities, should not be considered as general assets in an analysis of the firm’s liquidity or solvency because they are not available to management for general corporate uses.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-9

M9-27. (15 minutes) LO 4 a. 1/1/2013

1/1/2019

Cash (+A) ……………………………………..... Bonds payable (+L) ………………..…… Bond premium (+L) ………………..……

432,000

Bonds payable (-L) ………………………..….. Bond premium (-L) ……………………..…….. Cash (-A) ………………………………..... Gain on retirement of bonds (+R, +SE)

400,000 27,809

400,000 32,000

412,000 15,809

b. + 1/1/13

Cash (A) 432,000 412,000

1/1/19

Gain on Retirement of Bonds (R) + 15,809 1/1/19

1/1/19

Bonds Payable (L) 400,000 400,000

Bond Premium (L) 32,000 27,809

1/1/13

c. Balance Sheet Transaction 1/1/13 Issue bonds at a premium.

Cash Asset

Noncash + Assets

432,000

Liabilities

+400,000

Cash

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

= +15,809

Bonds Payable +32,000 Bond Premium

1/1/19 -412,000 Retired Cash bonds issued on 1/1/13.

-400,000

+15,809

Bonds Payable

Retained Earnings

Gain on Retirement of Bonds

-27,809 Bond Premium

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M9-28. (15 minutes) LO 4 a. 7/1/2012

7/1/2019

Cash (+A) ……………………………………. Bond discount (+XL, -L) …………….….…. Bonds payable (+L) …………………..

240,000 10,000

Bonds payable (-L) ………………………… Loss on retirement of bonds (+E, -SE) … Bond discount (-XL, +L) ……….…… Cash (-A) ……………………………….

250,000 9,314

250,000

6,814 252,500

b. + 7/1/12

Cash (A) 240,000 252,500

7/1/19

+ Loss on Retirement of Bonds (E) 7/1/19 9,314

+ 7/1/12

Bonds Payable (L) 250,000 250,000

Bond Discount (XL) 10,000 6,814

7/1/12

7/1/19

c. Balance Sheet Transaction 7/1/12 Issue bonds at a discount

Cash Asset

Noncash Assets

+240,000

= Liabilities =

Cash

7/1/19 Retired -252,500 bonds issued Cash on 7/1/12

Income Statement

Contra Liability +

Contrib. Earned Capital + Capital

+250,000

+10,000

Bonds Payable

Bond Discount

-250,000

-6,814

-9,314

Bonds Payable

Bond Discount

Retained Earnings

Revenues

- Expenses = -

+9,314

Loss on retirement of Bonds

M9-29. (10 minutes) LO 4 Nissim:

$18,000  0.10  40/365

$197.26

Klein:

$14,000  0.09  18/365

62.14

Bildersee:

$16,000  0.12  12/365

63.12 $322.52

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

Net Income

9-11

-9,314

M9-30. (10 minutes) LO 5 a. Unless there has been a decline in the General Mills’ operating liabilities, the Debtto-Equity ratio (D/E) will increase. The net effects of financing cash flows are to increase financial liabilities and decrease shareholders’ equity. (although net income would then increase equity, but still by an amount less than the increase in debt). Times interest earned will likely decrease as additional interest cost on new borrowing is added to the denominator. How much of an effect this will have depends on the size of the change in net income. b. Generally, the higher (lower) the firm's solvency measures, the higher (lower) the firm's debt rating. In financial leverage terms, the higher (lower) the firm's leverage the lower (higher) the firm's debt rating. Increasing the amount of debt while decreasing equity may harm General Mills’ debt ratings, though increases in operating results , could support additional financial liabilities.

M9-31. (15 minutes) LO 3 a. Selling price of 9% bonds discounted at 8% Present value of principal repayment ($500,000  0.45639) Present value of interest payments ($22,500  13.59033) Selling price of bonds

$228,195 305,782 $533,977

b. Selling price of 9% bonds discounted at 10% Present value of principal repayment ($500,000  0.37689) Present value of interest payments ($22,500  12.46221) Selling price of bonds

$188,445 280,400 $468,845

M9-32. (15 minutes) LO 3 a. Selling price of zero-coupon bonds discounted at 8%: Present value of principal repayment ($500,000  0.45639)

$228,195

b. Selling price of zero coupon bonds discounted at 10%: Present value of principal repayment ($500,000  0.37689)

$188,445

c. Based on the debt-to-equity ratio, financial leverage would increase from 2.0 [=($3 $1)/$1] to 2.19 [=($3 - $1 + $0.188)/$1)

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M9-33. (15 minutes) LO 1 a. Month Income statement: Revenue Cost of goods sold Operating expenses Income Operating cash flows Receipts Payments to suppliers Payments for operating expenses Net cash flow from operations

$420 300 110 $10

$420 0 110 $310

$420 300 110 $10

b. Month Income statement: Revenue Cost of goods sold Operating expenses Income Operating cash flows Receipts Payments to suppliers Payments for operating expenses Net cash flow from operations

The CFO’s proposal would increase the cash generated by operations, but only for one month. Then the cash flows would revert to their original pattern. Therefore, “leaning on the trade,” (deferring payables) is not likely to produce a steady source of cash for expansion of the business.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-13

M9-34. (30 minutes) LO 3, 4

©Cambridge Business Publishers, 2021 9-14

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M9-35. (15 minutes) LO 3, 4 a. Gain on bond retirement

Reported in the income statement under other (nonoperating) income

b. Discount on bonds payable

Contra-liability netted against bonds payable under long-term liabilities in the balance sheet

c. Mortgage notes payable

Long-term liability in the balance sheet; the amount due within one year would be reported as a current liability

d. Bonds payable

Long-term liability in the balance sheet; the amount due within one year would be reported as a current liability

e. Bond interest expense

Nonoperating expense reported in the income statement

f. Bond interest payable

A current liability in the balance sheet

g. Premium on bonds payable

Adjunct-liability added to bonds payable under long-term liabilities in the balance sheet

M9-36. (15 minutes) LO 3, 4 a. 12/31/18

6/30/19

12/31/19

Cash (+A) …………………………………….. Mortgage note payable (+L) …………..

700,000

Interest expense (+E, -SE) ……………………. Mortgage note payable (-L) …………………… Cash (-A) …………………………………..

42,000 8,854

Interest expense (+E, -SE) …………………… Mortgage note payable (-L) ………………….. Cash (-A) ………………………………….

41,469* 9,385

700,000

50,854

* $41,469 = ($700,000 – $8,854) x 12%/2.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-15

b. + 12/31/18

Cash (A) 700,000

50,854 50,854

+ 6/30/19 12/31/19

Interest Expense (E) 42,000 41,469

6/30/19 12/31/19

Mortgage Note Payable (L) + 700,000 12/31/18 6/30/19 8,854 12/31/19 9,385

c. Balance Sheet Transaction

Cash Asset

12/31/18 Borrow $700,000 on a 15-year mortgage note payable.

+700,000

6/30/19 Interest payment on note.

-50,854

12/31/19 Interest payment on note.

-50,854

Noncash Assets

= Liabilities +

Contrib. Capital +

Earned Capital

Revenues

= +700,000

Cash

Expenses

Net = Income =

Mortgage Note Payable

Cash

Income Statement

-8,854

-42,000

Mortgage Note Payable

Retained Earnings

-9,385

-41,469

Mortgage Note Payable

Retained Earnings

+42,000

= -42,000

Interest Expense -

+41,469

= -41,469

Interest Expense

M9-37. (5 minutes) LO 3 $900,000 x 0.55839 + [(900,000 x 10%/2) x 7.36009] = $833,755. $833,755 / $900,000 = 92.6% of par value.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

EXERCISES E9-38. (15 minutes) LO 1 a. Total expected failures from units sold in the current period .............

1,380*

Average cost per failure ...................................................................... Total expected warranty costs for current period sales ......................

 $50 $ 69,000

Plus beginning warranty liability..........................................................

$ 30,000

Minus warranty services provided ...................................................... Ending warranty liability ......................................................................

$ 27,000 $ 72,000

*(69,000 x 0.02)

The product warranty liability must be increased by $69,000 to cover the expected repair costs of products sold during the period, and that amount would be recognized as expense. With the opening liability balance of $30,000 and warranty services provided of $27,000, the ending liability balance would be $72,000. b. The warranty liability should be equal, at all times, to the expected dollar cost of future repairs. Waymire Company should conduct an analysis similar to an aging of accounts to determine which products are still under warranty and what the expected cost will be. That estimate will provide the correct value for the warranty liability and determines any required adjustments in the period’s warranty expense. Analysis issues relate to whether the warranty liability exists and, if so, whether it is at the correct amount. Understating (overstating) the accrual overstates (understates) current period income at the expense (benefit) of future income. c. The debt-to-equity ratio will increase and the operating cash flow to liabilities will decrease. The times-interest earned ratio will decrease, because the increase in liability causes an increase in warranty expense, which decreases earnings before interest and taxes.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-17

E9-39. (10 minutes) LO 1 Item

Accounting Treatment

Neither record nor disclose (neither probable nor reasonably possible)

Record a current liability for the note, no liability for interest until incurred as time passes.

Disclose in a footnote (at least reasonably possible) (Also, if Shevlin is an SEC registrant and the amount is material, the line item “Commitment and contingencies” may need to be shown on the face of the balance sheet, with no associated amounts for that line item.)

Record warranty liability on balance sheet and recognize expense in income statement (costs are probable and reasonably estimable).

E9-40. (15 minutes) LO 1 The company must accrue the $25,000 of wages that have been earned by employees even though these wages will not be paid until the first of next month. The required accounting accrual will: • Increase wages payable by $25,000 on the balance sheet • Increase wages expense by $25,000 in the income statement Failure to make this accounting accrual (called an adjusting entry) would understate liabilities, understate expenses, overstate income, and overstate stockholders’ equity.

E9-41. (15 minutes) LO 3, 4 a. Selling price of bonds: Present value of principal repayment ($300,000  0.30832) Present value of interest payments ($16,500  17.29203) Selling price of bonds

$ 92,496 285,318 $377,814

b. 1/1/19

6/30/19

Cash (+A) …………………………………….. Bond premium (+L) …………………… Bonds payable (+L) ……………...……

377,814

Interest expense (+E, -SE) ………………… Bond premium (-L) ……………...………….. Cash (-A) ………………………………..

15,113 1,387

77,814 300,000

16,500

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. continued 12/31/19 Interest expense (+E, -SE) ………………… Bond premium (-L) …………………………. Cash (-A) ………………………………..

15,057 1,443 16,500

$15,057 = ($377,814 – $1,387) x 8%/2.

c. + 1/1/19

Cash (A) 377,814

16,500 16,500

+ 6/30/19 12/31/19

Interest Expense (E)

Bonds Payable (L) 300,000

Bond Premium (L) 77,814 1,387 1,443

1/1/19

6/30/19 12/31/19 -

15,113 15,057

6/30/19 12/31/19

1/1/19

d. Balance Sheet Transaction 1/1/19 Issue bonds at a premium.

Cash Asset +377,814

Noncash Assets =

Liabilities

+300,000

Cash

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Net - Expenses = Income -

Bonds Payable

+77,814 Bond Premium 6/30/19 Interest payment on bonds.

-16,500

12/31/19 Interest payment on bonds.

-16,500

Cash

-1,387

-15,113

Bond Premium

Retained Earnings

-1,443

-15,057

Bond Premium

Retained Earnings

+15,113

= -15,113

Interest Expense

+15,057

= -15,057

Interest Expense

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-19

E9-42. (10 minutes) LO 3 Selling price of bonds Present value of principal repayment ($900,000  0.44230) Present value of interest payments ($49,500  9.29498) Selling price of bonds

$398,070 460,102 $858,172

E9-43. (15minutes) LO 1 a. Additions to the Warranty provision would be reflected in Warranty expense. Warranty expense (+E, -SE) ………………………. Warranty provision (+L)……………………

1,786 1,786

b. Usage of the warranty provision would reflect Siemens providing warranty services to its customers. The provision liability would be reduced, as would balances in cash and perhaps inventory reflecting the resources needed for the warranty work. Warranty provision (-L) …………………………….. Cash or inventory (-A)…………………….

993 993

c. It can be useful to report the additions and reversals separately for a couple of reasons. First, the reversals would reflect past periods’ errors in estimates, while the additions could reflect the expected cost of providing warranty service for sales made in the current period. In addition, it may provide insights into whether Siemens tends to be systematically optimistic or pessimistic in its estimates. The numbers reported indicate that Siemens tends to overestimate its warranty expenses. d. 2018: €1,786/€83,044 = 2.15% 2017: €1,820/€82,863 = 2.20% Warranty expense appears to have increased in 2014 as a percentage of sales revenue.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E9-44. (15 minutes) LO 3, 4 a. Cash (+A) ………………………………………... Bonds payable (+L) ……………………….

500,000

10/31/18 Interest expense (+E, -SE) ……………………. Cash (-A) …………………………………...

22,5001

Bonds payable (-L) ……………………………... Loss on retirement of bonds (+E, -SE) ………. Cash (-A) ……………………………………

300,000 3,000

5/1/18

11/1/19

500,000

22,500

303,0002

$500,000 x 0.09 x 1/2 = $22,500 interest expense. Because the bonds were sold at par, there is no discount or premium amortization.

Cash required to retire $300,000 of bonds at 101 = $300,000 x 1.01 = $303,000. The difference between the cash paid and the carrying amount of the bonds is the gain or loss on the redemption. In this case, the loss is $3,000. This calculation assumes that the interest was paid on 10/31/19, so accrued interest is not recorded.

b. + 5/1/18

Cash (A) 500,000

22,500 303,000 + 10/31/18

Interest Expense (E) 22,500

10/31/18 11/1/19 -

Bonds Payable (L) 500,000

11/1/18

+ 5/1/18

300,000

+ Loss on Retirement of Bonds (E) 11/1/18 3,000

c. Balance Sheet Transaction

Cash Asset

5/1/18 Issue bonds.

+500,000

10/31/18 Interest payment on bonds.

-22,500

11/1/19 Early retirement of bonds.

-303,000

Noncash Assets = Liabilities +

Contrib. Capital +

Earned Capital

= +500,000

Cash

Revenues

- Expenses

Net Income

Bonds Payable =

-22,500

Cash

Income Statement

Retained Earnings = -300,000

-3,000

Bonds Payable

Retained Earnings

+22,500

-22,500

-3,000

Interest Expense -

+3,000 Loss on Retirement of Bonds

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-21

E9-45. (25 minutes) LO 3, 4 a. Selling price of bonds Present value of principal repayment ($250,000  0.41552) Present value of interest payments ($10,000  11.68959) Selling price of bonds

$103,880 116,896 $220,776

b. 1/1/19

6/30/16

Cash (+A) ………………………………………. Bond discount (+XL, -L) ……………………… Bonds payable (+L) ……………………..

220,776 29,224

Interest expense (+E, -SE) …………………… Bond Discount (-XL, +L) ………….……. Cash (-A) …………………………………..

11,039

250,000 1,039 10,000

$11,039 = $220,776  0.05

12/31/19 Interest expense (+E, -SE) …………………. Bond Discount (-XL, +L) …………….…. Cash (-A) …………………………………..

11,091 1,091 10,000

$11,091 = [$220,776 + $1,039]  0.05

c. +

Cash (A) 220,776 10,000 10,000

1/1/19

Bonds Payable (L) 250,000

+ 1/1/19

Bond Discount (XL) 29,224 1,039 1,091

6/30/19 12/31/19

Interest Expense (E)

6/30/19 12/31/19

11,039 11,091

6/30/19 12/31/19

d. Balance Sheet Transaction

Cash Asset

Noncash Assets

= Liabilities =

Contra Contrib. Liability + Capital +

6/30/19 Interest payment on bonds.

-10,000

-1,039

-11,039

+11,039

Cash

Bond Discount

Retained Earnings

Interest Expense

12/31/19 Interest payment on bonds.

-10,000

-1,091

-11,091

Bond Discount

Retained Earnings

Cash

Bond Discount

Revenues - Expenses

+220,776

+29,224

Bonds Payable

Earned Capital

1/1/19 Issue bonds at a discount.

Cash

+250,000

Income Statement

Net = Income =

+11,091

-11,039

= -11,091

Interest Expense

©Cambridge Business Publishers, 2021 9-22

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E9-46. (25 minutes) LO 3, 4 a. Selling price of bonds: Present value of principal repayment ($800,000  0.20829) Present value of interest payments ($36,000  19.79277) Selling price of bonds

$166,632 712,540 $879,172

b. Cash (+A) ………………………………………... Bond premium (+L) ……………………… Bonds payable (+L) ………………………

879,172

6/30/19 Interest expense (+E,-SE) ……………………. Bond premium (-L) …………….……………… Cash (-A) …………………………………..

35,167 833

1/1/19

79,172 800,000

36,000

$35,167 = $879,172 x 0.04

12/31/19 Interest expense (+E,-SE) ……………………. Bond premium (-L) …………….……………… Cash (-A) …………………………………..

35,134 866 36,000

$35,134 = ($879,172 - $833) x 0.04

c. + 1/1/19

Cash (A) 879,172

36,000 36,000

+ 6/30/19 12/31/19

Interest Expense (E) 35,167 35,134

Bonds Payable (L) 800,000

+ 1/1/19

Bond Premium (L) 79,172 6/30/19 833 12/31/19 866

+ 1/1/19

6/30/19 12/31/19 -

d. Balance Sheet Cash Noncash Transaction Asset + Assets = 1/1/19 +879,172 = Issue Cash bonds at a premium.

6/30/19 Interest payment on bonds. 12/31/19 Interest payment on bonds.

Liabilities +800,000 Bonds Payable +79,172 Bond Premium

Income Statement +

Contrib. Capital +

Earned Capital

Revenues

Expenses

= =

Net Income

-36,000 Cash

-833 Bond Premium

-35,167 Retained Earnings

+35,167 Interest Expense

-35,167

-36,000 Cash

-866 Bond Premium

-35,134 Retained Earnings

+35,134 Interest Expense

-35,134

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 9

9-23

E9-47. (20 minutes) LO 3, 4 a. There is an inverse relation between interest rates and bond prices (examine the increasing discount rates as the yield increases in present value tables). Since the bonds now trade at a premium and assuming that Deere’s credit ratings have not changed, we can conclude that interest rates have fallen since the bonds were issued. b. No, once the bond is initially recorded, neither the coupon rate nor the yield used to compute interest expense is changed. Bonds are recorded at historical cost (like most other balance sheet assets and liabilities). As a result, changes in the general level of interest rates have no effect on interest expense (or the interest payment) that is reflected in the financial statements. c. Because the bonds trade at a premium in the market, Deere would be paying more to retire the bonds than the amount at which they are carried on its balance sheet. This would result in a loss on the repurchase that would lower current profitability. d. The face amount of the bonds will be paid at maturity. As a result, the market price of the bonds must also equal their face amount ($200 million) at that time.

E9-48. (25 minutes) LO 3 4 a. Selling price of bonds Present value of principal repayment ($600,000  0.09722) Present value of interest payments ($33,000  15.04630) Selling price of bonds

$ 58,332 496,528 $554,860

b. Cash (+A) …………………………………….. Bond discount (+XL, -L) ………………..…… Bonds payable (+L) ……………………

554,860 45,140

6/30/19 Interest expense (+E, -SE) …………………. Bond discount (-XL, +L) ………………. Cash (-A) …………………………………

33,292

1/1/19

600,000

292 33,000

$33,292 = $554,860  .06.

12/31/19 Interest expense (+E, -SE) ………………… Bond discount (-XL, +L) …………….…. Cash (-A) ………….…………………….

33,309 309 33,000

$33,309 = ($554,860 + $292)  0.06.

©Cambridge Business Publishers, 2021 9-24

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. + 1/1/19

+ 6/30/19 12/31/19

Cash (A) 554,860 33,000 33,000 Interest Expense (E)

Bonds Payable (L) 600,000

+ 1/1/19

Bond Discount (XL) 45,140 292 309

6/30/19 12/31/19 -

33,292 33,309

6/30/19 12/31/19

d. At December 31, 2019 (after the coupon payment recorded in b), the book value of the bonds would be $554,860 + $292 + $309 = $555,461. The market value would be $600,000 X 1.01 = $606,000. Thus, a fair value adjustment of $50,539 (=$606,000-$555,461) would be recorded as follows: 12/31/19 Loss due to adjustment of bonds to fair value +E, -SE) Fair value adjustment (+L)

50,539 50,539

The loss would be reported in net income for the period. e. Coupon payments ($33,000 X 2) Discount amortization ($292 + $309) Total interest expense Fair value adjustment (loss) Total effect on income (deduction)

$ 66,000 601 66,601 50,539 $117,140

E9-49. (10 minutes) LO 2, 4 Current liabilities: Bond interest payable Current maturities of long-term debt: 10% bonds payable due 2019 Total current liabilities

$ 25,000 500,000 $525,000

Long-term debt: 9% bonds payable due 2020, net of $19,000 discount Zero coupon bonds payable due 2021 8% bonds payable due 2023, including $2,000 premium Total long-term debt

$581,000 170,500 102,000 $853,500

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E9-50. (20 minutes) LO 3, 4 a. 12/31/18 Cash (+A) …………………………………………… Mortgage note payable (+L) ……………….

500,000

Interest expense (+E, -SE) ………………………. Mortgage note payable (-L) ……………………... Cash (-A) ………………………………………

10,000 8,278

Interest expense (+E, -SE) ………………………. Mortgage note payable (-L) ……………………... Cash (-A) ………………………………………

9,834 8,444

3/31/19

6/30/19

500,000

18,278

$9,834 = ($500,000 – $8,278) x 8%/4.

b. + 12/31/18

Cash (A) 500,000

18,278 18,278

+ 3/31/19 6/30/19

Interest Expense (E) 10,000 9,834

3/31/19 6/30/19

Mortgage Note Payable (L) + 500,000 12/31/18 3/31/19 8,278 6/30/19 8,444

c. Balance Sheet Transaction

Cash Asset

12/31/18 Borrow $500,000 on a 10-year mortgage note payable.

+500,000

3/31/19 Payment on note.

-18,278

6/30/19 Payment on note.

-18,278

Noncash Assets

= Liabilities

Contrib. Capital +

Earned Capital

= +500,000

Cash

Revenues

Expenses

Net = Income =

Mortgage Note Payable

Cash

Income Statement

-8,278

-10,000

Mortgage Note Payable

Retained Earnings

-8,444

-9,834

Mortgage Note Payable

Retained Earnings

+10,000

-10,000

-9,834

Interest Expense -

+9,834 Interest Expense

©Cambridge Business Publishers, 2021 9-26

Financial & Managerial Accounting for Decision Makers, 4 th Edition

PROBLEMS P9-51. (20 minutes) LO 1 a. -

Hewlett-Packard Enterprise Company Accrued Warranty Liability (L) + 475 17 bal. 265 18 exp. 310 430 18 bal.

Cisco Systems Accrued Warranty Liability (L) + 407 17bal. 582 18 exp. 630 359 18 bal.

Hewlett-Packard incurred $310 million in warranty repair costs and settlements in 2018 while Cisco Systems, Inc. incurred costs of $630 million. b. HPE’s ratio of warranty expense to sales was 1.40% in 2018 ($265/$19,504) down slightly from 1.7% in 2017 ($292/$17,597). Cisco’s ratio was 1.59% in 2018 ($582/$36,709) and 1.94% ($691/$35,705) in 2017. Cisco’s warranty expense is slightly higher relative to sales revenue than that of HPE. In general, reasons for the higher warranty expense-to-sales ratio include: (1) perhaps Cisco products require more repairs than HPE products or (2) HPE may have a less generous warranty policy than Cisco, resulting in fewer warranty repairs, even if the quality is the same. The slight decrease in HPE’s warranty expense as a percent of sales indicates that either (1) warranty costs have gone down, (2) the company overestimated warranty costs in the past and needed to record smaller than normal accruals in 2018 to correct the overestimation; or (3) HPE was building up a “cookie-jar reserve” by increasing its warranty liability in past years.

P9-52. (20 minutes) LO 3, 4 a. Cash (+A) ………………………………………….. Accrued interest payable (+L) …………… Bonds payable (+L) ………………………..

518,750 18,750 500,000

$18,750 = $500,000 x .09 x 5/12

b. Interest expense (+E, -SE)………………………. Accrued interest payable (-L) ………………….. Cash (-A) ……………………………………..

3,750 18,750 22,500

$22,500 = $500,000 x 9% x 6/12

c. Interest expense (+E, -SE) ……………………… Accrued interest payable (+L) ……………

7,500 7,500

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9-27

d. Fair value adjustment (+XL, -L) ……………….. Gain from adjustment of bonds to fair value (+R, +SE) ……………………………..

5,000

e. Interest expense (+E, -SE) ……………………… Accrued interest payable (-L) ………………….. Cash (-A) ……………………………………..

15,000 7,500

Bonds payable (-L) ………………………………. Loss on retirement of bonds (+E, -SE) ………. Cash (-A) …………………………………….. Fair value adjustment (-XL, +L) … *($15,000 x 60%) = $9,000

300,000 12,000

5,000

22,500

303,000 9,000*

g. If gains/losses on bond revaluations were reported in other comprehensive income rather than net income, Eskew, Inc.’s December 31, 2018 income statement would be lower because it would not include the $5,000 gain from part d above. The $5,000 gain (after accounting for expected taxes) would increase the balance in an account entitled accumulated other comprehensive income in Eskew, Inc.’s shareholders’ equity, so shareholders’ equity would be unchanged. (Such gains/losses would go through the income statement when Eskew, Inc. redeems the bonds.)

P9-53. (15 minutes) LO 3, 4 a. CVS reports interest expense of $1.04 billion, plus $8 million in capitalized interest, giving a total interest cost of $1.048 billion on average debt of $27,266.5 million ([$27,002million + $27,531million]/2) for an average rate of 3.8%. Using interest paid ($1.07 billion) instead of interest expense yields 3.92%. See the answer to c below. b. CVS reports coupon rates of 1.9% to 6.25%. In addition, no rates are reported for capital leases, mortgage notes, commercial paper, or the floating rate notes. So, the average rate seems reasonable given the information disclosed in the long-term debt footnote. c. Interest paid can differ from interest expense if bonds are sold at a premium or a discount. It can also differ because of capitalized interest. CVS reported capitalized interest of $8 million in 2017. Thus, CVS apparently amortized $22 million in net bond discounts ($1,070 million - $1,040 million - $8 million).

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P9-54. (25 minutes) LO 3, 4 Cash (+A) ……………………………………. Accrued interest payable (+L) ……. Bonds payable (+L) …………………

a. 7/1/19

824,000 24,000 800,000

$24,000 = $800,000 x .09 x 4/12

Interest expense (+E, -SE) ……………..… Accrued interest payable (-L) ……………. Cash (-A) ………………………………

b. 9/1/19

12,000 24,000 36,000

$36,000 = $800,000 x 9%/2

Interest expense (+E, -SE) ………………… Accrued interest payable (+L) …….

c. 12/31/19

24,000 24,000

$24,000 = $800,000 x .09 x 4/12

d. 3/1/20

e. 3/1/20

+ a.

+ b. c. d.

Interest expense (+E) ……………………… Accrued interest payable (-L) ……………. Cash (-A) ………………………………

12,000 24,000

Bonds payable (-L) ………………………… Loss on retirement of bonds (+E, -SE) … Cash (-A) ……………………………..

200,000 2,000

Cash (A) 824,000

36,000 36,000 202,000

Interest Expense (E) 12,000 24,000 12,000

b. d. e. -

e. -

36,000

202,000 Bonds Payable (L) + 800,000

200,000 Accrued Interest Payable (L) b. 24,000 24,000 d. 24,000 24,000

+ a. c.

+ Loss on Retirement of Bonds (E) e. 2,000

continued next page

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9-29

e. continued Balance Sheet Transaction a. 7/1/19 Issue bonds.

Cash Noncash Asset + Assets +824,000 Cash

= Liabilities = +800,000 Bonds Payable

Income Statement Contrib. Capital +

Earned Capital

Revenues

- Expenses = =

Net Income

+24,000 Interest Payable b. 9/1/19 Interest payment on bonds.

-36,000 Cash

c. 12/31/9 Accrued interest on bonds.

-24,000 Interest Payable

-12,000 Retained Earnings

+12,000 Interest Expense

-12,000

+24,000 Interest Payable

-24,000 Retained Earnings

+24,000 Interest Expense

-24,000

d. 3/1/20 Interest payment on bonds.

-36,000 Cash

-24,000 Interest Payable

-12,000 Retained Earnings

+12,000 Interest Expense

-12,000

e. 3/1/120 Early retirement of bonds.

-202,000 Cash

-200,000 Bonds Payable

-2,000 Retained Earnings

+2,000 = Loss on Retirement of bonds

-2,000

P9-55. (20 minutes) LO 3, 4 a. Period 0 1 2

Interest Expense

Cash Interest Paid

Discount Amortization

$39,600 $39,600

$1,122 $1,190

$40,722 $40,790

Discount Balance $41,292 $40,170 $38,980

Bond Payable Net $678,708 $679,830 $681,020

$40,722 = $678,708 x 12%/2 $40,790 = $679,830 x 12%/2

b. 12/31/18 Cash (+A) ………………………………….. Bond discount (+XL) ……………………. Bonds payable (+L) ………………..

678,708 41,292

Interest expense (+E,-SE) ………………. Bond discount (-XL) ……………….. Cash (-A) ……………………………..

40,722

12/31/19 Interest expense (+E,-SE) ………………. Bond discount (-XL) ……………….. Cash (-A) ……………………………..

40,790

6/30/19

720,000 1,122 39,600 1,190 39,600

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. + 12/31/18

Cash (A) 678,708 39,600 39,600

Bonds Payable (L) 720,000

+ 12/31/18

6/30/19 12/31/19

Interest Expense (E)

6/30/19 12/31/19

+ Bond Discount (XL) 12/31/18 41,292 1,122 1,190

40,722 40,790

6/30/19 12/31/19

d. Balance Sheet Cash Asset

Transaction

Noncash Assets

= Liabilities

Contra Contrib. Retained Liability + Capital + Earnings Revenues

- Expenses = -

12/31/18 +678,708 Issue bonds Cash at a discount.

= +720,000

+41,292

Bonds Payable

Bond Discount

6/30/19 Interest payment on bonds.

-39,600

12/31/19 Interest payment on bonds.

-39,600

Cash

Income Statement

-1,122

-40,722

Bond Discount

Retained Earnings

-1,190

-40,790

Bonds Discount

Retained Earnings

Net Income

+40,722

-40,722

-40,790

Interest Expense -

+40,790 Interest Expense

P9-56. (20 minutes) LO 3, 4 a. Period 0 1 2

Interest Expense $8,271 $8,302

Cash Interest Paid

Discount Amortization

$7,500 $7,500

$771 $802

Discount Balance $43,230 $42,459 $41,657

Bond Payable Net $206,770 $207,541 $208,343

$8,271= $206,770 x 8%/2 $8,302 = $207,541 x 8%/2

b. Cash (+A) …………………….……….………..…… Bond discount (+XL, -L) …………………………. Bonds payable (+L) …….……………………

206,770 43,230

10/31/19 Interest expense (+E, -SE) ………………..….….. Bond discount (-XL, +L) ……………………. Cash(-A) ………………………………………..

8,271

4/30/19

250,000

771 7,500

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b. continued 12/31/19 Interest expense (+E, -SE) ………………..….….. Bond discount (-XL, +L) ……………………. Accrued interest payable (+L) ……………..

2,767*

Interest expense (+E, -SE) …………………...….. Accrued interest payable (-L) ………..….………. Bond discount (-XL, +L) ……………………. Cash(-A) ………………………………………..

5,535** 2,500

4/30/20

267 2,500

535 7,500

Within each six-month period, interest is apportioned to individual months on a straight-line basis:

*$2,767 = ($8,302 x 2/6) **$5,535 = ($8,302 x 4/6) c. + 4/30/19

Cash (A) 206,770

7,500 7,500

Bonds Payable (L) 250,000

+ 4/30/19

10/31/19 4/30/20

Interest Expense (E)

10/31/19 12/31/19 4/30/20

+ Bond Discount (XL) 4/30/19 43,230 771 267 535

8,271 2,767 5,535

10/31/18 12/31/18 4/30/20

Accrued Interest Payable (L) + 2,500 12/31/19 4/30/20 2,500

d. Balance Sheet Cash Asset

Noncash + Assets = Liabilities

4/30/19 Issue bonds at a discount.

+206,770

10/31/19 Interest payment on bonds.

-7,500

Transaction

Cash

4/30/20 Interest payment on bonds.

+43,230

Bonds Payable

Bond Discount

-7,500

Cash

Contra Liability

+250,000

Contrib. Capital +

Earned Capital

Revenues

Net - Expenses = Income -

-771

-8,271

Bond Discount

Retained Earnings

+2,500

-267

-2,767

Accrued Interest Payable

Bond Discount

Retained Earnings

-2,500

-535

-5,535

Accrued Interest Payable

Bond Discount

Retained Earnings

Cash

12/31/19 Accrued interest on bonds.

Income Statement

+8,271

-8,271

-2,767

-5,535

Interest Expense -

+2,767 Interest Expense

+5,535 Interest Expense

©Cambridge Business Publishers, 2021 9-32

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P9-57. (20 minutes) LO 3, 4 a. Payment x 12.46221 = $500,000; Payment = $500,000/12.46221 = $40,121. b. 12/31/18

6/30/19

Cash (+A) ………………………………………..…… Mortgage note payable (+L) …………………

500,000

Interest expense (+E, -SE) ………………………… Mortgage note payable (-L) ………………………. Cash (-A) …………………………………..……

25,000 15,121

500,000

40,121

$25,000 = $500,000 x 10%/2

12/31/19

Interest expense (+E, -SE) ……………………….… Mortgage note payable (-L) ……………………….. Cash (-A) …………………………………..……

24,244 15,877 40,121

$24,244 = ($500,000 – $15,121) x 10%/2

c. + 12/31/18

+ 6/30/18 12/31/18

Cash (A) 500,000 40,121 40,121

6/30/19 12/31/19

Interest Expense (E)

Mortgage Note Payable (L) + 500,000 12/31/18 6/30/19 15,121 12/31/19 15,877

25,000 24,244

d. Balance Sheet Transaction

Cash Asset

Noncash + Assets

Contrib. = Liabilities + Capital +

12/31/18 +500,000 Borrow Cash $500,000 on a 10-year mortgage note payable.

= +500,000

6/30/19 Interest payment on note.

-40,121

12/31/19 Interest payment on note.

-40,121

Revenues

- Expenses

Net = Income

Mortgage Note Payable

Cash

Income Statement Earned Capital

-15,121

-25,000

Mortgage Note Payable

Retained Earnings

-15,877

-24,244

Mortgage Note Payable

Retained Earnings

+25,000

-25,000

-24,244

Interest Expense

+24,244 Interest Expense

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P9-58. (20 minutes) LO 3, 4 a. Payment x 16.35143 = $950,000; Payment = $950,000/16.35143 = $58,099. b. 12/31/18 Cash (+A) ………………………………………..…… Mortgage note payable (+L) …………………

950,000

Interest expense (+E, -SE) ………………………… Mortgage note payable (-L) ………………………. Cash (-A) …………………………………..……

19,000* 39,099

3/31/19

950,000

58,099

* $19,000 = $950,000 x 8%/4

6/30/19

Interest expense (+E, -SE) ………………………… Mortgage note payable (-L) ………………………. Cash (-A) …………………………………..……

18,218* 39,881 58,099

* $18,218 = ($950,000 – $39,099) x 8%/4.

c. + 12/31/18

+ 3/31/19 6/30/19

Cash (A) 950,000 58,099 58,099

3/31/19 6/30/19

Interest Expense (E)

Mortgage Note Payable (L) + 950,000 12/31/18 3/31/19 39,099 6/30/19 39,881

19,000 18,218

d. Balance Sheet Transaction

Cash Asset

Noncash + Assets

= Liabilities

12/31/18 +950,000 Borrow Cash $950,000 on a 5-year mortgage note payable.

= +950,000

3/31/19 Payment on note.

-58,099

6/30/19 Payment on note.

-58,099

Earned Capital

Revenues - Expenses = -

Net Income

Mortgage Note Payable

Cash

Income Statement Contrib. Capital +

-39,099

-19,000

Mortgage Note Payable

Retained Earnings

-39,881

-18,218

Mortgage Note Payable

Retained Earnings

+19,000

-19,000

-18,218

Interest Expense

+18,218 Interest Expense

©Cambridge Business Publishers, 2021 9-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P9-59. (10 minutes) LO 1

a. BP recorded the $9.2 billion estimate as an expense on its 2010 income statement. This increased the company’s liabilities. b. If BP had prepared its financial statements in accordance with U.S. GAAP, the accrual would most likely have been at the low end of the range -- $6 million, instead of the expected amount (best reliable estimate), or mid-point in the range.

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CASES and PROJECTS C9-60. (30 minutes) LO 3, 4, 5 a. The difference between interest expense and interest paid can be caused by three factors: (1) interest capitalized as part of self-constructed assets is paid but not part of interest expense (a detailed discussion is beyond the scope of this text); (2) coupon payments differ from interest expense charged on bonds due to amortization of discounts or premiums; (3) interest payments may not coincide with the fiscal period, thus requiring the company to record accrued interest payable. b. In 2017, Comcast’s debt had a fair value of $71.7 billion while its historical cost was $64.6 billion. Thus, Comcast would report a fair value adjustment as a credit in its balance sheet of $7.1 billion ($71.7 - $64.6). In 2016, the fair value was $66.3 billion and the historical cost was $61.0 billion yielding a credit balance in the fair value adjustment account of $5.3 billion ($66.3 - $61.0). The change in the fair value adjustment from 2016 to 2017 ($1.8 = $7.1 – $5.3) would be recorded as follows: 12/31/17 Loss due to adjustment of bonds to fair value (+E, -SE) Fair value adjustment (+L)

1.8 1.8

c. Debt-to-equity: $117,500 million/$69,449 million = 1.69 Times interest earned: ($15,322 million + $3,086 million)/$3,086 million = 5.97 Creditors are naturally concerned about the risk of default. The debt-to-equity ratio measures the extent to which a company is relying on debt financing and the higher the ratio, the greater chance of default. In addition, the times interest earned ratio measures the company’s ability to pay the interest on the debt. d. Management may bypass profitable investment projects or cut discretionary expenditures such as R&D or advertising. It may also engage in questionable accounting practices in an attempt to manage the ratios. e. Note16 for Comcast discusses various contractual commitments – payment schedules for future cash outflows as a result of their contractual agreements. These are not recorded liabilities on the balance sheet, however. (We discuss these more in Chapter 10). Comcast also discusses various contingent liabilities that it may have, often as a result of litigation.

©Cambridge Business Publishers, 2021 9-36

Financial & Managerial Accounting for Decision Makers, 4 th Edition

C9-61. (20 minutes) LO 3, 4, 5 a. The gain results from the difference between the book value of the debt ($3,000,000) and the current redemption (market) value ($2,200,000). The gain would be reported in the income statement under other (nonoperating) income. The source of the gain should be adequately disclosed in the notes. b. Currently, Foster is paying 4% interest on the $3,000,000 of long-term debt, or $120,000 per year. Under the proposed refinancing, Foster would pay 8%, or $240,000. The refinancing would generate an additional $800,000 in cash. However, because interest costs are increasing by $120,000 per year ($240,000 $120,000), Foster is effectively borrowing the additional $800,000 at a rate of almost 15% ($120,000 / $800,000). As such, Foster would be paying in the future (in the form of higher interest costs) for a one-time boost in current earnings. c. The potential ethical conflict exists because Foster’s president is concerned that his job might be dependent on producing short-term earnings. Because of this, he might be tempted to accept this proposal and boost current earnings at the cost of lower earnings in future years. This thinking is misguided because, given adequate disclosure, analysts and investors would be able to identify and discount the source of the earnings boost. The most serious unethical act would be to try to hide (or obfuscate) the bond refinancing with inadequate disclosure.

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Chapter 10 Reporting and Analyzing Leases, Pensions, Income Taxes, and Commitments and Contingencies Learning Objectives – coverage by question MiniExercises

Exercises

LO1 – Define off-balance-sheet financing and explain its effects on financial analysis.

LO2 – Account for leases using the finance lease method and the operating lease method. Compare and analyze the two methods.

13 – 17

24, 26, 27

36 – 37

LO3 – Explain and interpret the reporting for pension plans.

18 -21

25, 30, 31

39, 40

LO4 – Analyze and interpret pension footnote disclosures.

19 – 21

25, 30, 31

39, 40

32 – 35

41 – 44

47, 48

28, 29

LO5 – Describe and interpret accounting for income taxes. LO6 – Describe disclosures regarding future commitments and contingencies. Analyze financial statements after converting offbalance sheet items to be considered on the balance sheet.

Problems

Cases and Projects

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-1

QUESTIONS Q10-1. Under the old lease accounting standard for an operating lease, the lessee did not record either the leased asset or the lease liability on the balance sheet, and normally charged each lease payment to rent expense. Under the new lease accounting standard, the lessee in an operating lease contract records a right-of-use asset on the balance sheet as well as a lease liability on the balance sheet. The expense is a straight-line lease expense (total cost of the lease divided by the number of lease payments). Under the old standard, the other type of lease was a capital lease and under the new standard the other type is a finance lease. The lessee accounted for a capital lease by recording the leased property as an asset and establishing a liability for the lease obligation. The leased asset was subsequently depreciated, and interest expense accrued on the lease liability. Under the new standard, the other type of a lease is a finance-type lease. The lessee records a lease asset and a lease liability on the balance sheet -- the lease asset is amortized and amortization expense is recorded, and in addition, interest expense is recorded, and the lease liability is reduced as payments are made. Q10-2. As adoption occurs, the year of adoption (and years after adoption)_ will be presented using the new standard, while prior years will likely be presented using the old standard. Thus, financial statement users will need to compute ratios for analysis after adjusting the year(s) prior to adoption to have “as-if” capitalized operating leases. For the years presented before the new leasing standard is adopted, the leasing footnote is reasonably complete to allow for capitalization of operating leases for analysis purposes. Q10-3. In general, yes. Over the term of the lease the straight-line lease expense for an operating lease will be equal to the sum of the interest and amortization on a finance lease. Only the timing of the expense recognition changes. Q10-4. Under defined contribution plans, companies and employees make contributions to the plans which, together with earnings on the amounts invested, provide the sole source of funding for payments to retirees. Under defined benefit plans, the obligations are defined with payment to be made in the future from general corporate funds. These plans may or may not be fully funded. Since the company’s obligation is extinguished upon contribution for a defined contribution plan, the accounting is relatively simple: record an expense when paid or accrued. Defined benefit plans present a number of complications in that the liability is very difficult to estimate and involves a number of critical assumptions. In addition, companies lobbied for (and the FASB agreed to) various mechanisms to smooth the impact of pension costs on reported earnings. These smoothing mechanisms further complicate the accounting for defined benefit plans vis-à-vis defined contribution plans.

©Cambridge Business Publishers, 2021 10-2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q10-5. Although the accounting can get complicated, a net pension asset will be reported if the fair market value of the plan assets exceeds the plan obligation. Otherwise, a net liability will be reported on the balance sheet to represent the underfunding of the pension obligation. Q10-6. Service cost, interest cost and the expected return on plan investments (a reduction of the pension cost) are the basic components of pension expense. Companies might also report amortization of deferred gains and losses. Q10-7. The use of expected returns and the deferral of unexpected gains and losses act to smooth corporate earnings by removing the effects of swings in the market values of investments and variation in pension liabilities resulting from changes in actuarial assumptions or plan amendments. Q10-8. For a finance or operating lease, the initial value of the lease liability is determined by calculating the present value of the remaining lease payments. The remaining lease payments include those payments that are not subject to options or contingencies, including any guaranteed residual value. The initial right-of-use asset value for both types is the lease liability computed as just described, adjusted for some items occurring at or before the lease commencement date (e.g., add lease prepayments, subtract lease incentives, and add initial direct costs). Q10-9. Retirement benefits are normally expensed in the period in which they are earned by the employee, not when they are paid. Some benefits are calculated for periods of employment prior to the inception of a pension plan or prior to a plan amendment. The cost of these benefits (called prior service costs) is expensed by amortizing the cost over the average expected future period of employee service. Q10-10. Income tax expense is a financial accounting expense measured using accrual accounting. Thus, the expense includes the cash taxes paid but also includes accruals for future tax payments and future tax benefits that result from transactions in the current period. Q10-11. A tax payment would be recorded as a deferred tax asset or liability under two situations. First, if the company is required to make a tax payment based on a temporary difference that makes taxable income reported on the tax return higher than the income reported for financial accounting. In this case, the tax on the temporary difference would not be recorded as tax expense. Recall that tax expense is the expense related to the accounting income. For example, consider a company that receives a cash payment in advance of delivering a service. For financial accounting this is recorded as unearned revenue and not recognized as revenue until earned and thus is not in accounting earnings. However, generally for tax purposes such a payment would be included in taxable income. Thus, a cash tax payment would be required to be made on this amount. For financial accounting, this would increase current tax expense continued

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10-3

but a deferred tax asset and corresponding deferred tax benefit (negative tax expense) would need to be recorded yielding a zero effect on total income tax for the year. The second situation arises when a deferred tax liability reverses. In this situation, tax expense has been recognized in excess of tax payments in prior years. When the tax return “catches up with” the income statement, the tax deferral reverses and the deferred tax liability is reduced (debited). Consider the example of depreciation discussed in the text. In the later years of the asset’s life, taxable income will be higher than book income. The cash tax payments related to that temporary difference will be recorded as current tax expense. In addition, the deferred tax liability will also be reversed along with a reduction to deferred tax expense, thus, again, the net effect on the total tax expense will be zero. Q10-12. An unrecognized tax benefit is recorded as a liability on a firm’s balance sheet (and on the income statement increases to the unrecognized tax benefit account are recorded as additional tax expense). The unrecognized tax benefit (UTB) is essentially a contingent liability. It represents management’s estimate of the amount that is more likely than not going to be owed to tax authorities in the future (e.g., upon audit) for tax positions taken to date.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

MINI EXERCISES M10-13. (35 minutes) LO 2 a. i. 1/3

Right-of-use asset – operating lease (+A) ................... Operating lease liability (+L) ...................................

57,198 57,198

$57,198 = $12,000 x 4.76654

12/31 Operating lease liability (L) .......................................... Cash (-A) ................................................................

12,000

12/31 Operating lease expense (+E) ..................................... Operating lease liability (+L) ................................... Right-of-use asset – operating lease (-A) ...............

12,000

Right-of-use lease asset – finance lease (+A) ............. Finance lease liability (+L) ......................................

57,198

12,000

4,004 7,996

ii. 1/3

57,198

$57,198 = $12,000 x 4.76654

12/31 Amortization expense – finance lease (+E, -SE).......... Accumulated amortization – finance lease (+XA) ...

9,533 9,533

$9,533 = $57,198 / 6 (note that the company could choose to credit the right-of-use asset for the finance lease directly)

12/31 Finance lease liability (-L) ............................................ Interest expense (+E, -SE) .......................................... Cash (-A) ................................................................

7,996 4,004 12,000

$4,004 = $57,198 x 0.07; $7,996 = $12,000 - $4,004

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b. Operating Lease (i): +

Cash (A) 12,000

Operating Lease Liability – (L) + 57,198 1/3 12/31 12,000 4,004 12/31

12/31

+ Right-of-use Asset (A)—Operating Lease 1/3 57,198 7,996 12/31 + Lease Expense – Operating Lease (E) 12/31 12,000

Finance Lease (ii): +

Cash (A) 12,000

Finance Lease Liability (L) 57,198 12/31 7,996

12/31

+ Right-of-use Asset (A) – Finance Lease 1/3 57,198

+ 12/31

- Accumulated Amortization – Finance + Lease (XA) 9,533 12/31

Interest Expense (E) 4,004

+ 1/3

Amortization Expense – Finance Lease (E) 12/31 9,533

c. Operating Lease (i): Balance Sheet Transaction

Noncash + Assets +57,198 Right-of- use asset – Operating lease

-12,000 Cash

-12,000 Operating Lease Liability

-7,996 Right-of-use asset – Operating lease

4,004 Operating Lease Liability

Operating lease commences.

Lease payment.

Record lease expense and changes to asset and liability.

Contra Assets

Income Statement

Cash Asset

= Liabilities + = +57,198 Operating Lease Liability

Contrib. Capital

Earned Capital

Revenues -

- Expenses = =

-12,000 Retained Earnings

+12,000 Lease Expense

continued

©Cambridge Business Publishers, 2021 10-6

Net Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

-12,000

c. continued Finance Lease (ii): Balance Sheet Transaction Finance lease commences

Cash Asset

Noncash Assets +57,198 Right-ofuse asset – Finance lease

Amortization of leased asset.

Made annual -12,000 lease payment. Cash

Contra Assets

+9,533 Accum. Amortization.

= Liabilities + = +57,198 Finance Lease Liability =

-7,996 Finance Lease Liability

Income Statement Contrib. Capital

Earned Capital

Revenues

Net - Expenses = Income =

-9,533 Retained Earnings

+9,533 Amort. Expense

-9,533

-4,004 Retained Earnings

+4,004 Interest Expense

-4,004

d. The amount of interest plus amortization expense in the finance-type lease is greater early in the asset’s life than the straight-line lease expense amount under the operating lease. This is driven by the amortization portion meaning that the net rightof-use asset value on the balance sheet for an operating lease will be higher than for the finance-type lease early in the asset’s life.

M10-14. (20 minutes) LO 2 Right-of-use asset – finance lease (+A) 123,100 Finance lease liability (+L) .................................

a. 7/1

123,100

$123,100 = $4,500 x 27.35548

b. 9/30

Amortization expense (+E, -SE) Accumulated amortization (+XA, -A) ................. $3,078 = $123,100 / (10 x 4)

3,078 3,078

(note the company could directly reduce the right-of-use asset value)

9/30

Finance lease liability (-L) ....................................... Interest expense (+E, -SE) ..................................... Cash (-A) ...........................................................

2,038 2,462 4,500

$2,462 = $123,100 x (0.08/4); $2,038 = $4,500 - $2,462

12/31 Amortization expense (+E, -SE).............................. Accumulated amortization (+XA, -A) .................

3,078

12/31 Finance lease liability (-L) ....................................... Interest expense (+E, -SE) ..................................... Cash (-A) ...........................................................

2,079 2,421

3,078

4,500

$2,421 = ($123,100 - $2,038) x (0.08/4); $2,079 = $4,500 - $2,421

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c. +

Cash (A) 4,500 4,500

9/30 12/31

Right-of-use Asset – Finance Lease (A) 7/1 123,100

9/30 12/31

Finance Lease Liability (L) 123,100 2,038 2,079 +

- Accumulated Amort. – Finance lease (XA) + 3,078 9/30 3,078 12/31

9/30 12/31

Interest Expense (E) 2,462 2,421

+ 9/30 12/31

Amortization Expense (E) 3,078 3,078

+ 7/1

d. Balance Sheet Transaction

Cash Asset

7/1/20 Finance lease commences.

+123,100

Liabilities

+123,100

+3,078

Revenues

Net - Expenses = Income -

-3,078

-2,038

-2,462

Finance

Retained Earnings

Lease Liability -

+3,078

-3,078

Accum. Amort. -

Cash

Retained Earnings

Cash

-4,500

Earned Capital

Lease Liability

Accum. Amort. -4,500

Income Statement Contrib. + Capital +

Finance

12/31/20 Amortization on leased asset. 12/31/20 Made quarterly lease payment.

Contra Assets

Right-of-use asset – finance lease

9/30/20 Amortization on leased asset. 9/30/20 Made quarterly lease payment.

Noncash Assets

-2,079

-2,421

Finance

Retained Earnings

Lease Liability

= -3,078

Amort. Expense -

+2,462

= -2,462

Interest Expense

Retained Earnings =

+3,078

= -3,078

Amort. Expense -

+2,421

= -2,421

Interest Expense

©Cambridge Business Publishers, 2021 10-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M10-15 (10 minutes) LO 2 a. Right-of-use asset – finance lease (+A)............................. Finance lease liability (+L) ......................................

74,520

b. Right-of-use asset – operating lease ................................. Operating lease liability (+L) ...................................

5,853

Operating lease liability (-L) ............................................... Cash (-A) ................................................................

1,000

74,520

5,853

1,000

M10-16. (25 minutes) LO 2 Determine the PV of the lease payments → $130,000 X 4.10020 ((or use excel or a financial calculator) = $533,026. Note: Table amounts may not compute precisely and all totals may not foot, due to rounding. a. Operating Lease Liability Amortization Schedule Date

Lease Payment

January 1, 2020 December 31, 2020 $ December 31, 2021 December 31, 2022 December 31, 2023 December 31, 2024 $

Interest on Liability

Reduction of Lease Liability $

130,000 130,000 130,000 130,000 130,000

$ $ $ $ $

650,000 $

37,312 30,824 23,881 16,453 8,505

$ $ $ $ $

92,688 99,176 106,119 113,547 121,495

116,974 $

533,026

Lease Liability 533,026 440,337 341,161 235,042 121,495 0

b. Right-of-Use Asset Amortization Schedule Date

Straight-line Expense

Interest on Liability

Amortization of Right-of-Use Asset

January 1, 2020 December 31, 2020 $ December 31, 2021 December 31, 2022 December 31, 2023 December 31, 2024

130,000 $ 130,000 130,000 130,000 130,000

37,312 $ 30,824 23,881 16,453 8,505

92,688 99,176 106,119 113,547 121,495

650,000 $

116,974 $

533,026

Right-of-Use Asset 533,026 440,338 341,161 235,043 121,496 0

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c. Journal Entries January 1, 2020 Right-of-use asset – operating lease (A) ........................... Operating lease liability (L) .....................................

533,026

December 31, 2020 Operating lease Liability .................................................... Cash .......................................................................

130,000

December 31, 2020 Operating lease expense ................................................... Operating lease liability ........................................... Right-of-use asset – operating lease ...................... December 31, 2021 Operating lease liability ..................................................... Cash ....................................................................... December 31, 2021 Operating lease expense ................................................... Operating lease liability ........................................... Right-of-use asset – operating lease ......................

533,026

130,000

130,000 37,312 92,688

130,000 130,000

130,000 30,824 99,176

M10-17. (20 minutes) LO 2 Determine the PV of the payments – annuity due → $130,000 X 4.3872 (or use excel or a financial calculator) =$570,377. a. Operating Lease Liability Amortization Schedule Date

Lease Payment

Interest on Liability

Reduction of Lease Liability

January 1, 2020 January 1, 2020 $ January 1, 2021 January 1, 2022 January 1, 2023 January 1, 2024

$ 130,000 $ 130,000 130,000 130,000 130,000

$ 30,824 23,881 16,453 8,505

130,000 99,176 106,119 113,547 121,495

650,000 $

79,663 $

570,337

Lease Liability 570,337 440,337 341,161 235,042 121,495 0

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Right-of-Use Asset Amortization Schedule Date

Straight-line Expense

Interest on Liability

Amortization of Right-of-Use Asset

January 1, 2020 Year 2020 $ Year 2021 Year 2022 Year 2023 Year 2024

130,000 $ 130,000 130,000 130,000 130,000

30,824 $ 23,881 16,453 8,505 -

99,176 106,119 113,547 121,495 130,000

650,000 $

79,663 $

570,337

Right-of-Use Asset 570,337 471,161 365,042 251,495 130,000 0

c. Journal entries January 1, 2020 Right-of-use asset ................................................................ Operating lease liability .............................................

570,337

January 1, 2020 Operating lease liability ........................................................ Cash..........................................................................

130,000

December 31, 2020 Operating lease expense ..................................................... Operating lease liability ............................................. Right-of-use-asset – operating lease ........................ January 1, 2021 Operating lease liability ........................................................ Cash.......................................................................... December 31, 2021 Operating lease expense ..................................................... Operating lease liability ............................................. Right-of-use asset – operating lease ........................

570,337

130,000

130,000 30,824 99,176

130,000 130,000

130,000 23,881 106,119

M10-18 (10 minutes) LO 3 a. Pension expense (+E, -SE) ....................................................... Cash (-A) .............................................................................. $16,000 = $400,000 x 0.04

16,000 16,000

b. Bartov would report a net liability of $450,000 ($625,000 - $175,000) in its 2019 balance sheet. Because Bartov is effectively self-insured, it must report the estimated death benefit obligation net of any assets set aside to meet that obligation.

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M10-19. (10 minutes) LO 3, 4 a. Exxon Mobil is reporting $2,769 million in pension expense for 2017. b. Expected returns are an offset to service and interest costs and serve to reduce reported pension expense. c. “Expected” refers to the use of long-term average returns for the investment portfolio. Expected returns are used in the computation of pension expense, rather than actual returns, in order to smooth reported income.

M10-20. (10 minutes) LO 3, 4 a. Yum! Brands is reporting $17 million of pension expense for 2017. b. Expected returns are an offset to service and interest costs and serve to reduce reported pension expense. c. “Expected” refers to the use of long-term average returns for the investment portfolio. Expected returns are used in the computation of pension expense, rather than actual returns, in order to smooth reported income.

M10-21. (10 minutes) LO 3, 4 a. A&F maintains a defined contribution plan for the benefit of its employees. b. Contributions are expensed when made. The entry to record expenses for 2014 was ($ millions): Pension expense (+E, -SE)..................................................... Cash (-A) ...........................................................................

14.4 14.4

c. Only the unpaid contribution, if any, appears on the A&F balance sheet.

©Cambridge Business Publishers, 2021 10-12

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M10-22. (15 minutes) LO 1 a. The use of contract manufacturers removes the manufacturing assets and related liabilities from Nike’s balance sheet. Because sales are unaffected, PPE turnover is increased by the removal of assets. The effect on net operating profit after taxes (NOPAT) is uncertain; depreciation is removed (interest on the liabilities incurred to purchase the manufacturing assets is also removed, but this is a nonoperating expense and, therefore, does not affect NOPAT), but Nike will pay a higher price for its manufactured goods in order to provide the manufacturer with a return on its investment. If the contract manufacturer is more efficient than Nike, however, the price increase is mitigated. Profitability will increase if the turnover effect more than offsets the negative effect on NOPAT and profit margin, which is likely. b. Executory contracts are not recognized under GAAP. As a result, the use of contract manufacturers achieves off-balance-sheet financing. This is one motivating factor for their use.

M10-23. (20 minutes) LO 5 a, b, and c. Year

Book Value

Temporary Difference

Tax Rate

Deferred Tax Liability

2021

$300,000

$173,000

$127,000

25%

$31,750

2022

$200,000

$173,000 - ($100,000 - $31,000) = $104,000

$96,000

25%

$24,000

2023

$100,000

$104,000 - ($100,000 - $31,000) = $35,000

$65,000

25%

$16,250

Tax Basis (after depreciation deduction)

d. Deferred tax assets and liabilities are all recorded as non-current assets and liabilities.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-13

EXERCISES E10-24. (45 minutes) LO 2 a. Present value of operating leases = $4,897, 005 , computed using the PV function in Excel: =PV(0.04,5,1100000,0) or using the PV of annuity table in Appendix A: 4.45182 X $1,100,000 (or using a financial calculator or the formula for PV of an annuity) [Note there will be small rounding differences between the methods.] This amount is both the value of the asset and the liability (because there are no payments already made or other complicating terms of this lease). b. Lease liability amortization schedule Date Lease Payment 01-Jan-20 31-Dec-20 $ 1,100,000 $ 31-Dec-21 1,100,000 31-Dec-22 1,100,000 31-Dec-23 1,100,000 31-Dec-24 1,100,000 Total $ 5,500,000 $

Interest on Liability

Reduction of Lease Liability

195,880 $ 159,715 122,104 82,988 42,308 602,996 $

904,120 940,285 977,896 1,017,012 1,057,693 4,897,005

Lease Liability $4,897,005 $ 3,992,885 3,052,601 2,074,705 1,057,693 0

Right-of-use Asset Amortization Schedule – operating lease Date 01-Jan-20 31-Dec-20 $ 31-Dec-21 31-Dec-22 31-Dec-23 31-Dec-24 $

Straight-line Expense 1,100,000 1,100,000 1,100,000 1,100,000 1,100,000 5,500,000

Interest on Liability $

195,880 159,715 122,104 82,988 42,308 602,996

Amortization of Right-of-Use Asset $

904,120 940,285 977,896 1,017,012 1,057,693 4,897,005

Right-of-Use Asset $4,897,005 $ 3,992,885 3,052,601 2,074,705 1,057,693 0

*Note: there are some small differences due to rounding in the tables above.

©Cambridge Business Publishers, 2021 10-14

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Entries if a finance lease: January 1, 2020 Right-of-use asset – finance lease .......................... Finance lease liability ....................................

4,897,005

December 31, 2020 Amortization expense .............................................. Accumulated amortization – finance lease....

979,401

4,897,005

979,401

$4,897,005 / 5 (note that company could choose to reduce the asset value directly)

Finance lease liability .............................................. Interest expense ...................................................... Cash .............................................................

904,120 195,880 1,100,00

December 31, 2021 Amortization expense .............................................. Accumulated amortization – finance lease....

979,401 979,401

$4,897,005 / 5 (Note that company could choose to reduce the asset value directly)

940,285 159,715 1,100,00

Balance Sheet Equation: January 1, 2020 Balance Sheet Transaction

Cash Asset

Lease equipment using financetype lease

Noncash Assets

Liabilities

+4,897,005

Right-of-use asset

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Net Income

- Expenses = -

Lease liability

December 31, 2020 Balance Sheet Transaction

Cash Asset

Record amortization of asset

Noncash Assets

–979,401

Liabilities

Income Statement Contrib. + Capital +

Earned Capital –979,401

- Expenses = -

Accum. Amort. – finance lease

Cash Asset

Record –1,100,000 interest and cash payment

Noncash Assets

+979,401

= –979,401

Liabilities

–904,120

Income Statement +

Contrib. Capital +

Earned Capital –195,880

Revenues

- Expenses = -

+195,880 Interest expense

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

Net Income

Amort. expense

Balance Sheet Transaction

Revenues

10-15

Net Income

= –195,880

d. Entries if an operating lease January 1, 2020 Right-of-use asset – operating lease ................................. 4,897,005 Operating lease liability ...........................................

4,897,005

December 31, 2020 Operating lease liability ..................................................... 1,100,000 Cash .......................................................................

1,100,000

Lease expense .................................................................. 1,100,000 Operating lease liability ..................................................... Right-of-use asset – operating lease ......................

195,880 904,120

(note company could choose to maintain an accumulated amortization account)

December 31, 2021 Operating lease liability ..................................................... 1,100,000 Cash .......................................................................

1,100,000

Lease expense .................................................................. 1,100,000 Operating lease liability ........................................... Right-of-use asset – operating lease ......................

159,715 940,285

Balance Sheet Equation January 1, 2020 Balance Sheet Transaction

Cash Asset

Lease equipment operating-type lease

Noncash Assets

Liabilities

+4,897,005

Right-of-use asset

Income Statement Contrib. + Capital +

Earned Capital

Revenues

- Expenses = -

Net Income

Lease liability

December 31, 2020 Balance Sheet Transaction Record payment

Cash Asset

Noncash Assets

–1,100,000

Liabilities

–1,100,000

Income Statement Contrib. Capital +

Earned Capital

Contrib. + Capital +

Earned Capital

Balance Sheet Transaction Record lease expense, reduction in asset value & adjust liability for interest

Cash Asset

Noncash Assets

Liabilities

–904,120

+195,880

Right-of-use asset – operating lease

Lease liability

Revenues

- Expenses =

Income Statement

–1,100,000

Revenues

- Expenses =

Net Income

- +1,100,000 = –1,100,000 Lease expense

continued ©Cambridge Business Publishers, 2021 10-16

Net Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

d. continued Alternative Entry for Dec. 31, 2020 Because this lease has no prepayments and no incentives and payments are at the end of the year, the entries could be recorded as follows (they are equivalent): Operating lease liability ............................................... Lease expense ............................................................ Cash ................................................................. Right-of-use asset – operating lease ................

904,120 1,100,000 1,100,000 904,120

e. Operating lease treatment and finance lease treatment both require the recording of a lease liability at the present value of the remaining lease payments. Both types of leases require the recording a right-of-use asset for the total cost of the lease. Thus, both types of leases are now ‘on-balance sheet’. However, the income statement treatment differs between the two types of leases and the asset amortization differs. Finance leases record amortization expense for the straight-line amortization of the right-of-use lease asset. Finance leases also record interest expense on the lease liability. In contrast, operating lease treatment involves one straight-line lease expense amount each period. There is no separate amortization expense and no separate interest expense. As a result, whereas a finance lease records interest expense in non-operating expenses, an operating lease will record one lease expense in operating expenses. Overall, expenses are greater in the early part of the asset’s life for finance leases relative to operating leases. As a result, the asset value on the balance sheet will remain higher over the term of the lease for operating leases relative to finance leases as can be seen in the table below: Right-of-Use Asset Balance Finance Lease

Operating Lease

January 1, 2020

4,897,005

December 31, 2020

3,917,604

3,992,885

December 31, 2021

2,938,203

3,052,600

December 31, 2022

1,958,802

2,074,704

December 31, 2023

979,401

1,057,692

December 31, 2024

Amounts may differ slightly due to rounding.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-17

E10-25. (15 minutes) LO 3, 4 a. Target maintains only a defined contribution plan for the benefit of its employees. b. Contributions are expensed when made. c. Only the unpaid contribution, if any, appears on Target’s balance sheet. d. First, employees who do not meet the unspecified eligibility requirements will not be covered. Second, matching contributions can be reduced or eliminated in bad times. Third, employees covered by defined contribution plans must choose how those funds are invested and, consequently, they bear all of the risks of price volatility.

E10-26. (20 minutes) LO 2 a. JetBlue will record $1.2 billion more in assets, thus total assets would be $1.2 billion + $10.426 billion for a total of $11.626 billion. JetBlue will also have $1.2 billion more in liabilities, thus total liabilities would be $1.2 billion + $5.815 billion for a total of $7.015 billion (again, assuming nothing else changed for JetBlue). •

Total debt-to-equity based on recorded numbers is 1.26 or 126% computed as $5.815 B/ $4.611 B.

•

Using the numbers after operating lease assets and liabilities are added to the balance sheet, the debt-to-equity ratio would be 1.52 or 152% computed as $7.015/$4.611B.

The increase is quite significant – nearly a 21%increase of the debt-to-equity ratio! b. Delta already adopted the lease standard. Thus, to make a correct comparison between Delta and JetBlue – one that adopted the standard and one that did not – the analyst will need to adjust JetBlue’s financial statements to be comparable to Delta’s. One step, and likely the most important as JetBlue states, is the step in part a above, putting the assets and liabilities on the balance sheet. Some companies do not provide such clear disclosures of what the amounts will be. In that case, the analyst needs to find the present value of the future minimum lease payments as disclosed in the notes to estimate the liability (and asset) to add to the balance sheet. Any difference would likely affect equity.

©Cambridge Business Publishers, 2021 10-18

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E10-27. (25 minutes) LO 1, 2

a. According to Verizon’s lease footnote, it has both capital and operating leases. As of the end of 2018, the company states that only the capital leases are reported onbalance sheet: a liability in the amount of $905 million ($316 million in current liabilities and $589 million as long-term liabilities). However, this is not the total obligation to its lessors. Verizon also has a significant amount of leases that it has classified as operating, which before the recent changes to the accounting for leases were “offbalance sheet”. Looking at the 2018 data, we can see that in fact, the minimum lease payments under operating leases are more than 26 times that for capital leases!

b. Verizon states in their disclosures that do not know for certain what the amounts will be, but that their estimates are that the new standard will require the addition of somewhere in the range of $21.0 billion and $23.0 billion in additional assets and liabilities.

c. Debt-to-equity as reported = $210,119 M/$54,710 M = 3.84 or 384%. Debt-to-equity after adjusting for estimating operating leases = $232,119/$54,710 = 4.24 or 424%

d. Return-on-assets will likely decline because assets will be much larger but the income statement effect will not be very large. Rent was already being expensed and FASB settled on straight-line-expensing for the operating leases under the new standard. Thus, essentially the same income will be compared to a larger asset base and ROA will likely decline (based on reported numbers).

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-19

E10-28. (25 minutes) LO 6 a. The payments promised to sponsored athletes are economically similar to a liability in many ways. The payments do not rise to the level of a recognizable liability for GAAP because the athlete is yet to wear the product and be sponsored (and Under Armour has not taken control of an asset at the point when the sponsorship contract begins). Yet, an analyst may want to consider these payments as economically equivalent to liabilities for at least some analysis purposes. Arguably, there is an “asset” related to these expenditures – but advertising is expensed as incurred for financial accounting so an asset would not be considered for analysis purposes most likely. b. The estimated amount would be the present value of the future payments. •

First we need to specify the future payments (in thousands) o o o o o o

o o

•

2019 $126,221 2020 $106,782 2021 $101,543 2022 $98,353 2023 $91,337 Then for 2024 and after, we can estimate by dividing the total by the payment in 2023 ▪ $210,634/$91,337 = 2.3 years. ▪ Round to 2 years for simplicity and find the payment for the next two years: $210,634/2 = $105,317 2024 $105,317 2025 $105,317

Using Excel’s NPV function to estimate the amount, using the 3% interest rate stated in the problem: [NPV(0.03, 126221,106782,101543,98353,91337,105317,105317) = $656,130 thousand.

}

c. Under Armour does not record a liability for the lawsuit. The accrual of an expense and recording of a liability would occur if the loss was estimable and probable, and if the amount is material. The company says the amount is likely not material and that the company has insurance that will cover the costs.

©Cambridge Business Publishers, 2021 10-20

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E10-29. (30 minutes) LO 6 a. The present value of the future payments at 2.5% using Excel’s NPV function and assuming the “thereafter” amount on the table is all paid in 2024 is: NPV(0.025, 2447,3202,1749,1596,268,66) = $8,799 million.

b. An analyst might consider this to be essentially equivalent to a liability. The company has promised future payments. We do not have additional information to estimate any associated assets, however. c. Apple has recorded a liability with respect to the Qualcomm royalty payments (and an associated accrued expense). Apple does not disclose the amount of the liability it has recorded, just that it has accrued its “best estimate” of the amount it will have to pay for the resolution of the dispute.

E10-30. (15 minutes) LO 3, 4 a. Service cost is the increase in the pension obligation resulting from employees working another year for the company. Interest cost is the accrual of interest on the (discounted) pension obligation. b. Payments to retirees are made from the pension investment account. There is a corresponding reduction in the pension obligation. c. The funded status is the pension obligation less the fair value of the plan assets. In this case $1,007 million (pension obligation) – $864 million (plan assets) = $(143) million funded status (when pension obligations are greater than the plan assets it is an underfunded amount). d. A $143 million net pension liability is reported in the balance sheet.

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E10-31. (20 minutes) LO 3, 4 a. Service cost is the increase in the pension obligation resulting from employees working another year for the company. Interest cost is the accrual of interest on the (discounted) pension obligation. b. Payments to retirees are made from the pension investment account. There is a corresponding reduction in the pension obligation. c. The funded status is the pension benefit obligation less the fair value of the plan assets. In this case $21,531 million – $19,175 million = $(2,356) million funded status (underfunded amount). d. A $2,356 million net pension liability is reported on the balance sheet.

E10-32. (20 minutes) LO 5 a. In 2019, the temporary difference is $8,000. $8,000 x 25% = $2,000. In 2020, the temporary difference reverses and no liability would be reported as of the end of the year. b. 2019 Income tax expense (+E, -SE) ................................................ Income taxes payable* (+L) ............................................... Deferred income tax liability (+L) .......................................

57,000 55,000 2,000

*($236,000 - $16,000) x 25% = $55,000

2020 Income tax expense (+E, -SE) ................................................ Deferred income tax liability (-L) ............................................. Income taxes payable* (+L) ...............................................

59,250 2,000 61,250

*($245,000 - $0) x 25% = $61,250

c. 2019 Income tax expense (+E, -SE) ................................................ Income taxes payable* (+L) ............................................... Deferred income tax liability** (+L) ....................................

57,800 55,000 2,800

*($236,000 – $16,000) x 25% = $55,000 **($8,000 x 35% = $2,800)

82,950 2,800 85,750

*($245,000 - $0) x 35% = $85,750

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

10-33. (15 minutes) LO 5 a. $12,000 x 25% = $3,000. (None would be depreciable for book purposes b. The entire amount will be a non-current liability. c. $8,000 x 25% = $2,000.

E10-34. (15 minutes) LO 5 a. Balance Sheet Transaction To record income tax expense

Cash Asset

Noncash + Assets

Contrib. = Liabilities + Capital + = +1,745 Taxes Payable

Income Statement Earned Capital -2,392 Retained Earnings

Revenues

Expenses +2,392 Income Tax Expense

= =

Net Income -2,392

+647 Deferred Tax Liability

b. Income tax expense (+E, -SE) .......................................... Income taxes payable (+L) .......................................... Deferred income tax liability (+L) .................................

2,392 1,745 647

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash—Cash would be reduced. Either is correct.)

c. An expense of $2,392 million is recorded in the income statement, thereby reducing both net income and retained earnings. Liabilities are increased by $2,392 million, $1,745 million in income taxes payable (assuming the amount due this year has not been paid yet) and the increase of of $647million in deferred income tax liability. d. 2016: 18.67% ($863/$4,623) 2017: 13.22% ($646/$4,886) 2018: 55.31% ($2,392/$4,325) Nike’s tax rate is much higher in the year ended May 31, 2018 because the TCJA was passed during this fiscal year for Nike. Examining their disclosures, they state that they accrued an additional tax expense of $1.8 billion because of the one-time Transition Tax (aka mandatory deemed repatriation tax) on unremitted foreign earnings prior to the TCJA. In addition, they had an additional expense of $158 million because all their deferred tax assets and liabilities had to be re-measured at the new tax rate.

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E10-35. (15 minutes) LO 5 a. Balance Sheet Transaction a. To record income tax expense.

Cash Asset

Noncash Assets

= Liabilities + = +2,139 Taxes Payable

Income Statement Contrib. Capital +

Earned Capital -1,144 Retained Earnings

Revenues

Expenses +1,144 Income Tax Expense

= =

Net Income -1,144

-995 Deferred Tax Liability

b. Deferred tax liability (-L)............................................................. Income tax expense (+E ) ......................................................... Income tax payable (+L ) .....................................................

995 1,144 2,139

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash—Cash would be reduced. Either is correct. Also, in this problem if you increased a Deferred Income Tax Asset for $995 million rather than decrease the Deferred Tax Liability that is acceptable as well because the disclosures are not presented that show whether the company has a net deferred tax asset or liability. )

c. An expense of $1,144 million is recorded in the income statement, thereby reducing both net income and retained earnings. This total tax expense is composed of two parts – current tax expense and deferred tax expense. The current portion ($2,139 million) approximates income taxes on the tax return for the current year (ignoring some more complicated factors like unrecognized tax benefits, a detailed discussion of which is beyond the scope of this text). Boeing also records an decrease in deferred tax liabilities (or an increase in deferred tax assets) of $995 million and a deferred tax benefit of $955.

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PROBLEMS P10-36. (25 minutes) LO 2 a. $5,262 million ($2,380 + $2,882). b. $5,995 million ($719 +$5,276) c. Net book value of $346 ($992 - $646) for the asset. The liability is $347 ($123 + $224) d. Operating leases were previously ‘off-balance’ sheet. Thus, companies often structured their lease contracts to obtain this ‘off-balance’ sheet outcome. These numbers tell us that operating lease liabilities are roughly 17 times the liability for finance-type leases. How United and other companies adjust their use of operating leases following the implementation of the new standard remains to be seen. e. Reported ROA = 0.0475 or 4.75% ( $2,129/$44,792) Reported Debt-to-equity = 3.48 or 348% ($34,797/$9,995) Adjusted ROA = 0.0425 or 4.25% ($2,129/($44,792 + $5,262)) Adjusted Debt-to-Equity = 4.40 or 440% (($34,797 + $5,995)/($9,995 + (-$733*))) *($2,380 + $2,882 -$719 - $5,276 = -$733)

P10-37. (60 minutes) LO 2 a. $9,151 million b. $545 million d. $9,556 million. The amount is the present value of the remaining lease payments. e. Amortization expense for finance leases is $78 million. Amortization expense for operating leases is zero. There is no separate amortization expense recorded for operating leases, only a straight-line ‘lease expense’ that expenses to the total cost of the leased asset over the lease term.

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f. Interest expense for the finance lease is $48 million. Interest expense on the operating leases is zero. There is no separate interest expense recorded for operating leases, only a straight-line ‘lease expense’ that expenses the total cost of the leased asset over the lease term. g. Right-of-use asset – operating lease ...................................... Operating lease liability ...........................................

$10 B $10 B

P10-38. (40 minutes) LO 6 a. The use of contract manufacturers removes the manufacturing assets and related liabilities from Cisco’s balance sheet. Because sales are unaffected, PPE turnover is increased by the removal of assets. The effect on net operating profit after taxes (NOPAT) is uncertain; depreciation is removed (interest on the liabilities incurred to purchase the manufacturing assets is also removed, but this is a nonoperating expense and, therefore, does not affect NOPAT), but Cisco will likely pay a higher price for its manufactured goods in order to provide the manufacturer with a return on its investment. If the contract manufacturer is more efficient than Cisco, however, the price increase is mitigated. Profitability will increase if the turnover effect more than offsets the negative effect on NOPAT and profit margin, which is likely. b. The estimate of the present value given the assumptions in the problem is $6,163 million. c. Cisco states that it has accrued $159 million – meaning it has reported that amount as a (current) liability on its balance sheet.

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P10-39. (30 minutes) LO 3, 4 a. Hoopes Corporation recognized $543 million as pension expense in 2019. b. The expected return is computed as the beginning fair market value of the pension plan assets multiplied by the long-term expected return on these investments. For 2019, this is computed as $13,295  8% = $1063.6, slightly more than the reported amount of $1,062 million. The plan assets reported an actual return of $2,425 million. U.S. GAAP permits the use of the expected long-term rate of return in order to smooth earnings. If actual returns were to be used, corporate profits would fluctuate greatly with swings in investment returns. The logic behind using the long-term rate is that investment returns are expected to fluctuate around this average and its use more accurately captures the average cost of the pension plan. (It is similar to the logic of reporting held-to-maturity bond investments at historical cost rather than current market value.) c. The pension liability is increased by the service and interest costs and decreased by any payments made to plan participants. The actuarial loss (gain) relates to the effects on the pension obligation of changes in assumptions used to compute it, such as the discount rate or the rate of expected wage inflation. The pension plan assets are increased (decreased) by investment gains (losses), are increased by company contributions and are decreased by benefits paid to plan participants. d. The “funded status” is the excess (deficiency) of the pension obligation over plan assets. If plan assets exceed pension obligation, the funded status is positive or overfunded. If pension obligations exceed the fair value of plan assets, the funded status is negative or underfunded. The funded status of the Hoopes Corporation pension plan is $(1,531) million at the end of 2019. Pension obligations are $17,372 million and plan assets are $15,841 million. Hoopes should report its net funded status as a net pension liability of $1,531 million on its balance sheet. e. Because the pension obligation is the present value of expected pension payments, a decrease in the discount rate increases the present value reported on the balance sheet. The effect on the income statement is more difficult to predict (when the same discount rate is used to compute interest expense and the PBO). The interest cost component of pension expense is the product of the beginning of the year pension obligation and the discount rate. In 2019, the effect of a decrease in the discount rate is to apply a lower discount rate to a higher pension obligation. These two effects are offsetting, but usually result in lower interest cost. f. The estimated wage inflation rate is used to project future benefit payments. Decreasing the estimated inflation rate decreases the pension obligation because a lower amount of payments to plan participants is projected. Decreasing the expected wage inflation rate reduces service cost and decreases the pension obligation reported on the balance sheet and, consequently, the interest component of pension expense. It is an income-increasing action. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

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P10-40. (20 minutes) LO 3, 4 a. Service cost is the increase in the pension obligation resulting from employees working another year for the company. Interest cost is the accrual of interest on the (discounted) pension obligation. b. The “actual” return on plan assets is $4,274 million in 2017. c. Actuarial losses (gains) generally arise as a result of decreases (increases) in the discount rate used to compute the pension obligation (PBO). Because the PBO is the present value of expected future payouts to retirees, a decrease in the discount rate results in an increase in the PBO. This decrease is recorded as an actuarial loss. d. Payments to retirees are made from the plan assets account. There is a corresponding reduction in the pension obligation. e. Johnson and Johnson contributed $664 million to its pension plans in 2017. f. Johnson and Johnson paid $1,050 million in benefits to its retirees in 2017. g. The funded status is the pension obligation less the fair value of the plan assets. In this case $33,221 million – $28,404 million = $(4,817) million underfunded amount. h. A $4,817 million net pension liability is reported on the balance sheet.

P10-41. (20 minutes) LO 5 a.

Tax expense – 2018: $1,727 million; 2017: $971 million; 2016: $700 million. Current tax expense – 2018: $247 mil.; 2017: $871 mil.; 2016: $417 mil. Deferred tax expense – 2018: $1,480 mil.; 2017: $100 mil.; 2016: $283 mil.

2018: $1,727 / $4,070.7 = 42.43% 2017: $971 / $3,153.8 = 30.79% 2016: $700 / $2,224.0 = 31.47%

c. Deferred tax liabilities are created when a company reports greater revenues and/or lower expenses in the income statement than are reported on the tax return. The most common cause is the use of accelerated depreciation for taxes and straightline depreciation for financial reporting. When these deferred taxes reverse (late in the asset’s life) the deferred tax liability is reduced.

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P10-42. (15 minutes) LO 5 a. Temporary differences 2019: $32,000 - $24,000 = $8,000; 2020: ($32,000 + $37,000) – ($24,000 + $26,000) = $19,000. b. Deferred tax liability 2019: $8,000 x 25% = $2,000; 2020: $19,000 x 25% = $4,750 c. $12,000 + ($4,750 – $2,000) = $14,750 d. Income tax expense (+E, -SE)................................................... Income taxes payable (+L)................................................... Deferred tax liability (+L) ...................................................... + Income Tax Expense (E) (d) 14,750

14,750 12,000 2,750

- Income Taxes Payable (L) + 12,000 (d)

- Deferred Tax Liability (L) + 2,750 (d)

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash—Cash would be reduced. Either is correct.)

P10-43. (15 minutes) LO 5 a. Temporary differences 2019: $140,000 - $130,000 = $10,000; 2020: ($140,000 + $122,000) – ($130,000 + $128,000) = $4,000. b. Deferred tax liability 2019: $10,000 x 25% = $2,500; 2020: $4,000 x 25% = $1,000 c. $45,150 + ($1,000 – $2,500) = $43,650 d. Income tax expense (+E, -SE)................................................... Deferred tax liability (-L)............................................................. Income taxes payable (+L)................................................... + Income Tax Expense (E) (d) 43,650

- Income Taxes Payable (L) + 45,150 (d)

43,650 1,500 45,150 - Deferred Tax Liability (L) + (d) 1,500

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash (Cash would be reduced). Either is correct.)

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P10-44. (20 minutes) LO 5 a. Macy’s reported an income tax benefit of $571 million. b. Macy’s reported a benefit because its deferred income tax liabilities are greater than its deferred income tax assets. When the value of the liabilities is reduced to the new lower rate, this reduces deferred tax expense (creates a benefit). Recall that when the liability was originally recorded it was recorded as follows (in general form): Deferred tax expense (+E) …………………. Deferred tax liability (+L) …………….

XX XX

Now upon the TCJA enactment, the net liability is devalued to a new lower rate; the entry is as follows (in general form): Deferred tax liability (+L) ………………….. Deferred tax expense (-E)……………..

YY YY

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CASES and PROJECTS C10-45. (30 minutes) LO 3, 4 a. DowDuPont reported net pension expense of $58 million for 2018. b. The expected rate of return is computed as the beginning fair value of the pension plan assets multiplied by the long-term expected return on these investments. For 2018, expected return was $2,846 on assets of $43,685 million. This implies an expected rate of return of 6.51% ($2,846 / $43,685). c. The pension liability is increased by the service and interest costs and decreased by any payments made to plan participants. The actuarial loss (gain) relates to the effects of changes in assumptions used to compute the pension obligation, such as the discount rate or the rate of expected wage inflation. The pension plan assets are increased (decreased) by investment gains (losses), are increased by company contributions, and are decreased by benefits paid to plan participants. d. The “funded status” is the excess (deficiency) of the pension obligation over plan assets. If plan assets exceed pension obligation, the funded status is positive. If pension obligations exceed the fair value of plan assets, the funded status is negative. The funded status of DowDuPont’s pension plan is $(11,552) million at the end of 2018. Thus, the pension is underfunded and the balance sheet should show a net pension liability of $11,552 million. e. Since the pension obligation is the present value of expected pension payments, an increase in the discount rate decreases the present value reported on the balance sheet (and a decrease in the discount rate increases the present value reported on the balance sheet). The effect on the income statement is more difficult to predict. The interest cost component of pension expense is the product of the beginning-of-the-year pension obligation and the discount rate. The effect of an increase (decrease) in the discount rate is to apply a higher (lower) interest rate to a smaller (larger) pension obligation. Interest expense on the pension liability will usually increase (decrease) in this circumstance. However, the actuarial “gain” or “loss” resulting from the change in the liability amount may offset the differential interest cost f. An increase in expected return unambiguously increases profitability as pension cost is reduced. This result occurs because the long-term expected rate of return is used to compute the expected return that is subtracted in the computation of pension expense.

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g. Inflation rates differ from country to country. For 2018, those rates are generally higher outside the U.S. where Dow operates. Inflation is expected to increase in the U.S. and could exceed the rates in other countries implying relatively higher compensation levels. Discount rates vary across countries as well, due in part to differences in inflation.

C10-46. (40 minutes) LO 1, 2 a. $1,965 million b. $872 million (net of amortization) c. $2,170 million. The amount is the present value of the remaining lease payments. d. $65 million e. $42 million f. Lease expense of $251 million. g. Amortization expense (+E) ........................................................ Accumulated Amortization – finance lease (+XA) ..........

Finance Lease liability (-L ) ........................................................ Interest expense (+E) ................................................................ Cash (A) .........................................................................

83 42

125

h. The lease expense for operating leases is all recorded in SG&A, which is included in operating income. For finance leases, the amortization expense may be included in Cost of Goods sold (thus reducing gross profit) or in SG&A, or partially in both (as it looks like the expense for Target is). For finance leases, interest expense is reported as non-operating on income statement. Thus, finance leases have 1) a greater annual expense amount early in the asset’s life, 2) lower net book values early in the asset’s life, and 3) expenses allocated to various parts of the income statement in each reporting period (whereas operating lease expense is in one place, SG&A). i.

Target has reported debt-to-equity of 2.65 or 265% ($29,993/$11,297). Without operating leases being “on balance sheet” Target would have had a reported debt-toequity of 2.51 or 251% (($29,993 - $2,170)/($11,297 + (- $205*))). Debt-to-equity is higher when the operating leases are capitalized because there are significant liabilities added to the balance sheet. More specifically these are debt-financed assets essentially, thus adding substantial amounts to assets but also often very similar amounts to liabilities. Thus, the debt-to-equity ratio rises when operating leases are recorded on the balance sheet. *($1,965 - $166 - $2,004 = -$205)

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C10-47. (45 minutes) LO 5 a. $192,894 thousand b. 2018: $192,894 / $452,439 = 42.63%. 2017: $166,524 / $471,911 = 35.29%. 2016: $177,839/488,007 = 36.44% Current US: $97,202 / $379,000 = 25.65% Deferred US: $62,893 / $379,000 = 16.59%; Total US rate: $160,095/$379,000 = 42.24%. c. $23,245 - $56,783 + $129,513 = $95,975 thousand d. Income tax expense (+E, -SE)................................................... Deferred tax liability (+L)................................................. Income taxes payable (+L) .............................................

192,894 63,381 129,513

e. $932,283 – ($17,361/0.21) = $849,612 thousand. f. Prepaid catalog expenses are capitalized and amortized for financial reporting purposes. However, for tax reporting purposes, the costs are expensed when paid. Consequently, the tax deduction is recognized before the expense is recognized in the income statement. The prepaid catalog expense of $58,693 thousand represents a temporary difference between financial and tax reporting. The resulting deferred tax liability shown of $5,386 thousand offsets the current deferred tax assets in the balance sheet. g. $13,200 thousand. This amount increased income tax expense in the year ended January 2018 (likely by the full amount because the company says they did not have any U.S. tax accrued prior to the TCJA.) h. A valuation allowance is a contra-asset account related to deferred tax assets. Management establishes a valuation allowance if it thinks the deferred tax assets will not be realized in the future. That is, management does not think the company will generate enough future taxable income to be able to offset the future deductions represented by the deferred tax assets. Recognizing a valuation allowance lowers the amount of deferred tax assets recognized and reduces income (increases tax expense). i. Williams Sonoma recorded $28.3 million in additional tax expense related to the devaluation of its net deferred tax assets from the U.S. statutory tax rate of 33.9% to the new, lower rate of 21%. Deferred tax assets and liabilities are to be valued at the enacted rate expected to be in effect with the deferred tax item reverses. In a big picture sense, an asset the company has is now worth less. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

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C10-48. (30 minutes) LO 5 a. Domestic: 2018: ($2,153 + $907) / $15,800 = 19.4% 2017: ($12,608 + $220 ) / $10,700 = 119.9 % 2016: ($3,826 - $70 ) / $12,000 = 31.3% Foreign: 2018: ($1,251 - $134) / $19,100 = 5.85% 2017: ($1,746 - $43) / $16,500 = 10.32% 2016: ($966 - $50) / $12,100 = 7.57% Total: 2018: $4,177 / ($34,900) = 12.0% 2017: $14,531 / ($27,200) = 53.4% 2016: $4,672 / ($24,100) = 19.4% b. Alphabet states that they have $10.2 billion due for the one-time transition tax. This amount increased tax expense on the income statement, and reduced net income. The amount was not paid in cash (they have eight years to pay the tax) and thus, the company would have recorded a liability for this amount.

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Chapter 10 Reporting and Analyzing Leases, Pensions, Income Taxes, and Commitments and Contingencies Learning Objectives – coverage by question MiniExercises

Exercises

LO1 – Define off-balance-sheet financing and explain its effects on financial analysis.

LO2 – Account for leases using the finance lease method and the operating lease method. Compare and analyze the two methods.

13 – 17

24, 26, 27

36 – 37

LO3 – Explain and interpret the reporting for pension plans.

18 -21

25, 30, 31

39, 40

LO4 – Analyze and interpret pension footnote disclosures.

19 – 21

25, 30, 31

39, 40

32 – 35

41 – 44

47, 48

28, 29

Problems

Cases and Projects

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QUESTIONS Q10-1.

Under the old lease accounting standard for an operating lease, the lessee did not record either the leased asset or the lease liability on the balance sheet, and normally charged each lease payment to rent expense. Under the new lease accounting standard, the lessee in an operating lease contract records a right-of-use asset on the balance sheet as well as a lease liability on the balance sheet. The expense is a straight-line lease expense (total cost of the lease divided by the number of lease payments). Under the old standard, the other type of lease was a capital lease and under the new standard the other type is a finance lease. The lessee accounted for a capital lease by recording the leased property as an asset and establishing a liability for the lease obligation. The leased asset was subsequently depreciated, and interest expense accrued on the lease liability. Under the new standard, the other type of a lease is a finance-type lease. The lessee records a lease asset and a lease liability on the balance sheet -- the lease asset is amortized and amortization expense is recorded, and in addition, interest expense is recorded, and the lease liability is reduced as payments are made.

Q10-2.

As adoption occurs, the year of adoption (and years after adoption)_ will be presented using the new standard, while prior years will likely be presented using the old standard. Thus, financial statement users will need to compute ratios for analysis after adjusting the year(s) prior to adoption to have “as-if” capitalized operating leases. For the years presented before the new leasing standard is adopted, the leasing footnote is reasonably complete to allow for capitalization of operating leases for analysis purposes.

Q10-3.

In general, yes. Over the term of the lease the straight-line lease expense for an operating lease will be equal to the sum of the interest and amortization on a finance lease. Only the timing of the expense recognition changes.

Q10-4.

Under defined contribution plans, companies and employees make contributions to the plans which, together with earnings on the amounts invested, provide the sole source of funding for payments to retirees. Under defined benefit plans, the obligations are defined with payment to be made in the future from general corporate funds. These plans may or may not be fully funded. Since the company’s obligation is extinguished upon contribution for a defined contribution plan, the accounting is relatively simple: record an expense when paid or accrued. Defined benefit plans present a number of complications in that the liability is very difficult to estimate and involves a number of critical assumptions. In addition, companies lobbied for (and the FASB agreed to) various mechanisms to smooth the impact of pension costs on reported earnings. These smoothing mechanisms further complicate the accounting for defined benefit plans vis-à-vis defined contribution plans.

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Q10-5.

Although the accounting can get complicated, a net pension asset will be reported if the fair market value of the plan assets exceeds the plan obligation. Otherwise, a net liability will be reported on the balance sheet to represent the underfunding of the pension obligation.

Q10-6.

Service cost, interest cost and the expected return on plan investments (a reduction of the pension cost) are the basic components of pension expense. Companies might also report amortization of deferred gains and losses.

Q10-7.

The use of expected returns and the deferral of unexpected gains and losses act to smooth corporate earnings by removing the effects of swings in the market values of investments and variation in pension liabilities resulting from changes in actuarial assumptions or plan amendments.

Q10-8.

For a finance or operating lease, the initial value of the lease liability is determined by calculating the present value of the remaining lease payments. The remaining lease payments include those payments that are not subject to options or contingencies, including any guaranteed residual value. The initial right-of-use asset value for both types is the lease liability computed as just described, adjusted for some items occurring at or before the lease commencement date (e.g., add lease prepayments, subtract lease incentives, and add initial direct costs).

Q10-9.

Retirement benefits are normally expensed in the period in which they are earned by the employee, not when they are paid. Some benefits are calculated for periods of employment prior to the inception of a pension plan or prior to a plan amendment. The cost of these benefits (called prior service costs) is expensed by amortizing the cost over the average expected future period of employee service.

Q10-10. Income tax expense is a financial accounting expense measured using accrual accounting. Thus, the expense includes the cash taxes paid but also includes accruals for future tax payments and future tax benefits that result from transactions in the current period. Q10-11. A tax payment would be recorded as a deferred tax asset or liability under two situations. First, if the company is required to make a tax payment based on a temporary difference that makes taxable income reported on the tax return higher than the income reported for financial accounting. In this case, the tax on the temporary difference would not be recorded as tax expense. Recall that tax expense is the expense related to the accounting income. For example, consider a company that receives a cash payment in advance of delivering a service. For financial accounting this is recorded as unearned revenue and not recognized as revenue until earned and thus is not in accounting earnings. However, generally for tax purposes such a payment would be included in taxable income. Thus, a cash tax payment would be required to be made on this amount. For financial accounting, this would increase current tax expense continued

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MINI EXERCISES M10-13. (35 minutes) LO 2 a. i. 1/3

Right-of-use asset – operating lease (+A) ................... Operating lease liability (+L) ...................................

57,198 57,198

$57,198 = $12,000 x 4.76654

12/31 Operating lease liability (L) .......................................... Cash (-A) ................................................................

12,000

12/31 Operating lease expense (+E) ..................................... Operating lease liability (+L) ................................... Right-of-use asset – operating lease (-A) ...............

12,000

Right-of-use lease asset – finance lease (+A) ............. Finance lease liability (+L) ......................................

57,198

12,000

4,004 7,996

ii. 1/3

57,198

$57,198 = $12,000 x 4.76654

12/31 Amortization expense – finance lease (+E, -SE).......... Accumulated amortization – finance lease (+XA) ...

9,533 9,533

$9,533 = $57,198 / 6 (note that the company could choose to credit the right-of-use asset for the finance lease directly)

7,996 4,004 12,000

$4,004 = $57,198 x 0.07; $7,996 = $12,000 - $4,004

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-5

b. Operating Lease (i): +

Cash (A) 12,000

Operating Lease Liability – (L) + 57,198 1/3 12/31 12,000 4,004 12/31

12/31

+ Right-of-use Asset (A)—Operating Lease 1/3 57,198 7,996 12/31 + Lease Expense – Operating Lease (E) 12/31 12,000

Finance Lease (ii): +

Cash (A) 12,000

Finance Lease Liability (L) 57,198 12/31 7,996

12/31

+ Right-of-use Asset (A) – Finance Lease 1/3 57,198

+ 12/31

- Accumulated Amortization – Finance + Lease (XA) 9,533 12/31

Interest Expense (E) 4,004

+ 1/3

Amortization Expense – Finance Lease (E) 12/31 9,533

c. Operating Lease (i): Balance Sheet Transaction

Noncash + Assets +57,198 Right-of- use asset – Operating lease

-12,000 Cash

-12,000 Operating Lease Liability

-7,996 Right-of-use asset – Operating lease

4,004 Operating Lease Liability

Operating lease commences.

Lease payment.

Record lease expense and changes to asset and liability.

Contra Assets

Income Statement

Cash Asset

= Liabilities + = +57,198 Operating Lease Liability

Contrib. Capital

Earned Capital

Revenues -

- Expenses = =

-12,000 Retained Earnings

+12,000 Lease Expense

continued

©Cambridge Business Publishers, 2021 10-6

Net Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

-12,000

c. continued Finance Lease (ii): Balance Sheet Transaction Finance lease commences

Cash Asset

Noncash Assets +57,198 Right-ofuse asset – Finance lease

Amortization of leased asset.

Made annual -12,000 lease payment. Cash

Contra Assets

+9,533 Accum. Amortization.

= Liabilities + = +57,198 Finance Lease Liability =

-7,996 Finance Lease Liability

Income Statement Contrib. Capital

Earned Capital

Revenues

Net - Expenses = Income =

-9,533 Retained Earnings

+9,533 Amort. Expense

-9,533

-4,004 Retained Earnings

+4,004 Interest Expense

-4,004

M10-14. (20 minutes) LO 2 Right-of-use asset – finance lease (+A) 123,100 Finance lease liability (+L) .................................

a. 7/1

123,100

$123,100 = $4,500 x 27.35548

b. 9/30

Amortization expense (+E, -SE) Accumulated amortization (+XA, -A) ................. $3,078 = $123,100 / (10 x 4)

3,078 3,078

(note the company could directly reduce the right-of-use asset value)

9/30

2,038 2,462 4,500

$2,462 = $123,100 x (0.08/4); $2,038 = $4,500 - $2,462

12/31 Amortization expense (+E, -SE).............................. Accumulated amortization (+XA, -A) .................

3,078

2,079 2,421

3,078

4,500

$2,421 = ($123,100 - $2,038) x (0.08/4); $2,079 = $4,500 - $2,421

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-7

c. +

Cash (A) 4,500 4,500

9/30 12/31

Right-of-use Asset – Finance Lease (A) 7/1 123,100

9/30 12/31

Finance Lease Liability (L) 123,100 2,038 2,079 +

- Accumulated Amort. – Finance lease (XA) + 3,078 9/30 3,078 12/31

9/30 12/31

Interest Expense (E) 2,462 2,421

+ 9/30 12/31

Amortization Expense (E) 3,078 3,078

+ 7/1

d. Balance Sheet Transaction

Cash Asset

7/1/20 Finance lease commences.

+123,100

Liabilities

+123,100

+3,078

Revenues

Net - Expenses = Income -

-3,078

-2,038

-2,462

Finance

Retained Earnings

Lease Liability -

+3,078

-3,078

Accum. Amort. -

Cash

Retained Earnings

Cash

-4,500

Earned Capital

Lease Liability

Accum. Amort. -4,500

Income Statement Contrib. + Capital +

Finance

12/31/20 Amortization on leased asset. 12/31/20 Made quarterly lease payment.

Contra Assets

Right-of-use asset – finance lease

9/30/20 Amortization on leased asset. 9/30/20 Made quarterly lease payment.

Noncash Assets

-2,079

-2,421

Finance

Retained Earnings

Lease Liability

= -3,078

Amort. Expense -

+2,462

= -2,462

Interest Expense

Retained Earnings =

+3,078

= -3,078

Amort. Expense -

+2,421

= -2,421

Interest Expense

©Cambridge Business Publishers, 2021 10-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M10-15 (10 minutes) LO 2 a. Right-of-use asset – finance lease (+A)............................. Finance lease liability (+L) ......................................

74,520

b. Right-of-use asset – operating lease ................................. Operating lease liability (+L) ...................................

5,853

Operating lease liability (-L) ............................................... Cash (-A) ................................................................

1,000

74,520

5,853

1,000

Lease Payment

January 1, 2020 December 31, 2020 $ December 31, 2021 December 31, 2022 December 31, 2023 December 31, 2024 $

Interest on Liability

Reduction of Lease Liability $

130,000 130,000 130,000 130,000 130,000

$ $ $ $ $

650,000 $

37,312 30,824 23,881 16,453 8,505

$ $ $ $ $

92,688 99,176 106,119 113,547 121,495

116,974 $

533,026

Lease Liability 533,026 440,337 341,161 235,042 121,495 0

b. Right-of-Use Asset Amortization Schedule Date

Straight-line Expense

Interest on Liability

Amortization of Right-of-Use Asset

January 1, 2020 December 31, 2020 $ December 31, 2021 December 31, 2022 December 31, 2023 December 31, 2024

130,000 $ 130,000 130,000 130,000 130,000

37,312 $ 30,824 23,881 16,453 8,505

92,688 99,176 106,119 113,547 121,495

650,000 $

116,974 $

533,026

Right-of-Use Asset 533,026 440,338 341,161 235,043 121,496 0

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-9

c. Journal Entries January 1, 2020 Right-of-use asset – operating lease (A) ........................... Operating lease liability (L) .....................................

533,026

December 31, 2020 Operating lease Liability .................................................... Cash .......................................................................

130,000

533,026

130,000

130,000 37,312 92,688

130,000 130,000

130,000 30,824 99,176

Lease Payment

Interest on Liability

Reduction of Lease Liability

January 1, 2020 January 1, 2020 $ January 1, 2021 January 1, 2022 January 1, 2023 January 1, 2024

$ 130,000 $ 130,000 130,000 130,000 130,000

$ 30,824 23,881 16,453 8,505

130,000 99,176 106,119 113,547 121,495

650,000 $

79,663 $

570,337

Lease Liability 570,337 440,337 341,161 235,042 121,495 0

©Cambridge Business Publishers, 2021 10-10

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Right-of-Use Asset Amortization Schedule Date

Straight-line Expense

Interest on Liability

Amortization of Right-of-Use Asset

January 1, 2020 Year 2020 $ Year 2021 Year 2022 Year 2023 Year 2024

130,000 $ 130,000 130,000 130,000 130,000

30,824 $ 23,881 16,453 8,505 -

99,176 106,119 113,547 121,495 130,000

650,000 $

79,663 $

570,337

Right-of-Use Asset 570,337 471,161 365,042 251,495 130,000 0

c. Journal entries January 1, 2020 Right-of-use asset ................................................................ Operating lease liability .............................................

570,337

January 1, 2020 Operating lease liability ........................................................ Cash..........................................................................

130,000

570,337

130,000

130,000 30,824 99,176

130,000 130,000

130,000 23,881 106,119

16,000 16,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-11

14.4 14.4

c. Only the unpaid contribution, if any, appears on the A&F balance sheet.

©Cambridge Business Publishers, 2021 10-12

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M10-23. (20 minutes) LO 5 a, b, and c. Year

Book Value

Temporary Difference

Tax Rate

Deferred Tax Liability

2021

$300,000

$173,000

$127,000

25%

$31,750

2022

$200,000

$173,000 - ($100,000 - $31,000) = $104,000

$96,000

25%

$24,000

2023

$100,000

$104,000 - ($100,000 - $31,000) = $35,000

$65,000

25%

$16,250

Tax Basis (after depreciation deduction)

d. Deferred tax assets and liabilities are all recorded as non-current assets and liabilities.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-13

Interest on Liability

Reduction of Lease Liability

195,880 $ 159,715 122,104 82,988 42,308 602,996 $

904,120 940,285 977,896 1,017,012 1,057,693 4,897,005

Lease Liability $4,897,005 $ 3,992,885 3,052,601 2,074,705 1,057,693 0

Right-of-use Asset Amortization Schedule – operating lease Date 01-Jan-20 31-Dec-20 $ 31-Dec-21 31-Dec-22 31-Dec-23 31-Dec-24 $

Straight-line Expense 1,100,000 1,100,000 1,100,000 1,100,000 1,100,000 5,500,000

Interest on Liability $

195,880 159,715 122,104 82,988 42,308 602,996

Amortization of Right-of-Use Asset $

904,120 940,285 977,896 1,017,012 1,057,693 4,897,005

Right-of-Use Asset $4,897,005 $ 3,992,885 3,052,601 2,074,705 1,057,693 0

*Note: there are some small differences due to rounding in the tables above.

©Cambridge Business Publishers, 2021 10-14

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Entries if a finance lease: January 1, 2020 Right-of-use asset – finance lease .......................... Finance lease liability ....................................

4,897,005

December 31, 2020 Amortization expense .............................................. Accumulated amortization – finance lease....

979,401

4,897,005

979,401

$4,897,005 / 5 (note that company could choose to reduce the asset value directly)

904,120 195,880 1,100,00

December 31, 2021 Amortization expense .............................................. Accumulated amortization – finance lease....

979,401 979,401

$4,897,005 / 5 (Note that company could choose to reduce the asset value directly)

940,285 159,715 1,100,00

Balance Sheet Equation: January 1, 2020 Balance Sheet Transaction

Cash Asset

Lease equipment using financetype lease

Noncash Assets

Liabilities

+4,897,005

Right-of-use asset

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Net Income

- Expenses = -

Lease liability

December 31, 2020 Balance Sheet Transaction

Cash Asset

Record amortization of asset

Noncash Assets

–979,401

Liabilities

Income Statement Contrib. + Capital +

Earned Capital –979,401

- Expenses = -

Accum. Amort. – finance lease

Cash Asset

Record –1,100,000 interest and cash payment

Noncash Assets

+979,401

= –979,401

Liabilities

–904,120

Income Statement +

Contrib. Capital +

Earned Capital –195,880

Revenues

- Expenses = -

+195,880 Interest expense

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

Net Income

Amort. expense

Balance Sheet Transaction

Revenues

10-15

Net Income

= –195,880

4,897,005

December 31, 2020 Operating lease liability ..................................................... 1,100,000 Cash .......................................................................

1,100,000

195,880 904,120

(note company could choose to maintain an accumulated amortization account)

December 31, 2021 Operating lease liability ..................................................... 1,100,000 Cash .......................................................................

1,100,000

Lease expense .................................................................. 1,100,000 Operating lease liability ........................................... Right-of-use asset – operating lease ......................

159,715 940,285

Balance Sheet Equation January 1, 2020 Balance Sheet Transaction

Cash Asset

Lease equipment operating-type lease

Noncash Assets

Liabilities

+4,897,005

Right-of-use asset

Income Statement Contrib. + Capital +

Earned Capital

Revenues

- Expenses = -

Net Income

Lease liability

December 31, 2020 Balance Sheet Transaction Record payment

Cash Asset

Noncash Assets

–1,100,000

Liabilities

–1,100,000

Income Statement Contrib. Capital +

Earned Capital

Contrib. + Capital +

Earned Capital

Balance Sheet Transaction Record lease expense, reduction in asset value & adjust liability for interest

Cash Asset

Noncash Assets

Liabilities

–904,120

+195,880

Right-of-use asset – operating lease

Lease liability

Revenues

- Expenses =

Income Statement

–1,100,000

Revenues

- Expenses =

Net Income

- +1,100,000 = –1,100,000 Lease expense

continued ©Cambridge Business Publishers, 2021 10-16

Net Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

904,120 1,100,000 1,100,000 904,120

Operating Lease

January 1, 2020

4,897,005

December 31, 2020

3,917,604

3,992,885

December 31, 2021

2,938,203

3,052,600

December 31, 2022

1,958,802

2,074,704

December 31, 2023

979,401

1,057,692

December 31, 2024

Amounts may differ slightly due to rounding.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-17

Total debt-to-equity based on recorded numbers is 1.26 or 126% computed as $5.815 B/ $4.611 B.

•

Using the numbers after operating lease assets and liabilities are added to the balance sheet, the debt-to-equity ratio would be 1.52 or 152% computed as $7.015/$4.611B.

©Cambridge Business Publishers, 2021 10-18

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E10-27. (25 minutes) LO 1, 2

c. Debt-to-equity as reported = $210,119 M/$54,710 M = 3.84 or 384%. Debt-to-equity after adjusting for estimating operating leases = $232,119/$54,710 = 4.24 or 424%

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-19

First we need to specify the future payments (in thousands) o o o o o o

o o

•

Using Excel’s NPV function to estimate the amount, using the 3% interest rate stated in the problem: [NPV(0.03, 126221,106782,101543,98353,91337,105317,105317) = $656,130 thousand.

}

©Cambridge Business Publishers, 2021 10-20

Financial & Managerial Accounting for Decision Makers, 4 th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-21

57,000 55,000 2,000

*($236,000 - $16,000) x 25% = $55,000

59,250 2,000 61,250

*($245,000 - $0) x 25% = $61,250

57,800 55,000 2,800

*($236,000 – $16,000) x 25% = $55,000 **($8,000 x 35% = $2,800)

82,950 2,800 85,750

*($245,000 - $0) x 35% = $85,750

©Cambridge Business Publishers, 2021 10-22

Financial & Managerial Accounting for Decision Makers, 4 th Edition

10-33. (15 minutes) LO 5 a. $12,000 x 25% = $3,000. (None would be depreciable for book purposes b. The entire amount will be a non-current liability. c. $8,000 x 25% = $2,000.

E10-34. (15 minutes) LO 5 a. Balance Sheet Transaction To record income tax expense

Cash Asset

Noncash + Assets

Contrib. = Liabilities + Capital + = +1,745 Taxes Payable

Income Statement Earned Capital -2,392 Retained Earnings

Revenues

Expenses +2,392 Income Tax Expense

= =

Net Income -2,392

+647 Deferred Tax Liability

2,392 1,745 647

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash—Cash would be reduced. Either is correct.)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-23

E10-35. (15 minutes) LO 5 a. Balance Sheet Transaction a. To record income tax expense.

Cash Asset

Noncash Assets

= Liabilities + = +2,139 Taxes Payable

Income Statement Contrib. Capital +

Earned Capital -1,144 Retained Earnings

Revenues

Expenses +1,144 Income Tax Expense

= =

Net Income -1,144

-995 Deferred Tax Liability

995 1,144 2,139

©Cambridge Business Publishers, 2021 10-24

Financial & Managerial Accounting for Decision Makers, 4 th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-25

$10 B $10 B

©Cambridge Business Publishers, 2021 10-26

Financial & Managerial Accounting for Decision Makers, 4 th Edition

10-27

P10-41. (20 minutes) LO 5 a.

2018: $1,727 / $4,070.7 = 42.43% 2017: $971 / $3,153.8 = 30.79% 2016: $700 / $2,224.0 = 31.47%

©Cambridge Business Publishers, 2021 10-28

Financial & Managerial Accounting for Decision Makers, 4 th Edition

14,750 12,000 2,750

- Income Taxes Payable (L) + 12,000 (d)

- Deferred Tax Liability (L) + 2,750 (d)

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash—Cash would be reduced. Either is correct.)

- Income Taxes Payable (L) + 45,150 (d)

43,650 1,500 45,150 - Deferred Tax Liability (L) + (d) 1,500

(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes payable used above would be replaced with Cash (Cash would be reduced). Either is correct.)

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-29

XX XX

YY YY

©Cambridge Business Publishers, 2021 10-30

Financial & Managerial Accounting for Decision Makers, 4 th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 10

10-31

83 42

125

©Cambridge Business Publishers, 2021 10-32

Financial & Managerial Accounting for Decision Makers, 4 th Edition

192,894 63,381 129,513

10-33

©Cambridge Business Publishers, 2021 10-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Chapter 11 Reporting and Analyzing Stockholders’ Equity Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Describe business financing through stock issuances.

19, 37

41, 45

62, 63

LO2 – Explain and account for the issuance and repurchase of stock.

20 - 22, 24, 25, 36, 37

39 - 41, 45, 52, 54

55 - 59

62 - 65

LO3 – Describe how operations increase the equity of a business.

30, 37

48, 49, 51

55 - 57

63, 64

LO4 – Explain and account for dividends and stock splits.

23, 26 - 31, 36

42, 44, 46 - 51, 54

56, 58

LO5 – Define and illustrate comprehensive income.

56, 59, 60

LO6 – Describe and illustrate basic and diluted earnings per share computations.

24, 25, 32 - 34, 36 - 38

41, 43, 44, 50

55 - 57, 59

LO7 – Appendix 11A: Analyze the accounting for convertible securities, stock rights, and stock options.

59, 60

61, 65

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-1

QUESTIONS Q11-1. Par value stock is stock that has a face value printed (identified) on the stock certificate. From an accounting standpoint, the par value of the common stock is the amount added to the common stock portion of paid-in-capital upon the issuance of stock. The remainder of the issue price is added to the additional paid-incapital portion of paid-in-capital. There are no analysis implications of the par value of stock. Q11-2. Preferred stock usually takes priority over common stock in the receipt of a specified amount of dividends and in the distribution of assets if the corporation is ever liquidated. Also, preferred stock does not usually have voting rights. Typically, preferred stock has the following features: 1) Preferential claim to dividends and to assets in liquidation, 2) Cumulative dividend rights, and 3) No voting rights. Q11-3. Preferred stock is similar to debt when 1. Dividends are cumulative. 2. Dividends are nonparticipating. 3. It has a preference to assets in liquidation. Preferred stock is similar to common stock when 1. Dividends are not cumulative. 2. Dividends are fully participating. 3. It is convertible into common stock. 4. It does not have a preference to assets in liquidation. Q11-4. Dividend arrearage on preferred stock is the aggregate amount of dividends on cumulative preferred stock that has not been declared to date. The amount of dividends in arrears and a current dividend must be paid to preferred stockholders before common stockholders can receive any dividends. In the example, preferred stockholders must receive $90,000 in dividends ($500,000  0.06  3 years = $90,000) before common stockholders receive any dividends.

©Cambridge Business Publishers, 2021 11-2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q11-5. A corporation's authorized stock is the maximum number of shares of stock it may issue. The authorized amounts and classes of stock are enumerated in the company's charter when the corporation is formed. A corporation can later amend its charter to change the amount of authorized capital, but such action must have the approval of the company’s shareholders. Shares that have been sold and issued to stockholders are the company's issued stock. Shares that have been sold and issued can be subsequently reacquired by the corporation—called treasury stock. When treasury stock is held, the issued shares exceed the outstanding shares. Q11-6. Contributed capital represents the total investment that has been paid in to the company by its shareholders as a result of the purchase of stock. Earned capital represents the cumulative net income that has been earned, less the portion of that income that has been paid out to shareholders in the form of dividends. When profit is earned, shareholders have the option of paying out that profit as a dividend or reinvesting the earnings in order to grow the company. In fact, many companies title the Retained Earnings account as Reinvested Earnings. Earned capital, thus, represents an implicit investment by the shareholders in the form of forgone dividends. Q11-7. Paid-in capital is divided into two accounts: the common or preferred stock account and additional paid-in capital. The common stock or preferred stock accounts are increased by the par value of the shares issued and the additional paid-in capital account is increased for the balance of the proceeds received from the sale of the shares. The balance of the paid-in capital account is affected by the par value of the stock; the higher (lower) the par value, the lower (higher) the additional paid-in capital. Although paid-in capital will, in general, be higher if the stock price is higher, the breakdown of paid-in capital between the common or preferred stock accounts and additional paid-in capital does not yield any inferences regarding the financial condition of the company. Q11-8. A stock split refers to the issuance of additional shares of a class of stock to the current stockholders in proportion to their ownership interests, normally accompanied by a proportionate reduction in the par or stated value of the stock. For example, a 2-for-1 stock split doubles the number of shares outstanding and halves the par or stated value of the shares. Consequently, there is no change in the amount of contributed capital associated with that class of stock. The major reason for a stock split is to reduce the per-share market price of the stock. Another possible reason is to influence shareholders’ in believing there has been some distribution of value.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-3

Q11-9. Treasury stock is a corporation's issued stock that has been reacquired by the issuing corporation through purchases of its stock from its shareholders. A corporation often purchases treasury stock for distribution to employees under stock option plans or to offset dilution resulting from such sales. It is also used by management to prop up stock price when management believes its stock is inappropriately underpriced. On the balance sheet, treasury stock should be carried at its cost and is shown as a deduction in deriving the total stockholders' equity—known as a contra equity account. Q11-10. The $2,400 increase should not be shown on the income statement as any form of income or gain. The $2,400 is properly treated as additional paid-in capital and is shown as such in the stockholders' equity section of the balance sheet. The latter treatment is justified because treasury stock transactions are considered capital rather than operating transactions. Q11-11. The book value per share of common stock is the total stockholders' equity divided by the number of shares outstanding, or $4,628,000/260,000 = $17.80. Q11-12. A stock dividend is the distribution of additional shares of a corporation's stock to its stockholders. A stock dividend does not change a stockholder's relative ownership interest, because each stockholder owns the same fractional share of the corporation before and after the stock dividend. There is empirical evidence, however, suggesting that the stock price does not decline fully for the additional shares issued—various hypotheses, such as signaling theory, have been asserted as explanations of this phenomenon. Q11-13. The stock dividend transfers capital from retained earnings to contributed capital. For a small stock dividend, this transfer is recorded at the market price of the shares at the time of the dividend. For a large stock dividend, the transfer is made at the par value of the stock. Q11-14. Many companies repurchase shares (as Treasury Stock) in order to offset the dilutive effects of exercised stock options which increase the number of outstanding shares. This repurchase results in a cash outflow, and has been used by those arguing for the expensing of employee stock options as evidence of the cash effect of these options and linkage to the payment of wages. Q11-15. The statement of stockholders' equity analyzes and reconciles changes in all major components of stockholders' equity for an accounting period. The statement begins with the beginning balances of those key stockholders' equity components, reports the items causing changes in these components, and ends with the period-end balances.

©Cambridge Business Publishers, 2021 11-4

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q11-16. Other Comprehensive Income (OCI) represents changes in stockholders’ equity that are caused by factors other than profit (loss) and the sale (repurchase) of equity securities. Some examples include unrealized gains (losses) on available-for-sale debt securities, foreign currency translation adjustments, unrealized gains (losses) on some derivatives, and pension liability adjustments. Q11-17. A stock option vesting period is a period of time after the grant date that an employee must wait before exercising stock options. For example, a company may grant five-year options that vest in three years. An employee would then be able to exercise the options in Years 4 or 5, but not before. Typically, the vesting period requires that the employee remains employed at the company until the options vest; otherwise he/she forfeits the options. GAAP requires that the fair value of the option be recorded as a compensation expense ratably over the vesting period. Q11-18. When a convertible bond is converted, both the face amount and any associated unamortized premium or discount are removed from the balance sheet. The stock is, then, issued considering the “purchase price” to be the book value (face amount ± an unamortized premium or discount) of the bond. This purchase price is, then, allocated to common stock and additional paid-in capital. No gain or loss is reported upon the conversion.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-5

MINI EXERCISES M11-19. (10 minutes) LO 1 a. These transactions increase Beatty Corp.’s contributed capital. Earned capital is affected by net income, other comprehensive income and dividends. b. Transactions between a company and its shareholders do not affect the income statement. c. Preferred stock has priority over common stock in the payment of dividends and in liquidation. That is, a company cannot pay common dividends until after it has fulfilled its preferred dividend obligation. And, if a company liquidates, the claims of the preferred shareholders are met before those of the common shareholders.

M11-20. (15 minutes) LO 2 a. Balance Sheet Transaction Issue 18,000 shares of $10 par value preferred stock at $48 per share.

Issue 120,000 shares of $2 par value common at $37 per share.

Cash Asset +864,000 Cash

Noncash + Assets

= Liabilities =

Income Statement

Contrib. + Capital + +180,000 Preferred Stock

Earned Capital

Revenues

Expenses

Net = Income =

+684,000 Additional Paid-in Capital +4,440,000 Cash

+240,000 Common Stock

+4,200,000 Additional Paid-in Capital

b. 9/1

Cash (+A) ......................................................................................... 864,000 Preferred stock (+SE) ...................................................................... 180,000 Additional paid-in capital (+SE) ........................................................ 684,000

9/1

Cash (+A) ......................................................................................... 4,440,000 Common stock (+SE) ....................................................................... 240,000 Additional paid-in capital (+SE) ........................................................ 4,200,000

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. +

Cash (A) 864,000 4,440,000 - Common Stock (SE) + 240,000

9/1 9/1

- Preferred Stock (SE) + 180,000

9/1

- Additional Paid-in Capital (SE) + 684,000 9/1 4,200,000 9/1

9/1

M11-21. (10 minutes) LO 2 (in millions) Common stock ....................................... $ 4.614a Additional paid in capital......................... 42,815.39 Total ....................................................... $42,820 a 4,614 million shares issued  $0.001 par value.

M11-22. (15 minutes) LO 2 a. Income Statement

Balance Sheet Cash Transaction Asset Issue 5,000 +1,250,000 shares of $100 Cash par value preferred stock at $250 per share.

Repurchase 5,000 shares of $1 par value common stock at $83 per share.

-415,000 Cash

Noncash + Assets = =

Liabilities

Contrib. Capital +500,000 Preferred Stock

Earned + Capital -

Contra Equity

Net Revenues - Expenses = Income =

+750,000 Add’l Paid-in Capital =

- +415,000 Treasury Stock

b. 1/1

Cash (+A) ................................................................................... 1,250,000 Preferred stock (+SE) .................................................................. 500,000 Additional paid-in capital (+SE) .................................................... 750,000

3/1

Treasury stock (+XSE, -SE) ......................................................... 415,000 Cash (-A) ....................................................................................

415,000

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11-7

c. 1/1

+ Cash (A) 1,250,000

415,000

3/1

- Preferred Stock (SE) + 500,000

1/1

3/1

+ Treasury Stock (XSE) 415,000

- Additional Paid-in Capital (SE) + 750,000 1/1

M11-23. (10 minutes) LO 4 A stock split that is affected as a large stock dividend requires an entry into the accounting records. The number of outstanding shares must be changed in the parenthetical note to the common and preferred stock accounts in the stockholders’ equity section of the balance sheet. The par value of the new shares must be taken out of retained earnings and put into the common stock at par account. In the two-for-one stock split effected by Aflac, each shareholder receives one additional share for each share owned, thus doubling the outstanding shares, and – because the split was effected as a large stock dividend – the par value of the shares is unchanged. The dollar amount of total paid-in capital increases, but the total dollar amount of stockholders’ equity is unchanged. Earnings per share is recomputed for all years presented in the income statement to reflect the additional shares outstanding.

M11-24. (15 minutes) LO 2, 6 a. Basic EPS: [$501,000 – (16,000 x $2)] / 134,000 = $3.50 Calculation of weighted average shares outstanding: 120,000 130,000 146,000 140,000

x x x x

2/12 5/12 3/12 2/12

= = = =

20,000 54,167 36,500 23,333 134,000

b. Diluted EPS: $501,000 / (134,000 + 16,000) = $3.34 c. Given a simple capital structure, only basic EPS need be reported.

©Cambridge Business Publishers, 2021 11-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M11-25. (10 minutes) LO 2, 6 a. Treasury shares are deducted from issued shares to yield outstanding shares. The outstanding shares are, therefore: Shares outstanding = 3,262,997,492 – 353,073,500 = 2,909,923,992 b. If the stock repurchase took place on July 1, 2017, three months after the end of the previous fiscal year, the denominator of the basic EPS calculation would decrease by 353,073,500 x 9/12. That is, the weighted average shares outstanding would be 3,262,997,492 – [353,073,500 x (9/12)] = 2,998,192,367 shares.

M11-26. (15 minutes) LO 4 a. Balance Sheet Cash Asset

Transaction

Noncash + Assets

Declared and paid cash dividend on preferred stock.

-18,000

Declared and paid cash dividend on common stock.

-88,000

= Liabilities + =

Income Statement Contrib. Capital +

Earned Capital -18,000

Cash

Revenues

Expenses

Net = Income

Retained Earnings

-88,000

Cash

Retained Earnings

b. Preferred dividend: 12/31 Retained earnings (-SE) ........................................................ 18,000 Cash (-A) ......................................................................................... 18,000 Common dividend: 12/31 Retained earnings (-SE) ................................................................... 88,000 Cash (-A) ..........................................................................................88,000 c. +

Cash (A)

18,000 88,000

12/31 12/31

- Retained Earnings (SE) + 12/31 18,000 12/31 88,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-9

M11-27. (15 minutes) LO 4 Because this is a small stock dividend (4%), retained earnings is debited for the market value of the 2,800 additional shares of stock (70,000 x 4% x $21). a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Declaration and distribution of stock dividend.

= Liabilities + =

Income Statement Contrib. Capital +

Earned Capital

+14,000

-58,800

Common Stock

Retained Earnings

Revenues

- Expenses

Net Income

+44,800 Additional Paid-in Capital

b. 12/31 Retained earnings (-SE) .............................................................. 58,800 Common stock (+SE) .................................................................. 14,000 Additional paid-in capital (+SE) .................................................... 44,800 c. 12/31

Retained Earnings (SE) 58,800

- Common Stock (SE) + 14,000

12/31

- Additional Paid-in Capital (SE) + 44,800 12/31

M11-28. (10 minutes) LO 4 a. Immediately after the 3-for-2 stock split, the company has 375,000 shares of $10 par value common stock [250,000 shares  (3/2) = 375,000 shares] issued and outstanding. b. The dollar balance in the Common Stock account is unchanged by the stock split; the balance remains at $3,750,000 (375,000 shares at the new $10 par value per share). c. The usual reason for a corporation to split its stock is to reduce the per share market price of the stock and, therefore, improve the stock's marketability. The market price of the common stock prior to the split is $165 per share, which is somewhat high. Splitting the stock would reduce the per-share price (though not the total market value).

©Cambridge Business Publishers, 2021 11-10

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M11-29. (15 minutes) LO 4 Distribution to Preferred Common a. $1,000,000  6% ........................................................... $60,000 Balance to common ....................................................... $100,000 Per share $60,000/20,000 shares ....................................... $3.00 $100,000/80,000 shares ..................................... $1.25 b. $1,000,000  6%  2 years............................................ Balance to common ....................................................... Per share $120,000/20,000 shares ..................................... $40,000/80,000 shares .......................................

$120,000 $40,000 $6.00 $0.50

M11-30. (10 minutes) LO 3, 4 MAFFETT COMPANY Statement of Retained Earnings For the Year Ended December 31, 2019 Retained earnings, December 31, 2018 .................................................. Add: Net income ...................................................................................... Less: Cash dividends declared ................................................. $35,000 Stock dividends declared ................................................ 28,000 Retained earnings, December 31, 2019 ..................................................

$347,000 94,000 441,000 63,000 $378,000

M11-31. (10 minutes) LO 4 a. No entry is made when the dividend is declared; an entry is required only when the additional stock is issued. Because this is a large stock dividend, the dividend is recorded at par value: Retained earnings (-SE) .............................................................. 400,000 Common stock (+SE) ...................................................................400,000 b. The stock split would reduce the par value, but no journal entry would be recorded. As a consequence, neither the common stock nor the retained earnings accounts are affected. Neither method changes total shareholders’ equity.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-11

M11-32. (10 minutes) LO 6 a. Basic EPS: [$440,000 – (10,000 x $50 x 8%)] / 50,000 = $8.00 per share b. Diluted EPS: $440,000 / [50,000 + (10,000 x 3)] = $5.50 per share

M11-33. (15 minutes) LO 6 a. Basic EPS: $234,000 / 45,000 = $5.20 Calculation of weighted average shares outstanding: 38,000 48,000 49,000

x x x

4/12 4/12 4/12

= = =

12,667 16,000 16,333 45,000

b. Basic EPS: [$234,000 – (6,000 x $50 x 6%)] / 45,000 = $4.80

M11-34. (15 minutes) LO 6 a. Basic earnings per share is computed as net income less any preferred dividends divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share adjusts for dilutive securities (such as convertible securities or employee stock options) by including the securities in the denominator and also adjusting for any effect on the numerator. Consequently, diluted earnings per share is always less than or equal to basic earnings per share. b. In the case of Siemens, it has 815,063 thousand weighted average common shares outstanding, and an additional 13,253 thousand weighted average common shares that could potentially be issued (dilutive). These dilutive shares relate to employee stock options warrants, that potentially could be converted into common shares. (Note: with 815,063 thousand shares and a basic EPS of €6.97, the implied earnings number is €5,680,989 thousand, computed as 815,063 thousand  €6.97. For diluted EPS, 828,316 thousand times €6.86 implies earnings of €5,682,248 thousand, a difference of €1,259 thousand. This difference is likely due to the interest/dividends on convertible securities and rounding of EPS.) c. While diluted EPS is favored over basic EPS by analysts, the data reflect events that have not and may never occur. In addition, the dilution is assumed to be made at the year’s start.

©Cambridge Business Publishers, 2021 11-12

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M11-35. (15 minutes) LO 7 a. No entry is required when the options are granted. The compensation expense is recognized ratably over the vesting period. As the options vest, the following entry is required (assume one-third vested in 2017): Compensation expense (+E, -SE) ................................................ 9,931,093 Additional paid in capital (+SE) ............................................... [(($7.04 X 4,232,000)/3) = $9,931,093]

9,931,093

b. Granted stock options (whether vested or not) are included in the denominator of diluted EPS whenever the stock price is greater than the exercise price. These options would reduce diluted EPS but have no effect on basic EPS. c. Cash (+A) ................................................................................... 499,000,000 Contributed capital (+SE) ........................................................

499,000,000

The details of the credit to contributed capital would depend on where the shares came from. If they had been held as treasury shares, the credit would have been to the treasury shares contra asset, with either a debit or credit in additional paid-in capital. If the shares were newly issued, the credit would have been to the par value and additional paid-in capital for Merck’s common stock. d. When options are exercised, the number of outstanding shares increases. This would reduce basic EPS. It might also lower diluted EPS, though most likely to a lesser degree. This is because the dilutive effect may already be reflected in diluted EPS prior to exercise.

M11-36. (10 minutes) LO 2, 4, 6

Year

Total Assets

Total Liabilities

Total Stockholders’ Equity

EPS

Operating Income

1 ….. 2 ….. 3 …..

Increase Decrease No effect

No effect No effect Increase

Increase Decrease Decrease

Decrease Increase No effect

No effect No effect No effect

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-13

M11-37. (15 minutes) LO 1, 2, 3, 6 a. $30 = $18,000,000 / 600,000 shares b. $10 = $6,000,000 / 600,000 shares c. $12,000,000 = $18,000,000 - $6,000,000 d. $4,000,000 = $5,000,000 – $1,000,000 e. 50,000 shares = 600,000 – 550,000 f. $8.70 = $5,000,000 ÷ (600,000 + 550,000)/2. 600,000 shares were outstanding for the first half year but only 550,000 during the second half of the year.

M11-38. (10 minutes) LO 6 a. The diluted EPS calculation is made to reflect a worst-case scenario (conservative) EPS figure. b. $759/326.5 = $2.32 per share c. $761/342.2 = $2.22 per share d. When the options are not in-the-money. Options that are “under water” (the stock price is below the exercise price) are not included in the calculation of diluted EPS. This is because diluted EPS is supposed to be a conservative possible outcome, but not so conservative that it assumes “under water” options would be exercised.

©Cambridge Business Publishers, 2021 11-14

Financial & Managerial Accounting for Decision Makers, 4 th Edition

EXERCISES E11-39. (15 minutes) LO 2 a. Balance Sheet Transaction Issue 10,000 shares of $1 par value common stock at $25 per share.

Cash Asset +250,000 Cash

Noncash + Assets = =

Liabilities

Contrib. Capital +10,000 Common Stock

Income Statement Earned + Capital -

Contra Net Equity Revenues - Expenses = Income =

+240,000 Add’l Paid-in Capital

Issued 15,000 +4,125,000 shares of Cash $100 par preferred stock at $275 per share.

Purchased 2,000 shares of treasury stock at $15 per share.

-30,000 Cash

Sold 1,000 shares of treasury stock at $21 per share.

+21,000 Cash

+1,500,000 Preferred Stock

- +30,000 Treasury Stock

+2,625,000 Add’l Paid-in Capital

+6,000 Add’l Paid-in Capital

-15,000 Treasury Stock

b. 2/20

Cash (+A) ......................................................................................... 250,000 Common stock (+SE) .......................................................................10,000 Additional paid-in capital (+SE) ........................................................ 240,000

2/21 Cash (+A) ......................................................................................... 4,125,000 Preferred stock (+SE) ....................................................................... 1,500,000 Additional paid-in capital (+SE) ........................................................ 2,625,000 6/30

Treasury stock (+XSE, -SE) ............................................................. 30,000 Cash (-A) ........................................................................................... 30,000

9/25

Cash (+A) ......................................................................................... 21,000 Treasury stock (-XSE, +SE) ............................................................. 15,000 Additional paid-in capital (+SE) ........................................................6,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-15

c. +

Cash (A) 250,000 4,125,000

2/20 2/21

30,000 9/25

6/30

21,000 + Treasury Stock (XSE) 30,000 15,000

9/25

- Preferred Stock (SE) + 1,500,000

2/21

- Common Stock (SE) + 10,000

2/20

- Additional Paid-in Capital (SE) 240,000 2,625,000 6,000

+ 2/20 2/21 9/25

E11-40. (20 minutes) LO 2 a. Balance Sheet

Transaction

Cash Asset

Noncash LiabilAssets = ities

Issue 25,000 shares of $5 par common stock at $17 per share.

+425,000 Cash

Issued 6,000 shares of $50 par preferred stock at $78 per share.

+468,000 Cash

Repurchased 3,000 shares of treasury stock at $20 per share.

-60,000 Cash

Sold 2,000 shares of treasury stock at $26 per share.

+52,000 Cash

Sold 1,000 shares of treasury stock at $19 per share.

+19,000 Cash

Income Statement

Contrib. Capital

Earned + Capital -

Contra Equity

+125,000 Common Stock

Revenues

Net - Expenses = Income

+300,000 Add’l Paid-in Capital =

+300,000 Preferred Stock +168,000 Add’l Paid-in Capital

+60,000 Treasury Stock

+12,000 Add’l Paid-in Capital

-40,000 Treasury Stock

-1,000 Add’l Paid-in Capital

-20,000 Treasury Stock

©Cambridge Business Publishers, 2021 11-16

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. 1/15

Cash (+A) ......................................................................................... 425,000 Common stock (+SE) ....................................................................... 125,000 Additional paid-in capital (+SE) ........................................................ 300,000

1/20

Cash (+A) ......................................................................................... 468,000 Preferred stock (+SE) ...................................................................... 300,000 Additional paid-in capital (+SE) ........................................................ 168,000

3/31

Treasury stock (+XSE, -SE) ............................................................. 60,000 Cash (-A) ..........................................................................................60,000

6/25

Cash (+A) ......................................................................................... 52,000 Treasury stock (-XSE, +SE) ............................................................. 40,000 Additional paid-in capital (+SE) ........................................................ 12,000

7/15

Cash (+A) ......................................................................................... 19,000 Additional paid-in capital (-SE) ......................................................... 1,000 Treasury stock (-XSE, +SE) ............................................................. 20,000

c. + 1/15 1/20

Cash (A) 425,000 468,000

60,000 6/25 7/15

3/31

52,000 19,000 + Treasury Stock (XSE) 60,000 40,000 20,000

6/25 7/15

- Preferred Stock (SE) + 300,000

1/20

- Common Stock (SE) + 125,000

1/15

- Additional Paid-in Capital (SE) + 300,000 1/15 168,000 1/20 12,000 6/25 7/15 1,000

E11-41. (20 minutes) LO 1, 2, 6 a. 7,040 million - 2,781 million = 4,259 million shares outstanding. b. ($1,760 million + $15,864 million) / 7,040 million shares = $2.50 per share. c. $50,677 million / 2,781 million shares = $18.22 per share. d. EPS is computed based on the number of shares outstanding. The number of shares in treasury stock is subtracted from shares issued to get the number of shares outstanding. Thus, the number of treasury shares is subtracted from the denominator in computing EPS. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-17

E11-42. (20 minutes) LO 4 Dividend Distribution

2018 2019

2020

Preferred Common Arrearage on preferred [7%  (20,000  $60)] Current year on preferred [7%  (20,000  $60)] Remainder to common Total distribution Per share Preferred ($168,000/20,000) Common ($15,000/100,000) Current year on preferred [7%  (20,000  $60)] Remainder to common Per share Preferred ($84,000/ 20,000) Common ($116,000/100,000)

Preferred $0

Common

Preferred per Share $0.00

Common per Share $0.00

$84,000 84,000 $168,000

$15,000 $15,000 $8.40 $0.15

$84,000 $116,000 $4.20 $1.16

b. 2018 2019

2020

Preferred Common Arrearage on preferred [7%  (20,000  $60)] Per share Preferred ($84,000/20,000) Common Arrearage on preferred [7%  (20,000  $60)] Partial current year on preferred Total distribution Per share Preferred ($150,000/20,000) Common

$0.00 $0

$0.00

$84,000 $4.20 $0.00

$ 84,000 66,000 $150,000 $7.50 $0.00

©Cambridge Business Publishers, 2021 11-18

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E11-43. (15 minutes) LO 6 a. Basic EPS: [$230,000 – (5,000 x $4)] / 30,000 = $7.00 Calculation of weighted average shares outstanding: 25,000 x 4/12 = 8,333 34,000 x 2/12 = 5,667 28,000 x 2/12 = 4,667 34,000 x 4/12 = 11,333 30,000 b. Diluted EPS: $230,000 / [(30,000 + (5,000 x 2)] = $5.75 c. If Soliman Corporation had a simple capital structure, only basic EPS ($7.00) would be reported.

E11-44. (25 minutes) LO 4, 6

a. Year 1

Distribution to Preferred Common $ 0 $ 0

Year 2: Arrearage from Year 1 ($750,000  8%) Current year dividend ($750,000  8%) Balance to common Total for Year 2

60,000 _______ $120,000

$160,000 $160,000

Year 3: Current year dividend ($750,000  8%)

$ 60,000

b. Year 1 Year 2: Current year dividend ($750,000  8%) Balance to common Year 3: Current year dividend ($750,000  8%)

$ 60,000

$ 60,000 $220,000 $ 60,000

c. Because the preferred stock is not convertible, Potter Company has a simple capital structure and would only report basic EPS. Basic EPS would be reduced in Years 2 and 3 when the preferred dividends are subtracted from net income in the numerator. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-19

E11-45. (20 minutes) LO 1, 2

a. 35,852 thousand  $0.01 = $358.52 thousand rounded to $359 thousand. b. ($359 thousand + $1,305,090 thousand) / 35,852 thousand shares = $36.41 per share

c. 35,852 thousand shares issued – 7,826 thousand shares in treasury = 28,026 thousand shares outstanding

d. $2,334,409 thousand / 7,826 thousand shares = $298.29 per share e. Companies repurchase stock for a variety of reasons: 1. To offset the dilutive effects of shares issued to employees as part of equitybased compensation plans. 2. To mitigate a takeover threat by concentrating the remaining shares in “friendly hands.” 3. To send a signal to the market that the company feels its shares are undervalued.

E11-46. (30 minutes) LO 4 a. Preferred 2018 Current year on preferred [6%  (18,000  $50)] Remainder to common Per share Preferred ($54,000/18,000) Common ($9,000/90,000) 2019 Preferred Common 2020 Arrearage on preferred [6%  (18,000  $50)] Current year on preferred [6%  (18,000  $50)] Remainder to common Total distribution Per share Preferred ($108,000/18,000) Common ($270,000/90,000)

Dividend Distribution Preferred Common per Share

Common per Share

$54,000 $9,000 $3.00 $0.10 $0

$0.00 $0

$0.00

$54,000 54,000 $108,000

$270,000 $270,000 $6.00 $3.00

©Cambridge Business Publishers, 2021 11-20

Financial & Managerial Accounting for Decision Makers, 4 th Edition

2018 Preferred Common 2019 Arrearage on preferred [6%  (18,000  $50)] Current year on preferred [6%  (18,000  $50)] Common Total distribution Per share Preferred ($108,000/18,000) Common 2020 Current year on preferred [6%  (18,000  $50)] Remainder to common Per share Preferred ($54,000/18,000) Common ($135,000/90,000)

Preferred

Dividend Distribution Preferred Common per Share

$0.00 $0

Common per Share

$0.00

$ 54,000 54,000 $0 $0

$108,000

$6.00 $0.00

$54,000 $135,000 $3.00 $1.50

E11-47. (15 minutes) LO 4 a. Balance Sheet Transaction Declared and paid cash dividend.

Cash Asset -47,500 Cash

Declared and issued stock dividend.

Noncash + Assets

Income Statement

Contrib. = Liabilities + Capital +

Earned Capital

-47,5001 Retained Earnings

-35,0002 Retained Earnings

+10,000 Common Stock

Revenues

Expenses

Net Income

+25,000 Additional Paid-in Capital 1

$1.90  25,000 = $47,500.

Retained Earnings is reduced by the market price of the shares distributed (25,000 shares  4%  $35 market value = $35,000). Common Stock is increased by the par value with the balance of the market price reflected in an increase in Additional Paid-in Capital.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-21

b. 1)

Retained earnings (-SE) ................................................................... 47,500 Cash (-A) .......................................................................................... 47,500

Retained earnings (-SE) ................................................................... 35,000 Common stock (+SE) ....................................................................... 10,000 Additional paid-in capital (+SE) ........................................................ 25,000

c. +

Cash (A)

47,500

1) 2)

Retained Earnings (SE) 47,500 35,000

- Common Stock (SE) + 10,000

1) +

- Additional Paid-in Capital (SE) + 25,000 2)

E11-48. (20 minutes) LO 3, 4 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Declared and paid stock dividend.

= =

Liabilities

Income Statement Contrib. Capital +

Earned Capital

+56,000 Common Stock

-100,8001 Retained Earnings

-64,2002 Retained Earnings

Revenues

Expenses

Net Income

+44,800 Add’l Paid-in Capital Declared and issued cash dividend.

-64,200 Cash

The 7% dividend is a small stock dividend and, accordingly, Retained Earnings is reduced by the market value of the shares distributed (7%  80,000 shares  $18 = $100,800). Common Stock is increased by the par value of the shares ($56,000) and Additional Paid-in Capital in increased by the remainder ($44,800).

Retained Earnings is reduced by $0.75 per share on 85,600 shares outstanding and Cash is decreased by the payment.

b. 5/12

Retained earnings (-SE) ............................................................... 100,800 Common stock (+SE) .................................................................. 56,000 Additional paid-in capital (+SE) .................................................... 44,800

12/31 Retained earnings (-SE) .............................................................. 64,200 Cash (-A) .............................................................................

64,200

©Cambridge Business Publishers, 2021 11-22

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. +

5/12 12/31

Cash (A)

64,200

Retained Earnings (SE) 100,800 64,200

- Common Stock (SE) + 56,000

12/31 +

5/12

- Additional Paid-in Capital (SE) + 44,800 5/12

d. PALEPU COMPANY Statement of Retained Earnings For the Year Ended December 31, 2019 Retained earnings, December 31, 2018 Add: Net income

$305,000 283,000 588,000

Less:

Cash dividends declared Stock dividends declared Retained earnings, December 31, 2019

$ 64,200 100,800

165,000 $423,000

E11-49. (20 minutes) LO 3, 4 a. Balance Sheet Transaction

Cash Asset

Noncash + Assets

Declared and paid 100% stock dividend.

Income Statement

Contrib. = Liabilities + Capital +

Earned Capital

+250,000 Common Stock

-250,0001 Retained Earnings

+15,000 Common Stock

-42,0002 Retained Earnings

Declared and paid 3% stock dividend.

Revenues

Expenses

Net Income

+27,000 Additional Paid-in Captal Declared and issued cash dividend.

-102,400 Cash

-102,4003 Retained Earnings

The large stock dividend is reflected as a reduction of Retained Earnings at the par value of the shares distributed (50,000 shares  100%  $5 par value per share = $250,000). Common Stock is increased by the same amount. This is a small stock dividend. As a result, Retained Earnings is decreased by the market value of the shares to be distributed (3%  100,000 shares  $14 per share = $42,000). Common Stock is increased by the par value of the shares distributed (3%  100,000  $5 = $15,000) and Additional Paid-in Capital is increased by the balance ($27,000). Total dividends are 4,000  $5 = $20,000 for the preferred shares and 103,000  $0.80 = $82,400 for the common shares. Retained Earnings and Cash are reduced to reflect the payment.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-23

b. 4/1

Retained earnings (-SE) ............................................................... 250,000 Common stock (+SE) ................................................................... 250,000

12/7

Retained earnings (-SE) .............................................................. 42,000 Common stock (+SE) .................................................................. 15,000 Additional paid-in capital (+SE) .................................................... 27,000

12/20 Retained earnings (-SE) .............................................................. 102,400 Cash (-A) .................................................................................... 102,400 c. +

4/1 12/7 12/20

Cash (A)

102,400

Retained Earnings (SE) 250,000 42,000 102,400

12/20

- Common Stock (SE) + 250,000 15,000

4/1 12/7

- Additional Paid-in Capital (SE) + 27,000 12/7

d. KINNEY COMPANY Statement of Retained Earnings For the Year Ended December 31, 2019 Retained earnings, December 31, 2018 Add: Net income Less:

Cash dividends declared Stock dividends declared Retained earnings, December 31, 2019

$656,000 253,000 909,000 $102,400 292,000

394,400 $514,600

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E11-50. (15 minutes) LO 4, 6 a. Immediately after the stock split, 800,000 shares (2 x 400,000 shares) of $10 par value common stock are issued and outstanding. b. The stock split does not change the Common Stock account balance. The account balance is $8,000,000 just before and immediately after the stock split. c. The stock split does not change the Paid-in Capital in Excess of Par Value account. The account balance is $3,400,000 just before and immediately after the stock split. d. The 2-for-1 split will reduce EPS by half. The EPS numbers currently reported in previous years’ income statements would also be reduced by half for comparison purposes.

E11-51. (20 minutes) LO 3, 4 a. Beginning retained earnings + Net income – Dividends = Ending retained earnings, so $7,297 million + $1,211 million – Dividends = $8,101 million. Dividends = $407 million. b. The change in shares outstanding was 258,616 thousand – 255,668 thousand = an increase of 2,948 thousand shares. Therefore, Intuit must have issued 1,078 thousand shares for the exercise of stock options. c. When a company reissues treasury shares, the difference between the value received and the treasury share cost is either put in or taken from Additional paid-in capital (APIC). In this case, the option exercises increased APIC, implying that the average exercise price exceeded the average cost of the treasury shares.

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E11-52. (20 minutes) LO 2 a. Shares issued  Par value = Common Stock amount 3,577 million shares  $0.50 = $1,788.5 million b. (Common Stock + Other Paid-In Capital)/Shares issued = Average Issue price ($1,788 million + $39,902 million) / 3,577 million = $11.66 per share c. Treasury Stock / Treasury shares = Treasury cost per share $43,794 million / 880.5 million = $49.74 per treasury share d. Shares issued – Treasury shares = Shares outstanding 3,577,103,522 – 880,491,914 = 2,696,611,608 shares outstanding

E11-53. (15 minutes) LO 7 a. Using diluted EPS and average shares outstanding, ($1.27) per share × 235 million shares = a loss of $ 298.45 million. This amount is after tax. Stock options and restricted stock units are not outstanding shares of stock and are thus, not included in the basic EPS computation. They are, however, potentially dilutive securities because when the holder of the security can exercise the option or when the restricted stock unit becomes a share, then more shares will be outstanding. Thus, both of these need to be considered when computing diluted EPS. b. In 2018, the assumed conversion of Class B stock into Class A stock results in a reallocation of income, meaning more income allocated to Class A stockholders, of $3,701 million. This amount increases the numerator for the diluted EPS calculation. The number of Class A shares assumed to be outstanding is also increased (the ‘asif converted amount’), and in 2018 the increase in the number of shares due to the assumed conversion of Class B shares is 484 million shares.

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E11-54. (20 minutes) LO 2, 4 a. Yes, the number of shares outstanding increased by 6 million from “equity compensation activity”. b. Net income + other comprehensive income = total comprehensive income. $12,598 million + $ 431 million = $13,029 million. c. Balance Sheet Cash Asset

Transaction

Noncash LiabilAssets = ities

-3,577

Cash

Contrib. Capital

Income Statement Earned + Capital -

Contra Equity

+3,577

Revenues

Net Expenses = Income

Treasury Stock

Treasury stock (+XSE, -SE) .......................................................... 3,577 Cash (-A) ..................................................................................... +

Cash (A)

3,577

+ Treasury Stock (XSE) 3,577

d. The $14 million difference between $2,529 million and $2,515 million went into the Common Stock account. Perhaps Disney paid some portion of its dividends into a dividend reinvestment account that effectively provides a stock dividend.

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PROBLEMS P11-55. (45 minutes) LO 2, 3, 6 a.

Transaction

Cash Asset

Noncash Assets

1/10: Issued common stock.1

+476,000 Cash

1/23: Purchased treasury stock.2

-152,000 Cash

3/14: Sold treasury stock.3

+84,000 Cash

7/15: Issued preferred stock.4

+128,000 Cash

11/15: Sold treasury stock.5

+24,000

Balance Sheet LiabilContrib. + ities Capital +280,000 Common Stock

Income Statement Earned + Capital

Contra Equity

Revenues

Expen -ses

- +152,000 Treasury Stock

+8,000 Additional Paid-in Capital

+80,000 Preferred Stock

Net Income

+196,000 Additonal Paid-in Capital

-76,000 Treasury Stock

+48,000 Additional Paid-in Capital =

+5,000 Additonal Paid-in Capital

-19,000 Treasury Stock

Total proceeds of 28,000  $17 = $476,000 are reflected as an increase in Cash. Common Stock is increased by the par value of the shares issued (28,000  $10 = $280,000) and Additional Paid-in Capital is increased for the balance ($196,000).

Cash is decreased and Treasury Stock is increased by the purchase price of 8,000 shares  $19 = $152,000. The increase in Treasury Stock reduces contributed capital.

Cash received is 4,000 shares  $21 = $84,000. Treasury Stock is reduced by the original cost of $19 per share and the remainder of $8,000 is reflected as an increase in Additional Paid-in Capital.

Cash received is $128,000. The Preferred Stock account is increased by the par value of the preferred shares issued (3,200  $25 = $80,000) and Additional Paid-in Capital is increased for the balance.

Cash received is 1,000 shares  $24 = $24,000. Treasury Stock is reduced by its original cost of 1,000 shares  $19 = $19,000, thus increasing contributed capital, and Additional Paid-in Capital is increased for the balance ($5,000).

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b. 1/10

Cash (+A) ................................................................................... 476,000 Common stock (+SE) .................................................................. 280,000 Additional paid-in capital (+SE) .................................................... 196,000

1/23 Treasury stock (+XSE, -SE) ......................................................... 152,000 Cash (-A) .................................................................................... 152,000 3/14

Cash (+A) ................................................................................... 84,000 Treasury stock (-XSE, +SE) ......................................................... 76,000 Additional paid-in capital (+SE) .................................................... 8,000

7/15

Cash (+A) ................................................................................... 128,000 Preferred stock (+SE) .................................................................. 80,000 Additional paid-in capital (+SE) ..................................................... 48,000

11/15 Cash (+A) ................................................................................... 24,000 Treasury stock (-XSE, +SE) ......................................................... 19,000 Additional paid-in capital (+SE) .................................................... 5,000 c. 1/10 3/14 7/15 11/15 + 1/23

+ Cash (A) 476,000 84,000 128,000 24,000

152,000

1/23

Treasury Stock (XSE) 152,000 76,000 3/14 19,000 11/15

Common Stock (SE) + 280,000

1/10

Preferred Stock (SE) + 80,000

7/15

- Additional Paid-in Capital (SE) + 196,000 1/10 8,000 3/14 48,000 7/15 5,000 11/15

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d. 1/10:

Decrease basic EPS

1/23:

Increase basic EPS

3/14:

Decrease basic EPS

7/15:

Decrease basic EPS

11/15:

Decrease basic EPS

Note: These answers ignore the effect of cash balances on earnings. Each transaction changed the cash balance. If cash is invested in operations or in securities to earn a return, net earnings would be affected by each transaction.

e. Stockholders’ Equity Paid-in capital 8% Preferred stock, $25 par value,50,000 shares authorized; 10,000 shares issued and outstanding Common stock, $10 par value, 200,000shares authorized; 78,000 shares issued, of which 3,000 shares are in treasury

$ 250,000 780,000

$1,030,000

Additional paid-in capital Paid-in capital in excess of par value—Preferred stock

116,000

Paid-in capital in excess of par value—Common stock

396,000

Paid-in capital from Treasury stock

13,000

525,000

Total paid-in capital

1,555,000

Retained earnings

329,000 1,884,000

Less: Treasury stock (3,000 common shares) at cost Total stockholders’ equity

57,000 $1,827,000

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P11-56. (30 minutes) LO 2, 3, 4, 5, 6 a. Balance Sheet Transaction

Cash Asset

Noncash Assets =

Liabilities

Contrib. Capital

Income Statement Earned + Capital -

Contra Equity

+100,0001 Treasury Stock

-15,0002 Treasury Stock

Purchased -100,000 10,000 shares Cash of treasury stock for cash.

Sold 1,500 +18,000 shares of Cash treasury stock.

+3,000 Add’l Paid-in Capital

Issued 5,000 shares of common stock.

+25,0003 Common Stock

+55,000 Cash

Sold 1,200 +10,800 shares of Cash treasury stock.

Revenues

Net - Expenses = Income

+30,000 Add’l Paid-in Capital =

-1,200 Add’l Paid-in Capital

-12,0004 Treasury Stock

Notes: 1

The stock is acquired for 10,000 shares  $10 = $100,000. This is reflected as a reduction in Cash and a corresponding increase in the Treasury Stock account, a contra-equity account which reduces contributed capital.

Cash received is 1,500 shares  $12 per shares = $18,000. Treasury Stock is reduced by its original cost of $10 per share and the balance ($3,000) is reflected as an increase in Additional Paid-in Capital.

Cash received is 5,000 shares  $11 per share. Common Stock is increased by the par value of the shares issued (5,000  $5 = $25,000) and Additional Paid-in Capital is increased by the balance ($30,000).

Cash received is 1,200 shares  $9 = $10,800. Treasury Stock is reduced by the original cost of the shares (1,200 shares  $10 = $12,000) and Additional Paid-in Capital is reduced by the balance ($10,800 - $12,000 = -$1,200).

b. 1/12 No entry is required for the 3-for-1 stock split. 9/1

Treasury stock (+XSE, -SE) ......................................................... 100,000 Cash (-A) ....................................................................................

100,000

10/12 Cash (+A) ................................................................................... 18,000 Treasury stock (-XSE, +SE) ......................................................... 15,000 Additional paid-in capital (+SE) .................................................... 3,000 11/21 Cash (+A) ................................................................................... 55,000 Common stock (+SE) ................................................................... 25,000 Additional paid-in capital (+SE) ..................................................... 30,000 12/28 Cash (+A) ................................................................................... 10,800 Additional paid-in capital (-SE) ..................................................... 1,200 Treasury stock (-XSE, +SE) ......................................................... 12,000 ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

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c. 10/12 11/21 12/28 + 9/1

d. 1/12: 9/1: 10/12: 11/21: 12/28:

+ Cash (A) 18,000 100,000 55,000 10,800 Treasury Stock (XSE) 100,000 15,000 12,000

9/1

- Common Stock (SE) + 25,000

10/12 12/28

- Additional Paid-in Capital (SE) + 12/28 1,200 3,000 10/12 30,000 11/21

11/21

stock split – decrease basic EPS purchase treasury stock – increase basic EPS sold treasury stock – decrease basic EPS issued common stock – decrease basic EPS sold treasury stock – decrease basic EPS

e. Stockholders’ Equity Paid-in capital 7% Preferred stock, $100 par value, 20,000 shares authorized; 5,000 shares issued and outstanding Common stock, $5 par value, 300,000 shares authorized; 125,000 shares issued, of which 7,300 shares are in the treasury Additional paid-in capital Paid-in capital in excess of par value—Preferred stock Paid-in capital in excess of par value—Common stock Paid-in capital from treasury stock Total paid-in capital Retained earnings

$500,000

625,000 24,000 390,000 1,800

Less: Treasury stock (7,300 common Shares) at cost Total stockholders' equity

$1,125,000

415,800 1,540,800 408,000 1,948,800 73,000 $1,875,800

f. Because Sougiannis did not pay the 7% dividend on its preferred stock, ROCE is computed as follows: $83,000 / [($1,875,800+$1,809,000)/2 -$500,000] = 0.062 or 6.2%

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P11-57. (45 minutes) LO 2, 3, 6 a. Balance Sheet Transaction

Cash Asset

Noncash Liabil+ Assets = ities

Issued +120,000 10,000 shares Cash of common stock.1

Purchased 4,000 shares of treasury stock.2

-56,000 Cash

Sold 1,000 shares of treasury stock.3

+17,000 Cash

Sold 500 shares of treasury stock.4

+6,500 Cash

Issued 5,000 shares of preferred stock.5

+175,000 Cash

Income Statement

Contrib. + Capital

Earned + Capital -

+50,000 Common Stock

Contra Equity Revenues

Net - Expenses = Income -

+70,000 Add’l Paid-in Capital -

+56,000 Treasury Stock

+3,000 Add’l Paid-in Capital

-14,000 Treasury Stock

-500 Add’l Paid-in Capital

-7,000 Treasury Stock

+125,000 Preferred Stock

+50,000 Add’l Paid-in Capital

Cash is increased by the proceeds from the stock sale (10,000 shares  $12 = $120,000). Common Stock is increased by the par value (10,000 shares  $5) and Additional Paid-in Capital for the balance ($70,000). Cash is reduced by the cost of the Treasury Stock (4,000 shares  $14 = $56,000). The Treasury Stock account is increased accordingly. Since this account has a negative balance in stockholders’ equity, contributed capital is reduced. Cash is increased by the proceeds from the sale of the Treasury Stock (1,000 shares  $17 = $17,000). The Treasury Stock account is reduced by the original cost of the shares (1,000  $14 = $14,000) and Additional Paid-in Capital is increased for the balance. Cash is increased by the proceeds from the sale of the Treasury Stock (500 shares  $13 = $6,500). Treasury Stock is reduced by its original cost (500 shares  $14 = $7,000) and Additional Paid-in Capital is reduced for the balance. Cash is increased by the proceeds from the sale of the Preferred Stock (5,000 shares  $35 per share = $175,000). Preferred Stock is increased by its par value (5,000 shares  $25 = $125,000) and Additional Paid-in Capital is increased for the balance ($50,000).

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b. 1/5

Cash (+A) ................................................................................... 120,000 Common stock (+SE) ................................................................... 50,000 Additional paid-in capital (+SE) ..................................................... 70,000

1/18

Treasury stock (+XSE, -SE) ......................................................... 56,000 Cash (-A) ....................................................................................

56,000

3/12

Cash (+A) ................................................................................... 17,000 Treasury stock (-XSE, +SE) ......................................................... 14,000 Additional paid-in capital (+SE) .................................................... 3,000

7/17

Cash (+A) ................................................................................... 6,500 Additional paid-in capital (-SE) ..................................................... 500 Treasury stock (-XSE, +SE) .........................................................

10/1

7,000

Cash (+A) ................................................................................... 175,000 Preferred stock (+SE) .................................................................. 125,000 Additional paid-in capital (+SE) .................................................... 50,000

c. 1/5 3/12 7/17 10/1 + 1/18

+ Cash (A) 120,000 17,000 6,500 175,000

56,000

1/18 -

Treasury Stock (XSE) 56,000 14,000 3/12 7,000 7/17

Common Stock (SE) + 50,000

1/5

Preferred Stock (SE) + 125,000

10/1

- Additional Paid-in Capital (SE) + 70,000 1/5 7/17 500 3,000 3/12 50,000 10/1

d. Stockholders’ Equity Paid-in capital 8% Preferred stock, $25 par value, 50,000 shares authorized, 5,000 Shares issued and outstanding Common stock, $5 par value, 350,000 shares authorized; 160,000 shares issued; 2,500 shares in treasury Additional paid-in capital Paid-in capital in excess of par value—Preferred stock Paid-in capital in excess of par value—Common stock Paid-in capital from Treasury stock Total paid-in capital Retained earnings Less: Treasury stock (2,500 shares) at cost Total stockholders' equity

$125,000 800,000 50,000 670,000 2,500

$ 925,000

722,500 1,647,500 418,500 2,066,000 35,000 $2,031,000

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e. The transactions on January 5 (stock issue), March 12 and July 17 (both treasury stock sales), and the transaction on October 1 (issued preferred stock) would decrease basic EPS. The transaction on January 18 (treasury stock purchase) would increase basic EPS.

P11-58. (30 minutes) LO 2, 4 a. See explanations in part b below. Balance Sheet Transaction

Cash Asset

Noncash Liabil+ Assets = ities

Issued 1,000 shares of preferred stock.

+62,000

Issued 4,000 shares of common stock.

+144,000

Issued 2,000 shares of common stock.

+60,000

Purchased 2,500 shares of treasury stock.

-45,000 Cash

Sold 900 shares of treasury stock.

+18,900 Cash

Issued 500 shares of preferred stock.

+29,500 Cash

Income Statement

Contrib. Capital

Earned + Capital -

Contra Net Equity Revenues - Expenses = Income

+50,000 Preferred Stock

+12,000 Additional Paid-in Capital =

Cash

+80,000 Common Stock +64,000 Additional Paid-in Capital

Cash

+20,000 Common Stock +40,000 Additional Paid-in Capital

+45,000 Treasury Stock

+2,700 Additional Paid-in Capital

-16,200 Treasury Stock

+25,000 Preferred Stock

+4,500 Additional Paid-in Capital

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b. 1/15

Cash (+A) ................................................................................... 62,000 Preferred stock (+SE) .................................................................. 50,000 Additional paid-in capital (+SE) ..................................................... 12,000

Cash is increased by the proceeds from the sale of the Preferred Stock (1,000 shares  $62 per share = $62,000). The Preferred Stock account is increased for its par value (1,000 shares  $50 par = $50,000) and Additional Paid-in Capital is increased for the balance ($12,000).

1/20

Cash (+A) ................................................................................... 144,000 Common stock (+SE) ................................................................... 80,000 Additional paid-in capital (+SE) ..................................................... 64,000

Cash is increased by the proceeds from the sale of the Common Stock (4,000 shares  $36 = $144,000). Common Stock is increased by its par value (4,000  $20 = $80,000) and Additional Paidin Capital is increased for the remainder ($64,000).

5/18

No entry is required for the 2-for-1 stock split

6/1

Cash (+A) ................................................................................... 60,000 Common stock (+SE) .................................................................. 20,000 Additional paid-in capital (+SE) ..................................................... 40,000

Common Stock is increased by its par value (2,000  $10 = $20,000) and Additional Paid-in Capital is increased for the balance ($40,000).

9/1

Treasury stock (+XSE, -SE) ......................................................... 45,000 Cash (-A) ...................................................................................

45,000

Cash is reduced by the cost of the Treasury Stock (2,500 shares  $18 per share = $45,000). The Treasury Stock account is increased by its cost, thereby reducing contributed capital.

10/12 Cash (+A) ................................................................................... 18,900 Treasury stock (-XSE, +SE) ......................................................... 16,200 Additional paid-in capital (+SE) .................................................... 2,700

Cash is increased by the proceeds from the sale of the Treasury Stock (900  $21 = $18,900). The Treasury Stock account is reduced by its cost (900  $18 = $16,200), thereby increasing contributed capital, and Additional Paid-in Capital is increased by the balance ($2,700).

12/22 Cash (+A) ................................................................................... 29,500 Preferred stock (+SE) .................................................................. 25,000 Additional paid-in capital (+SE) ..................................................... 4,500

Cash is increased by the proceeds from the sale of the preferred shares (500  $59 = $29,500). The Preferred Stock account is increased for its par value (500 shares  $50 = $25,000) and Additional Paid-in Capital is increased for the balance ($4,500).

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c. 1/15 1/20 6/1

+ Cash (A) 62,000 144,000 60,000

10/12 12/22

18,900 29,500

45,000

+ 9/1

9/1

Treasury Stock (XSE) 45,000 16,200 10/12

Common Stock (SE) + 80,000 20,000

1/20 6/1

Preferred Stock (SE) + 50,000 1/15 25,000 12/22

- Additional Paid-in Capital (SE) + 12,000 1/15 64,000 1/20 40,000 6/1 2,700 10/12 4,500 12/22

P11-59. (50 minutes) LO 1, 2, 5, 6, 7 a. 2018: 4,009.2 – 1,511.2 = 2,498 million 2017: 4,009.2 – 1,455.9 = 2,553.3 million Estimated average shares outstanding: ($9,750 - $265)/$3.75 = 2,529.33 million. Average shares outstanding is slightly greater than the number of shares outstanding at year-end because P&G has more shares in treasury stock at the end of 2018 than at the end of 2017. Meaning, P&G repurchases shares during the year. b. 2018: $99,217/1,511.2 = $65.65 2017: $93,715/1,455.9 = $64.37 c. Preferred stock (-SE) ……………………………………… 39 Additional paid-in capital (+SE) ............................................. Treasury stock (-XSE, +SE) .........................................................

6 33

The reported value for preferred stock includes additional paid-in capital. This fact can be discerned by noting that 600 million of class A preferred shares are authorized and if all 600 million shares were issued, the stated value of $1 per share would yield $600 million of preferred stock. But if the $967 million is assumed to be the stated value, the number of issued shares exceeds the number authorized. Therefore, the $967million figure must include additional paid-in capital and the additional paid-in capital account refers only to common stock. d. P&G’s diluted EPS reflects the effects of convertible preferred stock and, most likely, outstanding stock options and other equity-based pay. e. 2018 ($millions): ($9,750 - $265) / [($52,293-$967+$55,184-$1,006)/2] = 0.18 or 18%

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P11-60. (50 minutes) LO 5, 7 a. Class A and B common shares are identical except for voting rights. Class A shares have 1 vote per share while class B shares have 10 votes per share. This means that class B shareholders have greater control in the governance of the corporation. Presumably, class B shares were retained by the original management team of the firm when the class A shares were offered. Class C capital shares have no voting rights at all, though they participate in any dividends declared for common shares. Class C shares allow Alphabet executives to continue using shares to make acquisitions and motivate employees, while ensuring that the Class B shares retain more than 50% of the voting power. b. Retained Earnings Capital Stock Cash

8,499 576 9,075 (millions)

c. RSUs vest over 4 years. The fair value of the RSUs at grant date = 12,669,251 shares x $1,095.89 average FV per share = $13,884,105,478. Assume pro-rate vesting: $13,884,105,478/4 = $3,471,026,370 Compensation expense (+E, -SE) Paid-in Capital – Restricted Stock (+SE)

3,471,026,370 3,471,026,370

This entry would reduce Alphabets’ income before tax by $3,471,026,370. d. This cost is related to RSUs that are granted but not vested and not yet recorded as compensation cost yet (the cost related to the latter part of the vesting period that has not occurred yet). The unrecognized compensation cost related to unvested employee RSUs is not a liability because Alphabet has not incurred the cost yet — the employees have not worked yet. In addition, the amount is recorded as an increase to equity (not an increase in liabilities) when the compensation expense is recorded because the company is issuing equity shares to the employees. e. $30,736 million / $44.22 = 695 million shares. Alphabet had 694.8 million shares outstanding at the end of 2017 and 695.6 million shares outstanding at the end of 2018.

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f. If all outstanding stock options were exercised, basic EPS would decrease. Assume Alphabet had 15.0 million options outstanding at the end of 2018. If all of these options had been exercised and added to shares outstanding, basic EPS would have been $30,736 / (695 + 15.0) = $43.29 per share (compared to $44.22). g. The diluted EPS figure includes an adjustment only for outstanding options that are not “under water,” i.e., are anti-dilutive. But this would cause the diluted EPS to be higher than the amount calculated in part f. The difference is due to the fact that Google has stock-based compensation besides stock options, like restricted stock units.

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CASES and PROJECTS C11-61. (30 minutes) LO 7

a. Mandatorily redeemable means that the issuing company can decide to repurchase all of the remaining shares that have not been converted before the redemption date specified in the preferred issue contract. Prior to that date, holders of the preferred shares can convert their shares to common stock. Northrop Grumman preferred holders converted most of their shares and the rest were redeemed by the company. “Convertible” means that the preferred stock can be exchanged for common stock. Usually this option rests with the holder of the preferred stock. Sometimes, companies retain an option to force the conversion. Northrop Grumman did so. This option is spelled out in the preferred stock contract. The issue may also include a “liquidation preference”, which would indicate the amount that will be paid to the preferred shareholders in the event that the company fails. This amount must be paid in full before the common shareholders can be paid anything in the event of the liquidation of the company.

b. $350 million/$3.5 million = $100 c. The conversion option has increased substantially in value since issue. This increase is likely due to an expected new government contract most likely for an aircraft.

d. The answer depends on whether the remaining preferred shares are redeemed for cash or converted into common shares. If Northrop Grumman pays for the conversion in cash, cash is reduced, as is preferred stock. If converted into common, the preferred stock is removed from the balance sheet and the common stock is “sold” for the book value of the preferred; that is, the par value and additional paid-in capital accounts increase as if the common were sold for the book value of the preferred.

e. Outstanding convertible preferred shares need to be considered in our analysis of the company, as the potential shares to be issued represent a contingent claim to the future cash flows of the company. Convertible preferred shares are considered in the computation of diluted EPS, which assumes conversion at the earliest possible opportunity. The forgone preferred dividends are removed from (added back to) the numerator, and the additional shares issued are added to the denominator. The net effect is a reduction in the diluted EPS over basic EPS.

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C11-62. (15 minutes) LO 1, 2 King’s responsibility is to the shareholders of Image, Inc. Hatcher’s offer is beneficial to the shareholders, so, in theory, King should support Hatcher’s efforts. However, since it is likely that King and other managers will lose their jobs if Hatcher’s takeover attempt is successful, King’s inclination may be to resist Hatcher’s move. It would be unethical to pay Hatcher 50% above current market price to repurchase his stock. This would harm the remaining shareholders in two ways. First, blocking the takeover would deprive shareholders of the opportunity to sell their shares at a price that is substantially higher than current market price. Second, King would be using company funds to purchase Hatcher’s stock, so the other shareholders are essentially paying for King’s job security. A tactic that would be ethical and beneficial to shareholders is for King, along with other managers and directors, to make a competing offer to shareholders for the outstanding stock. In that way, shareholders benefit by receiving the higher stock price (whether from King or Hatcher) and if King acquires the company, he keeps his job.

C11-63. (30 minutes) LO 1, 3 a. There are no cash proceeds from the stock dividend. b. 2018: $9,450,000 / 250,000 = $37.80 per share 2019: $10,285,000 / 275,000 = $37.40 per share c. Because of the stock dividend, the number of shares you own increased by 10% to 8,250 in 2019. Your percentage ownership in Pillar has remained the same. The market value of your shares at the end of 2019 is $214,500 (8,250 x $26). At December 14, just prior to the stock dividend, your shares were worth $210,000 (7,500 x $28). d. Stock dividends, like stock splits, do not increase the book value of stockholders’ equity. Stock dividends are paid to indicate a continued expectation of earnings and earnings growth in periods when cash must be maintained for investment needs. Stock dividends also serve to keep the per share price of the stock at manageable levels during growth periods. e. Retained earnings are restricted as to the amount of cash dividends that Pillar can pay. Except for this restriction, paying a cash dividend then allowing shareholders to purchase additional shares would have accomplished the same thing as a stock dividend. However, some of the shareholders may have chosen not to purchase the additional shares. If this had happened, the company would have to make a public offering in order to raise the required cash. A public offer that is this small is not economical. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

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f. The dividend cut is due to the restrictions on retained earnings and the amount of cash needed to fund the plant addition. g. Retained earnings are not the same as cash. The company is borrowing $500,000 cash because that is how much additional cash will be needed to build the plant addition. The restriction on retained earnings simply prevents the company from using available cash to pay cash dividends.

C11-64. (20 minutes) LO 2, 3, 6 The projected 5% decline in net income will reduce net income from $7,800,000 last year to $7,410,000 this year. The proposed stock buyback of 600,000 shares at midyear would reduce the weighted average shares outstanding from 4,000,000 to 3,700,000 (4,000,000 x 6/12 + 3,400,000 x 6/12). The resulting earnings per share would be $7,410,000 / 3,700,000 = $2.00 per share. Plummer is likely concerned about the proposal because the stock repurchase appears to manipulate EPS in order to achieve the goal of increasing EPS each year, earning management a nice bonus. This raises ethical concerns, since the cash might be better used to make profitable investments or pay a cash dividend to shareholders. A less obvious question is why Sunlight has so much “excess cash?” If the cash that would be used to repurchase stock (600,000 shares x market price per share) were invested in a profitable investment, management may be able to make up for the expected decline in earnings. It would be hard to believe that no profitable investment opportunities exist. Even a short-term investment in marketable securities might make up for the $390,000 decrease in earnings.

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C11-65. (20 minutes) LO 2, 7 a. The shares were listed in the mezzanine section of the balance sheet – between liabilities and equity. The preferred stock was contingently convertible – the shares were potentially redeemable upon the occurrence of events outside the control of the issuer. b. $3,000 million. ($43.775848 x $68,530,939 shares) c. $547 million ($3,297 - ($3,000 - $250)). This amount was recorded as a reduction in income. d. Answers may vary here. FASB requires that these shares be in the mezzanine section of the balance sheet, meaning that they have characteristics of both debt and equity. Some idicia that one might consider them more debt-like are that 1) they are not convertible into common shares, and 2) the company increased the carrying value to the redemption value in 2014. Another indicator – though only known after the redemption - is that the company funded the redemption by issuing debt.

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Chapter 11 Reporting and Analyzing Stockholders’ Equity Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Describe business financing through stock issuances.

19, 37

41, 45

62, 63

LO2 – Explain and account for the issuance and repurchase of stock.

20 - 22, 24, 25, 36, 37

39 - 41, 45, 52, 54

55 - 59

62 - 65

LO3 – Describe how operations increase the equity of a business.

30, 37

48, 49, 51

55 - 57

63, 64

LO4 – Explain and account for dividends and stock splits.

23, 26 - 31, 36

42, 44, 46 - 51, 54

56, 58

LO5 – Define and illustrate comprehensive income.

56, 59, 60

LO6 – Describe and illustrate basic and diluted earnings per share computations.

24, 25, 32 - 34, 36 - 38

41, 43, 44, 50

55 - 57, 59

LO7 – Appendix 11A: Analyze the accounting for convertible securities, stock rights, and stock options.

59, 60

61, 65

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QUESTIONS Q11-1.

Par value stock is stock that has a face value printed (identified) on the stock certificate. From an accounting standpoint, the par value of the common stock is the amount added to the common stock portion of paid-in-capital upon the issuance of stock. The remainder of the issue price is added to the additional paid-in-capital portion of paid-in-capital. There are no analysis implications of the par value of stock.

Q11-2.

Preferred stock usually takes priority over common stock in the receipt of a specified amount of dividends and in the distribution of assets if the corporation is ever liquidated. Also, preferred stock does not usually have voting rights. Typically, preferred stock has the following features: 1) Preferential claim to dividends and to assets in liquidation, 2) Cumulative dividend rights, and 3) No voting rights.

Q11-3.

Preferred stock is similar to debt when 1. Dividends are cumulative. 2. Dividends are nonparticipating. 3. It has a preference to assets in liquidation. Preferred stock is similar to common stock when 1. Dividends are not cumulative. 2. Dividends are fully participating. 3. It is convertible into common stock. 4. It does not have a preference to assets in liquidation.

Q11-4.

Dividend arrearage on preferred stock is the aggregate amount of dividends on cumulative preferred stock that has not been declared to date. The amount of dividends in arrears and a current dividend must be paid to preferred stockholders before common stockholders can receive any dividends. In the example, preferred stockholders must receive $90,000 in dividends ($500,000  0.06  3 years = $90,000) before common stockholders receive any dividends.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q11-5.

A corporation's authorized stock is the maximum number of shares of stock it may issue. The authorized amounts and classes of stock are enumerated in the company's charter when the corporation is formed. A corporation can later amend its charter to change the amount of authorized capital, but such action must have the approval of the company’s shareholders. Shares that have been sold and issued to stockholders are the company's issued stock. Shares that have been sold and issued can be subsequently reacquired by the corporation—called treasury stock. When treasury stock is held, the issued shares exceed the outstanding shares.

Q11-6.

Contributed capital represents the total investment that has been paid in to the company by its shareholders as a result of the purchase of stock. Earned capital represents the cumulative net income that has been earned, less the portion of that income that has been paid out to shareholders in the form of dividends. When profit is earned, shareholders have the option of paying out that profit as a dividend or reinvesting the earnings in order to grow the company. In fact, many companies title the Retained Earnings account as Reinvested Earnings. Earned capital, thus, represents an implicit investment by the shareholders in the form of forgone dividends.

Q11-7.

Paid-in capital is divided into two accounts: the common or preferred stock account and additional paid-in capital. The common stock or preferred stock accounts are increased by the par value of the shares issued and the additional paid-in capital account is increased for the balance of the proceeds received from the sale of the shares. The balance of the paid-in capital account is affected by the par value of the stock; the higher (lower) the par value, the lower (higher) the additional paid-in capital. Although paid-in capital will, in general, be higher if the stock price is higher, the breakdown of paid-in capital between the common or preferred stock accounts and additional paidin capital does not yield any inferences regarding the financial condition of the company.

Q11-8.

A stock split refers to the issuance of additional shares of a class of stock to the current stockholders in proportion to their ownership interests, normally accompanied by a proportionate reduction in the par or stated value of the stock. For example, a 2-for-1 stock split doubles the number of shares outstanding and halves the par or stated value of the shares. Consequently, there is no change in the amount of contributed capital associated with that class of stock. The major reason for a stock split is to reduce the per-share market price of the stock. Another possible reason is to influence shareholders’ in believing there has been some distribution of value.

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Q11-9.

Treasury stock is a corporation's issued stock that has been reacquired by the issuing corporation through purchases of its stock from its shareholders. A corporation often purchases treasury stock for distribution to employees under stock option plans or to offset dilution resulting from such sales. It is also used by management to prop up stock price when management believes its stock is inappropriately underpriced. On the balance sheet, treasury stock should be carried at its cost and is shown as a deduction in deriving the total stockholders' equity—known as a contra equity account.

Q11-10. The $2,400 increase should not be shown on the income statement as any form of income or gain. The $2,400 is properly treated as additional paid-in capital and is shown as such in the stockholders' equity section of the balance sheet. The latter treatment is justified because treasury stock transactions are considered capital rather than operating transactions. Q11-11. The book value per share of common stock is the total stockholders' equity divided by the number of shares outstanding, or $4,628,000/260,000 = $17.80. Q11-12. A stock dividend is the distribution of additional shares of a corporation's stock to its stockholders. A stock dividend does not change a stockholder's relative ownership interest, because each stockholder owns the same fractional share of the corporation before and after the stock dividend. There is empirical evidence, however, suggesting that the stock price does not decline fully for the additional shares issued—various hypotheses, such as signaling theory, have been asserted as explanations of this phenomenon. Q11-13. The stock dividend transfers capital from retained earnings to contributed capital. For a small stock dividend, this transfer is recorded at the market price of the shares at the time of the dividend. For a large stock dividend, the transfer is made at the par value of the stock. Q11-14. Many companies repurchase shares (as Treasury Stock) in order to offset the dilutive effects of exercised stock options which increase the number of outstanding shares. This repurchase results in a cash outflow, and has been used by those arguing for the expensing of employee stock options as evidence of the cash effect of these options and linkage to the payment of wages. Q11-15. The statement of stockholders' equity analyzes and reconciles changes in all major components of stockholders' equity for an accounting period. The statement begins with the beginning balances of those key stockholders' equity components, reports the items causing changes in these components, and ends with the period-end balances.

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M11-20. (15 minutes) LO 2 a. Balance Sheet Transaction Issue 18,000 shares of $10 par value preferred stock at $48 per share.

Issue 120,000 shares of $2 par value common at $37 per share.

Cash Asset +864,000 Cash

Noncash + Assets

= Liabilities =

Income Statement

Contrib. + Capital + +180,000 Preferred Stock

Earned Capital

Revenues

Expenses

Net = Income =

+684,000 Additional Paid-in Capital +4,440,000 Cash

+240,000 Common Stock

+4,200,000 Additional Paid-in Capital

b. 9/1

9/1

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. +

Cash (A) 864,000 4,440,000 - Common Stock (SE) + 240,000

9/1 9/1

- Preferred Stock (SE) + 180,000

9/1

- Additional Paid-in Capital (SE) + 684,000 9/1 4,200,000 9/1

9/1

M11-22. (15 minutes) LO 2 a. Income Statement

Balance Sheet Cash Transaction Asset Issue 5,000 +1,250,000 shares of $100 Cash par value preferred stock at $250 per share.

Repurchase 5,000 shares of $1 par value common stock at $83 per share.

-415,000 Cash

Noncash + Assets = =

Liabilities

Contrib. Capital +500,000 Preferred Stock

Earned + Capital -

Contra Equity

Net Revenues - Expenses = Income =

+750,000 Add’l Paid-in Capital =

- +415,000 Treasury Stock

b. 1/1

3/1

Treasury stock (+XSE, -SE) ......................................................... 415,000 Cash (-A) ....................................................................................

415,000

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c. 1/1

+ Cash (A) 1,250,000

415,000

3/1

- Preferred Stock (SE) + 500,000

1/1

3/1

+ Treasury Stock (XSE) 415,000

- Additional Paid-in Capital (SE) + 750,000 1/1

M11-24. (15 minutes) LO 2, 6 a. Basic EPS: [$501,000 – (16,000 x $2)] / 134,000 = $3.50 Calculation of weighted average shares outstanding: 120,000 130,000 146,000 140,000

x x x x

2/12 5/12 3/12 2/12

= = = =

20,000 54,167 36,500 23,333 134,000

b. Diluted EPS: $501,000 / (134,000 + 16,000) = $3.34 c. Given a simple capital structure, only basic EPS need be reported.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

M11-26. (15 minutes) LO 4 a. Balance Sheet Cash Asset

Transaction

Noncash + Assets

Declared and paid cash dividend on preferred stock.

-18,000

Declared and paid cash dividend on common stock.

-88,000

= Liabilities + =

Income Statement Contrib. Capital +

Earned Capital -18,000

Cash

Revenues

Expenses

Net = Income

Retained Earnings

-88,000

Cash

Retained Earnings

Cash (A)

18,000 88,000

12/31 12/31

- Retained Earnings (SE) + 12/31 18,000 12/31 88,000

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Cash Asset

Noncash Assets

Declaration and distribution of stock dividend.

= Liabilities + =

Income Statement Contrib. Capital +

Earned Capital

+14,000

-58,800

Common Stock

Retained Earnings

Revenues

- Expenses

Net Income

+44,800 Additional Paid-in Capital

Retained Earnings (SE) 58,800

- Common Stock (SE) + 14,000

12/31

- Additional Paid-in Capital (SE) + 44,800 12/31

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

$120,000 $40,000 $6.00 $0.50

$347,000 94,000 441,000 63,000 $378,000

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11-11

M11-32. (10 minutes) LO 6 a. Basic EPS: [$440,000 – (10,000 x $50 x 8%)] / 50,000 = $8.00 per share b. Diluted EPS: $440,000 / [50,000 + (10,000 x 3)] = $5.50 per share

M11-33. (15 minutes) LO 6 a. Basic EPS: $234,000 / 45,000 = $5.20 Calculation of weighted average shares outstanding: 38,000 48,000 49,000

x x x

4/12 4/12 4/12

= = =

12,667 16,000 16,333 45,000

b. Basic EPS: [$234,000 – (6,000 x $50 x 6%)] / 45,000 = $4.80

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

9,931,093

499,000,000

M11-36. (10 minutes) LO 2, 4, 6

Year

Total Assets

Total Liabilities

Total Stockholders’ Equity

EPS

Operating Income

1 ….. 2 ….. 3 …..

Increase Decrease No effect

No effect No effect Increase

Increase Decrease Decrease

Decrease Increase No effect

No effect No effect No effect

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

EXERCISES E11-39. (15 minutes) LO 2 a. Balance Sheet Transaction Issue 10,000 shares of $1 par value common stock at $25 per share.

Cash Asset +250,000 Cash

Noncash + Assets = =

Liabilities

Contrib. Capital +10,000 Common Stock

Income Statement Earned + Capital -

Contra Net Equity Revenues - Expenses = Income =

+240,000 Add’l Paid-in Capital

Issued 15,000 +4,125,000 shares of Cash $100 par preferred stock at $275 per share.

Purchased 2,000 shares of treasury stock at $15 per share.

-30,000 Cash

Sold 1,000 shares of treasury stock at $21 per share.

+21,000 Cash

+1,500,000 Preferred Stock

- +30,000 Treasury Stock

+2,625,000 Add’l Paid-in Capital

+6,000 Add’l Paid-in Capital

-15,000 Treasury Stock

b. 2/20

9/25

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c. +

Cash (A) 250,000 4,125,000

2/20 2/21

30,000 9/25

6/30

21,000 + Treasury Stock (XSE) 30,000 15,000

9/25

- Preferred Stock (SE) + 1,500,000

2/21

- Common Stock (SE) + 10,000

2/20

- Additional Paid-in Capital (SE) 240,000 2,625,000 6,000

+ 2/20 2/21 9/25

E11-40. (20 minutes) LO 2 a. Balance Sheet

Transaction

Cash Asset

Noncash LiabilAssets = ities

Issue 25,000 shares of $5 par common stock at $17 per share.

+425,000 Cash

Issued 6,000 shares of $50 par preferred stock at $78 per share.

+468,000 Cash

Repurchased 3,000 shares of treasury stock at $20 per share.

-60,000 Cash

Sold 2,000 shares of treasury stock at $26 per share.

+52,000 Cash

Sold 1,000 shares of treasury stock at $19 per share.

+19,000 Cash

Income Statement

Contrib. Capital

Earned + Capital -

Contra Equity

+125,000 Common Stock

Revenues

Net - Expenses = Income

+300,000 Add’l Paid-in Capital =

+300,000 Preferred Stock +168,000 Add’l Paid-in Capital

+60,000 Treasury Stock

+12,000 Add’l Paid-in Capital

-40,000 Treasury Stock

-1,000 Add’l Paid-in Capital

-20,000 Treasury Stock

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. 1/15

1/20

3/31

6/25

7/15

c. + 1/15 1/20

Cash (A) 425,000 468,000

60,000 6/25 7/15

3/31

52,000 19,000 + Treasury Stock (XSE) 60,000 40,000 20,000

6/25 7/15

- Preferred Stock (SE) + 300,000

1/20

- Common Stock (SE) + 125,000

1/15

- Additional Paid-in Capital (SE) + 300,000 1/15 168,000 1/20 12,000 6/25 7/15 1,000

11-17

E11-42. (20 minutes) LO 4 Dividend Distribution

2018 2019

2020

Preferred $0

Common

Preferred per Share $0.00

Common per Share $0.00

$84,000 84,000 $168,000

$15,000 $15,000 $8.40 $0.15

$84,000 $116,000 $4.20 $1.16

b. 2018 2019

2020

$0.00 $0

$0.00

$84,000 $4.20 $0.00

$ 84,000 66,000 $150,000 $7.50 $0.00

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E11-44. (25 minutes) LO 4, 6

a. Year 1

Distribution to Preferred Common $ 0 $ 0

Year 2: Arrearage from Year 1 ($750,000  8%) Current year dividend ($750,000  8%) Balance to common Total for Year 2

60,000 _______ $120,000

$160,000 $160,000

Year 3: Current year dividend ($750,000  8%)

$ 60,000

b. Year 1 Year 2: Current year dividend ($750,000  8%) Balance to common Year 3: Current year dividend ($750,000  8%)

$ 60,000

$ 60,000 $220,000 $ 60,000

11-19

E11-45. (20 minutes) LO 1, 2

a. 35,852 thousand  $0.01 = $358.52 thousand rounded to $359 thousand. b. ($359 thousand + $1,305,090 thousand) / 35,852 thousand shares = $36.41 per share

c. 35,852 thousand shares issued – 7,826 thousand shares in treasury = 28,026 thousand shares outstanding

Dividend Distribution Preferred Common per Share

Common per Share

$54,000 $9,000 $3.00 $0.10 $0

$0.00 $0

$0.00

$54,000 54,000 $108,000

$270,000 $270,000 $6.00 $3.00

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Preferred

Dividend Distribution Preferred Common per Share

$0.00 $0

Common per Share

$0.00

$ 54,000 54,000 $0 $0

$108,000

$6.00 $0.00

$54,000 $135,000 $3.00 $1.50

E11-47. (15 minutes) LO 4 a. Balance Sheet Transaction Declared and paid cash dividend.

Cash Asset -47,500 Cash

Declared and issued stock dividend.

Noncash + Assets

Income Statement

Contrib. = Liabilities + Capital +

Earned Capital

-47,5001 Retained Earnings

-35,0002 Retained Earnings

+10,000 Common Stock

Revenues

Expenses

Net Income

+25,000 Additional Paid-in Capital 1

$1.90  25,000 = $47,500.

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b. 1)

c. +

Cash (A)

47,500

1) 2)

Retained Earnings (SE) 47,500 35,000

- Common Stock (SE) + 10,000

1) +

- Additional Paid-in Capital (SE) + 25,000 2)

E11-48. (20 minutes) LO 3, 4 a. Balance Sheet Transaction

Cash Asset

Noncash Assets

Declared and paid stock dividend.

= =

Liabilities

Income Statement Contrib. Capital +

Earned Capital

+56,000 Common Stock

-100,8001 Retained Earnings

-64,2002 Retained Earnings

Revenues

Expenses

Net Income

+44,800 Add’l Paid-in Capital Declared and issued cash dividend.

-64,200 Cash

Retained Earnings is reduced by $0.75 per share on 85,600 shares outstanding and Cash is decreased by the payment.

b. 5/12

12/31 Retained earnings (-SE) .............................................................. 64,200 Cash (-A) .............................................................................

64,200

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. +

5/12 12/31

Cash (A)

64,200

Retained Earnings (SE) 100,800 64,200

- Common Stock (SE) + 56,000

12/31 +

5/12

- Additional Paid-in Capital (SE) + 44,800 5/12

d. PALEPU COMPANY Statement of Retained Earnings For the Year Ended December 31, 2019 Retained earnings, December 31, 2018 Add: Net income

$305,000 283,000 588,000

Less:

Cash dividends declared Stock dividends declared Retained earnings, December 31, 2019

$ 64,200 100,800

165,000 $423,000

E11-49. (20 minutes) LO 3, 4 a. Balance Sheet Transaction

Cash Asset

Noncash + Assets

Declared and paid 100% stock dividend.

Income Statement

Contrib. = Liabilities + Capital +

Earned Capital

+250,000 Common Stock

-250,0001 Retained Earnings

+15,000 Common Stock

-42,0002 Retained Earnings

Declared and paid 3% stock dividend.

Revenues

Expenses

Net Income

+27,000 Additional Paid-in Captal Declared and issued cash dividend.

-102,400 Cash

-102,4003 Retained Earnings

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b. 4/1

Retained earnings (-SE) ............................................................... 250,000 Common stock (+SE) ................................................................... 250,000

12/7

4/1 12/7 12/20

Cash (A)

102,400

Retained Earnings (SE) 250,000 42,000 102,400

12/20

- Common Stock (SE) + 250,000 15,000

4/1 12/7

- Additional Paid-in Capital (SE) + 27,000 12/7

d. KINNEY COMPANY Statement of Retained Earnings For the Year Ended December 31, 2019 Retained earnings, December 31, 2018 Add: Net income Less:

Cash dividends declared Stock dividends declared Retained earnings, December 31, 2019

$656,000 253,000 909,000 $102,400 292,000

394,400 $514,600

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

E11-51. (20 minutes) LO 3, 4 a. Beginning retained earnings + Net income – Dividends = Ending retained earnings, so $7,297 million + $1,211 million – Dividends = $8,101 million. Dividends = $407 million. b. The change in shares outstanding was 258,616 thousand – 255,668 thousand = an increase of 2,948 thousand shares. Therefore, Intuit must have issued 4,818 thousand shares for the exercise of stock options. c. When a company reissues treasury shares, the difference between the value received and the treasury share cost is either put in or taken from Additional paid-in capital (APIC). In this case, the option exercises increased APIC, implying that the average exercise price exceeded the average cost of the treasury shares.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

Transaction

Noncash LiabilAssets = ities

-3,577

Cash

Contrib. Capital

Income Statement Earned + Capital -

Contra Equity

+3,577

Revenues

Net Expenses = Income

Treasury Stock

Treasury stock (+XSE, -SE) .......................................................... 3,577 Cash (-A) ..................................................................................... +

Cash (A)

3,577

+ Treasury Stock (XSE) 3,577

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PROBLEMS P11-55. (45 minutes) LO 2, 3, 6 a.

Transaction

Cash Asset

Noncash Assets

1/10: Issued common stock.1

+476,000 Cash

1/23: Purchased treasury stock.2

-152,000 Cash

3/14: Sold treasury stock.3

+84,000 Cash

7/15: Issued preferred stock.4

+128,000 Cash

11/15: Sold treasury stock.5

+24,000

Balance Sheet LiabilContrib. + ities Capital +280,000 Common Stock

Income Statement Earned + Capital

Contra Equity

Revenues

Expen -ses

- +152,000 Treasury Stock

+8,000 Additional Paid-in Capital

+80,000 Preferred Stock

Net Income

+196,000 Additonal Paid-in Capital

-76,000 Treasury Stock

+48,000 Additional Paid-in Capital =

+5,000 Additonal Paid-in Capital

-19,000 Treasury Stock

Cash is decreased and Treasury Stock is increased by the purchase price of 8,000 shares  $19 = $152,000. The increase in Treasury Stock reduces contributed capital.

Cash received is 4,000 shares  $21 = $84,000. Treasury Stock is reduced by the original cost of $19 per share and the remainder of $8,000 is reflected as an increase in Additional Paid-in Capital.

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. 1/10

7/15

+ Cash (A) 476,000 84,000 128,000 24,000

152,000

1/23

Treasury Stock (XSE) 152,000 76,000 3/14 19,000 11/15

Common Stock (SE) + 280,000

1/10

Preferred Stock (SE) + 80,000

7/15

- Additional Paid-in Capital (SE) + 196,000 1/10 8,000 3/14 48,000 7/15 5,000 11/15

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d. 1/10:

Decrease basic EPS

1/23:

Increase basic EPS

3/14:

Decrease basic EPS

7/15:

Decrease basic EPS

11/15:

Decrease basic EPS

$ 250,000 780,000

$1,030,000

Additional paid-in capital Paid-in capital in excess of par value—Preferred stock

116,000

Paid-in capital in excess of par value—Common stock

396,000

Paid-in capital from Treasury stock

13,000

525,000

Total paid-in capital

1,555,000

Retained earnings

329,000 1,884,000

Less: Treasury stock (3,000 common shares) at cost Total stockholders’ equity

57,000 $1,827,000

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

P11-56. (30 minutes) LO 2, 3, 4, 5, 6 a. Balance Sheet Transaction

Cash Asset

Noncash Assets =

Liabilities

Contrib. Capital

Income Statement Earned + Capital -

Contra Equity

+100,0001 Treasury Stock

-15,0002 Treasury Stock

Purchased -100,000 10,000 shares Cash of treasury stock for cash.

Sold 1,500 +18,000 shares of Cash treasury stock.

+3,000 Add’l Paid-in Capital

Issued 5,000 shares of common stock.

+25,0003 Common Stock

+55,000 Cash

Sold 1,200 +10,800 shares of Cash treasury stock.

Revenues

Net - Expenses = Income

+30,000 Add’l Paid-in Capital =

-1,200 Add’l Paid-in Capital

-12,0004 Treasury Stock

Notes: 1

b. 1/12 No entry is required for the 3-for-1 stock split. 9/1

Treasury stock (+XSE, -SE) ......................................................... 100,000 Cash (-A) ....................................................................................

100,000

11-31

c. 10/12 11/21 12/28 + 9/1

d. 1/12: 9/1: 10/12: 11/21: 12/28:

+ Cash (A) 18,000 100,000 55,000 10,800 Treasury Stock (XSE) 100,000 15,000 12,000

9/1

- Common Stock (SE) + 25,000

10/12 12/28

- Additional Paid-in Capital (SE) + 12/28 1,200 3,000 10/12 30,000 11/21

11/21

$500,000

625,000 24,000 390,000 1,800

Less: Treasury stock (7,300 common Shares) at cost Total stockholders' equity

$1,125,000

415,800 1,540,800 408,000 1,948,800 73,000 $1,875,800

f. Because Sougiannis did not pay the 7% dividend on its preferred stock, ROCE is computed as follows: $83,000 / [($1,875,800+$1,809,000)/2 -$500,000] = 0.062 or 6.2%

©Cambridge Business Publishers, 2021 11-32

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P11-57. (45 minutes) LO 2, 3, 6 a. Balance Sheet Transaction

Cash Asset

Noncash Liabil+ Assets = ities

Issued +120,000 10,000 shares Cash of common stock.1

Purchased 4,000 shares of treasury stock.2

-56,000 Cash

Sold 1,000 shares of treasury stock.3

+17,000 Cash

Sold 500 shares of treasury stock.4

+6,500 Cash

Issued 5,000 shares of preferred stock.5

+175,000 Cash

Income Statement

Contrib. + Capital

Earned + Capital -

+50,000 Common Stock

Contra Equity Revenues

Net - Expenses = Income -

+70,000 Add’l Paid-in Capital -

+56,000 Treasury Stock

+3,000 Add’l Paid-in Capital

-14,000 Treasury Stock

-500 Add’l Paid-in Capital

-7,000 Treasury Stock

+125,000 Preferred Stock

+50,000 Add’l Paid-in Capital

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11-33

b. 1/5

1/18

Treasury stock (+XSE, -SE) ......................................................... 56,000 Cash (-A) ....................................................................................

56,000

3/12

7/17

10/1

7,000

c. 1/5 3/12 7/17 10/1 + 1/18

+ Cash (A) 120,000 17,000 6,500 175,000

56,000

1/18 -

Treasury Stock (XSE) 56,000 14,000 3/12 7,000 7/17

Common Stock (SE) + 50,000

1/5

Preferred Stock (SE) + 125,000

10/1

- Additional Paid-in Capital (SE) + 70,000 1/5 7/17 500 3,000 3/12 50,000 10/1

$125,000 800,000 50,000 670,000 2,500

$ 925,000

722,500 1,647,500 418,500 2,066,000 35,000 $2,031,000

©Cambridge Business Publishers, 2021 11-34

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P11-58. (30 minutes) LO 2, 4 a. See explanations in part b below. Balance Sheet Transaction

Cash Asset

Noncash Liabil+ Assets = ities

Issued 1,000 shares of preferred stock.

+62,000

Issued 4,000 shares of common stock.

+144,000

Issued 2,000 shares of common stock.

+60,000

Purchased 2,500 shares of treasury stock.

-45,000 Cash

Sold 900 shares of treasury stock.

+18,900 Cash

Issued 500 shares of preferred stock.

+29,500 Cash

Income Statement

Contrib. Capital

Earned + Capital -

Contra Net Equity Revenues - Expenses = Income

+50,000 Preferred Stock

+12,000 Additional Paid-in Capital =

Cash

+80,000 Common Stock +64,000 Additional Paid-in Capital

Cash

+20,000 Common Stock +40,000 Additional Paid-in Capital

+45,000 Treasury Stock

+2,700 Additional Paid-in Capital

-16,200 Treasury Stock

+25,000 Preferred Stock

+4,500 Additional Paid-in Capital

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11-35

b. 1/15

1/20

5/18

No entry is required for the 2-for-1 stock split

6/1

Common Stock is increased by its par value (2,000  $10 = $20,000) and Additional Paid-in Capital is increased for the balance ($40,000).

9/1

Treasury stock (+XSE, -SE) ......................................................... 45,000 Cash (-A) ...................................................................................

45,000

Cash is reduced by the cost of the Treasury Stock (2,500 shares  $18 per share = $45,000). The Treasury Stock account is increased by its cost, thereby reducing contributed capital.

©Cambridge Business Publishers, 2021 11-36

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. 1/15 1/20 6/1

+ Cash (A) 62,000 144,000 60,000

10/12 12/22

18,900 29,500

45,000

+ 9/1

9/1

Treasury Stock (XSE) 45,000 16,200 10/12

Common Stock (SE) + 80,000 20,000

1/20 6/1

Preferred Stock (SE) + 50,000 1/15 25,000 12/22

- Additional Paid-in Capital (SE) + 12,000 1/15 64,000 1/20 40,000 6/1 2,700 10/12 4,500 12/22

6 33

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11-37

8,499 576 9,075 (millions)

3,471,026,370 3,471,026,370

©Cambridge Business Publishers, 2021 11-38

Financial & Managerial Accounting for Decision Makers, 4 th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-39

CASES and PROJECTS C11-61. (30 minutes) LO 7

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Financial & Managerial Accounting for Decision Makers, 4 th Edition

11-41

©Cambridge Business Publishers, 2021 11-42

Financial & Managerial Accounting for Decision Makers, 4 th Edition

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 11

11-43

Chapter 12 Reporting and Analyzing Financial Investments Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Explain and interpret the three levels of investor influence over an investee – passive, significant, and controlling.

24, 25, 27, 32, 33 35 - 38

45, 47, 48

49 - 52

LO2 – Describe the term “fair value” and the fair value hierarchy.

45, 47

51, 52

LO3 – Describe and analyze accounting for passive investments.

12, 13, 20, 21, 22

24, 25, 27, 29, 32, 33, 35 - 37

45, 47

49 - 52

LO4 – Explain and analyze accounting for investments with significant influence.

15, 16, 19

30 - 32, 37, 38

47, 48

50 - 52

LO5 – Describe and analyze accounting for investments with control.

17,18,19, 23

26, 28, 34, 41, 42

46, 48

LO6 – Appendix 12A – Illustrate and analyze accounting mechanics for equity method investments.

LO7 – Appendix 12B – Apply consolidation accounting mechanics.

39, 40, 42

46, 48

LO8 – Appendix 12C – Discuss the reporting of derivative securities.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 12

12-1

QUESTIONS Q12-1. (a) Trading securities are reported at their fair value in the balance sheet. (b) Available-for-sale securities are reported at their fair value in the balance sheet. (c) Held-to-maturity securities are reported at their amortized cost in the balance sheet. Q12-2. An unrealized holding gain (loss) is an increase (decrease) in the fair value of an asset (in this case, an investment security) that is still owned. Investments in equity securities should be reported at their fair value on the balance sheet, with unrealized holding gains and losses reported in income in the period that they occur. There is a provision for non-marketable securities to use when the cost of estimating fair value is prohibitively expensive. Q12-3. Unrealized holding gains and losses related to trading securities are reported in the current-year income statement (and also retained earnings). Unrealized holding gains and losses related to available-for-sale securities are reported as a separate component of stockholders' equity called Other Comprehensive Income (OCI). Q12-4. Significant influence gives the owner of the stock the ability to significantly influence the operating and financing activities of the company whose stock is owned. Normally, this is accomplished with a 20% through 50% ownership of the company's voting stock. The equity method is used to account for investments with significant influence. Such an investment is initially recorded at cost; the investment is increased by the proportionate share of the investee company's net income, and equity income is reported in the income statement; the investment account is decreased by dividends received on the investment; and the investment account is reported in the balance sheet at its book value. Unrealized appreciation in the market value of the investment is not recognized. Q12-5. Yetman Company's investment in Livnat Company is an investment with significant influence, and should, therefore, be accounted for using the equity method. At year-end, the investment should be reported in the balance sheet at $258,000 [$250,000 + (40%  $80,000) - (40% x $60,000)]. Q12-6. A stock investment representing more than 50% of the investee company's voting stock is generally viewed as conferring “control” over the investee company. The investor and investee companies must be consolidated for financial reporting purposes. Q12-7. Consolidated financial statements attempt to portray the financial position, operating results, and cash flows of affiliated companies as a single economic unit so that the scope of the entire (whole) entity is more realistically conveyed.

©Cambridge Business Publishers, 2021 12-2

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q12-8. The $750,000 investment in Murray Company appearing in Finn Company's balance sheet and the $300,000 common stock and $450,000 retained earnings appearing on Murray Company's balance sheet are eliminated. The two balance sheets (less the accounts eliminated) are then summed to yield the consolidated balance sheet. Q12-9.B The $75,000 accounts payable on Dee's balance sheet and the $75,000 accounts receivable on Bradshaw's balance sheet are eliminated. In a consolidation, all intercompany items are eliminated so that the consolidated statements show only the interests of outsiders. Q12-10. Limitations of consolidated statements include the possibility that the performances of poor companies in a group are "masked" in consolidation. Likewise, rates of return, other ratios, and percentages calculated from consolidated statements might prove deceptive because they are composites. Consolidated statements also eliminate detail about product lines, divisional operations, and the relative profitability of various business segments. (Some of this information is likely to be available in the footnote disclosures relating to the business segments of certain public firms.) Finally, shareholders and creditors of subsidiary companies find it difficult to isolate amounts related to their legal rights by inspecting only consolidated statements.

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 12

12-3

MINI EXERCISES M12-11. (10 minutes) LO 1 a. SI

Griffin owns > 20% of Wright.

b. P

Bond investments are always classified as passive.

c. P

2,000 shares of Google is well below the number necessary to exert influence

d. C

Watts owns more than half of Zimmerman stock

e. SI

Even though Shevlin owns less than 20% of Bowen, the fact that it buys 60% of Bowen’s output means it is capable of exercising significant influence.

M12-12. (10 minutes) LO 3 a. Available-for-sale securities are reported at fair value on the balance sheet. For 2018, this is equal to the original cost ($37,512 million) plus unrecognized gains ($44 million) and less unrealized losses ($547 million), or $37,009 million. b. Unrealized gains (and losses) on available-for-sale securities are reported as a component of Accumulated Other Comprehensive Income (AOCI) in the shareholders’ equity section of the balance sheet.

M12-13. (15 minutes) LO 3 Investments in equity securities must be reported at fair value, with all gains and losses (realized and unrealized) recognized in income. Wasley will report $6,600 of dividend income plus income relating to the increase in the market price of the stock of $6,000 ($13 - $12 price increase for 6,000 shares). Total investment income is $12,600.

©Cambridge Business Publishers, 2021 12-4

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M12-14. (10 minutes) LO 2 a. All of these investments are marked to fair value, but the determination differs. Level 1 fair values are determined by reference to an active market where identical assets are traded. Level 2 fair values are determined by using a model (discounted cash flow, prices of similar assets, etc.) for which the inputs and assumptions can be found from observable value. Level 3 fair values are also determined by using a model, but the inputs and assumptions are not observable except to the reporting company. b. All are marked-to-fair-value, but only Level 1 investments are marked-to-market, the others are marked-to-model. Level 1 values would be the most objective since they come from an active market. Level 3 would be most subjective because they depend significantly on management’s judgments. c. Level 1 assets are most liquid, because they are traded in active markets. Level 3 assets are likely to be least liquid because their value depends significantly on information that is not publicly available.

M12-15. (20 minutes) LO 4 a. Given the 30% ownership, “significant influence” is presumed and the investment must be accounted for using the equity method. The year-end balance of the investment account is computed as follows: Beginning balance ....................... % Lang income earned ................ % Dividends received .................. Ending balance ............................

$1,000,000 30,000 (12,000) $1,018,000

($100,000  0.3) ($40,000  0.3)

b. $30,000 ($100,000  0.3) - Equity earnings are computed as the reported net income of the investee (Lang Company) multiplied by the percentage of the outstanding common stock owned. c. (1) In contrast to the market method, the equity method of accounting does not report investments at market value. The unrealized gain of $200,000 is not reflected in either the balance sheet or the income statement.

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12-5

d. 1.

Investment in Lang Company (+A) ................................................... 1,000,000 Cash (-A) .......................................................................................... 1,000,000

Investment in Lang Company (+A) ................................................... 30,000 Investment income (+R, +SE) ..........................................................

30,000

Cash (+A) ......................................................................................... 12,000 Investment in Lang Company (-A) ....................................................

12,000

e. + 3. + 1. 2.

Cash (A) 1,000,000 12,000

Investment in Lang Company (A) 1,000,000 30,000 12,000

Investment Income (R) 30,000

+ 2.

f. Transaction Purchase stock in Lang Company.

Cash Asset -1,000,000 Cash

Recognize share of Lang income. Receive dividend from Lang.

+12,000 Cash

Noncash Assets

Balance Sheet LiabilContrib. = ities + Capital +

+1,000,000 Investment

+30,000 Investment

-12,000 Investment

Income Statement Earned Capital

+30,000 Retained Earnings

Revenues

+30,000 Investment Income

Expenses

Net = Income

= +30,000

©Cambridge Business Publishers, 2021 12-6

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M12-16. (10 minutes) LO 4 Equity income on this investment is computed as the investee company (Penno) earnings multiplied by the percentage of the company owned. In this case, equity earnings equal: $600,000  40% = $240,000 Note that dividends are treated as a return of investment (reduce the investment balance by $80,000, computed as $200,000  40%), and not as income. Also, the investment is recorded at adjusted cost, not at market value, and unrealized gains (losses) are neither recognized on the balance sheet nor in the income statement.

M12-17. (10 minutes) LO 5 The $600,000 investment in Hirst Company appearing on Philipich Company's balance sheet and the $300,000 common stock and $450,000 retained earnings of Hirst Company would be eliminated. In addition, a $150,000 noncontrolling interest [20% of ($300,000 + $450,000)] would appear on the consolidated balance sheet as part of shareholders equity.

M12-18. (10 minutes) LO 5 Benartzi Company consolidated net income .............................. less net income attributable to noncontrolling interests.............. Net income attributable to Benartzi Company shareholders ......

$750,000 15,000 $735,000

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 12

12-7

M12-19. (20 minutes) LO 4, 5 a. If DeFond purchases 100% of Verduzco’s common stock, then it must produce consolidated reports.

Current assets

DeFond Company

(before investment)

(after investment)

Verduzco Company

Eliminating Entries

DeFond Company (Consolidated)

$ 800

$ 500

$ 100

–

300

–

Noncurrent assets

2,000

900

2,900

Liabilities

2,200

700

2,900

600

300

Investment

Shareholders’ Equity

$ 600 –

(300)

600

b. If DeFond purchases 50% of the common stock of Lin Company, it uses the equity method. DeFond Company

DeFond Company

(before investment)

(after investment)

Lin Company

$ 800

$ 500

$ 200

–

300

–

Noncurrent assets

2,000

1,800

Liabilities

2,200

1,400

600

Current assets Investment

Shareholders’ Equity

c. If we compare DeFond’s consolidated balance sheet to the equity method balance sheet, we can see that the total assets are higher and the liabilities are higher. DeFond’s stockholders’ equity accounts are the same. So, the Debt-to-Equity ratio will be higher if DeFond purchases the subsidiary rather than investing in the joint venture. If reported profits are the same under either scenario, then purchasing the subsidiary would produce a lower Return on Assets than the joint venture. Other ratios would change as well (like the Current Ratio), but not in a predictable direction.

©Cambridge Business Publishers, 2021 12-8

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M12-20. (40 minutes) LO 3 a. 2018 10/1

Investment in Skyline, Inc. (+A) ........................................................ 486,000 Cash (-A) ....................................................................................486,000

12/31 Interest receivable (+A) ..................................................................... 8,750 Interest revenue (+R, +SE) .........................................................

8,750

12/31 Investment in Skyline, Inc. (+A) ........................................................ 4,000 Unrealized gain (+R, +SE) ..........................................................

4,000

2019 3/31

4/1

Cash (+A) ........................................................................................ 17,500 Interest receivable (-A) ............................................................... Interest revenue (+R, +SE) ........................................................

8,750 8,750

Cash (+A) ........................................................................................ 492,300 Realized gain (+R, +SE) ............................................................. 2,300 Investment in Skyline, Inc. (-A) ................................................... 490,000

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $4,000 in Skyline Inc. bonds is closed to retained earnings in 2018 increasing net income and retained earnings. +

Interest Revenue (R) 8,750 8,750

+ 12/31/18 3/31/19

+ Investment in Skyline Bonds (A) 10/1/18 486,000 12/31/18 4,000 490,000 4/1/19

Unrealized Gain (R) 4,000

+ 12/31/18

+ 12/31/19

Realized Gain (R) 2,300

3/31/19 4/1/19

Cash (A)

486,000

10/1/18

17,500 492,300

Interest Receivable (A) 8,750 8,750

3/31/19

4/1/19

©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 12

12-9

c. Transaction 10/1/18 Purchase $500,000 of Skyline bonds at 97.

Cash Asset -486,000 Cash

Noncash Assets

Balance Sheet Liabil= ities +

Income Statement Contrib. Capital +

Earned Capital

Revenues

+ 486,000 Investment

12/31/18 Recognize interest revenue.

+8,750 Interest Receivable

+8,750 Retained Earnings

+8,750 Interest Revenue

12/31/18 Record unrealized gain.

+4,000 Investment

Expenses

Net Income

+8,750

+4,000 Retained Earnings

+4,000 Unrealized Gain

+4,000

3/31/19 Recognize interest income.

+17,500 Cash

-8,750 = Interest Receivable

+8,750 Retained Earnings

+8,750 Interest Revenue

+8,750

4/1/19 Sold Skyline investment.

+492,300 Cash

-490,000 Investment

+2,300 Retained Earnings

+2,300 Realized Gain

+2,300

M12-21. (40 minutes) LO 3 a. 2018 11/15 Investment in Lane, Inc. (+A) .................................................. 171,200 Cash (-A) ................................................................................

171,200

12/22 Cash (+A) ...............................................................................10,000 Dividend income (+R, +SE) ....................................................

10,000

12/31 Unrealized loss (+E, -SE) .......................................................16,200 Investment in Lane, Inc. (-A) ..................................................

16,200

2019 1/20

Cash (+A) ......................................................................................... 150,000 Loss on sale of investment in Lane, Inc. (+E, -SE) ........................... 5,000 Investment in Lane, Inc. (-A) ............................................................. 155,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Assuming the firm’s fiscal year ends 12/31, the unrealized loss of $16,200 is closed to the income summary in 2018, reducing net income and retained earnings. + Cash (A) 10,000 171,200 150,000

12/22 1/20

11/15

+ Investment in Lane Inc (A) 171,200 16,200 155,000 +

1/20 + 12/31

Unrealized Loss (E) 16,200

Loss (E) 5,000

12/31 1/20

- Dividend Income (R) + 10,000

12/22

c. Balance Sheet Transaction

Cash Asset

11/15 Purchase 10,000 shares of Lane Inc common.

-171,200 Cash

12/22 Dividend income.

+10,000 Cash

12/31 Decrease in Investment. 1/20 Sale of Lane common.

Noncash Assets

Liabil = -ities

+171,200 Investment

Income Statement Earned Capital

Revenues

Expenses

Net = Income =

+10,000 Retained Earnings

-16,200 Retained Earnings

+16,200 Unrealized Loss

= -16,200

-155,000 = Investment

-5,000 Retained Earnings

+5,000 Realized Loss

-16,200 Investment +150,000 Cash

Contrib. + Capital +

+10,000 Dividend Income

= +10,000

-5,000

12-11

M12-22. (30 minutes) LO 3 The main effect is to defer the gain in value experienced in 2018 to the year 2019. a. 2018 10/1 Investment in Skyline, Inc. (+A) ........................................................ 486,000 Cash (-A) ....................................................................................486,000 12/31 Interest receivable (+A) ..................................................................... 8,750 Interest revenue (+R, +SE) .........................................................

8,750

12/31 Investment in Skyline, Inc. (+A) ........................................................ 4,000 Unrealized gain AOCI (+SE) .......................................................

4,000

2019 3/31

4/1

8,750 8,750

Cash (+A) ........................................................................................ 492,300 Unrealized gain – AOCI (-SE) 4,000 Realized gain (+R, +SE) ............................................................. 6,300 Investment in Skyline, Inc. (-A) ................................................... 490,000

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $4,000 in Skyline Inc. bonds is closed to retained earnings in 2018 increasing net income and retained earnings. + 3/31/19 4/1/19

Cash (A)

486,000

10/1/18

17,500 492,300

+ Investment in Skyline Bonds (A) 10/1/18 486,000 12/31/18 4,000 490,000 4/1/19

+ 12/31/19

Interest Receivable (A) 8,750 8,750

3/31/19

Interest Revenue (R) 8,750 8,750

+ 12/31/18 3/31/19

Unrealized Gain (AOCI) + 4,000 12/31/18 4,000

4/1/19

Realized Gain (R) 6,300

+ 4/1/19

Note that most of the gain occurred in 2018, but was not recognized on the income statement until management decided to sell the securities in 2019.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Transaction 10/1/18 Purchase $500,000 of Skyline bonds at 97.

Cash Asset -486,000 Cash

Noncash Assets

Balance Sheet Liabil= ities +

Income Statement Contrib. Capital +

Earned Capital

+ 486,000 Investment

12/31/18 Recognize interest revenue.

+8,750 Interest Receivable

+8,750 Retained Earnings

12/31/18 Record unrealized gain.

+4,000 Investment

+4,000 Unrealized Gain-AOCI

Revenues

+8,750 Interest Revenue

Expenses

Net Income

+8,750

3/31/19 Recognize interest income.

+17,500 Cash

-8,750 = Interest Receivable

+8,750 Retained Earnings

+8,750 Interest Revenue

+8,750

4/1/19 Sold Skyline investment.

+492,300 Cash

-490,000 Investment

+6,300 Retained Earnings

+6,300 Realized Gain

+6,300

-4,000 Unrealized Gain-AOCI

M12-23. (10 minutes) LO 5 Halen Inc. now owns all of Jolson. The company reports will be consolidated. The total in the consolidated stockholder’s equity section on 1/1 is the stockholders’ equity section of the parent company, determined as follows: Common stock Retained earnings Total Equity

$600,000 310,000 $910,000

Jolson’s equity accounts are eliminated in the consolidation process.

12-13

EXERCISES E12-24. (30 minutes) LO 1, 3 a. Trading securities 1.

Investment in US Treasury bonds (+A) ........................................ 407,000 Cash (-A) ...................................................................................... 407,000

Cash (+A) ..................................................................................... 8,000 Interest income (+R, +SE) ............................................................

8,000

Investment in US Treasury bonds ................................................. 4,000 Unrealized holding gain (+R, +SE) ...............................................

4,000

4a. Cash (+A) ..................................................................................... 8,000 Interest income (+R, +SE) .............................................................

8,000

4b. Cash (+A) ..................................................................................... 408,000 Realized loss on sale of investment (+E, -SE) .............................. 3,000 Investment in US Treasury bonds (-A) ..........................................411,000 b. + Cash (A) 8,000 407,000 8,000 408,000

2. 4a. 4b

+ 3.

Unrealized Gain (R) 4,000

1. 3.

4b.

+ Investment in Liu (A) 407,000 4,000 411,000

4b.

- Interest Income (R) + 8,000 8,000

2. 4a.

+ Realized Loss on Sale (E) 3,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Balance Sheet Transaction 1. Purchase bonds for $407,000

-407,000 Cash

+407,000 = Investment

2. Receive interest payment of $8,000

+8,000 Cash

+8,000 Retained Earnings

+8,000 Interest Income

+8,000

+4,000 = Investment

+4,000 Retained Earnings

+4,000 Unrealized Holding Gain

+4,000

+8,000 Interest Income

+8,000

-3,000

3. Year-end market price of bonds is $411,000

Noncash Assets

Liabil= ities

Contrib. + Capital +

Income Statement

Cash Asset

Earned Capital

Revenues

- Expenses =

Net Income

4a. Receive interest payment of $8,000

+8,000 Cash

+8,000 Retained Earnings

4b. Sell bonds for $408,000

+408,000 Cash

-411,000 = Investment

-3,000 Retained Earnings

+3,000 Realized Holding Loss

d. Available-for-Sale Securities 1.

Investment in US Treasury bonds (+A) Cash (-A)

407,000 407,000

Cash (+A)

8,000 Interest income (+R, +SE)

8,000

Investment in US Treasury bonds Unrealized holding gain - AOCI (+SE)

4a. Cash (+A)

4,000 4,000 8,000

Interest income (+R, +SE)

8,000

4b. Cash (+A) Unrealized holding gain – AOCI (-SE) Investment in US Treasury bonds (-A) Realized holding gain (+R, +SE)

408,000 4,000 411,000 1,000

continued next page

12-15

d. continued + Cash (A) 8,000 407,000 8,000 408,000

2. 4a. 4b.

4b.

- Unrealized Gain AOCI (SE) + 4,000 4,000

Transaction

Cash Asset

1. Purchase bonds -407,000 for $407,000 Cash

2. Receive interest payment of $8,000

Noncash Assets

Balance Sheet LiabilContrib. = ities + Capital +

+ Investment in Liu (A) 407,000 4,000 411,000

4b.

- Interest Income (R) + 8,000 8,000

2. 4a.

- Realized Gain (R) + 1,000

+4,000 = Investment

4a. Receive interest payment of $8,000

+8,000 Cash

4b. Sell bonds for $408,000

+408,000 Cash

-411,000 = Investment

4b.

Income Statement Earned Capital

Revenues

+407,000 = Investment

+8,000 Cash

3. Year-end market price of bonds is $411,000

1. 3.

Expenses =

Net Income

+8,000 Retained Earnings

+8,000 Interest Income

+4,000 AOCI

+8,000 Retained Earnings

+1,000 Retained Earnings -4,000 AOCI

+8,000

+8,000 Interest Income

+8,000

+1,000 Realized Holding Gain

+1,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-25. (30 minutes) LO 1, 3 a. Equity investments measured at fair value, with all gains/losses recognized in income. 1.

2. 4.

Investment in Freeman, Co. (+A) ............................................80,000 Cash (-A) ................................................................................

80,000

Cash (+A) ............................................................................... 6,250 Dividend income (+R, +SE) ....................................................

6,250

Investment in Freeman, Co. (+A) ............................................ 7,500 Unrealized gain (+R, +SE) ......................................................

7,500

Cash (+A) ...............................................................................86,400 Loss on sale of investment (+E, -SE) ...................................... 1,100 Investment in Freeman, Co. (-A) ...................................

87,500

+ Cash (A) 6,250 80,000 86,400

- Unrealized Gain (R) + 7,500

1. 3.

+ Investment in Freeman (A) 80,000 7,500 87,500

- Dividend Income (R) + 6,250

+ Loss on Sale (E) 1,100

Balance Sheet Transaction 1. Ohlson Co. purchases 5,000 common shares of Freeman Co. at $16 cash per share. 2. Ohlson Co. receives a cash dividend of $1.25 per common share from Freeman. 3. Year-end market price of Freeman common stock is $17.50 per share.

Cash Asset -80,000 Cash

Noncash + Assets +80,000 Investment

4. Ohlson Co. sells +86,400 all 5,000 common Cash shares of Freeman for $86,400 cash.

Income Statement Earned Capital

Revenues

+6,250 Retained Earnings

+6,250 Dividend Income

= +6,250

+7,500 = Investment

+7,500 Retained Earnings

+7,500 Unrealized Gain

= +7,500

+6,250 Cash

-87,500 Investment

Liabil= ities =

Contrib. + Capital +

-1,100 Retained Earnings

Expenses

+1,100 Loss

Net = Income =

= -1,100

12-17

E12-26. (15 minutes) LO 5 a. The annual growth rates in revenues are (110,360/96,571)-1 = 14.3% for 2018 and (96,571/91,154)-1 = 5.9% for 2017. The cumulative average growth rate (CAGR) is (110,360/91,154)^0.5 - 1 = 10.0%. b. Microsoft’s acquisition of LinkedIn was completed in December 2016, and it was at that point that Microsoft began to include LinkedIn’s revenues in its income statement. Let’s say December 31, 2016 just to be concrete. As a result, 2016’s revenue included a full year of Microsoft’s revenues, 2017’s revenues included a full year of Microsoft’s revenues plus a half year of LinkedIn’s revenues, and 2018’s revenues included a full year of each of Microsoft’s and LinkedIn’ revenues. As a result, the growth trends over this period intermix the “organic growth” of these companies with the “acquisition growth.” The former is likely to continue, while the latter is dependent on acquisitions of other companies. c. The footnote information provides revenues for 2016 and 2017 as if Microsoft and LinkedIn had been one organization over this period. That is, the “acquisition growth” can be set aside to focus on the “organic growth.” In this case, the revised growth rates would be the following: The annual growth rates in revenues are (110,360/98,291)-1 = 12.3% for 2018 and (98,291/94,490)-1 = 4.0% for 2017. The cumulative average growth rate (CAGR) is ((110,360/94,490)^0.5) - 1 = 8.1%. So “acquisition growth” added about 2% to the growth pattern in reported revenue.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-27. (30 minutes) LO 1, 3 a. 2018 11/1

Investment in Joos, Inc. (+A) .............................................. 306,900 Cash (-A) ............................................................................

306,900

12/31 Interest receivable (+A) ...................................................... 4,500 Interest revenue (+R, +SE) .................................................

4,500

12/31 Unrealized loss (+E, -SE) ................................................... 5,400 Investment in Joos, Inc. (-A) ...............................................

5,400

2019 4/30

5/1

Cash (+A) ........................................................................... 13,500 Interest receivable (-A) ....................................................... Interest revenue (+R, +SE) .................................................

4,500 9,000

Cash (+A) ........................................................................... 300,900 Loss on sale of investments (+E, -SE) ............................... 600 Investment in Joos, Inc. (-A) ................................................

301,500

b. 4/30 5/1

+ Cash (A) 13,500 306,900 300,900

12/31

+ Unrealized Loss (E) 5,400

11/1

- Interest Revenue (R) + 4,500 9,000

12/31

+ 12/31 4/30

5/1

+ Investment in Joos Inc. (A) 306,900 5,400 301,500

12/31 5/1

+ Interest Receivable (A) 4,500 4,500

4/30

Loss on Sale of Investments (E) 600

12-19

c. Balance Sheet Transaction 11/1 Buy $300,000 Joos bonds @102.

Cash Asset -306,900 Cash

Noncash Assets

Liabilities

Income Statement Contrib. + Capital +

Earned Capital

+306,900 Investment

12/31 Accrue interest.

+4,500 Interest Receivable

+4,500 Retained Earnings

12/31 Recognize decline in value of bonds.

-5,400 Investment

-5,400 Retained Earnings

4/30 Receive interest.

+13,500 Cash

-4,500 Interest Receivable

+9,000 Retained Earnings

5/1 Sold Joos bonds.

+300,900 Cash

-301,500 Investment

-600 Retained Earnings

Revenues

+4,500 Interest Revenue

+9,000 Interest Revenue

- Expenses

Net = Income

+4,500

+5,400 = Unrealized Loss

-5,400

+9,000

-600

+600 Loss

E12-28. (10 minutes) LO 5 Baylor Company now owns 75% of Reed. The company reports will be consolidated. The total in the consolidated stockholders’ equity section on 1/1 is determined as follows: Common stock………………………………………… Retained earnings………………………………….…. Baylor Company shareholders’ equity Noncontrolling interests Total equity

900,000 440,000 $1,340,000 200,000 $1,540,000

E12-29. (15 minutes) LO 3 a. The fixed-maturity (debt) investment portfolio is reported in the balance sheet at its current fair value of $39,546 million. The cost of the portfolio is $38,085 million, there are $1,982 million in unrealized gains and $521 million of unrealized losses. b. Because the fixed-maturity (debt) investments are accounted for as available-for-sale, unrealized gains (losses) on investments are reported in Accumulated Other Comprehensive Income (AOCI), rather than current income. The investments are reported on the balance sheet at current market value on the statement date.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Impairment losses are recognized in current income when the securities decline in market value and the decline is deemed to be other than temporary. Gains and losses realized from the sale of securities are recognized in current income. A reclassification adjustment is required in Other Comprehensive Income. Because the gains and losses from the sale of securities will be recognized in current income (and retained earnings), they need to be removed from AOCI to avoid double-counting the gains and losses in stockholders’ equity.

E12-30. (30 minutes) LO 4 a. 1. Investment in Barth Co. (+A) ............................................................ 108,000 Cash (-A) .........................................................................................108,000 2. Cash (+A) ......................................................................................... 15,000 Investment in Barth Co. (-A) ............................................................ 15,000 3. Investment in Barth Co. (+A) ............................................................ 24,000 Investment income (+R, +SE) .......................................................... 24,000 4. Cash (+A) ......................................................................................... 120,500 Gain on sale of investment (+R, +SE) .............................................. 3,500 Investment in Barth Co. (-A) ............................................................117,000 b. 2. 4.

+ Cash (A) 15,000 108,000 120,500

- Gain (R) + 3,500

1. 3.

+ Investment in Barth (A) 108,000 15,000 24,000 117,000

2. 4.

- Investment Income (R) + 24,000

c. Balance Sheet Transaction

Cash Asset

1. Buy 30% of Barth stock.

-108,000 Cash

+108,000 Investment

2. Receive dividend.

+15,000 Cash

-15,000 Investment

+24,000 Investment

+24,000 Retained Earnings

+24,000 Investment Income

= +24,000

-117,000 Investment

+3,500 Retained Earnings

+3,500 Gain

3. Recognize share of net income of Barth. 4. Sold Barth investment.

+120,500 Cash

Noncash Assets

Liabilities

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

+3,500

12-21

E12-31. (30 minutes) LO 4 a. 1. Investment in Palepu Co. (+A) .................................................. 120,000 Cash (-A) ..................................................................................

120,000

2. Cash (+A) .................................................................................12,000 Investment in Palepu Co. (-A) ...................................................

12,000

3. Investment in Palepu Co. (+A) ..................................................30,000 Investment income (+R, +SE) ...................................................

30,000

4. Cash (+A) ................................................................................. 140,000 Gain on sale of investment (+R, +SE) ...................................... Investment in Palepu Co. (-A) ...................................................

2,000 138,000

b. 2. 4.

+ Cash (A) 12,000 120,000 140,000

- Gain (R) + 2,000

1. 3.

+ Investment in Palepu (A) 120,000 12,000 30,000 138,000

2. 4.

- Investment Income (R) + 30,000

c. Balance Sheet Transaction

Cash Asset

Noncash Assets

Liabilities

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

1. Buy 25% of Palepu stock.

-120,000 Cash

+120,000 Investment

2. Receive dividend.

+12,000 Cash

-12,000 Investment

3. Recognize share of net income of Palepu.

+30,000 Investment

+30,000 Retained Earnings

+30,000 Investment Income

= +30,000

4. Sold +140,000 Palepu Cash investment.

-138,000 Investment

+2,000 Retained Earnings

+2,000 Gain

Financial & Managerial Accounting for Decision Makers, 4 th Edition

+2,000

E12-32. (40 minutes) LO 1, 3, 4 a. 1. Fair Value Method 1.

Investment in Leftwich Co. (+A) ..................................... 150,000 Cash (-A) .......................................................................

150,000

No entry

Cash (+A) ....................................................................... 11,000 Dividend income (+R, +SE) ...........................................

11,000

Investment in Leftwich Co. (+A) ..................................... 40,000 Unrealized gain (+R, +SE) .............................................

40,000

2. + Cash (A) 11,000 150,000

- Unrealized Gain (R) + 40,000

1. 4.

+ Investment in Leftwich (A) 150,000 40,000 -

Dividend Income (R) + 11,000

3. Balance Sheet Transaction 1. Purchase Common shares.

Cash Asset -150,000 Cash

2. No entry. 3. Received a cash dividend of $1.10 per common share.

+11,000 Cash

4. Recognize increase in investment value at year end .

Noncash Assets

Liabilities

Contrib. + Capital +

Income Statement Earned Capital

Revenues

Expenses

+150,000 = Investment

Net Income

+11,000 Retained Earnings

+11,000 Dividend Income

+11,000

+40,000 = Investment

+40,000 Retained Earnings

+40,000 Unrealized Gain

= +40,000

12-23

b. 1. Equity Value Method 1. Investment in Leftwich Co. (+A) ................................................................ 150,000 Cash (-A) .................................................................................................. 150,000 2. Investment in Leftwich Co. (+A) ................................................................ 24,000 Investment income (+R, +SE) ................................................................... 24,000 3. Cash (+A) ................................................................................................. 11,000 Investment in Leftwich Co. (-A) ................................................................. 11,000 4. No entry

2. 3.

+ Cash (A) 11,000 150,000

1. 2.

+ Investment in Leftwich (A) 150,000 11,000 24,000

- Investment Income (R) + 24,000

3. Balance Sheet Transaction 1. Purchase Common shares.

Cash Asset -150,000 Cash

2. Recognize 30% portion of Leftwich net income. 3. Received a cash dividend of $1.10 per common share.

+11,000 Cash

Noncash Assets

+150,000 Investment

+24,000 Investment

-11,000 Investment

4. No entry.

Liabilities

Contrib. + Capital +

Income Statement Earned Capital

Revenues

Net - Expenses = Income -

= +24,000

+24,000 Retained Earnings

+24,000 Investment Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-33. (15 minutes) LO 1, 3 a. The amounts reported for all these separately-identifiable assets and liabilities must be fair values at the date of the acquisition. So, any property, plant and equipment would be reported at what we would expect to get for it, rather than historical cost. Any financial liabilities would be estimated at the value required to discharge them at the date of the acquisition. In the fair value hierarchy, most of these amounts will be determined using Level 2 or Level 3 approaches. b. Goodwill is equal to the amount of consideration given for the transaction minus the fair value of the net assets acquired. Other than goodwill, the asset fair value is $8,432 million and the fair value of liabilities is $3,970 million. So, the fair value of separately-identifiable net assets is $4,462 million (= $8,432 million - $3,970 million). As a result, the goodwill is $9,501 million (= $13,963 million - $4,462 million). This amount would not be amortized in the future, but Amazon would have to assess its value annually for impairment. If the goodwill value is impaired, the goodwill asset is reduced and a charge is recognized in income. c. Investors are likely to prefer acquisitions of identifiable net assets (even if intangible), rather than vaguely-defined “synergy effects.” When the acquired company goes to the highest bidder, there is a real risk that the highest bidder was the one that most overestimated the potential for future synergies. When purchase price allocations are disclosed subsequent to the acquisition, stock prices respond favorably (unfavorably) to the disclosure that less (more) goodwill was acquired

E12-34. (25 minutes) LO 5 a. The amounts reported for all these separately-identifiable assets and liabilities must be fair values at the date of the acquisition. So, any inventory would be reported at what we would expect to get for it, rather than historical cost. Any financial liabilities would be estimated at the value required to discharge them at the date of the acquisition. In the fair value hierarchy, most of these amounts will be determined using Level 2 or Level 3 approaches. b. Goodwill is equal to the amount of consideration given for the transaction minus the fair value of the net assets acquired. Other than goodwill, the asset fair value is $5,079 million and the fair value of liabilities is $487 million. So, the fair value of separately-identifiable net assets is $4,592 million (= $5,079 million - $487 million). As a result, the goodwill is $10,283 million (= $14,875 million - $4,592 million). This amount would not be amortized in the future, but Intel would have to assess its value annually for impairment. If the goodwill value is impaired, the goodwill asset is reduced and a charge is recognized in income.

12-25

c. Investors are likely to prefer acquisitions of identifiable net assets (even if intangible), rather than vaguely-defined “synergy effects.” When the acquired company goes to the highest bidder, there is a real risk that the highest bidder was the one that most overestimated the potential for future synergies. When purchase price allocations are disclosed subsequent to the acquisition, stock prices respond favorably (unfavorably) to the disclosure that less (more) goodwill was acquired. E12-35. (30 minutes) LO 1, 3 a. 2019: 11/15 Investment in Core, Inc. (+A) ............................................... 80,900 Cash (-A) ..............................................................................

80,900

12/22 Cash (+A) ............................................................................6,250 Dividend income (+R, +SE) ..................................................

6,250

12/31 Investment in Core, Inc. (+A) ...............................................6,600 Unrealized gain (+R, +SE) ...................................................

6,600

2020: 1/20 Cash (+A) ............................................................................ 86,400 Loss on sale of investment (+E, -SE) ..................................1,100 Investment in Core, Inc. (-A) ................................................

87,500

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of 6,600 increases net income and retained earnings in 2019.

12/22/19 1/20/20

+ Cash (A) 6,250 80,900 86,400

11/15/19

11/15/19 12/31/19

+ Investment in Core Inc (A) 80,900 6,600 87,500 1/20/20

+ Loss on Sale of Investment (E) 1/20/20 1,100 -

Unrealized Gain (R) 6,600

+ 12/31/19

- Dividend Income (R) + 6,250

12/22/19

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Balance Sheet Transaction

Cash Asset

11/15 Purchase 5,000 shares of Core Inc common.

-80,900 Cash

12/22 Dividend income.

+6,250 Cash

12/31 Increase in Investment. 1/20 Sale of Core common.

Noncash Assets +80,900 Investment

Liabilities

Contrib. Capital +

Earned Capital

Revenues

Net - Expenses = Income

+6,250 Retained Earnings

+6,250 Dividend Income

+6,250

+6,600 Retained Earnings

+6,600 Unrealized Gain

+6,600

-87,500 = Investment

-1,100 Retained Earnings

-1,100

+6,600 Investment +86,400 Cash

Income Statement

+1,100 Loss on Sale

E12-36 (30 minutes) LO 1, 3 a. 2018: 11/15 Investment in Core, Inc. (+A) ............................................... 80,900 Cash (-A) .............................................................................

80,900

12/22 Cash (+A) ............................................................................6,250 Dividend income (+R, +SE) .................................................

6,250

12/31 Investment in Core, Inc. (+A) ...............................................6,600 AOCI (+SE) .........................................................................

6,600

2019: 1/20 Cash (+A) ............................................................................ 86,400 AOCI (-SE) ……………………………………………….. 1,100 Investment in Core, Inc. (-A) ................................................

87,500

+ Cash (A) 12/22/18 1/20/19

1/20/19

6,250 86,400

80,900

AOCI 1,100

+ 6,600

+ Investment in Core Inc (A) 11/15/18

11/15/18 12/31/18

12/31/18

80,900 6,600

87,500

1/20/19

- Dividend Income (R) + 6,250

12/22/18

12-27

a. continued

Transaction

Cash Asset

11/15 Purchase 5,000 shares of Core Inc common.

-80,900 Cash

12/20 Dividend income.

+6,250 Cash

12/31 Increase in Investment. 1/20 Sale of Core common.

Noncash Assets

+80,900 Investment

Income Statement Earned Capital

Revenues

+6,250 Retained Earnings

+6,600 AOCI

-87,500 = Investment

-1,100 AOCI

+6,600 Investment +86,400 Cash

Balance Sheet LiabilContrib. = ities + Capital +

+6,250 Dividend Income

Net - Expenses = Income

+6,250

b. Some companies complained that marking equity investments to fair value and reporting fair value changes in the income statement did not fit their business model. They wanted to make smaller investments in companies with whom they had a strategic relationship or a continuing interest, but falling short of the significant influence needed for the equity method. These companies said that they were not interested in the possible holding gains that they might achieve. So, the IASB allowed IFRS companies to make an irrevocable choice at the time of investment. If they chose FVOCI, all holding gains and losses will end up in AOCI and never go through the income statement.

E12-37. (30 minutes) LO 1, 2, 3, 4 a. The trading stock investments will be reported at $225,300. This amount is computed using their market values at year-end; specifically, $65,300 + $160,000, or $225,300. b. The available-for-sale debt investments will be reported at $346,700. This amount is computed using their market values at year-end; specifically, $192,000 + 154,700, or $346,700. c. The equity method stock investments will be reported at $236,000. This amount is computed using their equity method value at year-end; specifically, $100,000 + $136,000, or $236,000.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

d. Unrealized holding losses of $5,200 will appear in the 2019 income statement. These losses relate to the trading securities; specifically— Barth: $68,000 - $65,300 = $2,700; Foster: $162,500 - $160,000 = $2,500; total of $2,700 + $2,500 = $5,200. e. Unrealized holding losses of $7,300 will appear in the stockholders' equity section of the December 31, 2019, balance sheet under other comprehensive income. These losses relate to the available-for-sale debt securities; specifically— 30-Year Treasury Bond: $197,000 - $192,000 = $5,000; 10-Year Treasury Note: $157,000 - $154,700 = $2,300; total of $5,000 + $2,300 = $7,300. f. A fair value adjustment to investments of $7,300 will appear in the December 31, 2019, balance sheet. This adjustment relates to the available-for-sale securities. See part (e) for the supporting computations. The fair value adjustment decreases the book value of the available-for-sale securities to their year-end market value.

E12-38. (30 minutes) LO 1, 4 (Entries in $ millions) a. Record share of income: Investment in affiliates (+A)……………………………. Income from affiliates (+R, +SE)…………...

42 42

b. Record receipt of cash dividends: Cash (+A)………………………………………………… Investment in affiliates (-A)……………………

2 2

c. The ending balance should be $715 million + $42 million - $2 million = $755 million. The actual balance, $767 million, was $12 million higher. The difference could be due to advances (loans) made to the affiliates, foreign currency changes or AOCI adjustments at the affiliates or some other transactions (or adjustments) besides the ones described above.

12-29

E12-39.B (40 minutes) LO 7 1. & 2.

Current assets Investment in Miller

Healy $1,700,000 500,000

Miller $120,000

Plant assets .................................

3,000,000

Goodwill .......................................

Consolidating Adjustments $(500,000)

Consolidated $ 1,820,000 0

410,000

15,000

3,425,000

_________

________

45,000

Total assets .................................

$5,200,000

$530,000

$5,290,000

Liabilities ......................................

$ 700,000

$ 90,000

$790,000

Contributed capital ......................

3,500,000

400,000

(400,000)

3,500,000

Retained earnings .......................

1,000,000

40,000

(40,000)

1,000,000

Total liabilities & stockholders’ equity ........................................

$5,200,000

$530,000

$5,290,000

3. Miller contributed capital (-SE) ........................................................... 400,000 Miller retained earnings (-SE) ............................................................. 40,000 Plant assets (+A) ............................................................................... 15,000 Goodwill (+A) ..................................................................................... 45,000 Investment in Miller Co. (-A) ............................................................. 500,000 4. + Investment in Miller Co. (A) 500,000 1/1

+ Goodwill (A) 45,000

1/1 -

Miller Contributed Capital (SE) + 400,000

Miller Retained Earnings (SE) + 40,000

1/1

+ Plant Assets (A) 15,000

1/1

5. Balance Sheet Transaction 1/1 To consolidate Healy & Miller.

Cash Asset

Noncash Assets -500,000 Investment in Miller +45,000 Goodwill +15,000 Plant Assets

= =

Liabilities

Income Statement Contrib. Capital +

Earned Capital -400,000 Miller Contributed Capital

Revenues

- Expenses

Net = Income

-40,000 Miller Retained Earnings

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-40.B (30 minutes) LO 7 1. & 2. Rayburn Company purchased all of Kanodia Company's common stock for cash on January 1, after which the separate balance sheets of the two corporations appeared as follows:

Investment in Kanodia ................ Other assets ................................ Goodwill ....................................... Total assets ................................. Liabilities ...................................... Contributed capital ...................... Retained earnings ....................... Total liabilities & stockholders’ equity ........................................

Rayburn $ 600,000 2,300,000 . $2,900,000 $ 900,000 1,400,000 600,000

Kanodia

$2,900,000

$700,000

$700,000 . $700,000 $160,000 300,000 240,000

Consolidating Adjustments (600,000) 20,000 40,000

Consolidated $ 0 3,020,000 40,000 $3,060,000 $1,060,000 1,400,000 600,000

(300,000) (240,000)

$3,060,000

3. Kanodia contributed capital (-SE) ...................................................... 300,000 Kanodia retained earnings (-SE) ........................................................ 240,000 Other assets (+A) ............................................................................... 20,000 Goodwill (+A) ..................................................................................... 40,000 Investment in Kanodia Co. (-A) .........................................................600,000 4. + Investment in Kanodia Inc. (A) 600,000 1/1

+ Goodwill (A) 40,000

1/1 -

Kanodia Contributed Capital (SE) + 300,000

1/1

+ Other Assets (A) 20,000

1/1

Kanodia Retained Earnings (SE) + 240,000

5. Balance Sheet Transaction

Cash Asset

1/1 To consolidate Rayburn & Kanodia.

Noncash Assets -600,000 Investment in Kanodia +40,000 Goodwill +20,000 Other Assets

Liabil= ities =

Contrib. + Capital +

Income Statement Earned Capital -300,000 Kanodia Contributed Capital

Revenues

Net Expenses = Income =

-240,000 Kanodia Retained Earnings

12-31

E12-41. (20 minutes) LO 5 a. The investment is initially recorded on Engel’s balance sheet at the purchase price of $16.8 million, including $6.6 million of goodwill. Because the fair value of Ball is less than the carrying amount of the investment on Engel’s balance sheet, the goodwill is deemed to be impaired. To determine impairment, the imputed value of the goodwill is determined to be 12.5 million - $10.2 million = $2.3 million. b. Goodwill must be written down by $4.3 million. The write-down will reduce the carrying amount of goodwill by this amount, and the write-down will be recorded as a loss in Engel’s income statement, thereby reducing retained earnings by that amount.

E12-42.B (60 minutes) LO 5, 7 a. Cash paid .......................................................................... Fair market value of shares issued ................................... Purchase price .................................................................. Less: Book value of Harris ................................................ Excess payment................................................................

$210,000 180,000 390,000 280,000 110,000

Excess payment assigned to specific accounts based on fair market value: Buildings ........................................................................... 40,000 Patent ............................................................................... 30,000 Goodwill ............................................................................ $ 40,000 $110,000 b. Accounts Cash Receivables Inventory Investment in Harris

Easton Company $ 84,000 160,000 220,000 390,000

Harris Co. $ 40,000 90,000 130,000

100,000 400,000 120,000 0 $1,474,000

60,000 110,000 50,000 ---$480,000

Land Buildings, net Equipment, net Patent Goodwill Totals

Consolidation Entries

[S] [A]

$(280,000) (110,000)

[A]

40,000

[A] [A]

30,000 40,000

Consolidated Totals $ 124,000 250,000 350,000 160,000 550,000 170,000 30,000 40,000 $1,674,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. continued Table continued from previous page Accounts Accounts payable Long-term liabilities Common stock Additional paid-in capital Retained earnings Totals

Easton Company $ 160,000 380,000 500,000 74,000 360,000 $1,474,000

Harris Co. $ 30,000 170,000 40,000 240,000 $ 480,000

Consolidation Entries

[S]

(40,000)

[S]

(240,000)

Consolidated Totals $ 190,000 550,000 500,000 74,000 360,000 $1,674,000

c. The tangible assets are accounted for just like any other acquired asset. The receivables are removed when collected, inventories affect future cost of goods sold, and depreciable assets are depreciated over their estimated useful lives. Intangible assets with a determinable life are amortized (depreciated) over that useful life. Finally, intangible assets with an indeterminate useful life (such as goodwill) are not amortized, but are either tested annually for impairment, or more often if circumstances require. E12-43.A (20 minutes) LO 6 a. Investment in Harris Company (+A) ................................................... 28,800 Equity in earnings of Harris Company (-SE) ......................................

28,800

The equity in earnings of Harris Company is calculated as follows: 40% x [$80,000 – ($40,000  20) – ($30,000  5)] = $28,800 b. $156,000 + $28,800 – 40% x $40,000 = $168,800.

12-33

E12-44.C (20 minutes) LO 8 a. Companies use derivative securities in order to mitigate risks, such as commodity price risks, risks relating to foreign exchange fluctuations, or risks relating to fluctuations in interest rates. b. Derivatives are reported on the balance sheet as are the assets or liabilities to which they relate. Generally, derivatives and the related assets/liabilities are reported on the balance sheet at their fair market value. c. The unrealized gains (losses) on HPE’s derivatives are reported in the Accumulated Other Comprehensive Income section of its stockholders’ equity. This reporting indicates that the underlying item being hedged has not yet affected HPE’s profits. Once the underlying item appears in income, these unrealized gains (losses) will be removed from AOCI and transferred into current income, thus affecting HPE’s profitability.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

PROBLEMS P12-45. (50 minutes) LO 1, 2, 3 a. Available-for-sale investments are reported at market value on the balance sheet. Thus, Met Life’s bond investments are reported at: $308,931 million as of 2017 $289,563 million as of 2016 b. Net unrealized gains (losses) at the end of 2017 are: $22,820 million ($24,765 million - $1,945 million) Net unrealized gains (losses) at the end of 2016 are: $17,880 million ($21,826 million - $3,946 million) Because the investments are accounted for as available-for-sale, these unrealized gains (losses) did not affect reported income for 2017 and 2016. (Note: Had these investments been accounted for as trading securities, those unrealized gains (losses) would have affected reported income.) c. Realized gains (losses) are gains (losses) that occur as a result of sales of securities. These are reported in the income statement and affect reported income. Unrealized gains (losses) reflect the difference between the current market price of the security and its acquisition cost. Only unrealized gains (losses) from trading securities are reported in income. If MetLife had sold all of the AFS securities on which it had gains, its pre-tax income would have increased by $24,765 million. d. The evaluation of investment performance is difficult as companies have discretion over the timing of realized investment gains (losses) and can, thereby, affect reported income. By including unrealized gains (losses) in the analysis, we are able to get a clearer picture of overall investment performance—albeit, with an understanding that these gains and losses are not yet realized. These returns could then be compared with those of competitors and market rates in general for investments of comparable risk. We believe this reporting metric provides useful insights as noted.

12-35

P12-46.B (30 minutes)

Current assets ............................. Investment in Alpine ................... Plant assets (net) ....................... Total assets ................................. Liabilities ...................................... Common stock ............................ Retained earnings....................... Noncontrolling interest ................ Total liabilities & stockholders’ equity ........................................

Gem $258,000 392,000 265,000 $915,000

Alpine $160,000

$ 50,000 700,000 165,000

$ 60,000 420,000 140,000

$915,000

$620,000

Consolidating Adjustments $(392,000)

460,000 $620,000

(420,000) (140,000) 168,000

Consolidated $ 418,000 0 725,000 $1,143,000 $ 110,000 700,000 165,000 168,000 $1,143,000

P12-47. (40 minutes) LO 1, 2, 3, 4 a. The trading security investments will be reported at $375,300. This value is computed using their market values at year-end; specifically, $105,300 + $270,000. b. The available-for-sale investments will be reported at $359,000. This value is computed using their market values at year-end; specifically, $199,000 + 160,000. c. The held-to-maturity bond investments will be reported at $237,200. This value is computed using their amortized cost value at year-end; specifically, $101,200 + $136,000. d. Unrealized holding gains of $10,400 will appear in the 2019 income statement. These gains relate to the trading securities; specifically— Ling: $105,300 - $102,400 = $2,900 gain; Wren: $270,000 - $262,500 = $7,500; total of $2,900 + $7,500 = $10,400. The calculation is only possible because this is the first year the bonds have been held. Therefore, the entire price difference occurred this year. e.

Unrealized holding gains of $8,000 will appear in the stockholders' equity section of the December 31, 2019, balance sheet under accumulated other comprehensive income (AOCI). These losses relate to the available-for-sale securities; specifically — Olanamic: $199,000 - $197,000 = $2,000; Fossil: $160,000 - $154,000 = $6,000; total of $2,000 + $6,000 = $8,000.

A fair market value adjustment to investments of $8,000 will appear in the December 31, 2019, balance sheet. This adjustment relates to the available-for-sale securities. See part (e) for the supporting computations. The fair value adjustment increases the book value of the available-for-sale securities to their year-end market value.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

P12-48.A,B (60 minutes) LO 1, 4, 5, 6, 7 a. Yes, each individual company (e.g., parent and subsidiary) maintains its own financial statements. This approach is necessary to report on the activities of the individual units and to report to the respective stakeholders of each unit. The purpose of consolidation is to combine these separate statements to more clearly reflect the operations and financial condition of the combined (whole) entity. b. The Investment in Financial Products Subsidiaries is reported on the parent’s (Machinery and Power Systems’) balance sheet at $3,672 million. This amount is the same balance as reported for stockholders’ equity of the Financial Products subsidiary. This relation will always exist so long as the investment is originally purchased at book value (e.g., the parent created and funded the subsidiary). c. The consolidated balance sheet more clearly reflects the actual assets and liabilities of the combined company vis-à-vis that revealed in the equity method of accounting. That is, it better reflects operations as one entity as far as investors and creditors are concerned. The equity method of accounting that is used by the parent company to account for its investment in the subsidiary reflects only its proportionate share (100% in this case) of the investee company stockholders’ equity and does not report the individual assets and liabilities comprising that equity. d. The consolidating adjustments generally accomplish three objectives: (i) They eliminate the equity method investment on the parent’s balance sheet and replace it with the actual assets and liabilities of the investee company to which it relates. (ii) They record any additional assets that are included in the investment balance that may not be reflected on the subsidiary’s balance sheet, like goodwill, for example. (iii) They eliminate any intercompany sales and receivables/payables.

12-37

e. The consolidated stockholders’ equity and the stockholders’ equity of the parent company are equal. This equality will always be the case. The consolidation process replaces the investment account with the assets and liabilities to which it relates. Thus, stockholders’ equity remains unaffected. f. Consolidated net income will equal the net income of the parent company. The reason for this result is that the parent reflects the income of the subsidiary via the equity method of accounting for its investment. The consolidation process merely replaces the equity income account with the actual and individual sales and expenses to which it relates. Net income is unaffected. g. The equity method of accounting reports investments at adjusted cost (beginning balance plus equity earnings and less dividends received)—this contrasts with the market method. Unrealized gains for a subsidiary are, therefore, not reflected on the consolidated balance sheet and income statement. Instead, the subsidiary is reflected on the balance sheet at its purchase price net of depreciation and amortization, just like any other asset. The consolidation process merely replaces the investment account with the actual assets and liabilities to which it relates. Thus, there can exist substantial unrealized gains subsequent to the acquisition that are not reflected in the consolidated financial statements.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

CASES C12-49. (60 minutes) LO 1, 3 a. Return on assets: ROA =

$59,531 + (1 – 0.25)*$3,420 ($365,725 + $375,319)/2

0.168 or 16.8%

9.196 or 919.6%

b. Return on net operating assets RNOA =

(1 – 0.25)*$70,896 ($10,443 + $1,121)/2

RNOA above 900% is a very high number. One factor contributing to this return is Apple’s well-known use of contract manufacturers. Apple concentrates on the product design, but they let other companies do much of the manufacturing. Another factor is that Apple develops much of its intellectual property in-house, which means that it doesn’t show up on the balance sheet. Apple reports no goodwill asset in its balance sheet and no intangible assets, meaning that it does not buy other companies to acquire intellectual property. This reduces the company’s reported assets and increases its RNOA. c. Apple is using the available-for-sale method to account for its fixed-income investments. The value that will be used on the balance sheet is the fair value at the end of the fiscal year. The unrealized gains and losses are reported in the accumulated other comprehensive income section of the shareholders’ equity. d. Return on financial assets: The return on financial assets is measured as the income from interest and dividends divided by the average balance of financial assets (which Apple refers to as marketable securities). Return on Financial Assets =

(1 – 0.25)*$5,686 ($211,187 + $248,606)/2

0.019 or 1.9%

Apple’s return on its financial assets is much lower than its return on its operating assets. And, the dividend and interest income doesn’t tell the whole story. The unrealized holding gains (losses) have decreased (increased) over 2018, meaning that the value of the portfolio has dropped, but the decrease is not being reported in income (as it would be if the investments were accounted for using the trading method. The other comprehensive income (OCI) disclosure that there was a $3,407 million loss (after a provision for taxes) means that the total income from this portfolio (average value almost $230 billion) was less than a billion dollars after provision for taxes. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 12

12-39

C12-50. (50 minutes) LO 1, 3, 4 a. 2019: 1/2 Investment in Dye, Inc. (+A) ............................................................. 420,000 Cash (-A) .......................................................................................... 420,000 12/31 Dividend receivable (+A) .................................................................. 16,000 Dividend income (+R, +SE) .............................................................. 16,000 12/31 Unrealized loss (+E, -SE) ................................................................. 60,000 Investment in Dye, Inc. (-A) .............................................................. 60,000 2020: 1/18 Cash (+A) ......................................................................................... 16,000 Dividend receivable (-A) ................................................................... 16,000 b. + Cash (A) 16,000 420,000

1/18/20

12/31/19

1/2/19

+ Investment in Dye Inc. (A) 420,000 60,000 12/31/19

12/31/19

+ Dividend Receivable (A) 16,000 16,000

1/18/20

- Dividend Income (R) + 16,000

12/31/19

+ Unrealized Loss (E) 60,000

c. Balance Sheet Transaction 1/2/19 Buy 20,000 shares of Dye.

Cash Asset

Noncash Assets

Liabilities

Contrib. + Capital +

Earned Capital

+420,000 Investment

12/31/19 Declare dividend $.8/share.

+16,000 Dividend Receivable

+16,000 Retained Earnings

12/31/19 Recognize decline in investment.

-60,000 Investment

-60,000 Retained Earnings

1/18/20 Receipt of dividend.

-420,000 Cash

Income Statement

+16,000 Cash

-16,000 = Dividend Receivable

Revenues

+16,000 Dividend Income

Expenses

Net Income

+16,000

-60,000

+60,000 Unrealized Loss

Financial & Managerial Accounting for Decision Makers, 4 th Edition

d. 2019: ½ Investment in Dye, Inc. (+A) ............................................................. 420,000 Cash (-A) .......................................................................................... 420,000 12/31 Dividend receivable (+A) .................................................................. 16,000 Investment in Dye, Inc. (-A) ..............................................................16,000 12/31 Investment in Dye, Inc. (+A) ............................................................. 112,000 Investment income (+R, +SE) ........................................................... 112,000 2020: 1/18 Cash (+A) ......................................................................................... 16,000 Dividend receivable (-A) ...................................................................16,000 e. + Cash (A) 16,000 420,000

1/18/20

1/2/19

1/2/19 12/31/19

- Investment Income (R) + 112,000 12/31/19

+ Investment in Dye Inc. (A) 420,000 112,000 16,000 12/31/19

+ Dividend Receivable (A) 12/31/19 16,000 16,000

1/18/20

f. Balance Sheet Transaction 1/2/19 Buy 20,000 shares of Dye.

Cash Asset

Noncash Assets

Liabilities

Contrib. + Capital +

Earned Capital

Net

Revenues

- Expenses

= Income

+420,000 Investment

12/31/19 Declare dividend $.8/share.

+16,000 Dividend Receivable

12/31/19 Recognize income from investment.

+112,000 Investment

1/18/20 Receipt of dividend.

-420,000 Cash

Income Statement

-16,000 Investment

+16,000 Cash

-16,000 = Dividend Receivable

+112,000 Retained Earnings

+112,000 Investment Income

= +112,000

12-41

C12-51. (15 minutes) LO 1, 2, 3, 4, 5 a. Consolidated statements present the total assets and liabilities of all firms in which the reporting firm has more than a fifty percent ownership with intercompany accounts and transactions eliminated. b. Demski has a controlling interest in Asare and Demski Finance. Therefore, their assets and liabilities are all added to those of Demski Inc. Demski does not have a controlling interest in Knechel. Therefore, it must show its investment in Knechel Inc. as a financial asset. c. This excess is the amount paid to Asare in excess of the net book value of Asare’s assets (assets less liabilities assumed) when Asare was acquired by Demski. The amount is known more commonly as Goodwill and reflects the fact that Demski believed the company was worth more than the net book value of its assets. d. The amount represents the outside ownership claim on Asare’s net assets, which are aggregated in the balances of Demski’s accounts.

C12-52. (30 minutes) LO 1, 2, 3, 4 a. While the approach recommended by Gayle is not disallowed by a specific accounting standard, it is not consistent with the intent of GAAP. Certainly from a position of representational faithfulness, it specifically does not represent how management regards the investment or intends to treat it in the future. The approach recommended is a flagrant attempt to violate the spirit of GAAP in order to manage earnings. Such practice may get by the firm’s auditors once or twice, but failure to be consistent in the accounting treatment over time is unlikely to be tolerated under SOX and the increased scrutiny applied by the SEC in the wake of the numerous accounting scandals of the recent past. Further, such practice can lead to lawsuits by investors who can argue that management was not accounting truthfully. b. We believe the suggested approach to be highly unethical.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Chapter 12 Reporting and Analyzing Financial Investments Learning Objectives – coverage by question MiniExercises

Exercises

Problems

Cases and Projects

LO1 – Explain and interpret the three levels of investor influence over an investee – passive, significant, and controlling.

24, 25, 27, 32, 33 35 - 38

45, 47, 48

49 - 52

LO2 – Describe the term “fair value” and the fair value hierarchy.

45, 47

51, 52

LO3 – Describe and analyze accounting for passive investments.

12, 13, 20, 21, 22

24, 25, 27, 29, 32, 33, 35 - 37

45, 47

49 - 52

LO4 – Explain and analyze accounting for investments with significant influence.

15, 16, 19

30 - 32, 37, 38

47, 48

50 - 52

LO5 – Describe and analyze accounting for investments with control.

17,18,19, 23

26, 28, 34, 41, 42

46, 48

LO6 – Appendix 12A – Illustrate and analyze accounting mechanics for equity method investments.

LO7 – Appendix 12B – Apply consolidation accounting mechanics.

39, 40, 42

46, 48

LO8 – Appendix 12C – Discuss the reporting of derivative securities.

12-1

QUESTIONS Q12-1.

(a) Trading securities are reported at their fair value in the balance sheet. (b) Available-for-sale securities are reported at their fair value in the balance sheet. (c) Held-to-maturity securities are reported at their amortized cost in the balance sheet.

Q12-2.

An unrealized holding gain (loss) is an increase (decrease) in the fair value of an asset (in this case, an investment security) that is still owned. Investments in equity securities should be reported at their fair value on the balance sheet, with unrealized holding gains and losses reported in income in the period that they occur. There is a provision for non-marketable securities to use when the cost of estimating fair value is prohibitively expensive.

Q12-3.

Unrealized holding gains and losses related to trading securities are reported in the current-year income statement (and also retained earnings). Unrealized holding gains and losses related to available-for-sale securities are reported as a separate component of stockholders' equity called Other Comprehensive Income (OCI).

Q12-4.

Significant influence gives the owner of the stock the ability to significantly influence the operating and financing activities of the company whose stock is owned. Normally, this is accomplished with a 20% through 50% ownership of the company's voting stock. The equity method is used to account for investments with significant influence. Such an investment is initially recorded at cost; the investment is increased by the proportionate share of the investee company's net income, and equity income is reported in the income statement; the investment account is decreased by dividends received on the investment; and the investment account is reported in the balance sheet at its book value. Unrealized appreciation in the market value of the investment is not recognized.

Q12-5.

Yetman Company's investment in Livnat Company is an investment with significant influence, and should, therefore, be accounted for using the equity method. At year-end, the investment should be reported in the balance sheet at $258,000 [$250,000 + (40%  $80,000) - (40% x $60,000)].

Q12-6.

A stock investment representing more than 50% of the investee company's voting stock is generally viewed as conferring “control” over the investee company. The investor and investee companies must be consolidated for financial reporting purposes.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Q12-7.

Consolidated financial statements attempt to portray the financial position, operating results, and cash flows of affiliated companies as a single economic unit so that the scope of the entire (whole) entity is more realistically conveyed.

Q12-8.

The $750,000 investment in Murray Company appearing in Finn Company's balance sheet and the $300,000 common stock and $450,000 retained earnings appearing on Murray Company's balance sheet are eliminated. The two balance sheets (less the accounts eliminated) are then summed to yield the consolidated balance sheet.

Q12-9.B The $75,000 accounts payable on Dee's balance sheet and the $75,000 accounts receivable on Bradshaw's balance sheet are eliminated. In a consolidation, all intercompany items are eliminated so that the consolidated statements show only the interests of outsiders. Q12-10. Limitations of consolidated statements include the possibility that the performances of poor companies in a group are "masked" in consolidation. Likewise, rates of return, other ratios, and percentages calculated from consolidated statements might prove deceptive because they are composites. Consolidated statements also eliminate detail about product lines, divisional operations, and the relative profitability of various business segments. (Some of this information is likely to be available in the footnote disclosures relating to the business segments of certain public firms.) Finally, shareholders and creditors of subsidiary companies find it difficult to isolate amounts related to their legal rights by inspecting only consolidated statements.

12-3

MINI EXERCISES M12-11. (10 minutes) LO 1 a. SI

Griffin owns > 20% of Wright.

b. P

Bond investments are always classified as passive.

c. P

2,000 shares of Google is well below the number necessary to exert influence

d. C

Watts owns more than half of Zimmerman stock

e. SI

Even though Shevlin owns less than 20% of Bowen, the fact that it buys 60% of Bowen’s output means it is capable of exercising significant influence.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

$1,000,000 30,000 (12,000) $1,018,000

($100,000  0.3) ($40,000  0.3)

12-5

d. 1.

Investment in Lang Company (+A) ................................................... 30,000 Investment income (+R, +SE) ..........................................................

30,000

Cash (+A) ......................................................................................... 12,000 Investment in Lang Company (-A) ....................................................

12,000

e. + 3. + 1. 2.

Cash (A) 1,000,000 12,000

Investment in Lang Company (A) 1,000,000 30,000 12,000

Investment Income (R) 30,000

+ 2.

f. Transaction Purchase stock in Lang Company.

Cash Asset -1,000,000 Cash

Recognize share of Lang income. Receive dividend from Lang.

+12,000 Cash

Noncash Assets

Balance Sheet LiabilContrib. = ities + Capital +

+1,000,000 Investment

+30,000 Investment

-12,000 Investment

Income Statement Earned Capital

+30,000 Retained Earnings

Revenues

+30,000 Investment Income

Expenses

Net = Income

= +30,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

$750,000 15,000 $735,000

12-7

M12-19. (20 minutes) LO 4, 5 a. If DeFond purchases 100% of Verduzco’s common stock, then it must produce consolidated reports.

Current assets

DeFond Company

(before investment)

(after investment)

Verduzco Company

Eliminating Entries

DeFond Company (Consolidated)

$ 800

$ 500

$ 100

–

300

–

Noncurrent assets

2,000

900

2,900

Liabilities

2,200

700

2,900

600

300

Investment

Shareholders’ Equity

$ 600 –

(300)

600

b. If DeFond purchases 50% of the common stock of Lin Company, it uses the equity method. DeFond Company

DeFond Company

(before investment)

(after investment)

Lin Company

$ 800

$ 500

$ 200

–

300

–

Noncurrent assets

2,000

1,800

Liabilities

2,200

1,400

600

Current assets Investment

Shareholders’ Equity

Financial & Managerial Accounting for Decision Makers, 4 th Edition

M12-20. (40 minutes) LO 3 a. 2018 10/1

Investment in Skyline, Inc. (+A) ........................................................ 486,000 Cash (-A) ....................................................................................486,000

12/31 Interest receivable (+A) ..................................................................... 8,750 Interest revenue (+R, +SE) .........................................................

8,750

12/31 Investment in Skyline, Inc. (+A) ........................................................ 4,000 Unrealized gain (+R, +SE) ..........................................................

4,000

2019 3/31

4/1

8,750 8,750

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $4,000 in Skyline Inc. bonds is closed to retained earnings in 2018 increasing net income and retained earnings. +

Interest Revenue (R) 8,750 8,750

+ 12/31/18 3/31/19

+ Investment in Skyline Bonds (A) 10/1/18 486,000 12/31/18 4,000 490,000 4/1/19

Unrealized Gain (R) 4,000

+ 12/31/18

+ 12/31/19

Realized Gain (R) 2,300

3/31/19 4/1/19

Cash (A)

486,000

10/1/18

17,500 492,300

Interest Receivable (A) 8,750 8,750

3/31/19

4/1/19

12-9

c. Transaction 10/1/18 Purchase $500,000 of Skyline bonds at 97.

Cash Asset -486,000 Cash

Noncash Assets

Balance Sheet Liabil= ities +

Income Statement Contrib. Capital +

Earned Capital

Revenues

+ 486,000 Investment

12/31/18 Recognize interest revenue.

+8,750 Interest Receivable

+8,750 Retained Earnings

+8,750 Interest Revenue

12/31/18 Record unrealized gain.

+4,000 Investment

Expenses

Net Income

+8,750

+4,000 Retained Earnings

+4,000 Unrealized Gain

+4,000

3/31/19 Recognize interest income.

+17,500 Cash

-8,750 = Interest Receivable

+8,750 Retained Earnings

+8,750 Interest Revenue

+8,750

4/1/19 Sold Skyline investment.

+492,300 Cash

-490,000 Investment

+2,300 Retained Earnings

+2,300 Realized Gain

+2,300

171,200

12/22 Cash (+A) ...............................................................................10,000 Dividend income (+R, +SE) ....................................................

10,000

12/31 Unrealized loss (+E, -SE) .......................................................16,200 Investment in Lane, Inc. (-A) ..................................................

16,200

2019 1/20

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. Assuming the firm’s fiscal year ends 12/31, the unrealized loss of $16,200 is closed to the income summary in 2018, reducing net income and retained earnings. + Cash (A) 10,000 171,200 150,000

12/22 1/20

11/15

+ Investment in Lane Inc (A) 171,200 16,200 155,000 +

1/20 + 12/31

Unrealized Loss (E) 16,200

Loss (E) 5,000

12/31 1/20

- Dividend Income (R) + 10,000

12/22

c. Balance Sheet Transaction

Cash Asset

11/15 Purchase 10,000 shares of Lane Inc common.

-171,200 Cash

12/22 Dividend income.

+10,000 Cash

12/31 Decrease in Investment. 1/20 Sale of Lane common.

Noncash Assets

Liabil = -ities

+171,200 Investment

Income Statement Earned Capital

Revenues

Expenses

Net = Income =

+10,000 Retained Earnings

-16,200 Retained Earnings

+16,200 Unrealized Loss

= -16,200

-155,000 = Investment

-5,000 Retained Earnings

+5,000 Realized Loss

-16,200 Investment +150,000 Cash

Contrib. + Capital +

+10,000 Dividend Income

= +10,000

-5,000

12-11

8,750

12/31 Investment in Skyline, Inc. (+A) ........................................................ 4,000 Unrealized gain AOCI (+SE) .......................................................

4,000

2019 3/31

4/1

8,750 8,750

Cash (A)

486,000

10/1/18

17,500 492,300

+ Investment in Skyline Bonds (A) 10/1/18 486,000 12/31/18 4,000 490,000 4/1/19

+ 12/31/19

Interest Receivable (A) 8,750 8,750

3/31/19

Interest Revenue (R) 8,750 8,750

+ 12/31/18 3/31/19

Unrealized Gain (AOCI) + 4,000 12/31/18 4,000

4/1/19

Realized Gain (R) 6,300

+ 4/1/19

Note that most of the gain occurred in 2018, but was not recognized on the income statement until management decided to sell the securities in 2019.

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Transaction 10/1/18 Purchase $500,000 of Skyline bonds at 97.

Cash Asset -486,000 Cash

Noncash Assets

Balance Sheet Liabil= ities +

Income Statement Contrib. Capital +

Earned Capital

+ 486,000 Investment

12/31/18 Recognize interest revenue.

+8,750 Interest Receivable

+8,750 Retained Earnings

12/31/18 Record unrealized gain.

+4,000 Investment

+4,000 Unrealized Gain-AOCI

Revenues

+8,750 Interest Revenue

Expenses

Net Income

+8,750

3/31/19 Recognize interest income.

+17,500 Cash

-8,750 = Interest Receivable

+8,750 Retained Earnings

+8,750 Interest Revenue

+8,750

4/1/19 Sold Skyline investment.

+492,300 Cash

-490,000 Investment

+6,300 Retained Earnings

+6,300 Realized Gain

+6,300

-4,000 Unrealized Gain-AOCI

$600,000 310,000 $910,000

Jolson’s equity accounts are eliminated in the consolidation process.

12-13

EXERCISES E12-24. (30 minutes) LO 1, 3 a. Trading securities 1.

Investment in US Treasury bonds (+A) ........................................ 407,000 Cash (-A) ...................................................................................... 407,000

Cash (+A) ..................................................................................... 8,000 Interest income (+R, +SE) ............................................................

8,000

Investment in US Treasury bonds ................................................. 4,000 Unrealized holding gain (+R, +SE) ...............................................

4,000

4a. Cash (+A) ..................................................................................... 8,000 Interest income (+R, +SE) .............................................................

8,000

2. 4a. 4b

+ 3.

Unrealized Gain (R) 4,000

1. 3.

4b.

+ Investment in Liu (A) 407,000 4,000 411,000

4b.

- Interest Income (R) + 8,000 8,000

2. 4a.

+ Realized Loss on Sale (E) 3,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Balance Sheet Transaction 1. Purchase bonds for $407,000

-407,000 Cash

+407,000 = Investment

2. Receive interest payment of $8,000

+8,000 Cash

+8,000 Retained Earnings

+8,000 Interest Income

+8,000

+4,000 = Investment

+4,000 Retained Earnings

+4,000 Unrealized Holding Gain

+4,000

+8,000 Interest Income

+8,000

-3,000

3. Year-end market price of bonds is $411,000

Noncash Assets

Liabil= ities

Contrib. + Capital +

Income Statement

Cash Asset

Earned Capital

Revenues

- Expenses =

Net Income

4a. Receive interest payment of $8,000

+8,000 Cash

+8,000 Retained Earnings

4b. Sell bonds for $408,000

+408,000 Cash

-411,000 = Investment

-3,000 Retained Earnings

+3,000 Realized Holding Loss

d. Available-for-Sale Securities 1.

Investment in US Treasury bonds (+A) Cash (-A)

407,000 407,000

Cash (+A)

8,000 Interest income (+R, +SE)

8,000

Investment in US Treasury bonds Unrealized holding gain - AOCI (+SE)

4a. Cash (+A)

4,000 4,000 8,000

Interest income (+R, +SE)

8,000

4b. Cash (+A) Unrealized holding gain – AOCI (-SE) Investment in US Treasury bonds (-A) Realized holding gain (+R, +SE)

408,000 4,000 411,000 1,000

continued next page

12-15

d. continued + Cash (A) 8,000 407,000 8,000 408,000

2. 4a. 4b.

4b.

- Unrealized Gain AOCI (SE) + 4,000 4,000

Transaction

Cash Asset

1. Purchase bonds -407,000 for $407,000 Cash

2. Receive interest payment of $8,000

Noncash Assets

Balance Sheet LiabilContrib. = ities + Capital +

+ Investment in Liu (A) 407,000 4,000 411,000

4b.

- Interest Income (R) + 8,000 8,000

2. 4a.

- Realized Gain (R) + 1,000

+4,000 = Investment

4a. Receive interest payment of $8,000

+8,000 Cash

4b. Sell bonds for $408,000

+408,000 Cash

-411,000 = Investment

4b.

Income Statement Earned Capital

Revenues

+407,000 = Investment

+8,000 Cash

3. Year-end market price of bonds is $411,000

1. 3.

Expenses =

Net Income

+8,000 Retained Earnings

+8,000 Interest Income

+4,000 AOCI

+8,000 Retained Earnings

+1,000 Retained Earnings -4,000 AOCI

+8,000

+8,000 Interest Income

+8,000

+1,000 Realized Holding Gain

+1,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-25. (30 minutes) LO 1, 3 a. Equity investments measured at fair value, with all gains/losses recognized in income. 1.

2. 4.

Investment in Freeman, Co. (+A) ............................................80,000 Cash (-A) ................................................................................

80,000

Cash (+A) ............................................................................... 6,250 Dividend income (+R, +SE) ....................................................

6,250

Investment in Freeman, Co. (+A) ............................................ 7,500 Unrealized gain (+R, +SE) ......................................................

7,500

87,500

+ Cash (A) 6,250 80,000 86,400

- Unrealized Gain (R) + 7,500

1. 3.

+ Investment in Freeman (A) 80,000 7,500 87,500

- Dividend Income (R) + 6,250

+ Loss on Sale (E) 1,100

Cash Asset -80,000 Cash

Noncash + Assets +80,000 Investment

4. Ohlson Co. sells +86,400 all 5,000 common Cash shares of Freeman for $86,400 cash.

Income Statement Earned Capital

Revenues

+6,250 Retained Earnings

+6,250 Dividend Income

= +6,250

+7,500 = Investment

+7,500 Retained Earnings

+7,500 Unrealized Gain

= +7,500

+6,250 Cash

-87,500 Investment

Liabil= ities =

Contrib. + Capital +

-1,100 Retained Earnings

Expenses

+1,100 Loss

Net = Income =

= -1,100

12-17

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-27. (30 minutes) LO 1, 3 a. 2018 11/1

Investment in Joos, Inc. (+A) .............................................. 306,900 Cash (-A) ............................................................................

306,900

12/31 Interest receivable (+A) ...................................................... 4,500 Interest revenue (+R, +SE) .................................................

4,500

12/31 Unrealized loss (+E, -SE) ................................................... 5,400 Investment in Joos, Inc. (-A) ...............................................

5,400

2019 4/30

5/1

4,500 9,000

301,500

b. 4/30 5/1

+ Cash (A) 13,500 306,900 300,900

12/31

+ Unrealized Loss (E) 5,400

11/1

- Interest Revenue (R) + 4,500 9,000

12/31

+ 12/31 4/30

5/1

+ Investment in Joos Inc. (A) 306,900 5,400 301,500

12/31 5/1

+ Interest Receivable (A) 4,500 4,500

4/30

Loss on Sale of Investments (E) 600

12-19

c. Balance Sheet Transaction 11/1 Buy $300,000 Joos bonds @102.

Cash Asset -306,900 Cash

Noncash Assets

Liabilities

Income Statement Contrib. + Capital +

Earned Capital

+306,900 Investment

12/31 Accrue interest.

+4,500 Interest Receivable

+4,500 Retained Earnings

12/31 Recognize decline in value of bonds.

-5,400 Investment

-5,400 Retained Earnings

4/30 Receive interest.

+13,500 Cash

-4,500 Interest Receivable

+9,000 Retained Earnings

5/1 Sold Joos bonds.

+300,900 Cash

-301,500 Investment

-600 Retained Earnings

Revenues

+4,500 Interest Revenue

+9,000 Interest Revenue

- Expenses

Net = Income

+4,500

+5,400 = Unrealized Loss

-5,400

+9,000

-600

+600 Loss

900,000 440,000 $1,340,000 200,000 $1,540,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

+ Cash (A) 15,000 108,000 120,500

- Gain (R) + 3,500

1. 3.

+ Investment in Barth (A) 108,000 15,000 24,000 117,000

2. 4.

- Investment Income (R) + 24,000

c. Balance Sheet Transaction

Cash Asset

1. Buy 30% of Barth stock.

-108,000 Cash

+108,000 Investment

2. Receive dividend.

+15,000 Cash

-15,000 Investment

+24,000 Investment

+24,000 Retained Earnings

+24,000 Investment Income

= +24,000

-117,000 Investment

+3,500 Retained Earnings

+3,500 Gain

3. Recognize share of net income of Barth. 4. Sold Barth investment.

+120,500 Cash

Noncash Assets

Liabilities

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

+3,500

12-21

120,000

2. Cash (+A) .................................................................................12,000 Investment in Palepu Co. (-A) ...................................................

12,000

3. Investment in Palepu Co. (+A) ..................................................30,000 Investment income (+R, +SE) ...................................................

30,000

2,000 138,000

b. 2. 4.

+ Cash (A) 12,000 120,000 140,000

- Gain (R) + 2,000

1. 3.

+ Investment in Palepu (A) 120,000 12,000 30,000 138,000

2. 4.

- Investment Income (R) + 30,000

c. Balance Sheet Transaction

Cash Asset

Noncash Assets

Liabilities

Income Statement Contrib. + Capital +

Earned Capital

Revenues

Expenses

Net = Income

1. Buy 25% of Palepu stock.

-120,000 Cash

+120,000 Investment

2. Receive dividend.

+12,000 Cash

-12,000 Investment

3. Recognize share of net income of Palepu.

+30,000 Investment

+30,000 Retained Earnings

+30,000 Investment Income

= +30,000

4. Sold +140,000 Palepu Cash investment.

-138,000 Investment

+2,000 Retained Earnings

+2,000 Gain

Financial & Managerial Accounting for Decision Makers, 4 th Edition

+2,000

E12-32. (40 minutes) LO 1, 3, 4 a. 1. Fair Value Method 1.

Investment in Leftwich Co. (+A) ..................................... 150,000 Cash (-A) .......................................................................

150,000

No entry

Cash (+A) ....................................................................... 11,000 Dividend income (+R, +SE) ...........................................

11,000

Investment in Leftwich Co. (+A) ..................................... 40,000 Unrealized gain (+R, +SE) .............................................

40,000

2. + Cash (A) 11,000 150,000

- Unrealized Gain (R) + 40,000

1. 4.

+ Investment in Leftwich (A) 150,000 40,000 -

Dividend Income (R) + 11,000

3. Balance Sheet Transaction 1. Purchase Common shares.

Cash Asset -150,000 Cash

2. No entry. 3. Received a cash dividend of $1.10 per common share.

+11,000 Cash

4. Recognize increase in investment value at year end .

Noncash Assets

Liabilities

Contrib. + Capital +

Income Statement Earned Capital

Revenues

Expenses

+150,000 = Investment

Net Income

+11,000 Retained Earnings

+11,000 Dividend Income

+11,000

+40,000 = Investment

+40,000 Retained Earnings

+40,000 Unrealized Gain

= +40,000

12-23

2. 3.

+ Cash (A) 11,000 150,000

1. 2.

+ Investment in Leftwich (A) 150,000 11,000 24,000

- Investment Income (R) + 24,000

3. Balance Sheet Transaction 1. Purchase Common shares.

Cash Asset -150,000 Cash

2. Recognize 30% portion of Leftwich net income. 3. Received a cash dividend of $1.10 per common share.

+11,000 Cash

Noncash Assets

+150,000 Investment

+24,000 Investment

-11,000 Investment

4. No entry.

Liabilities

Contrib. + Capital +

Income Statement Earned Capital

Revenues

Net - Expenses = Income -

= +24,000

+24,000 Retained Earnings

+24,000 Investment Income

Financial & Managerial Accounting for Decision Makers, 4 th Edition

12-25

80,900

12/22 Cash (+A) ............................................................................6,250 Dividend income (+R, +SE) ..................................................

6,250

12/31 Investment in Core, Inc. (+A) ...............................................6,600 Unrealized gain (+R, +SE) ...................................................

6,600

87,500

b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of 6,600 increases net income and retained earnings in 2019.

12/22/19 1/20/20

+ Cash (A) 6,250 80,900 86,400

11/15/19

11/15/19 12/31/19

+ Investment in Core Inc (A) 80,900 6,600 87,500 1/20/20

+ Loss on Sale of Investment (E) 1/20/20 1,100 -

Unrealized Gain (R) 6,600

+ 12/31/19

- Dividend Income (R) + 6,250

12/22/19

Financial & Managerial Accounting for Decision Makers, 4 th Edition

c. Balance Sheet Transaction

Cash Asset

11/15 Purchase 5,000 shares of Core Inc common.

-80,900 Cash

12/22 Dividend income.

+6,250 Cash

12/31 Increase in Investment. 1/20 Sale of Core common.

Noncash Assets +80,900 Investment

Liabilities

Contrib. Capital +

Earned Capital

Revenues

Net - Expenses = Income

+6,250 Retained Earnings

+6,250 Dividend Income

+6,250

+6,600 Retained Earnings

+6,600 Unrealized Gain

+6,600

-87,500 = Investment

-1,100 Retained Earnings

-1,100

+6,600 Investment +86,400 Cash

Income Statement

+1,100 Loss on Sale

80,900

12/22 Cash (+A) ............................................................................6,250 Dividend income (+R, +SE) .................................................

6,250

12/31 Investment in Core, Inc. (+A) ...............................................6,600 AOCI (+SE) .........................................................................

6,600

87,500

+ Cash (A) 12/22/18 1/20/19

1/20/19

6,250 86,400

80,900

AOCI 1,100

+ 6,600

+ Investment in Core Inc (A) 11/15/18

11/15/18 12/31/18

12/31/18

80,900 6,600

87,500

1/20/19

- Dividend Income (R) + 6,250

12/22/18

12-27

a. continued

Transaction

Cash Asset

11/15 Purchase 5,000 shares of Core Inc common.

-80,900 Cash

12/20 Dividend income.

+6,250 Cash

12/31 Increase in Investment. 1/20 Sale of Core common.

Noncash Assets

+80,900 Investment

Income Statement Earned Capital

Revenues

+6,250 Retained Earnings

+6,600 AOCI

-87,500 = Investment

-1,100 AOCI

+6,600 Investment +86,400 Cash

Balance Sheet LiabilContrib. = ities + Capital +

+6,250 Dividend Income

Net - Expenses = Income

+6,250

Financial & Managerial Accounting for Decision Makers, 4 th Edition

E12-38. (30 minutes) LO 1, 4 (Entries in $ millions) a. Record share of income: Investment in affiliates (+A)……………………………. Income from affiliates (+R, +SE)…………...

42 42

b. Record receipt of cash dividends: Cash (+A)………………………………………………… Investment in affiliates (-A)……………………

2 2

12-29

E12-39.B (40 minutes) LO 7 1. & 2.

Current assets Investment in Miller

Healy $1,700,000 500,000

Miller $120,000

Plant assets .................................

3,000,000

Goodwill .......................................

Consolidating Adjustments $(500,000)

Consolidated $ 1,820,000 0

410,000

15,000

3,425,000

_________

________

45,000

Total assets .................................

$5,200,000

$530,000

$5,290,000

Liabilities ......................................

$ 700,000

$ 90,000

$790,000

Contributed capital ......................

3,500,000

400,000

(400,000)

3,500,000

Retained earnings .......................

1,000,000

40,000

(40,000)

1,000,000

Total liabilities & stockholders’ equity ........................................

$5,200,000

$530,000

$5,290,000

+ Goodwill (A) 45,000

1/1 -

Miller Contributed Capital (SE) + 400,000

Miller Retained Earnings (SE) + 40,000

1/1

+ Plant Assets (A) 15,000

1/1

5. Balance Sheet Transaction 1/1 To consolidate Healy & Miller.

Cash Asset

Noncash Assets -500,000 Investment in Miller +45,000 Goodwill +15,000 Plant Assets

= =

Liabilities

Income Statement Contrib. Capital +

Earned Capital -400,000 Miller Contributed Capital

Revenues

- Expenses

Net = Income

-40,000 Miller Retained Earnings

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Rayburn $ 600,000 2,300,000 . $2,900,000 $ 900,000 1,400,000 600,000

Kanodia

$2,900,000

$700,000

$700,000 . $700,000 $160,000 300,000 240,000

Consolidating Adjustments (600,000) 20,000 40,000

Consolidated $ 0 3,020,000 40,000 $3,060,000 $1,060,000 1,400,000 600,000

(300,000) (240,000)

$3,060,000

+ Goodwill (A) 40,000

1/1 -

Kanodia Contributed Capital (SE) + 300,000

1/1

+ Other Assets (A) 20,000

1/1

Kanodia Retained Earnings (SE) + 240,000

5. Balance Sheet Transaction

Cash Asset

1/1 To consolidate Rayburn & Kanodia.

Noncash Assets -600,000 Investment in Kanodia +40,000 Goodwill +20,000 Other Assets

Liabil= ities =

Contrib. + Capital +

Income Statement Earned Capital -300,000 Kanodia Contributed Capital

Revenues

Net Expenses = Income =

-240,000 Kanodia Retained Earnings

12-31

$210,000 180,000 390,000 280,000 110,000

Easton Company $ 84,000 160,000 220,000 390,000

Harris Co. $ 40,000 90,000 130,000

100,000 400,000 120,000 0 $1,474,000

60,000 110,000 50,000 ---$480,000

Land Buildings, net Equipment, net Patent Goodwill Totals

Consolidation Entries

[S] [A]

$(280,000) (110,000)

[A]

40,000

[A] [A]

30,000 40,000

Consolidated Totals $ 124,000 250,000 350,000 160,000 550,000 170,000 30,000 40,000 $1,674,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

b. continued Table continued from previous page Accounts Accounts payable Long-term liabilities Common stock Additional paid-in capital Retained earnings Totals

Easton Company $ 160,000 380,000 500,000 74,000 360,000 $1,474,000

Harris Co. $ 30,000 170,000 40,000 240,000 $ 480,000

Consolidation Entries

[S]

(40,000)

[S]

(240,000)

Consolidated Totals $ 190,000 550,000 500,000 74,000 360,000 $1,674,000

28,800

The equity in earnings of Harris Company is calculated as follows: 40% x [$80,000 – ($40,000  20) – ($30,000  5)] = $28,800 b. $156,000 + $28,800 – 40% x $40,000 = $168,800.

12-33

Financial & Managerial Accounting for Decision Makers, 4 th Edition

12-35

P12-46.B (30 minutes)

Gem $258,000 392,000 265,000 $915,000

Alpine $160,000

$ 50,000 700,000 165,000

$ 60,000 420,000 140,000

$915,000

$620,000

Consolidating Adjustments $(392,000)

460,000 $620,000

(420,000) (140,000) 168,000

Consolidated $ 418,000 0 725,000 $1,143,000 $ 110,000 700,000 165,000 168,000 $1,143,000

Financial & Managerial Accounting for Decision Makers, 4 th Edition

12-37

Financial & Managerial Accounting for Decision Makers, 4 th Edition

CASES C12-49. (60 minutes) LO 1, 3 a. Return on assets: ROA =

$59,531 + (1 – 0.25)*$3,420 ($365,725 + $375,319)/2

0.168 or 16.8%

9.196 or 919.6%

b. Return on net operating assets RNOA =

(1 – 0.25)*$70,896 ($10,443 + $1,121)/2

(1 – 0.25)*$5,686 ($211,187 + $248,606)/2

0.019 or 1.9%

12-39

1/18/20

12/31/19

1/2/19

+ Investment in Dye Inc. (A) 420,000 60,000 12/31/19

12/31/19

+ Dividend Receivable (A) 16,000 16,000

1/18/20

- Dividend Income (R) + 16,000

12/31/19

+ Unrealized Loss (E) 60,000

c. Balance Sheet Transaction 1/2/19 Buy 20,000 shares of Dye.

Cash Asset

Noncash Assets

Liabilities

Contrib. + Capital +

Earned Capital

+420,000 Investment

12/31/19 Declare dividend $.8/share.

+16,000 Dividend Receivable

+16,000 Retained Earnings

12/31/19 Recognize decline in investment.

-60,000 Investment

-60,000 Retained Earnings

1/18/20 Receipt of dividend.

-420,000 Cash

Income Statement

+16,000 Cash

-16,000 = Dividend Receivable

Revenues

+16,000 Dividend Income

Expenses

Net Income

+16,000

-60,000

+60,000 Unrealized Loss

Financial & Managerial Accounting for Decision Makers, 4 th Edition

1/18/20

1/2/19

1/2/19 12/31/19

- Investment Income (R) + 112,000 12/31/19

+ Investment in Dye Inc. (A) 420,000 112,000 16,000 12/31/19

+ Dividend Receivable (A) 12/31/19 16,000 16,000

1/18/20

f. Balance Sheet Transaction 1/2/19 Buy 20,000 shares of Dye.

Cash Asset

Noncash Assets

Liabilities

Contrib. + Capital +

Earned Capital

Net

Revenues

- Expenses

= Income

+420,000 Investment

12/31/19 Declare dividend $.8/share.

+16,000 Dividend Receivable

12/31/19 Recognize income from investment.

+112,000 Investment

1/18/20 Receipt of dividend.

-420,000 Cash

Income Statement

-16,000 Investment

+16,000 Cash

-16,000 = Dividend Receivable

+112,000 Retained Earnings

+112,000 Investment Income

= +112,000

12-41

Financial & Managerial Accounting for Decision Makers, 4 th Edition

Chapter 13 Managerial Accounting: Tools for Decision Making QUESTIONS Q13-1.

Financial accounting is oriented toward external users and is concerned with general-purpose financial statements. These financial accounting statements are highly aggregated, report on relatively long time periods, are oriented toward the past, and must conform to external standards. These standards emphasize the use of objective data. Management accounting is oriented toward internal users and is concerned with special-purpose information. This information may be aggregated or disaggregated, depending on need, and the reporting period may be long or short, depending on need. The information is oriented primarily toward the future and does not need to conform to external standards. Consequently, the data may be subjective, if subjective information is relevant.

Q13-2.

Strategic cost management is a blending of three themes: cost driver analysis, strategic position analysis, and value chain analysis.

Q13-3.

An organization's mission is the basic purpose toward which its activities are directed. Organizations vary widely in their missions. A goal is a definable, measurable objective. Goals are based on an organization’s mission.

Q13-4.

The three strategic positions that lead to business success are cost leadership, product or service differentiation, and focus on a market niche. Cost leadership involves controlling costs to better the competitive position of the firm. Product or service differentiation involves creating something considered unique and worth a premium price, and focusing on a market niche says that the firm can better serve a narrow strategic market than a broad one.

Solutions Manual, Chapter 13

Q13-5.

With a strategy of cost leadership, an organization is unable to distinguish its product from that of competitors, and competition is primarily on the basis of price. Careful budgeting and cost control with frequent and detailed performance reports are critical for a cost leadership strategy to succeed. With a strategy of product differentiation, the organization’s products are easily distinguished from those of competitors, and customers are less sensitive to price. In this case, while managers must understand the financial consequences of their actions, frequent and detailed cost information is less important. Instead, costs should be analyzed from the customer’s viewpoint, and the organization should work closely with customers to enhance the value of products or services to them.

Q13-6.

Planning, organizing, and controlling are referred to as a continuous cycle because the process of controlling feeds back into the process of planning. Future plans and organizing to accomplish and implement them are modified on the basis of past experience. Information on how actual results differ from planned results is provided in the controlling phase of operations.

Q13-7.

Advances in telecommunications to move data, in computers to process data into information, and in transportation to move products and people have fostered the move away from isolated national economic systems toward an interdependent global economy.

Q13-8.

Today's competition takes place on the three interrelated dimensions of cost, quality, and service. Cost includes the purchase price and all subsequent operating and maintenance costs. Quality is the degree to which products or services meet customer needs. Service includes such things as the helpfulness of sales personnel, product modifications to satisfy a particular customer's needs, timely delivery, and subsequent support.

Q13-9.

Top management can help to set an ethical tone in the organization by ensuring that the company has a code of ethics and demonstrating its support for the code, but more importantly by leading the organization with ethical behavior.

Q13-10.

Many ethical dilemmas involve actions that are perceived to have desirable short-run consequences and highly probable undesirable long-run consequences. The ethical action is to face an undesirable situation now to avoid a worse situation later. Yet, the decision maker may prefer to believe that things will work out in the long run, be overly concerned with the consequences of not doing well in the short run, or simply not care about the future because the problem will then belong to someone else.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q13-11.

Activity cost drivers are affected by previous decisions concerning structural and organizational cost drivers. • Structural cost drivers result from fundamental decisions about the size and scope of operations and the technologies employed in delivering products or services to customers. • Organizational cost drivers result from choices concerning the organization of activities and choices concerning the involvement of persons inside and outside the organization in decision making. • Activity cost drivers are specific units of work (activities) performed to serve customers’ needs that consume costly resources.

Solutions Manual, Chapter 13

MINI EXERCISES M13-12. 1. 2. 3. 4. 5. 6. 7. 8.

l n o e b i c f

M13-13. a. Management accounting b. Financial accounting c. Financial accounting d. Management accounting e. Management accounting f. Management accounting

9. 10. 11. 12. 13. 14. 15.

g. h. i. j. k. l.

a d g h j k m

Financial accounting Financial accounting Financial accounting Management accounting Management accounting Financial accounting

M13-14. The IMA developed a framework emphasizing the need for management accountants to partner in planning and decision making, create performance management systems, and provide expertise in financial reporting and control. See http://www.imanet.org/tools-andresources/competency-framework. Globally, IMA supports the profession through research, the CMA® (Certified Management Accountant) program, continuing education, networking, and advocacy of the highest ethical business practices. The IMA’s CMA program focuses specifically on the competencies required by organizations and CFOs to protect investors and drive business value. The CMA tests one’s competency in financial planning and analysis, risk management and internal controls, strategic costing, decision support, performance management, corporate finance, ethics, and more.

Financial & Managerial Accounting for Decision Makers, 4th Edition

M13-15. a. Strategy b. Mission c. Mission d. Mission e. Goal

f. g. h. i. j.

Strategy Goal Strategy Strategy Goal*

*Note: Answers may vary depending on an individual’s time horizon and circumstances. Graduating is a goal for someone with a long time horizon. It may be a mission for someone with a short time horizon. It may be a strategy for persons seeking to advance in their current careers.

M13-16. a. Staff b. Line c. Line d. Staff e. Staff f. Staff

M13-17. a. Line b. Staff c. Staff d. Staff e. Staff f. Line

M13-18 • Global environment • Big data analysis • Enterprise risk management • Sustainability accounting • Corporate social responsibility • Corporate governance • (Lean manufacturing and just in time inventory are discussed in Chapter 19)

13-5

M13-19. a. Organizational b. Structural c. Structural d. Structural e. Activity

f. g. h. i. j.

Activity Organizational Organizational Activity Structural

M13-20. a. Structural b. Organizational c. Activity d. Activity e. Structural

f. g. h. i. j.

Structural Activity Organizational Structural Activity

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E13-21. The major differences between financial and managerial accounting are summarized in Exhibit 14-1. Important differences from Katie’s viewpoint are: • Financial accounting is a reporting system, while management accounting is a decisionmaking medium. • Financial accounting is concerned with external users, while management accounting is concerned with internal users. • Financial accounting concerns general-purpose financial statements, while management accounting concerns special-purpose information. • Financial accounting statements are highly aggregated, while management accounting information may be aggregated or disaggregated, depending on the needs of management. • Financial accounting reports are for a relatively long reporting period, while management accounting reports are for a long or a short period, depending on need. • Financial accounting reports on the past, while management accounting is oriented toward the future. Managerial accounting can help Katie be a better product manager by: • Providing her with a framework for analyzing decision alternatives. • Providing information needed to develop plans for a coming period. • Providing information needed to measure performance and identify possible areas of improvement. Note: There are many other possible answers.

Solutions Manual, Chapter 13

E13-22. Note: This is one of many possible solutions that can be developed from the given information.

E13-23. The answers to this question will vary. The purpose of the assignment is to help students realize that management accounting performance reports may include nonmonetary as well as monetary measurements. The assignment also attempts to stress the importance of time and quality, as well as the importance of dollars. Nonmonetary Monetary

Quality

Time

Average starting salary

Percentage employed

Average time to obtain employment

Operating costs

Percentage of correct initial diagnoses

Time waiting for attention

Sales revenue

Returned orders

Time telephone customers are on hold

Activity cost

Number of errors

Time waiting for service

Operating costs

Items delivered to wrong address

Items not shipped by promise date

Financial & Managerial Accounting for Decision Makers, 4th Edition

E13-24. The answers to this question will vary. The purpose of the assignment is to help students realize that management accounting performance reports may include nonmonetary as well as monetary measurements. The assignment also attempts to stress the importance of time and quality, as well as the importance of dollars. Nonmonetary Monetary

Quality

Time

a. Cost of maintaining servers

Number of outages

Time to download Earthlink’s home page

b. Average cost per installation

Percent installations on date promised

Average time to complete installation

Number of returns

Time between order and delivery

d. Average sale per connection

Number of downtime episodes

Time to download Web page to customer

e. Average activities cost per enrolled student

Satisfaction survey results

Average time spent by students at activities

Average cost per delivery

E13-25. The answers to this question will vary. The purpose of the assignment is to help students realize that management accounting performance reports may include nonmonetary as well as monetary measurements. The assignment also attempts to stress the importance of time and quality, as well as the importance of dollars. Nonmonetary Monetary

Quality

Time

a. Dollar sales volume

Number of referrals

Time to respond to customer phone calls

b. Dollar sales volume

Response to customer satisfaction surveys

Time between order and delivery

Number of repeat customers

Time customers unattended

d. Interest rate on financing

Error rate in processing invoices, checks, etc.

Days sales in accounts receivable

e. Return on investment

Employee turnover

Time to respond to phone calls

Dealership profit

Solutions Manual, Chapter 13

E13-26. Activity

Cost Driver

Pay vendors

Number of checks issued

Receive material deliveries

Number of deliveries

Inspect raw materials

Number of units of raw materials received

Plan for purchases of raw materials

Number of different raw material items

Packaging

Number of customer orders

Supervision

Number of employees

Employee training

Number of classes offered

Operating machines

Number of machine hours

Machine maintenance

Number of maintenance hours

10.

Opening accounts at a bank

Number of new customers

Financial & Managerial Accounting for Decision Makers, 4th Edition

CASES and PROJECTS C13-27. Answers to this question will vary. However, goals must be definable, measurable objectives and strategies are courses of action that will assist in achieving one or more goals. An important point to make is that a failure to set goals will lead to a lack of direction and inaction. a. Possible instructor goals include: • Helping students learn to answer questions, such as those posed by Drucker (What information do I need to do my job? When do I need it? From whom should I be getting it?) as well as other questions requiring the analysis of financial information. •

Having students master the basic elements of management accounting.

•

Having all students achieve a passing grade or perform at a certain level on examinations and papers.

•

Accomplishing the objectives stated on the course syllabus or presented in the first class period.

Possible instructor strategies include homework assignments, research papers, class discussions, team projects, guest speakers, examinations, and so forth. b. Possible student goals may parallel instructor goals. They may also be based on a desired grade. I stress that students who have goals do better than those who do not have goals. I also encourage students to set motivating goals rather than low goals such as passing. Possible student strategies include completing course assignments on time, budgeting time to study, forming study groups, asking for help when something is not clear, and so forth.

Solutions Manual, Chapter 13

c. Student goals for the semester may be based on performance in specific courses, or they may refer to milestones in achieving longer-range goals. At this point, I give a plug for the importance of developing a professional orientation through out-of-class activities by participating in professional organizations, reading business periodicals, making postgraduation plans, and so forth. Again, I stress that while establishing goals is a difficult unstructured task, it is an important element of success. Student strategies for the semester may include budgeting time for study and other activities, identifying professional meetings they will attend, and so forth. d. Students may not have an immediate career goal other than completing this course or their MBA degree. In this case, establishing an objective for their next job search is a good career goal for the current semester. Students might also discuss how course work, including management accounting, can help them achieve their career goals. They might also include the role of extracurricular activities, leadership experiences, work experience, and so forth.

C13-28. a. •

The company could have the sales managers hand out pamphlets to customers that tell them why Lobster's Unlimited lobsters are better than others.

•

The company could somehow mark the lobsters to distinguish them. Perhaps a rubber band bearing the company name and logo could be used to hold the claws together.

•

The firm could give free recipes with each lobster sold.

Note: There are many more possible solutions. b. Differentiation may increase customer demand for Lobster's Unlimited lobsters and may increase customer loyalty. It may establish the brand as a higher-quality product. However, students should realize that this differentiation would probably not be successful. It is extremely difficult to create differentiation for a product that has no difference. A lobster is a lobster. Unlike some other goods, such as bananas, where the inputs (sunlight, water) can be changed in production, the lobsters can be caught only from the sea. The firm has no power to make its lobsters any different from the rest.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C13-29. a. Rory’s behavior is not ethical. Although she replaces the money, she is still taking it without authorization – which, technically, is stealing. The partners of the law firm do not know that she "borrows" money. b. This behavior is definitely unethical. She is embezzling funds from the firm.

C13-30. Jake’s actions would be regarded as unethical by any reasonable standard because he lied on his expense report for his own personal gain. Such action would likely be grounds for dismissal in most companies. However, scenarios such as this are probably common in practice because it is often very easy for the perpetrator to overstate expenses and then rationalize his behavior to avoid a guilty conscience. Jake has probably told himself that it’s okay to overstate his expenses because he could have spent more to stay in a nicer hotel or to eat better food. His actions may be understandable, but cannot be justified.

C13-31. Based on the information given, it appears that Circuit Electronics has been improving its financial position at the expense of Household by: • Supplying inferior switches • Overcharging • Shipping more switches than needed Based on the information given about the expected life of the switches, it also appears that problems related to the quality of the switches will start to become apparent during the next two years. It is likely that the appearance of quality problems will lead to an independent investigation on the part of Household and possibly uncover the overcharging and excess inventory levels. It appears that Tom has three options: 1. Ignore the problems and hope they go away. 2. Start looking for another job. 3. Bring the problem to the attention of appropriate officials. Concerning the first alternative, the facts suggest that the problems will not go away. Worse, with the passage of time, the problems will become increasingly identified with Tom, to the detriment of his career. Continued

Solutions Manual, Chapter 13

If other opportunities are available, the second alternative may allow Tom to avoid facing the problems without damaging his career. Tom should be careful in seeking and accepting a new position as he has no assurance that he will not encounter similar, or worse, ethical problems at another company. Although most difficult, the third alternative, bringing the problem to the attention of appropriate officials, is best for both Household and Circuit Electronics. Household has formed a partnership with Circuit Electronics. That partnership is built on trust and assumes that Circuit Electronics will act in the best interest of Household. The failure of Circuit Electronics to uphold its part of the agreement has hurt Household financially. If the quality problem isn’t addressed immediately, Household’s reputation for quality may be severely damaged. If Circuit Electronics takes the initiative in notifying Household of the problem, there may be an opportunity to salvage its relationship with Household or, at least, to avoid significant negative publicity. Tom should start by notifying his immediate supervisor of the problem. If the results are not satisfactory, Tom might follow the additional procedures outlined in a code of ethics such as that for management accountants. Note: This problem was inspired by Fred R. Bleakly, “Strange Bedfellows: Some Companies Let Suppliers Work on Site and Even Place Orders,” The Wall Street Journal (January 13, 1995), pp. 1, 6. The assignment does not, however, incorporate any specific facts in the article.

C13-32. The lower courts found Exxon Mobil guilty of cheating the State of Alabama out of $63.8 million. They also assessed the company $3.5 billion in punitive damages, the third largest verdict ever. According to Business Week writer Mike France, Alabama jurors were inflamed by internal corporate documents indicating Exxon was aware it was shortchanging the state. According to jury foreman, Shae Fillingham, “They knew what they were doing wasn’t right, but they did it anyway.” Commenting on the verdict, Eugene Stearns (who won a $1 billion judgment against Exxon on behalf of gas station dealers who claimed they were overcharged) observed that they “don’t have much respect for the civil justice system. They fight over everything. They don’t concede the obvious.” Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

Exxon denounced the verdict as “meritless” and pledged to “take all legal steps to challenge the verdict.” According to Kenneth P. Cohen, “Alabama is notorious for excessive punitive damages, and, unfortunately, we are the latest in the saga.” The Business Week writer concluded his commentary noting “the company is once again bashing the American legal system. But the oil giant seems to be missing the broader point: that its own arrogance may be as much to blame for the big verdicts as irrational jurors.” (Note: In 2007, the Alabama Supreme Court struck down the punitive damages and reduced the actual damages to $51.9 million.)

C13-33. There are an almost unlimited number of possible answers to this question. The purpose of the question is to get students thinking about the interrelationships among the elements of the question and to assist them in applying them in practice. The nature of the business can easily be changed from class to class. a. The mission of the business is to earn a profit by selling and repairing bicycles. b. Service differentiation seems like the most realistic way to compete with local hardware and discount stores. Knowledgeable employees who take a personal interest in customers — plus have specialized maintenance skills — would be one approach to service differentiation. It might also be possible to have product differentiation by selling bicycles that have a quality reputation. c. Possible long-range goals include: • Adding one additional brand of bicycles each year. • Achieving an average 20 percent annual return on investment within three years. • Increasing the number of serious bicycle riders in the area. (Note: Strategy might be developing a program of activities to encourage bicycling, while making the sport more enjoyable for customers who buy the “high-end” bikes sold at the store.) d. Possible goals for the coming year include: • Finding a location for the store and acquiring the merchandise necessary to operate the business. • Obtaining a line of credit from a local bank. e. Decisions affecting structural cost drivers include: • The decision to enter the retail bicycle business. • Decisions concerning the number and types of bicycle products to be sold. • The decisions about the size and location of the store.

Solutions Manual, Chapter 13

Organizational cost drivers include: • Agreements with vendors that will provide for fast delivery and allow for lower inventory levels. • Empowering employees to order merchandise and make decisions concerning special price reductions. • Deciding to sell for store credit, accept bank cards, or sell strictly for cash. • Determining the layout of the store that will affect the number of employees who have to be on duty at any one time. (Will maintenance be in back or out in front?)

g. Activity cost drivers include: • Number of bicycles sold of each type. • Number of purchase orders processed. • Bank card charges. (There is a fee charged the merchant by the bank.) • Number of hours the store is open.

C13-34. This case was developed by Professor Chee Chow. The authors have used it during the first class period as an “icebreaking” overview to motivate interest in management accounting and preview a number of issues addressed in the course. After calling roll, over-viewing differences between financial and management accounting, and reviewing the course outline, ask the students to take five minutes to read the case. While they are doing that, you might supply the answer to requirement (a) and start the discussion with requirement (b). Invariably, the students respond with active and broad-based participation, setting a nice tone for the entire course. The following notes are a combination of those of Professor Chow and the authors. This case reduces psychological and technical barriers to student participation by (1) using a small business with which students are likely to be familiar, and by (2) keeping technical details to a minimum. While the essential elements of the case can be covered in 20 minutes, the case has enough facets and side issues to support a full class period. The type of business used in the example can easily be changed to one that is more common in the local environment, such as a taco shop. These notes are merely suggestive of the issues addressed using this short, nontechnical case. As the students discuss the case questions, it is useful to write their points on the board. Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

a. Develop an organization chart for The Cappuccino Express.

Optional: Drawing the organization chart provides an opportunity to overview line and staff relationships and the need to organize activities. b. What factors can be expected to have a major impact on the success of The Cappuccino Express? Identifying critical success factors is an important topic in many management courses. This question is aimed at getting students to view the situation from a manager’s (as opposed to an accountant’s) perspective. Students typically have no difficulty coming up with a rather long list of such factors, including location, the price that The Cappuccino Express charges per cup, the cost of coffee beans, the extent of competition (e.g., other coffee outlets in the vicinity), lease/rental cost, the cost of equipment, the serving capacity (e.g., cups per hour) of the establishment, and wage costs. As each new factor is suggested, ask the students to explain how they think it would affect the success of The Cappuccino Express. Students will explain, for example, that location affects the number of potential customers and the ease with which they can make their purchases. Optional: We usually close this part of the discussion after putting up six to eight of the students' suggested factors. An interesting extension of part (b) is to close the discussion by noting that some of these factors, such as location and pricing, are within Vincent's control. Others, such as the extent of competition and the cost of coffee beans, are substantially noncontrollable by him. Thus, Vincent needs both to monitor the external environment for impending threats and opportunities and to align the factors within his control to respond to these factors.

Solutions Manual, Chapter 13

c. What major tasks must Vincent undertake in managing The Cappuccino Express? This question starts to focus attention on the factors within the firm manager's control. The following items are among the most often suggested: 1. Evaluating whether he should stay in business (that is, whether the business is sufficiently profitable) 2. Evaluating each site to make sure that it continues to be profitable 3. Evaluating new sites or expansions to current sites 4. Evaluating changes in product offerings 5. Pricing 6. Deciding on the amount and types of promotions 7. Ensuring employee efficiency 8. Maintaining service and product quality If, after putting up six to eight items, the students had not suggested monitoring and motivating of each site manager as one of the tasks, we guide them in this direction by asking: "If you were Vincent, would you make all of these decisions yourself, or would you delegate some of them to the site managers?" Invariably, the students choose to delegate some decisions to each site manager, such as supervising employees and maintaining service and product quality. Based on these suggestions, the monitoring and motivating of each site manager can easily be added to the list. Although more time could be devoted to part (c), after listing approximately eight items, it is time to continue with part (d), which follows logically from part (c).

Financial & Managerial Accounting for Decision Makers, 4th Edition

d. What are the major costs of operating The Cappuccino Express? The students' responses will vary across class sections, as will the way that they label some cost items. Nevertheless, the students’ list generally includes the following items: 1. Vincent's assistant's salary 2. Rent at each site 3. Business license for each site 4. Insurance for each site 5. Employee wages at each site 6. Promotion/advertising 7. Equipment depreciation at each site 8. Utilities at each site 9. Cost of coffee beans 10. Cost of supplies Sometimes the students correctly include Vincent's forgone salary as a cost of The Cappuccino Express. If they do not, it is useful to prompt them in this direction by asking: "If Vincent were to seek employment with another company, what level of compensation might he command, given his experience and track record?" After the students have suggested a dollar figure, a good follow-up question is to ask whether this amount is a cost of operating The Cappuccino Express. This discussion helps the students to appreciate the nature and relevance of opportunity costs. (This also could lead to a discussion of the differences in the treatment of owners’ “salaries” by a proprietorship and a corporation.) This discussion helps the students understand that some monetary costs not included in financial accounting records are relevant to management decision making (e.g., Vincent's forgone salary). Further, there are unrecorded, nonmonetary costs and benefits (e.g., the psychological costs and benefits from running one's own business) which also are relevant. Letting the students develop these points helps them appreciate the need for managerial information systems, which go beyond simply following a set of rules developed for a different purpose (e.g., generally accepted accounting principles for external reporting).

Solutions Manual, Chapter 13

e. Vincent would like to monitor the performance of each site manager. What measures of performance should he use? This question moves the discussion to yet another level of detail. An item that always comes up early is the site's profitability. When this measure is first suggested, briefly discuss the need to differentiate between the performance of the site and that of its manager. Students readily accept that while each site's profitability is likely to be affected by factors that are within the manager's control (e.g., speed of service), it also is a function of factors not controllable by him or her (e.g., location). If the students stop after having suggested only site profitability, prompt them to think of additional factors. The list generally grows to include such other measures as employee turnover, service and product quality, and customer satisfaction. As each additional factor is suggested, ask the students why it is relevant and how they propose to measure it. The students often explain, for example, that high turnover among the hourly employees may lead to elevated hiring costs and poor service due to disgruntled or inexperienced employees, and that lower customer satisfaction will likely lead to lower future sales. Related to measuring customer satisfaction, their suggestions may range from conducting surveys to giving out discount coupons for repeat purchases and then counting the number of such coupons redeemed. Two points emerge from this discussion. The first is that accounting numbers often lag other measures in reflecting some aspects of operating conditions. Thus, while customer dissatisfaction and high employee turnover ultimately will reduce profits, the periodic profit measures may not reveal this downward trend until it is too late for corrective action. The second point is that accounting data capture only a subset of the information needed for effective management. It is important to collect and consider nonfinancial data, some of which are not easily quantified (e.g., customers' written feedback on comment forms).

Financial & Managerial Accounting for Decision Makers, 4th Edition

If you suggested more than one measure, which of these should Vincent select if he could use only one? This question brings the focus back to accounting data. Without fail, the students select profitability. A useful follow-up is to put a simple profit formula on the board Profit = Total revenues minus total costs and ask whether it would be difficult to determine the total revenues from each site. The answer is obviously "no" since the two sites are operated independently. Thus, the focus quickly shifts to determining each site's costs. Returning to the list of costs already on the board, ask the students to identify those costs that can be readily traced to each site. The students will agree that many items, such as rent, utilities, coffee bean costs and employee salaries are easily traced. They also will recognize some items as being indirect costs of each site. For example, since Vincent is overseeing the entire business, how should his opportunity cost be attributed to each site? What about his assistant's salary? What about advertising? Discussing these general administrative costs helps to bring out the idea of direct and indirect costs. A diagram similar to the one shown below can help solidify the students' understanding of these concepts. If the instructor desires, he or she also can briefly introduce the issue of indirect/service department cost allocations and note that more detailed treatment of this topic is deferred to a later part of the course.

Continued

Solutions Manual, Chapter 13

continued Optional: Depending on time constraints, you can preview segment reporting if you wish and preview the alternative (considered in Chapter 11) of computing each site’s contribution to common costs and a profit. Optional: Another possibility is to ask how advertising expenditures would be treated in financial accounting reports. The students will readily respond that advertising would be treated as an expense. I then ask whether the effects of advertising in a given period (a month or a year) totally dissipate when the period ends. Invariably, the students agree that while the effects of advertising do decay over time, this process may occur over a number of periods. Optional: As another follow-up, it is useful to briefly consider how Vincent might decide on the expense and asset components. You can bring up the distinction between financial accounting, which is objective, and management accounting, which is subjective. We generally conclude this discussion by noting that the choice is between being precisely wrong (i.e., expensing the entire advertising expenditures) and being only approximately right. Optional: The treatment of advertising expenses also can be used to introduce the behavioral consequences of performance measurement. Ask the students: "Suppose advertising is the responsibility of each site manager, that you are manager of the original site, and that your site's advertising expenditures are treated as a period expense. It is getting close to the end of the year, and you believe that at the current rate your site's profit will fail to meet Vincent's expectations. What are you likely to do regarding advertising?" Reducing advertising is invariably suggested, thus providing an illustration that accounting data can significantly affect managerial decisions via its role in performance evaluation.

Financial & Managerial Accounting for Decision Makers, 4th Edition

g. Suppose that last year, the original site had yielded total revenues of $146,000, total costs of $122,000, hence a profit of $24,000. Vincent had judged this profit performance to be satisfactory. For the coming year, Vincent expects that due to factors such as increased name recognition and demographic changes, the total revenues will increase by 20 percent to $175,200. What amount of profit should he expect from the site? Discuss the issues involved in developing an estimate of profit. If time is a concern, this question can be focused by asking whether profits would also increase by 20 percent to $28,800. If the students respond "no," then I ask them to explain why. If they respond "yes," pick a fixed cost from the list developed for part (d), e.g., rent, and ask them whether this cost, along with all of the other direct costs for the site, would increase by 20 percent also. The students quickly realize from this question the need to reconsider their answer. At this point, ask if we can develop a range within which the correct answer may be found. Once this is done, we might be able to develop a somewhat more educated, but highly subjective, estimate of profit. After a quick introduction to the notion of fixed and variable costs, we typically end with a range such as the following: All fixed costs

All variable costs

Sales

$175,200

Expenses

(122,000)

(146,400)

Profit

$ 53,200

$ 28,800

We then review the costs in part (d), trying to classify them as primarily fixed or primarily variable. Previewing the next Chapter, we may also talk about mixed and step costs and cost estimation. We often use rent to illustrate fixed costs and the cost of coffee beans to illustrate variable costs. This segment can be concluded by drawing a total cost line, such as that in Chapter 2. Optional: Other cost terms and concepts can be introduced by asking what actions a site manager can take to increase his/her site's profitability. The suggestions typically include special promotions, improving service, and increased advertising. After writing a number of suggestions on the board, I note that many involve the incurrence of cost to increase sales. For example, increasing service speed by adding employees may attract more customers. To evaluate these alternatives' effects on revenues and costs, the site manager needs to determine the profit contribution, hence unit costs, of each product.

Continued

Solutions Manual, Chapter 13

g. continued Optional: Another possibility is to ask students how they could determine the cost and profitability of the costs of each site. The discussion can immediately focus on attributing these costs to each type of coffee, and in turn, to each cup of each type. Asking how several of the direct costs should be handled can further strengthen students' grasp of the concepts of direct and indirect costs. For example, the cost of coffee beans can be clearly traced to each site, each type of coffee, and each cup. In contrast, the students will see that rental cost and employees' wages are direct costs to the site but indirect costs to each type of coffee. Here again, the emphasis is on distinguishing between rulebased financial reporting and reporting for internal management purposes. Optional: The case can also be used to discuss the following questions: • What is the mission of The Cappuccino Express? • What are a few goals for the next year? • What are one or more strategies for reaching each goal? • What strategic position should The Cappuccino Express seek? • What are two or more structural, organizational, and activity cost drivers?

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 14 Cost Behavior, Activity Analysis, and Cost Estimation QUESTIONS Q14-1.

Variable, fixed, mixed, and step costs and their related total cost functions are described as follows: • Variable costs are uniform for each incremental unit of activity. Total variable costs change in direct proportion to changes in activity, equaling zero dollars when activity is zero and increasing at a constant amount per unit of activity. • Fixed costs are a constant amount per period of time. The fixed cost curve is flat with a slope of zero. • Mixed costs contain a fixed and a variable cost element. They are positive when activity is zero and increase in a linear fashion as activity increases. • Step costs are constant within a given range of activity but differ between ranges of activity. They increase in a step-like fashion as activity increases.

Q14-2.

There are a multitude of underlying factors that drive costs. Typically, costs will have many different drivers and will therefore react differently to changes in volume. This can make presenting all costs of an organization as a function of a single independent variable not accurate enough to make specific decisions concerning products, services, or activities.

Q14-3.

The vertical axis intercept of the economists’ short-run total cost function represents capacity costs. Because of high marginal costs at low levels of activity, the initial slope is quite steep. In the normal activity range, where marginal costs are quite low, the slope becomes less steep. Then, because of high marginal costs above the normal activity range, the slope of the economists’ total cost function increases again. The range of operations within which a linear function is a reasonable approximation of total costs is called the relevant range.

Solutions Manual, Chapter 14

Q14-4.

Using the high-low method, the first step is to select representative observations for high and low activity levels. Next, variable costs per unit are found by dividing the difference in total costs by the difference in total activity. Once variable costs are determined, the fixed costs, which are identical in both periods, are computed by estimating the total variable costs of either the high or low activity period and subtracting them from the corresponding total costs.

Q14-5.

Cost estimation concerns the determination of previous or current relationships between activity and cost, while cost prediction is the forecasting of future costs. Cost estimating equations, developed using past data, are frequently used for predicting future costs.

Q14-6.

A scatter diagram helps in selecting high and low activity levels representative of normal operating conditions. It also can be used to determine if costs can be reasonably approximated by a straight line.

Q14-7.

Least-squares regression analysis uses all available data, rather than just two observations. It can also provide standardized information on how well the cost estimating equation fits the historical cost data.

Q14-8.

Matching activity and cost within a single observation is important because accuracy is reduced if activity is recorded in one time period and costs are recorded in another. This problem is most likely to exist with short time periods.

Q14-9.

During the past century • Direct materials have increased slightly as a percentage of total manufacturing costs. • Direct labor has decreased significantly as a percentage of total manufacturing costs. • Manufacturing overhead has increased significantly as a percentage of total manufacturing costs. In the past, when manufacturing overhead was relatively small, it was possible to ignore overhead and assume that units of product or service were the primary cost driver. With the increase in manufacturing overhead, units of final product or service are no longer an adequate explanation of changes in manufacturing overhead.

Q14-10.

In a manufacturing facility (such as Apple), unit-level activities are performed for each unit of product (each individual iPad), batch-level activities are performed for each batch of product (one run or shift of production), product-level activities are performed to support the production of the product (the iPad product line), and facility-level activities are performed to maintain general manufacturing capabilities (the plant that produces the iPad).

Financial & Managerial Accounting for Decision Makers, 4th Edition

MINI-EXERCISES M14-11. a. b. c. d. e.

Fixed Variable Fixed Step Variable

f. g. h. i. j.

Mixed Variable Mixed Variable Fixed

f. g. h. i. j.

Variable Mixed Fixed Variable Mixed

f. g. h. i. j.

8 7 5 2 3

k. 12 l. 5 m. 4 n. 3 o. 8

f. g. h. i. j.

9 6 1 7 2

k. 8 or 12 (Slope of total costs increases.) l. 3 m. 10

M14-12. a. b. c. d. e.

Fixed Mixed Mixed Variable Step

M14-13. a. b. c. d. e.

8 8 11 1 11, 6, 4

M14-14. a. b. c. d. e.

4 2 7 5 11

Solutions Manual, Chapter 14

EXERCISES E14-15. a. Monthly Volume

Total Fixed Costs

1,000 10,000 50,000 100,000

$40,000 40,000 40,000 40,000

Total Variable Costs (Unit x $0.75) $

750 7,500 37,500 75,000

Total Monthly Costs

Total Average Cost per order

$40,750 47,500 77,500 115,000

$40.75 4.75 1.55 1.15

b. Because the variable costs remain constant at $0.75 per unit, an average cost of $2.35 will occur when the average fixed cost is $1.60 per unit. This will occur at 25,000 orders per month: $40,000/$1.60 = 25,000 servings per month

E14-16. a.

Units

Current Process Variable Fixed Costs Total Costs ($0.15/unit) Costs

Proposed Process Variable Fixed Costs Total Costs ($0.05/unit) Costs

10,000 25,000

$5,500 5,500

$7,000 7,000

$ 1,500 3,750

$7,000 9,250

$ 500 1,250

$7,500 8,250

b. It is apparent from the solution to (a) and the difference in cost structures that the proposed process costs less at higher volumes, while the current process costs less at lower volumes. If the cost functions are set equal to each other to find the volume at which they yield identical costs, we can determine that the automatic process is preferred above this volume. Cost of current process $5,500 + $0.15X $0.10X X

= = = = =

Cost of automatic process $7,000 + $0.05X $1,500 $1,500 / $0.10 15,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

E14-17. a.

Student Help

Collating Machine

Units

Fixed Costs

Variable Costs*

Total Costs

Fixed Costs

Variable Costs**

Total Costs

1,000,000 2,000,000

$0 0

$2,000 4,000

$3,000 3,000

$50 100

$3,050 3,100

* $10.00 per hour/5,000 copies per hour = $0.002 per copy ** $0.05 per 1,000 copies/1,000 copies = $0.00005 per copy

b. It is apparent from the solution to (a) and the difference in cost structures that the collating machine costs less at higher volumes, while the student help costs less at lower volumes. If the cost functions are set equal to each other to find the volume at which they yield identical costs, we can determine that the collating machine process is preferred above this volume. Cost of student help $0.002X $0.00195X X

= = = = = =

Cost of collating machine $3,000 + $0.00005X $3,000 $3,000 / $0.00195 1,538,461.54 1,538,462 (rounded)

Beyond a monthly volume of 1,538,462 copies, the collating machine is preferred.

E14-18. Variable costs

= =

($267,500 − $219,500) / (855,000 − 695,000) $0.30 per mile

Fixed costs

= =

$267,500 − $0.30(855,000) $11,000

= =

$219,500 − $0.30(695,000) $11,000

Total annual costs = $11,000 + $0.30X where: X = annual fleet miles

Solutions Manual, Chapter 14

E14-19. a. Variable costs

= =

($132,770 − $47,410) / (4,840 − 1,320) $24.25 per sales order

Fixed costs

= = = =

$132,770 − $24.25(4,840) $15,400 $47,410 − $24.25(1,320) $15,400

Monthly order processing costs = $15,400 + $24.25X where: X = sales orders b.

Variable costs

= =

($90,970 − $47,410) / (3,300 – 1,320) $22 per sales order

Fixed costs

= = = =

$90,970 − $22(3,300) $18,370 $47,410 − $22(1,320) $18,370

Monthly order processing costs = $18,370 + $22X where: X = sales orders c. The equation used in (a) is influenced by the unusually high costs incurred at a volume of 4,840 sales orders. This volume may require the payment of overtime and cause inefficiencies resulting from operating beyond the capacity for which facilities were designed. The effect of basing a cost estimating equation on this observation is to overstate the variable costs and to understate the fixed costs. © Cambridge Business Publishers, 2021 14-6

Financial & Managerial Accounting for Decision Makers, 4th Edition

E14-20. a. Variable costs

= =

($8,310 − $4,960) / (325 − 75) $13.40 per mile

Fixed costs or

= =

$8,310 − $13.40(325) = $3,955 $4,960 − $13.40(75) = $3,955

Monthly labor costs = $3,955 + $13.40X where: X = miles mowed and cleaned b.

Variable costs

= =

($8,310 − $5,760) / (325 − 200) $20.40 per mile

Fixed costs or

= =

$8,310 − $20.40(325) = $1,680 $5,760 − $20.40(200) = $1,680

Monthly labor costs = $1,680 + $20.40X where: X = miles mowed and cleaned c. The equation used in (a) is influenced by the unusually high costs incurred in October relative to the fact that only 75 miles were mowed and cleaned. The October activity is low, perhaps due to the reduced growth of grass and less highway litter after the end of the summer vacation season. Employees may have had extra time and may have paced their work to fill the available time. The effect of including the October observation in the high-low cost estimate is to understate the variable costs and to overstate the fixed costs. d. The effect of an 5 percent wage increase is to increase the amount of each cost element by 5 percent. Total costs = $1,764 + $21.42X

Solutions Manual, Chapter 14

E14-21. a. Fixed costs are easily identified. They are the same at each activity level. Variable and mixed costs can be determined by dividing total costs by monthly sales at two activity levels. The quotients of variable costs will be the same at both levels. The quotients of mixed costs will be lower at the higher activity level. This is because the fixed costs are spread over a larger number of units. Cost Cost of food sold Wages and fringe benefits Fees paid delivery help Rent on building Depreciation on equipment Utilities Supplies (soap, floor wax, etc.) Administrative costs

Behavior Variable Mixed Variable Fixed Fixed Mixed Mixed Fixed

b. Fixed Costs V M

V F F M

Cost of food sold ($15,000 – 7,500) / (10,000 - 5,000) Wages and fringe benefits: [($6,000 − $5,900) / (10,000 − 5,000)] [$6,000 − ($0.02  10,000)] Fees paid delivery help ($12,000 – 6,000) / (10,000 - 5,000) Rent on building Depreciation on equipment Utilities: [($700 − $600) / (10,000 − 5,000)] [$700 − ($0.02  10,000)] Supplies: [($600 − $400 ) / (10,000 − 5,000)] [$600 − ($0.04  10,000)] Administrative costs Total costs equation

Variable Costs $1.50X 0.02X

$5,800 1.20X 3,500 850 0.02X 500 0.04X 200 1,200 $12,050

______ $2.78X

Where: X = unit sales Note: The computations can be performed at other activity levels. c. Total costs = $12,050 + $2.78(8,500) = $35,680

Financial & Managerial Accounting for Decision Makers, 4th Edition

E14-22. a. Dog Day Occupancy

Average Costs

150 600

Total Costs

$65.00 20.00

$ 9,750 12,000

Variable costs

= ($12,000 − $9,750) / (600 − 150) = $5 per dog-day

Fixed costs or

= $12,000 − $5.00(600) = $9,750 − $5.00(150)

= =

$9,000 per month $9,000 per month

Total cost = $9,000 + $5.00X where: X = dog-days per month b. Total Fixed costs ($9,000  12) Total Variable costs ($5  4,500) Total costs Dog-days Average cost per dog-day

Solutions Manual, Chapter 14

$ 108,000 22,500 $130,500  4,500 $ 29.00

E14-23. a.

Manufacturing costs appear to have a higher correlation with units manufactured than with units sold. This conclusion is based on a visual inspection of the scatter diagrams. Using correlation as a criterion, units manufactured is the better predictor of manufacturing costs. Note: The instructor may ask the student to compute the coefficients of determination (R Square) between each independent variable and manufacturing costs as an optional assignment. R Square between manufacturing costs and units manufactured is 0.934, and the coefficient between manufacturing costs and units sold is 0.03. b. Units are often produced in periods before the one in which they are sold. Because manufacturing costs are incurred in connection with the manufacture rather than the sale of products, it seems reasonable to expect that manufacturing costs will also have a higher correlation with units produced than they will with units sold. c. Because selling costs are incurred in connection with selling rather than manufacturing activities, unit sales should be the better predictor of selling costs.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E14-24. a. R-squared values between possible independent variables and shipping expenses are as follows (rounded to nearest thousandth): Units shipped Weight shipped Sales value

0.9433 0.7754 0.2266

Based on the coefficient of determination, units shipped has the closest relationship with shipping expenses. b. Shipping expenses = $6,194 + $3.14X (fixed and variable costs are rounded to the nearest cent or hundredth) where: X = units shipped c. Shipping expenses

Solutions Manual, Chapter 14

= =

$6,194 + ($3.14 x 14,000) $50,154

PROBLEMS P14-25. a. Signature’s cost estimation equation: b = ($35,336 – $25,000) / (7,800 – 1,000) = $1.52 a = $35,336 – (7,800 × $1.52) = $23,480 Y = $23,480 + $1.52(sales in dozens) b. Plot of equations and observations:

A review of the scatter diagram indicates the April unit volume is not representative. Revising the cost-estimating equation with the more representative February and June volumes: b = ($35,336 – $28,670) / (7,800 – 4,500) = $2.02 a = $35,336 – (7,800 × $2.02) = $19,580 Y = $19,580 + $2.02(sales in dozens) c. The representative values identified with the aid of a scatter diagram provide a better cost-estimating equation and better predictor of future costs. This is because it omits the outlier observation at a volume of 1,000 units. d. No. The observation for 1,000 units should be omitted because it does not appear representative of normal operating conditions. e. Reasons why the least-squares method is superior to the high-low and scatter diagram methods of cost estimation include. • It is objective. • It provides a measure of how well the cost-estimating equation explains the variation in the dependent variable. © Cambridge Business Publishers, 2021 14-12

Financial & Managerial Accounting for Decision Makers, 4th Edition

P14-26. a. Rate per machine hour

= =

($600,000 + $40,000 + $84,000)/20,000 hours $36.20 per machine hour

Predicted manufacturing overhead to produce 8,000 units of the lime vinaigrette: ($36.20  1,000 machine hours) = $36,200 b. Unit-level rate per machine hour Batch-level rate per order Product-level rate per product

= $600,000 / 20,000 hours = = $40,000 / 400 orders = = $84,000 / 15 products =

$30/hour $100/order $5,600/product

Predicted manufacturing overhead to produce 4,000 units of the lime vinaigrette using cost hierarchy: Unit-level costs ($30  1,000 hours) $30,000 Batch-level costs ($100  60 orders) 6,000 Product-level costs 5,600 Total $41,600 c. Predicted lime vinaigrette manufacturing overhead based on machine hours Predicted lime vinaigrette manufacturing overhead using cost hierarchy Under-prediction of manufacturing overhead costs with use of machine hours d. Batch-level rate per machine hour

= =

$36,200 −41,600 $ (5,400)

$40,000 / 20,000 hours $2 per machine hour

Batch-level costs predicted using machine hours ($2  1,000) Batch-level costs predicted using orders ($100  60 orders) Under-prediction of X1 batch-level costs with use of machine hours e. Product-level rate per machine hour

= =

$84,000 / 20,000 machine hours $4.20 per machine hour

Product-level costs predicted using machine hours ($4.20  1,000) Product-level costs predicted using rate per product Under-prediction of X1 product-level costs with use of machine hours

Solutions Manual, Chapter 14

$2,000 − 6,000 $ (4,000)

$4,200 − 5,600 $ (1,400)

P14-27. a. Chicken (5 bags1 x $5/bag) Wages (2 hours x $10/hour) Fresh oil Total batch cost 1 10 piece bags and each batch is 50 pieces

$25.00 20.00 9.00 $54.00

b. Batch cost (3 batches2 x $54/batch) = $162.00 Unit cost ($162 /150 units) = $ 1.08 2 150 pieces divided by 50 piece of chicken per batch c. 7 batches3 x $54/batch = $378.00 3 350 pieces divided by 50 pieces per batch d. It will increase $2.00 per hour  2 hours

e. Chicken (10 bags  $5/bag) Wages (4 hours  $10/hour) Fresh oil Total batch cost

$4.00 $50.00 40.00 9.00 $99.00

350 pieces / 100 pieces per batch = 4 batches With a batch size of 100 units four batches are required to obtain 350 pieces. Total cost = (4 batches  $99.00) Unit cost = ($396 / 350)

= =

$396.00 $ 1.13 (rounded)

P14-28. Management should not increase the batch size to 100. If they did increase the batch size, the unit costs would increase from $1.08 to $1.13. The increased batch size does not enable the exact number of pieces of chicken needed to be prepared with no waste. When the batch size is 100 pieces, 400 pieces must be prepared to get 350 pieces. Management should also consider quality issues. If the oil is replaced frequently, the taste of chicken may be better. Hence, producing 50-piece batches may result in both lower cost and better quality. Management should also be sure to follow Health Department regulations.

Financial & Managerial Accounting for Decision Makers, 4th Edition

CASES and PROJECTS C14-29. Mr. Connor’s reaction may be appropriate in this case. Apparently the assistant engaged in a random search for a high R-squared, testing relationships that had no logical relationship. If enough random relationships are tested, the laws of probability indicate that, sooner or later, a high R-squared will be found. Relationships determined in this way are merely hypotheses and they should be verified on a second set of independent data. Ultimately, it may be determined that ‘pounds of scrap’ has a high R-squared with manufacturing overhead, but it does not seem to be a feasible basis for predicting manufacturing overhead. In order to do this, it would be necessary to predict scrap. This would cause predictions of overhead to be two steps removed from their cause—production.

C14-30. a. Repairs and maintenance take place during periods of low production, perhaps because they are deferred until time is available or because the existence of a breakdown, requiring repairs, halts production. Think of miles driven and maintenance costs on an automobile. A car cannot be driven as much on the day it is in the garage being repaired. b. Weekly or monthly data might provide a better match of the relationship between production and repair costs. Production personnel might be asked how frequently machines need repairs under normal operating conditions. If it is weekly, then weekly data might be used.

Solutions Manual, Chapter 14

C14-31. James is in a difficult situation. There is a strong temptation to keep quiet and hope there is no problem. Perhaps the excess oil consumption was a random event. There is also a temptation to want to avoid detecting a pollution problem. If there is pollution, it might not be detected when Westfield is demolished and paved over; and if pollution is detected then, James will be in another position. If questioned at that later date, he could claim ignorance. On the other hand, if there is a pollution problem that continues for a couple more years, the cost of cleanup will be much higher than if the problem is corrected immediately. The increased awareness of the dangers of ground water pollution and the corresponding increase in regulations make it very unlikely that an oil tank leakage problem will go undetected. Hence, correcting the problem today will likely be significantly less expensive than correcting it at some future date when more oil has leaked, and the leaked oil has traveled further. No information is provided about the ethical climate set by top management. James would feel much more comfortable informing top management of the situation and making an appropriate recommendation if he believed top management wanted to do the right thing. On the other hand, if top management treated the bearers of bad news as “whistle-blowers,” he has some difficult decisions to make. If Westfield has a code of ethics, James should consult it. If a code is not available for Westfield, he might consult the code for another business or professional organization. The appropriate sequence of actions is outlined under the heading “Ethics in Management Accounting” from Module 13 of this text. In this case, James should start by discussing the problem with his immediate supervisor. He should explain the situation, outline the financial aspects of the alternative actions, and point out the advantage of developing a reputation as a “good corporate citizen, concerned about the environment.” Such a reputation will make the development of shopping malls in new communities easier.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C14-32. a. The relevant major assumption that limits the accuracy of the current cost estimating equation is that the volume of activity is the only cost driver. b. Incorporating the hierarchy of activity costs into the cost estimating equation will improve the accuracy of cost predictions. The current equation erroneously assumes that all varieties of soup cost the same to produce, that all packaging costs vary with gallons, and that all distribution activities vary with gallons. Recognizing the variability in each of these cost elements improves accuracy. c. A general form of a more accurate cost-estimating equation is as follows: Y = b1iX1i + b2iX2i + b3iX3i + b4iX4i + b5 iX5i Labels, descriptions, and examples of elements are: Y = total costs per month b1i, b2i, b3, b4i, b5i = cost per unit of cost driver X1i = unit-level driver, where the subscript i refers to a specific driver, such as pounds of raw materials X2i = batch-level driver, where the subscript i refers to a specific driver, such as batch inspection X3i = product-level driver, where the subscript “i” refers to a specific driver, such as maintaining a supplier for special ingredients, perhaps almonds X4i = customer driver, where the subscript “i” refers to a specific driver, such as packaging or advertising X5 = facility-level drivers, where the subscript “i” refers to a specific driver, such as property taxes

Solutions Manual, Chapter 14

C14-33. a. The following results are obtained using a spreadsheet program: Regression Output: Constant Std Err of Y EST R Squared No. of Observations X Coefficient(s) Std Err of Coef.

74.965 15.440

-4,275.29 812.14 0.90296 12 235.786 68.015

51.627 274.98 12.533 44.029

The resulting cost estimation equation and the cost per unit of each service is as follows: Y = –$4,275.29 + $74.97(X1) + $235.79(X2) + $51.63(X3) + $274.98(X4) This equation explains 90.3 percent of the variation in total monthly costs. b. A comparison of the proposed rates and the estimated variable costs is presented below: Procedure Proposed rate Est. cost Profit (loss)

X1 $ 100.00 −74.97 $25.03

X2 $200.00 −235.79 $(35.79)

X3 $60.00 −51.63 $ 8.37

X4 $300.00 −274.98 $ 25.02

The desirability of the proposal depends on the mix of services used by the employees of the local business. If the mix contained a significant portion of X2, the proposal might not be desirable. Perhaps the best recommendation is to negotiate on the rate for procedure X2 to make sure that service is profitable. Phoenix might even offer to reduce the rate on procedure X1 to obtain an increase in the rate for X2. c. According to the given information, the proposed rates are significantly below the current rates. Hence, accepting the proposal would require turning away regular customers who pay more for the identical services. This is not logical. Phoenix should reject the proposal.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C14-34. a. The high observation is April and the low observation is December. Slope = ($105,790 – $54,900) / (142 – 72) = $50,890/70 = $727 Vertical axis intercept = $105,790 – ($727 × 142) = $2,556 or Vertical axis intercept = $54,900 – ($727 × 72) = $2,556 Cost estimating equation: Y = $2,556 + $727X b. The scatter diagram is as follows:

It appears the April observation is not representative of normal operating conditions and should be excluded from an analysis of costs under normal operating conditions. c. The high observation is now August while the low observation remains December. Slope = ($79,724 – $54,900) / (130 – 72) = $24,824 / 58 = $428 Vertical axis intercept = $79,724 – ($428 × 130) = $24,084 or Vertical axis intercept = $54,900 – ($428 × 72) = $24,084 Cost estimating equation: Y = $24,084 + $428X The results are strikingly different from those obtained in part a. The vertical axis intercept is much higher while the slope is smaller. Basically, the unusual high observation in part a pulled the high end of the equation up from what it should be.

Solutions Manual, Chapter 14

d. Presented is a partial printout from an Excel spreadsheet, excluding the April observation, with items of interest highlighted in bold: SUMMARY OUTPUT Regression Statistics Multiple R 0. 936498 R Square 0.877028 Adjusted R Square 0.869342 Standard Error 2999.442 Observations 18

Intercept Tables produced

Coefficients 19749.30 450.11

Standard Error 4388.040 42.137

t Stat 4.501 10.682

P-value 0.0004 1.088E-07

A consideration of the data not presented in bold, although important in applications of regression analysis, is beyond the scope of this text where we focus on how cost data can be analyzed using regression analysis. The cost estimating equation is: Cost estimating equation: Y = $19,749.30 + $450.11X This equation has two advantages over that developed in part c. • It uses all observations (except April), rather than just two representative observations. • It provides information on how well the cost-estimating equation explains the variation in the dependent variable. In this case, the cost-estimating equation explains 87.70 percent of the variation in total manufacturing costs. Because of the least-squares criteria, the analyst must evaluate the data used in regression analysis and exclude unusual observations. Otherwise, a single large squared deviation will have a disproportionate influence in the cost-estimating equation.

Financial & Managerial Accounting for Decision Makers, 4th Edition

e. The key to solving requirement e is to recognize that all previous analysis failed to determine the separate influence of dining room table and living room tables on manufacturing costs. The offer of $452 per table is slightly above the computations of the variable cost per table in part d ($450.11). Hence, management might be tempted to accept the offer. Using multiple regression analysis with two independent variables, rather than one, illustrates this would be a mistake. Presented is a partial printout from an Excel spreadsheet with two independent variables, with items of interest highlighted in bold: SUMMARY OUTPUT Regression Statistics Multiple R 0.940132 R Square 0.883846 Adjusted R Square 0.868359 Standard Error 3010.708 Observations 18 ANOVA Regression Residual Total

df 2 15 17

SS 1.035E+09 135965426 1.171E+09

MS 5.17E+08 9064362

F 57.0694

Significance F 9.72208E-08

Standard Lower Upper Lower Upper Coefficients Error t Stat P-value 95% 95% 95.0% 95.0% 20427.14 4463.3 10913.7 29940.58 29940.58 Intercept 4 7 4.5766 .0004 0 7 10913.70 7 1.95ELiving room 416.193 55.639 7.4802 06 297.60 534.786 297.601 534.786 2.13EDining 455.968 42.752 10.665 08 364.843 547.092 364.843 547.092 The variable cost of a dining room table, $455.968, exceeds the offer of $452 per table. Management should reject the offer. If students do not have access to a computer and spreadsheet software, the instructor can assign the problem and provide the results of the regression.

Solutions Manual, Chapter 14

C14-35. If students do not have access to a computer and spreadsheet software, the instructor can still assign the problem after providing them with the following output: First, for simple regression analysis: Regression Output: Constant Std Err of Y EST R Squared No. of Observations X Coefficient(s) Std Err of Coef.

25.51627 1.930438 .6569224 10 1.112798 1.9304614

Second, for multiple regression analysis: Regression Output: Constant Std Err of Y EST R Squared No. of Observations X Coefficient(s) Std Err of Coef.

22.5994 1.60006 0.823102 10 1.22987 0.243153

1.02432 0.39714

1.54346 0.357627

1. An important part of determining what Dan should do is to determine how long it takes to recondition a desktop computer. Based on total unit and total hour information for the past 10 weeks, the average time to repair a piece of electronic equipment is 2.641 hours (441 total hours/167 total units). This suggests he can recondition approximately 15 desktop computers per week (40 hours per week/2.641 hours) to obtain total weekly revenues of $750 (15 computers  $50 each) and monthly revenues of $3,000 ($750  4 weeks). Subtracting the rental fee of $300 leaves him with $2,700 to cover other costs such as extra utilities. If he worked for the store, he would receive $2,240 per month ($14  40 hours  4 weeks). Based on this analysis, there is a monthly advantage of $460 to accepting the contract. One problem with this analysis is that it assumes that all pieces of electronic equipment require the same amount of time to recondition. It also assumes that all 40 hours are devoted to direct labor activities. It is likely that there are facility-level activities such as equipment maintenance, training, and paperwork.

Financial & Managerial Accounting for Decision Makers, 4th Edition

2. Based on simple regression analysis, 25.516 facility-level hours are required each week. This leaves 14.484 (40 − 25.516) hours to work on computers. Simple regression analysis indicates that the marginal time to repair a piece of electronic equipment is 1.113 hours. Using the available time, approximately 13 (14.484/1.113) computers can be reconditioned each week to obtain total weekly revenues of $650 (13 computers  $50 each) and monthly revenues of $2,600 ($650  4 weeks). Subtracting the rental fee of $300 leaves him with $2,300 to cover other costs such as extra utilities. If Dan worked for the store, he would receive $2,240 per month. Based on this analysis there is a monthly advantage of $60 to accepting the contract. While the simple regression approach recognizes the existence of facility-level activities, it also assumes that all pieces of electronic equipment require the same amount of time to recondition. An advantage of the regression approach is that we are provided with information on the goodness of fit. In this case the fit is fair but not strong. The coefficient of determination for the simple regression analysis is 0.6569, indicating that only 65.69% of the variation in total weekly hours is explained by the estimating equation. 3. Based on multiple regression analysis, 22.599 facility-level hours are required each week. This leaves 17.401 (40 − 22.599) hours to work on computers. Multiple regression analysis also indicates that the marginal time to repair a computer is 1.543 hours. Using the available time, approximately 11 (17.401  1.543) computers can be reconditioned each week to obtain total weekly revenues of $550 (11 computers  $50 each) and monthly revenues of $2,200 ($550  4 weeks). Subtracting the rental fee of $300 leaves him with $1,900 to cover other costs such as extra utilities. If Dan worked for the store he would receive $2,240 per month. Based on this analysis there is a monthly advantage of $340 for working for the computer repair shop. In this case, R-squared is 0.82310, implying that 82.31 percent of the variation in the dependent variable is explained by the cost-estimating equation.

Continued

Solutions Manual, Chapter 14

3. continued Because of the small monthly advantage of working for the computer repair shop other considerations will likely be important in making a decision. Additional considerations include: • If Dan can reduce the facility-level hours for setup and administrative activities and recondition 3 or 4 more computers, the economics would suggest accepting the contract. • Dan may find that by reducing his travel time to and from work he is able to devote additional time to reconditioning computers. This might change the economics of accepting the contract. • There are quality-of-work issues. Working at home, Dan can set his own hours. On the other hand, having a regular job provides some social interaction and clearly separates work from non-work activities. • Working at home requires a higher level of self-motivation than going to a more traditional job. • Fringe benefits are not mentioned in the case. If the store provides fringe benefits, such as health care and retirement benefits, the economics would clearly favor not accepting the contract. • Travel costs are not mentioned in the case. If they are high, this would favor working at home. Note: To avoid complexities related to self-employment taxes they are not considered in this assignment. Some students might mention self-employment taxes as an additional consideration.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 15 Cost-Volume-Profit Analysis and Planning QUESTIONS Q15-1.

Cost-volume-profit analysis is a technique used to examine the relationships among the total volume of some independent variable, total costs, total revenues, and profits during a time period. It is particularly useful in the early stages of planning when it provides a framework for discussing planning issues.

Q15-2.

The important assumptions that underlie cost-volume-profit analysis are: 1. 2. 3. 4.

All costs are classified as fixed or variable with unit-level activity cost drivers. The total cost function is linear within the relevant range. The total revenue function is linear within the relevant range. The analysis is for a single product, or the sales mix of multiple products is constant. 5. There is only one activity cost driver: unit or dollar sales volume. Q15-3.

The use of a single variable in cost-volume-profit analysis is most reasonable when analyzing the profitability of a specific event or the profitability of an organization that produces a single product or service on a continuous basis.

Q15-4.

In a contribution income statement, costs are classified according to behavior as variable or fixed, and the contribution margin (the difference between total revenues and total variable costs) that goes toward covering fixed costs and providing a profit is emphasized. In a functional income statement, costs are classified according to function (rather than behavior), such as manufacturing and selling and administrative. This is the type of income statement typically included in corporate annual reports.

Solutions Manual, Chapter 15

Q15-5.

The unit contribution margin is equal to the difference between the unit selling price and the unit variable costs. In computing the unit break-even point, the fixed costs are divided by the unit contribution margin.

Q15-6.

The contribution margin ratio is the portion of each dollar of sales revenue contributed toward covering fixed costs and earning a profit. It is especially useful in situations involving several products or when unit sales information is not available.

Q15-7.

The desired profit is added to the fixed costs, increasing the sales volume required to cover both.

Q15-8.

A profit-volume graph contains only one line showing the relationship between volume and profits, while a cost-volume-profit graph contains two lines – one for total revenues and one for total costs. A profit-volume graph is most likely to be used when management is primarily interested in the impact on profits of changes in sales volume and less interested in the related revenues and costs.

Q15-9.

Income taxes increase the sales volume required to earn a desired after-tax profit.

Q15-10.

Other things being equal, the higher the degree of operating leverage, the greater the opportunity for profit with increases in sales. Conversely, a higher degree of operating leverage magnifies the risk of large losses with a decrease in sales.

Financial & Managerial Accounting for Decision Makers, 4th Edition

MINI EXERCISES M15-11. a. Break-even point = $225,000/(1 − 0.45) = $409,091 (rounded) b. Margin of safety = $450,000 − $409,091 = $40,909 c. Sales volume for desired profit = ($225,000 + $200,000) = $772,727 (rounded) (1 − 0.45)

M15-12. a. 1. 2. 3. 4. 5.

Total variable costs Total revenue Total costs Variable costs Fixed costs

6. Total costs 7. Contribution margin 8. Break-even unit sales volume 9. Loss area 10. Profit area

Line CC Shift downward No change Increase slope Shift upward Shift downward and decrease slope

Line OR No change Increase slope No change Decrease slope No change

1. 2. 3. 4. 5.

Break-Even Point Shift left (decrease) Shift left (decrease) Shift right (increase) Shift right (increase) Shift left (decrease)

M15-13. a. 1. Loss area 2. Profit area 3. Break-even point b. 1. 2. 3. 4. 5.

4. Axis on which profit and loss are measured 5. Fixed costs 6. Profit at volume E

Line CF

Break-Even Point

Increase slope Decrease slope Shift upward Shift downward and decrease slope Shift upward and decrease slope

Shift left (decrease) Shift right (increase) Shift left (decrease) Shift right (increase) Can't tell; the two changes have opposite effects.

Solutions Manual, Chapter 15

M15-14. a.

Total revenue line: $20 per unit Total costs line: $35,000 + $6 per unit Variable costs line; $6 per unit

= 35,000/(20-6)=2,500

c. It is most appropriate to use a profit-volume graph when management is primarily interested in the impact on profits of changes in sales volume and less interested in the related revenues and costs.

Financial & Managerial Accounting for Decision Makers, 4th Edition

M15-15. a. Selling price Variable costs Contribution margin

$9.00 per taco −6.00 per taco $3.00

Break-even point = $120,000 / $3 = 40,000 tacos b.

Total revenue line: $9 per unit Total costs line: $120,000 + $6.00 per unit Variable costs line; $6.00 per unit

d. It is easier to determine profit or loss at any volume with a profit-volume graph than with a cost-volume-profit graph. This is especially true in situations, such as this, where the unit contribution margin is small, and the scale of activity is large. Although a profitvolume graph provides a clear illustration of profits, it does not illustrate revenues and costs. Hence, a manager using a profit-volume graph does not see the relationship between revenues, costs, and profits. Solutions Manual, Chapter 15

M15-16.

Product

Unit Contribution Margin

Bauer Warrior CCM

$60 45 40

Sales Mix (units)*

Weight

6 3 1 10

$60 x 6/10 = $36.00 45 x 3/10 = 13.50 40 x 1/10 = 4.00 $ 53.50

*Bauer = 2Warrior and Warrior = 3CCM, so Bauer = 3 x 2 = 6

Average unit contribution margin = $53.50 Break-even unit sales volume = $150,000 / $53.50 = 2,804 (rounded UP to the nearest whole unit) Number of Warrior sticks at break-even = 2,804 x 3/10 = 842 (841.20 rounded UP to the nearest whole unit)

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E15-17. a. PICNIC TIME Contribution Income Statement For the Month of July Sales (4,000 x $100) Less variable costs: Direct materials (4,000 x $25) Direct labor (4,000 x $15) Manufacturing overhead (4,000 x $5) Selling and administrative (4,000 x $4) Contribution margin Less fixed costs: Manufacturing overhead Selling and administrative Profit

$400,000 $ 100,000 60,000 20,000 16,000

36,000 68,000

(196,000) 204,000

(104,000) $ 100,000

Note: The instructor might extend this assignment in class, computing the break-even point, the margin of safety, and the impact on profits of a change in sales.

Solutions Manual, Chapter 15

E15-18. a. Sales Variable costs Contribution margin

$800,000 (400,000) $400,000

Contribution margin ratio = $400,000 / $800,000 = 0.50 Annual break-even dollar sales volume = $267,000 / 0.50 = $534,000 b. Annual margin of safety in dollars: Sales Break-even sales dollars Margin of safety

$800,000 (534,000) $266,000

c. To determine the variable and total cost lines, it is necessary to compute the variable cost ratio: Variable cost ratio

Variable costs Sales

$400,000 $800,000

0.50

At a volume of $1,000,000 sales dollars, variable costs are $500,000.

d. Revised annual break-even dollar sales: ($267,000 + $50,000) / 0.50 = $634,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

E15-19. a. Contribution margin Sales revenue Contribution margin ratio (rounded to nearest hundredths) Break-even point in sales revenue

b. Current sales revenue Break-even sales revenue Margin of safety

$ 660,000 1,200,000 0.55

= $440,000 / 0.55 = $800,000 $1,200,000 (800,000) $ 400,000

c. Current fixed costs Impact of increase New fixed costs

$440,000 80,000 $520,000

Revised break-even point = $520,000 / 0.55 Rounded UP to nearest dollar = $945,455* d. Required before-tax income

= $250,000 / (1 − 0.21) = $316,456*

Sales revenue required to provide an after-tax income of $250,000: ($440,000 + $316,456) / 0.55 = $1,375,375 (rounded UP to nearest dollar). e. Sales revenue Variable costs (45% of sales) Contribution margin (55% of sales) Fixed costs Net income before taxes Income taxes (21%) Net income after taxes

$1,375,375 (618,919)* 756,456* (440,000) 316,456 (66,456)* $ 250,000

*Calculations reflect rounding.

Solutions Manual, Chapter 15

E15-20. a. Fixed costs Contribution [($12,000 − $2,400)  2,000] Endowments and grants Required from other sources

$20,000,000 $19,200,000 400,000

(19,600,000) $ 400,000

b. Break-even price ($15,000 / 2,000) = $7.50 Revenues (1,500  $7.50) Fixed costs Deficit

$11,250 (15,000) $ (3,750)

c. Cost to city [($125 - $10)  5,000] = $575,000 d. Contribution [($2.50 − $1.75)  3,000] Fixed costs Amount raised

$2,250 (750) $1,500

e. Available funds Fixed costs Available for variable costs Variable costs per present Number of presents

$30,000 (10,000) 20,000  $20 1,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

E15-21. a.

Capital Intensive Fixed costs: Manufacturing overhead Selling Total Selling price Variable costs: Direct materials Direct labor Manuf. overhead Selling Unit cont. margin

Labor Intensive

$1,800,000 250,000 $2,050,000 $100.00 $10.00 4.00 5.00 4.00

Fixed costs Unit cont. margin Unit break-even point (rounded up)

(23.00) $77.00

$ 500,000 250,000 $750,000 $100.00 $ 12.00 12.00 2.00 4.00

(30.00) $70.00

$2,050,000  $77.00

$750,000  $ 70.00

26,624

10,715

b. Sharpie would be indifferent between the two methods at the unit volume, X, where total costs are equal. $23X + $2,050,000 $7X X

= = =

$30X + $750,000 $1,300,000 185,715 units (rounded up)

Identical results are obtained if profit, rather than cost, equations are used. ($100-23)X – $2,050,000 $7X X

= = =

($100 − $30)X – $750,000 $1,300,000 185,715 units (rounded up)

Sharpie should use the labor-intensive method if sales are less than 185,715 units and use the capital-extensive method if sales are above 185,715 units.

Solutions Manual, Chapter 15

c. 1. Operating leverage is a measure of the responsiveness of income to changes in sales. The higher a firm's operating leverage, the more sensitive are its profits to changes in sales volume. It is also an indication of an organization's cost structure. The higher the portion of an organization's fixed costs (in comparison with variable costs), the higher its operating leverage. 2. Capital-Intensive

Labor-Intensive

Unit contribution margin

77.00

70.00

Unit sales volume

100,000

Contribution margin

7,700,000

7,000,000

Fixed costs

(2,050,000)

(750,000)

Net income

$ 5,650,000

$ 6,250,000

Contribution margin

$7,700,000

$7,000,000

Net income

 5,650,000

 6,250,000

1.36*

1.12*

Operating leverage *Rounded to nearest hundredth

3. The capital-intensive method has a higher operating leverage because of the greater use of fixed assets.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E15-22. a. WILLAMETTE VALLEY FRUIT COMPANY Contribution Income Statement For the Year Ended December 31 Sales (650,000  $75) Variable costs (650,000  $42) Contribution margin Fixed costs Net income b. Operating leverage

= = =

$48,750,000 (27,300,000) 21,450,000 (14,250,000) $ 7,200,000

Contribution margin/Net income $21,450,000 / $7,200,000 2.98 (rounded to nearest hundredth)

c. Percentage change in profits

= = =

Percentage decrease in sales x Operating leverage 10% x 2.98 29.8 percent decrease

Profits should decrease by 29.8 percent to $5,054,400 computed as: [$7,200,000 − ($7,200,000 x 0.298)]. d. Contribution margin [650,000  ($75 − $40)] Fixed costs Net income Operating leverage ($22,750,000 / $7,250,000)

$ 22,750,000 (15,500,000) $ 7,250,000 3.14 (rounded)

The acquisition of the new packaging equipment will reduce variable costs, thereby increasing the contribution margin. It will also increase fixed costs, thereby increasing the difference between the contribution margin and net income. The net effect would be an increase in operating leverage.

Solutions Manual, Chapter 15

E15-23. a. Product Unit Selling Price Standard $ 125 Complex 250 Full-Service 150 Average unit selling price Unit Contribution Product Margin Standard $ 80 Complex 185 Full-Service 100 Average unit contribution margin

x x x

Sales Mix (units) 1,000/2,000 200/2,000 800/2,000

Weight $62.50 25.00 60.00 $147.50

x x x

Sales Mix (units) 1,000/2,000 200/2,000 800/2,000

Weight $40.00 18.50 40.00 $98.50

Contribution margin ratio

$98.50 / $147.50 =

0.6678 (rounded)

Break-even sales volume

$180,000 / 0.6678

$269,542 (rounded)

b. Sales at average rate = 2,000  $147.50 = $295,000 Break-even sales volume −269,542 Margin of safety $ 25,458 c.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E15-24. Once the following, or a similar, format is established, each case is solved by filling in the given information and working toward the unknowns. Case A

Case B

Case C

Case D

2,500

1,600

8,600*

6,000*

Sales revenue Variable costs: Unit cost Unit sales Total Contribution margin Fixed costs

$80,000

$4,800

$382,700

$240,000

$ 20 x 2,500 (50,000) $30,000 (14,000)

$ 2 x 1,600 (3,200) $ 1,600 (700)

Net income

$16,000

$ 900

$ 24 x 8,600* (206,400) $ 176,300 (164,000) $ 12,300#

$ 10.00 x 6,000 (60,000) $180,000 (120,000) $60,000#

Unit cont. margin: Cont. margin Unit sales Unit contribution

$30,000  2,500 $ 12.00

$ 1,600  1,600 $ 1

$176,300  8,600 $ 20.50

$180,000  6,000 $ 30

Break-even point: Fixed costs Unit cont. margin Unit break-even point

$14,000  $12.00 1,167##

$ 700  $1 700

$ 164,000  $20.5 8,000

$120,000  $30 4,000

1,333

900

600

2,000

Unit sales

Margin of safety (unit sales less unit break-even point)

*Solved as the unit break-even point plus the margin of safety. #Solved as the unit contribution margin times margin of safety. ##Rounded UP to the nearest whole unit.

Solutions Manual, Chapter 15

E15-25. Once the following or similar format is established, each case can be solved by filling in the known amounts and working toward the unknowns. Case 1

Case 2

Case 3

Case 4

$90,000  0.50 $ 45,000 ( 30,000) $ 15,000

$150,000  0.60 $90,000 (75,000) $ 15,000

$160,000  0.25 $40,000 (16,000) $24,000

$275,000*  0.40 $110,000 (60,000) $50,000

0.50 0.50 1.00

0.40 0.60 1.00

0.75 0.25 1.00

0.60 0.40 1.00

Break-even point: Fixed costs Cont. marg. ratio Dollar break-even point

$ 30,000  0.50 $ 60,000

$75,000  0.60 $125,000

$16,000  0.25 $64,000

$60,000  0.40 $150,000

Margin of safety (dollar sales less dollar break-even point)

$ 30,000

$25,000

$96,000

$125,000

Sales revenue Cont. margin ratio Contribution margin Fixed costs Net income Variable cost ratio Contribution margin ratio Total

*Computed as the break-even point plus the margin of safety.

E15-26. Weekly contribution per average customer: $10 sales per visit  (1 - 0.60) contribution ratio  2 visits = $8.00 Annual contribution per customer = $8.00  52 weeks = $416.00 Customers required for desired profit = ($75,000 + $125,000) / $416 = 481 (rounded UP to the next whole number) Required population = 481 customers / 0.05 customers in population = 9,620

Financial & Managerial Accounting for Decision Makers, 4th Edition

E15-27. a. Minimum order size to break even on order

b. Annual sales to break-even on average customer

$400 (0.10 – 0.05)

$8,000

($400 x 5 orders) + $1,000 (0.10 – 0.05)

$60,000

c. Average order size = $60,000 / 5 = $12,000 d. Order-level costs ($400  5 orders  100 customers) Customer-level costs ($1,000  100 customers) Facility-level costs Total costs Contribution margin ratio Minimum annual sales to break even

200,000 100,000 75,000 $ 375,000  0.05 $7,500,000

e. Average order size = $7,500,000 / (5 orders  100 customers) = $15,000 f.

Part (a) considers only order-level costs while part (c) also considers customer-level costs, and part (e) adds facility-level costs. In order for a company to break even on an order, it need only cover order-level costs. To break even on a customer, the company must cover order-level and customer-level costs. Finally, to achieve true break-even, all costs must be covered.

Solutions Manual, Chapter 15

PROBLEMS P15-28. a. Unit contribution margin: $50 − $24 = $26 Total contribution (30,000  $26) Fixed costs Net income before taxes Net income after taxes Income taxes Net income before taxes Tax rate b. Required before-tax income

$780,000 −436,250 343,750 − 275,000 68,750 $343,750 0.20

= =

$400,000 / (1 − 0.20) $500,000

Volume required to provide an after-tax income of $400,000: ($436,250 + $500,000) / $26 = 36,010 units (rounded UP to nearest whole unit) c. Contribution margin Current Impact of reduction in variable costs New Fixed costs: Current Impact of increase in fixed costs New

$26.00 4.00 $30.00 $436,250 53,000 $489,250

Volume required to provide an after-tax income of $400,000: ($489,250 + $500,000) / $30.00 = 32,975 The reduction in variable costs was more than enough to offset the increase in fixed costs. Consequently, the volume required to achieve an after-tax profit of $400,000 declined from 36,010 units to 32,975 units. d. Requirements (a) through (c) assume that taxable income and accounting income are equal and that the tax rate is constant.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P15-29. a. Jail and Sail: Alcatraz Tour and Cruise Contribution Income Statement For the Month of July Sales (2,200  $140) Less variable costs: Admission fees (2,200  $60) Overhead (2,200  $25) Hors d’oeuvres (2,200  $15) Selling and administrative (2,200  $2) Contribution margin Less fixed costs: Operations Selling and administrative Before-tax profit Income taxes ($21,100 × 0.21) After-tax profit

$308,000 $ 132,000 55,000 33,000 4,400

50,000 12,500

(224,400) 83,600

(62,500) 21,100 4,431 $ 16,669

b. Monthly break-even point in units. $62,500 / ($140 − 102) = 1,645 units (rounded UP) c. Margin of safety in units: Actual July sales Break even sales Margin of safety

2,200 units 1,645 units 555 units

d. Sales for an after-tax profit of $20,000: Required before-tax profit = $20,000 / (1 − 0.21) = $25,317 (rounded up) Required sales = ($25,317 + $62,500) / ($140 − 102) = 2,311 (rounded up) e.

Solutions Manual, Chapter 15

P15-30. a. Prior to solving this problem, it is necessary to determine the variable costs per unit, the fixed costs per year, and the unit selling price. Using the high-low method: Variable costs per unit = (105,000 − $85,000) / (9,375 − 6,250) = $6.40 Fixed costs or,

= $105,000 − $6.4(9,375) = $85,000 − $6.40(6,250)

= =

$45,000 $45,000

Unit selling price = $100,000 / 6,250 = $150,000 / 9,375 = $16 Unit contribution margin = $16 − $6.40 = $9.60 Break-even point = $45,000 / $9.60 = 4,688 units (rounded up) b. Sales volume required to earn a profit of $25,000: ($45,000 + $25,000) / $9.60 = 7,292 units (rounded up)

P15-31. a. Contribution ratio = 1.0 − 0.55 = 0.45 Break-even point = $1,560,000 / 0.45 = $3,466,667 (rounded up) b. Before-tax profit = $1,000,000 / (1 − 0.20) = $1,250,000 Required sales volume = ($1,560,000 + $1,250,000) / 0.45 = $6,244,445 (rounded up) c.

Profits of automation (1 − 0.50)X − ($1,560,000 + $250,000) 0.50X − $1,810,000 0.10X X

= = = = =

Profits of outsourcing (1 − 0.60)X − ($1,560,000 − $250,000) 0.4X − $1,310,000 $500,000 $5,000,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

d. Automation

Outsourcing

Strength:

•

• •

It will provide higher profits if sales increase. It may provide new opportunities. It may enhance quality.

• •

This alternative has less risk and a lower break-even point. It is preferred at the current sales volume. It allows focusing on core competencies.

Weakness:

•

This alternative has higher risk and a higher break-even point.

•

This alternative will not have as great a potential for high profits. It provides less control of operations.

P15-32. a. The break-even point in patient-days equals total fixed costs divided by the contribution margin per patient-day. Fixed costs: Melford Hospital charges Salaries Total Unit contribution margin: Revenues per patient-day Variable costs per patient-day Contribution margin per patient-day

$3,885,000 645,000 $4,530,000 $400.00 (131.75)* $268.25

*$8,000,000 total revenues/$400 revenue per patient-day equals 20,000 patient-days $2,635,000 total variable costs/20,000 patient-days equals $131.75 variable costs per patient-day Break-even point in patient-days

Solutions Manual, Chapter 15

= =

$4,530,000 / $268.25 16,888 patient-days (rounded up)

b. PEDIATRICS Schedule of Change in Earnings from Rental of 20 Additional Beds For the Year Increase in revenues (20 beds  90 days  $400/day) Increase in expenses: Fixed charges by Melford Hospital: Annual charge per bed ($3,885,000 / 80) Number of additional beds Total increase in fixed charges Variable charges by Melford Hospital ($131.75/patient-day  90 days  20 beds) Net decrease in earnings

720,000

$ 48,562.50  20 971,250 237,150

(1,208,400) $ (488,400)

(Note that the break-even on the additional 20 beds is 3,622, rounded up, bed days ($971,250/$268.25), or 182 bed days, rounded up, for each of the 20 additional beds. This is an increase of 1,822 bed days (or 92 days, rounded up, for each bed) above the estimated 1,800 bed days demand of 90 days for each of the 20 beds.)

P15-33. a. Required before-tax profit = $50,000 / (1– 0.20) = $62,500 Required sales for a $50,000 after-tax profit: Roadrunner = ($250,000* + $62,500) / ($140 – $80) = 5,209 pairs (rounded up) Trail Runner = ($200,000* + $62,500) / ($125 – $75) = 5,250 pairs *Because only one product will be produced the product-level costs and the facility-level costs are combined: $150,000 + $100,000 for Roadrunner and $100,000 + $100,000 for Trail Runner.

b. Required sales for identical before-tax profit: Roadrunner Profit ($140 – $80)X – $250,000 $60X – $50X $10X X

= = = = =

Trail Runner Profit ($125 – $75)X – $200,000 $50,000 $50,000 5,000 pairs

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. The after-tax profit or loss is the same with either product. Hence, it is only necessary to solve for one product. Roadrunner: [($140 – $80)5,000 – $250,000] × (1 – 0.20) = $40,000 Trail Runner: [($125 – $75)5,000 – $200,000] × (1 – 0.20) = $40,000 d. Without further analysis it is apparent that at a volume of 18,000 pairs the Road Runner is preferred. Road Runner requires fewer sales to achieve a $50,000 after-tax profit and the profits of both products are not identical until a total of 5,000 pairs of either product are sold. This answer can also be demonstrated analytically: Roadrunner: [($140 – $80)18,000 – $250,000] × (1 – 0.20) = $664,000 Trail Runner: [($125 – $75)18,000 – $200,000] × (1 – 0.20) = $560,000 e. Required Trail Runner variable costs for identical profit at 18,000 pairs: Because before-tax and after-tax profits will be the same for either product, it is simpler to develop a solution based on identical before-tax profits with X representing the required Roadrunner variable costs per pair. Roadrunner Profit ($140 - 80)18,000 – $250,000 $1,080,000 – $250,000 –1,220,000 X

= = = = =

Trail Runner Profit ($125 – X)18,000 – $200,000 $2,050,000 -18,000X -18,000X $67.78 (rounded)

The variable costs of Roadrunner must decline $12.22 ($80.00 – $67.78) Roadrunner Profit with reduced variable costs: = [($125 – $67.78)18,000 – $250,000] × (1 – 0.20) = $623,968 (with rounding error)

Solutions Manual, Chapter 15

P15-34. a. Cost-estimating equation: Variable cost ratio = ($82,884 - $75,302) / ($125,843 - $110,360) = 0.49 (rounded to nearest hundredth) Annual fixed costs = $82,884 – ($125,843 x 0.49) = $21,221 million (rounded) Total cost (in millions) = $21,221 + $0.49X where X is revenue in millions of dollars. b. Annual break-even point: Contribution margin ratio Break-even point

= =

1 – 0.49 ($21,221/0.51)

c. Predicted next year operating profit: Revenues Less: Variable costs (150,000 × 0.49) Fixed costs Operating profit

= =

0.51 $41,610 million (rounded)

$150,000 73,500 21,221 $ 55,279

d. The equations assume linear cost behavior, stable prices, and a stable cost structure. Any eventual difference between Microsoft’s predicted 2019 operating profit of $42,959 million and their actual results will likely be caused by changes in Microsoft’s cost structure, higher fixed costs and higher variable costs, as their product sales mix changes.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P15-35. a. Annual break-even point in sales dollars: Break-even point = $420,000 / (1 − 0.70 − 0.05) = $1,680,000 b. Annual break-even point in units: Break-even point = $420,000 / {$125 − [$125(0.70 + 0.05)]} = 13,440 units (or $1,680,000 / $125 = 13,440) c. On new books the contribution to other costs is 30 percent (1.00 less 0.70 to the publisher) of the suggested retail price. On used books the contribution to other costs is 50 percent of the suggested retail price (0.75 less 0.25 cost of the book). Shifting towards more used books and fewer new books will increase bookstore profitability with the same unit sales. d. Publisher project break-even point: Note: Solution is in terms of wholesale price to bookstore, not retail price to final buyer. Project break-even point = $285,000 / (1 − 0.20 − 0.15) = $438,462 (rounded) e. Profitability analysis of sales of 10,000 new books: 1. Bookstore’s unit-level contribution Final retail sales $125  10,000 Less unit-level costs (0.70 + 0.05) Bookstore’s unit-level contribution

$1,250,000 (937,500) $312,500

2. Publisher’s project-level contribution: Sales to bookstores $125  0.70  10,000 Unit-level costs (875,000 * (0.20 + 0.15)) Project-level costs Publisher’s project contribution

$875,000 (306,250) (285,000) $283,750

3. Author’s royalties: $875,000 net to publisher  0.15

$131,250

Solutions Manual, Chapter 15

P15-36. a. Current break-even point in sales dollars: Contribution margin ratio = $534,000 / $1,335,000 = 0.40 Break-even point = $425,630 / 0.40 = $1,064,075 b. Unit contribution margin and break-even point: Average unit contribution margin = $534,000 / (5,500) = $97.09 (rounded) Unit break-even point = $425,630 / $97.09 = 4,384 (rounded UP to nearest whole unit) c. The current average unit contribution margin is $97.09. Current unit contribution margin of individual products: Acrylic: $253,250 / 2,000 units = $127 (rounded to nearest dollar) Polycarbonate: $280,750 / 3,500 units = $80 (rounded to nearest dollar) Shifting the mix to 80:20 will change the average unit contribution margin: ($127  0.20) + ($80  0.80) = $89.40 Contribution with proposed plan = 5,750 units  $89.40 = $514,050 The current contribution margin is $534,000. The contribution margin with a shift in the mix, even with a 250-unit sales increase, is only $514,050. Hence, profits will decrease if the projected shift occurs. In the absence of capacity constraints, sales reps should emphasize increased sales of the product with the higher unit contribution margin.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P15-37. a. 1. Current contribution: Fixed costs Profit Contribution

$36,000 + 12,125 $48,125

Contribution margin ratio Current break-even point 2. Selling price Variable costs Unit contribution

= $48,125 / $68,750 = $36,000 / 0.70

Super Burgers $5.50 -1.65* $3.85

= =

0.70 $51,429 (rounded up)

Super Chickens $7.00 -2.50 $4.50

*$5.50 × (1.0 – 0.70) Short run Super Burgers Super Chickens

Super Burgers Super Chickens Average unit contribution

Volume 5,000 7,500

Mix 0.40 0.60

Unit Contribution $3.85 4.50

Mix 0.40 0.60

Short-run monthly profit: Contribution (12,500 units × $4.24) Less fixed costs ($36,000 + $5,400) Profit (loss)

$53,000 (41,400) $ 11,600

Short-run contribution ratio: Contribution margin Revenue [(5,000 × $5.50) + (7,500 × $7.00)] Contribution ratio

53,000 ÷80,000 0.66

Short-run break-even point = $41,400 / 0.66

Weight $1.54 2.70 $4.24

(rounded)

= $62,727.27*

*Rounded to nearest hundredth Continued

Solutions Manual, Chapter 15

a. continued 3.

Long run Super Burgers Super Chickens

Volume

Mix

16,000 9,000

.64 .36

Unit Contribution

Mix

Weight

$3.85 4.50

.64 .36

$2.464 1.62 $4.084

Super Burgers Super Chickens Average unit contribution

Long-run monthly profit: Contribution (25,000 units × $4.084) Less fixed costs ($36,000 + 5,400) Profit

$102,100 (41,400) $60,700

Long-run contribution ratio: Contribution margin Revenue [(16,000 × $5.50) + (9,000 × $7.00)] Contribution ratio

$ 102,100 ÷151,000 0.676*

Long-run break-even point = $41,400/0.676

$61,243 (rounded up)

*Rounded to nearest thousandth b. Answers to requirement (b) will vary. Two possible recommendations are as follows: •

Do not introduce the sandwich. There is too much risk. Introducing the sandwich causes a short-run loss in profit, a permanent decline in the contribution ratio, and an increase in the break-even point. If the predicted increase in sales does not occur, the company may not realize an acceptable profit. Also, it is unclear what the time period is for the short run.

•

Introduce the sandwich. While there is a short-run drop in profit, a permanent decline in the contribution ratio, and an increase in the break-even point, these negatives are more than offset by the long-run increase in volume. Introducing the sandwich is taking the business to the next level of size and profitability.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P15-38. a. AccuMeter Contribution Income Statement For the Year Sales Less variable costs: Direct materials Processing Setup Batch movement Order filling Contribution margin Less fixed costs: Manufacturing overhead Selling and administrative Net income (loss)

$4,875,000 $1,500,000 1,125,000 375,000 75,000 37,500

1,000,000 450,000

(3,112,500) 1,762,500

(1,450,000) $ 312,500

b. AccuMeter Multi-Level Contribution Income Statement For the Year Sales Less unit-level costs: Direct materials Processing Unit-level contribution Less lot-level costs: Setup Batch movement Order filling Lot-level contribution Less facility-level costs: Manufacturing overhead Selling and administrative Net income (loss)

Solutions Manual, Chapter 15

$4,875,000 $1,500,000 1,125,000

375,000 75,000 37,500

1,000,000 450,000

(2,625,000) 2,250,000

(487,500) 1,762,500

(1,450,000) $ 312,500

c. Sales (1,000 at $65) Less unit and lot-level costs: Direct materials (1,000 at $20) Processing (1,000 at $15) Setup Batch movement Order filling Contribution per lot d. Unit contribution margin: Selling price Less unit-level costs: Direct materials Processing Unit contribution

$20,000 15,000 2,500 500 250

(38,250) $ 26,750

$80 $35 15

Lot-level costs: Setup Movement Order filling Total Lot-level costs Desired contribution Unit contribution Required lot size

$65,000

(50) $30

$2,500 500 250 $3,250 $3,250 800

$4,050  $30 135 units

Financial & Managerial Accounting for Decision Makers, 4th Edition

CASES and PROJECTS C15-39. It is important for senior management to set the ethical climate for the organization. In this case, perhaps out of a true concern for employees, or perhaps out of a desire for a “big bonus,” the plant manager is proposing an unethical (illegal?) speedup of the assembly line. We do not know if New City Automotive has a code of ethics. If it does, Art Conroy should refer to it for guidance. Because Art is a management accountant, he should also refer to the Standards of Ethical Conduct for Management Accountants, published by the Institute of Management Accountants. Art has followed these standards so far. Faced with an issue that concerned him, he went to the appropriate company official. At this point, he should follow the procedures for resolution of ethical conflict. In particular, he needs to further discuss the situation with Paula, expressing his concern about what may happen if the speedup is detected (strikes, legal action, mistrust, plant closure) and what he believes are the advantages of facing the situation directly. He might recommend a general meeting with all employees and suggest that in this meeting financial information be shared. Employees should be made aware of the likelihood of closing the plant if financial performance is not improved. They should also be shown how a small increase in productivity will make a big difference in financial performance. They might even be invited to offer their own suggestions for increasing productivity. They should be treated as team members, rather than as adversaries. Finally Art might conclude his comments by noting how the careers of all plant employees, including management, will be adversely affected if the speedup is detected or if productivity is not improved. In this case, including employees in the decision is less risky than the alternative.

Solutions Manual, Chapter 15

C15-40. a. Using a unit-level analysis, develop a graph with two lines, (1) representing Cincinnati Bell’s cost structure in the 1970s and (2) representing Cincinnati Bell’s cost structure in the late 1990s. Be sure to label the axes and lines.

(1) 1970s cost structure

b. With sales revenue as the independent variable, the likely impact of the changed cost structure on Cincinnati Bell’s: Contribution margin percent:

Because variable costs decrease, the contribution margin percent will INCREASE

Break-even point

With an increase in fixed costs and a decrease in variable costs, the impact on the break-even point CANNOT BE DETERMINED. If there is a change, the BEP will likely increase because of downward pressure on prices.

c. The shift from human operators to mechanical devices increased Cincinnati Bell’s operating leverage, which means that if sales increase, the percentage increase in before-tax profits will exceed the percentage increase in sales. Conversely, if sales decrease, the percentage decrease in profits will exceed the percentage decrease in sales.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C15-41. a. To determine the break-even point, you must first find the contribution margin as a percent of sales and the fixed costs per period. Because there are no taxes at the breakeven point, our analysis is based on before-tax information: Variable costs as a percent of sales

Change in total costs Change in Sales

$1,614,650 − $1,442,650 $1,800,000 − $1,585,000

0.80

Fixed costs = $1,614,650 − ($1,800,000  0.80) = $174,650 Break-even point = $174,650 / (1 – 0.80) = $873,250 b. Sales volume required to earn an after-tax profit of $250,000: Required before-tax profit = $250,000 / (1 – 0.20) = $312,500 Required sales = ($174,650 + $312,500) / (1 – 0.80) = $2,435,750 c. Regional Distribution Inc. Contribution Income Statement For Next Year Sales Variable costs ($4,000,000  0.80) Contribution margin Fixed costs Before-tax profits Income taxes at 20 percent After-tax profit

$4,000,000 (3,200,000) 800,000 (174,650) 625,350 (125,070) $ 500,280

d. The method used for determining the cost equation for Regional Distribution with the available data was the high-low method, which used only two data points. There was not sufficient information to determine whether those two data points were representative of the larger population of data points. Also, it was not possible to determine the possible effects of inflation on the data from year to year. Also, if Regional Distribution has multiple products and or departments that have varying cost structures, using aggregate data for the company as a whole to estimate its costs and break-even point may not produce accurate results. The cost-volume-profit model works best when there is a single cost driver and all costs are either variable or fixed with respect to that cost driver. For that reason, the model is generally more effective for analyzing smaller segments of a business, such as a particular product line.

Solutions Manual, Chapter 15

Chapter 16 Relevant Costs and Benefits for Decision Making QUESTIONS Q16-1.

Relevant costs differ under each alternative. Irrelevant costs are identical under each alternative.

Q16-2.

In evaluating a cost reduction proposal, three alternatives are available to the management of a for-profit organization. These alternatives are: 1. Continue operations with existing operations. 2. Continue operations with cost reduction proposal. 3. Discontinue operations.

Q16-3.

Outlay costs are relevant when they differ under the decision alternatives at hand. They are irrelevant when they do not differ under the decision alternatives at hand.

Q16-4.

Product-level costs are relevant for any decision that causes future product-level outlay costs to increase or decrease, such as changing the lineup of products offered or increasing or decreasing the amount of a future outlay cost for an existing product. Any product-level opportunity cost would also be relevant, such as the benefit foregone from discontinuing one product to offer a new product.

Q16-5.

A differential analysis of relevant items is preferred to a detailed listing of all costs and revenues for several reasons: 1. Focusing only on those items that differ provides a clearer picture of the impact of the decision at hand. Management is less apt to be confused by a differential analysis than by an analysis that includes both relevant and irrelevant items. 2. Because a differential analysis contains fewer items, it is easier and quicker to prepare. 3. In complex situations, such as those encountered by multiple-product or multipleplant firms, it is difficult to develop complete firm-wide detailed statements to analyze all decision alternatives.

Solutions Manual, Chapter 16

Q16-6.

When an organization is operating at capacity, and accepting a special order requires the reduction of regular sales, opportunity costs are relevant to the evaluation of the special order.

Q16-7.

Even if buying a part appears more financially advantageous than making the part, management should not decide to buy before considering a variety of qualitative factors. Is the supplier attempting to use some temporarily idle capacity? If so, what will happen at the end of the contract period? What impact will the decision to buy have on the morale of employees? Will the outside supplier meet delivery schedules? Does the supplier meet quality standards?

Q16-8.

In the decision to sell or to process further, all costs incurred prior to the split-off point are irrelevant. This is because these costs are the same under both alternatives.

Q16-9.

To achieve short-run profit maximization, limited resources should be allocated in the manner that maximizes the contribution margin per unit of the constraining factor.

Q16-10.

To support the theory of constraints, performance reports should: •

Measure the utilization of bottleneck resources.

•

Measure factory throughput.

•

Not encourage the full utilization of non-bottleneck resources.

•

Discourage the buildup of excess inventory.

Financial & Managerial Accounting for Decision Makers, 4th Edition

MINI EXERCISES M16-11. 1. 2. 3. 4.

b e f h

5. 6. 7. 8.

g a c d

5. 6. 7. 8.

e c b d

M16-12. 1. 2. 3. 4.

g f h a

M16-13.

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Cost of furniture Cost of old generators Cost of new generators Operating cost of old generators Operating cost of new The police chief's salary Depreciation on old generators Salvage value of old generators Removal cost of old generators Cost of raising dam Maintenance costs of water plant Revenues from sale of electricity

Solutions Manual, Chapter 16

Proposal A Irrelevant Irrelevant Relevant Relevant Relevant Irrelevant Irrelevant Relevant Relevant Irrelevant Relevant Relevant

Proposal B Irrelevant Irrelevant Irrelevant Irrelevant Irrelevant Irrelevant Irrelevant Irrelevant Irrelevant Relevant Irrelevant Relevant

M16-14. Relevant Costs Opportunity Outlay 1.

The case will require three attorneys to stay four nights in a Boston hotel. The predicted hotel bill is $3,600. Greenberg Traurig’s professional staff is paid $2,000 per day for outof-town assignments.

Last year, depreciation on Greenberg Traurig’s Philadelphia office was $25,000. Round-trip transportation to Boston is expected to cost $250 per person. The firm has recently accepted an engagement that will require several partners to spend two weeks in Chicago. The predicted out-of-pocket costs of this engagement are $25,000. The firm has a maintenance contract on its computer equipment that will cost $2,200 next year. If the firm accepts the engagement in Boston, it will have to decline a conflicting engagement in Miami that would have provided a net cash flow of $15,000. The firm's variable overhead is $125 per client hour.

Irrelevant Costs Outlay Sunk

The firm pays $900 per year for Greenberg’s subscription to a law journal. 10. Last year, the firm paid $22,500 to increase the insulation in its building.

Financial & Managerial Accounting for Decision Makers, 4th Edition

M16-15. Replace Operating costs Old ($25,000  6 years) New ($15,000  6 years) Cost of new machine Total costs Advantage of replacement

Keep

Difference

$150,000 $90,000 50,000 $140,000

$150,000 $10,000

$60,000 (50,000) $10,000

The cost of the old machine is “sunk” and is, therefore, not relevant to the decision—unless it can be sold for some amount. Assuming the old machine is completely obsolete and cannot be sold, the advantage of buying the new machine is $10,000, the operating cost savings of $60,000 less the $50,000 cost of the new machine.

M16-16. The current production volume is 200,000 units ($5,600,000 / $28). The variable production costs are ($3,800,000 − $1,520,000) / 200,000 = $11.40 per unit. The variable selling costs are ($1,000,000 - $750,000)/200,000 = $1.25 per unit. Hence, at a unit selling price of $15, the order provides a contribution of $2.35 ($15 - $11.40 - $1.25) per unit and a total contribution of $23,500 ($2.35  10,000). Even if it is profitable, the large sale to the hospital supply company may take away some of the attention of management from regular customers, and it may upset regular customers who learn of the lower price, resulting in pressure to lower overall prices.

Solutions Manual, Chapter 16

M16-17. Relevant cost analysis Increase in revenues: Sell complete sailboats Sell sailboat hulls Costs of masts, sales, and rigging Advantage (disadvantage) of further processing

$10,500 (9,000)

$ 1,500 (2,500) $ (1,000)

An alternative analysis treats the selling price of the uncompleted hulls as an opportunity cost: Revenues from complete sailboats Costs: Outlay costs of masts, sails, and rigging Opportunity cost of not selling hull Advantage (disadvantage) of further processing

$ 10,500 $2,500 9,000

(11,500) $ (1,000)

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E16-18. a. Contribution from special order [($22 – $20 + $1 – 0.75) x 3,000 bags] Opportunity cost ($30 - $20) x 200 bags Profit from accepting order

$6,750 (2,000) $4,750

b. Expansion into a new area Larger market share Lost sales to regular customers Pressure from regular customers to receive the same price Unhappy regular customers c. For a long-term relationship, management must consider all of the factors raised in (b). They must also realize that in the long run all costs are variable. Hence, the profitability of the order might better be based on current average costs with an adjustment for shipping expenses. When this is done, the long-run average profit (loss) is: Total revenue $22  3,000 Total cost ($24 – 1 + 0.75)  3,000 Long-term loss on additional sales

$66,000 (71,250) $ (5,250)

Other considerations include the possibility of small crops in future years and the risk of changes in costs.

Solutions Manual, Chapter 16

E16-19. a. Current variable costs ($5.00  700) Fixed costs Total costs Number of meals Current average cost per meal

$ 3,500 1,575 $ 5,075  700 $ 7.25

b. The per-meal revenue from the Girl Scouts is $6.50 ($195/30). By subtracting the current average cost per meal from this amount, he concluded the restaurant would lose $0.75 per meal. This analysis is incorrect. Because the restaurant has excess capacity, the analysis should emphasize the contribution the sale would make toward covering fixed costs and providing a profit. The per-unit contribution is $1.50, ($6.50 − $5.00). The total contribution is $45, [$195 − ($5.00  30)], or ($1.50  30). This analysis assumes that there is no impact on other sales. c. The restaurant owner should not accept. At a superficial level it appears the 100 customers would be profitable because it would provide a daily contribution of $50 [100($5.50 − $5.00)]. However, with a current capacity of 750 meals per day it would be necessary to reduce the sales to other customers by 50 meals per day: Capacity Current sales Available Size of new order Reduction in regular sales

750 meals per day (700) meals per day 50 meals per day (100) meals per day 50 meals per day

This introduces an opportunity cost equal to the net cash flow that could be realized from the 50 regular sales. The net daily disadvantage of the proposed action is $600: Daily contribution from special order Daily opportunity cost [50($7 − $5)] Net advantage (disadvantage)

$ 50 (100) $(50)

The situation might be even worse if other customers demand similar special deals.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E16-20. a. The variable costs of manufacturing and selling can be determined using the high-low method: Variable costs per unit = ($3,825,000 − $3,680,000) = $29 (45,000− 40,000) Now we can determine the unit contribution margin and the total contribution from accepting the order. Unit selling price Unit variable costs Unit contribution margin Size of order Financial impact of accepting

65 (29) $ 36  100,000 $3,600,000

Accepting the order will increase profits by $3,600,000, rather than reducing profits by $2,000,000, as the general manager indicated. The general manager incorrectly compared the selling price to the average unit cost of 45 million units, rather than the incremental unit cost. b. If Autoliv was operating at capacity, there would be an opportunity cost associated with accepting the order. This opportunity cost would be equal to the net benefits of the regular business that Autoliv would have to turn away. Assuming a normal selling price of $120, the net disadvantage of accepting the order is $337,500: Contribution from special order Opportunity cost [100,000 ($120 − $29)] Net advantage (disadvantage) of accepting order

$ 3,600,000 (9,100,000) $(5,500,000)

E16-21. Cost to make: Variable costs (50,000 units  $35.00) Fixed costs (50,000 units  $8.00) Rent income (opportunity cost) Cost to buy (50,000 units  $50.00) Advantage (disadvantage) of buying

$1,750,000 400,000 75,000

$2,225,000 (2,500,000) $ (275,000)

Making has an advantage of $275,000.

Solutions Manual, Chapter 16

E16-22. a. Coway should make the electric motor. Cost to Make Purchase price ($5.25  50,000) Manufacturing costs: Direct mat. ($2.00  50,000) Direct labor ($2.00  0.50  50,000) Variable overhead ($3*  0.50  50,000) Total Advantage of making

$100,000 50,000 75,000 $225,000

Cost to Buy $262,500

_______ $262,500

Difference (Effect of Buying on Income) $(262,500) 100,000 50,000 75,000 $ (37,500)

$37,500

*Total factory overhead $ 12 per unit Fixed factory overhead ($450,000 / 50,000) (9) per unit Variable factory overhead $ 3 per unit

b. Coway should buy the electric motor. Cost to Make Purchase price Manufacturing costs: Outlay Opportunity Total Advantage of buying

$225,000 50,000 $275,000

Cost to Buy $262,500

_______ $262,500

Difference (Effect of Buying on Income) $(262,500) 225,000 50,000 $ 12,500

$12,500

c. Management should consider a number of non-quantitative factors in deciding whether to make or buy the motors. They should consider the quality of their own and the supplier's motors. They should also consider the dependability of the supplier. Does Mini Motor have a track record of meeting its commitments? They should also attempt to determine if Mini Motor will extend the contract to supply motors for a number of years or whether it is attempting to use some temporarily idle capacity.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E16-23. Relevant cost analysis Essentially, this is a make-or-buy decision with the costs of making being the cost of office billing and the cost of buying being the cost of the billing service. Note that there is an opportunity cost associated with office billing. This cost is based on the value of the three hours per week that would otherwise be available to see patients.

Cost to Make Contract price Cost of office billing: Outlay: Bookkeeper’s wages and fringe benefits (20 hours  50 weeks  $25) Rent on storage space (12 months  $250) Opportunity cost: Value of Dr. Rahavey’s time (3 hours  4 patients  50 weeks  $40) Total Advantage of outsourcing

Cost to Buy $36,000

Difference (Effect of Buying on Income) $(36,000)

$25,000

25,000

3,000

24,000 $52,000

24,000 $16,000

$36,000

$ 16,000

E16-24. Information is provided about the cost of raw material D and the cost of processing this material into E and F. However, students should recognize that these are joint costs incurred prior to the decision point. Consequently, they are irrelevant to a decision to sell product F or to process it further. Revenues from G Costs: Outlay cost of additional processing Opportunity cost of not selling F Advantage of further processing

$55 $12 40

(52) $ 3

Product F should be processed further into product G.

Solutions Manual, Chapter 16

E16-25. a. Unit contribution margin Labor hours per unit Contribution per labor hour

Stratocaster $570  15 $ 38

Telecaster $ 450  10 $45

Jaguar $550  20 27.50

1. The Jaguar has the highest unit selling price. 2. The Stratocaster has the highest unit contribution margin. 3. The Telecaster has the highest contribution per labor hour. The weekly contribution obtained with the use of each criterion is: Highest Highest Unit Contribution Selling Price per Unit Jaguar Stratocaster Labor hours available 960 960  20  15 Labor hours per unit Weekly production 48 64 Unit contribution  $550  $570 margin Weekly contribution $26,400 $36,480

Highest Contribution per Labor Hour Telecaster 960  10 96  $450 $43,200

b. To achieve short-run profit maximization, a for-profit organization should allocate limited resources in a manner that maximizes the contribution per unit of constraining factor. c. The decision to produce 15 Jaguars will result in a weekly opportunity cost of $13,500. This is the net benefit that would have been derived from producing 30 Telecasters. Labor hours to produce 15 Jaguars (15 units  20 hours per unit) Labor hours per Telecaster Required reduction in the production of Telecaster Unit contribution margin for Telecaster Opportunity cost

300  10 30  $450 $13,500

Producing 15 Jaguars will reduce profits by $5,250 from their maximum possible amount. Contribution from Jaguars (15  $550) Opportunity cost Net disadvantage of producing 15 Jaguars

$ 8,250 (13,500) $(5,250)

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. continued This can also be computed as the difference between the hourly contribution of Telecaster and Jaguar times the 300 labor hours that would be required to product 15 Telecasters, or ($27.50* – $45.00**)  300 = $(5,250). *($26,400/ 20) / 48 = $27.50 **($43,200/ 10) / 96 = $45.00

d. First, there may not be enough demand to allocate all limited resources to the most profitable product. Second, even if there is sufficient demand, it may be advisable to produce and sell some less profitable products for the sake of offering a full line of products and giving customers alternatives. Third, less profitable products may be offered if they are complimentary to the more profitable products. In some cases, what appears to be the main and most profitable product is actually the secondary product in terms of profits. For example, the warehouse retailers, such as Sam’s Club and Costco, essentially break even on the merchandise they sell in their stores and make most of their profit on membership fees. Similarly, some retailers earn more profit on warranty programs sold than on the products for which the warranties are offered.

E16-26. a. Maria’s time is a limited resource and our objective is to maximize the sales commissions from the use of this resource.

Average monthly sales per customer Commission/sales ratio Commission per customer Hours per customer Commission per hour

Large Business $ 4,000  0.05 $ 200  4 $ 50

Small Business $ 2,500  0.04 $ 100  2.5 $ 40

Individual $ 1,000  0.03 $ 30  1.5 $ 20

To maximize her commission per hour, Maria should visit large businesses first. However, she has only 10 small businesses, requiring 4 hours each, for a total of 40 hours per month. This leaves 120 hours per month to call on small businesses and individuals. Because small businesses have a higher commission per hour, she should call on them next. She has 45 small businesses, requiring 2.5 hours each, for a total of 112.50 hours per month. This leaves 7.5 hours per month to call on individuals. At 1.5 hours per visit, she can call on 5 individual customers.

Solutions Manual, Chapter 16

b. With this plan, Maria's monthly commissions should total $6,650: Large businesses (10  $200) Small businesses (45  $100) Individual customers (5  $30) Total commissions

$2,000 4,500 150 $6,650

With 100 individual customers, calling on 5 per month will result in each customer being visited every 20 months. Maria will likely lose many of these customers, or she may try to maintain individual customers using alternative contact methods, such as phone or Internet contact in place of personal visits. The above analysis should be regarded not as the final solution, but as a decision aid in determining how to allocate a scarce resource. c. First, it is likely that not all customers in a particular category require the same amount of time, but the times given in the problem were averages. It is typical that not all customers are equal in their demands on vendors. Accordingly, Maria may want to keep selected customers because individual customers may actually be profitable, even though the category is generally not very profitable. Other reasons for keeping a customer that is not highly profitable include that customer’s relationship with a highly profitable customer, or the potential to move the customer from a lower-profit category to a higher-profit category.

E16-27. Information is provided about the cost to produce the milk. Students should understand that those costs were incurred. (Note: That since .8 gallons of milk produce 1 pound of cheese, we must divide the gallons of milk provided (to make cheese) by .8 to determine the resulting pounds of cheese that can be produced.) a. Revenues from cheese [((1,400/2) / .8) x $10] Less: Retail value of milk ((1,400/2) x $1.25) Difference Less: Cost to produce the cheese (700 / .8 x $7) Profit

$8,750 (875) $7,875 (6,125) $1,750

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. Revenue from cheese [((1,400/2) / .8) x $10] Revenue from milk (1,400/2 x $1.25)

$8,750 875 $9,625

Additional cost to produce cheese [((1,400/2) / .8) x $7] Cost of milk production (1,400 x $1.60)

$6,125 2,240

c. Total costs to cover milk (1,400 x $1.60)

$2,240

(8,365) $1,260

Let X = a gallon of milk When used to make cheese: 0.8X yields $3.00 of Net Revenue Therefore: 0.8X = $3.00 Revenue X = $3.75 Revenue When used to sell milk to a processor: X = $1.25 Revenue Thus, to break even on all dairy operations, the formula is: 3.75X + [(1,400 - X) x 1.25] = 2,240 3.75X + 1,750 – 1.25X = 2,240 2.50X = 490 X =196 Thus, 196 gallons of milk should be used to make cheese and 1,204 gallons of milk (1,400 – 196) should be sold to a processor. PROOF: 3.75(196) + [(1400 – 196) x 1.25] = 735 + (1,204 x 1.25) = = 735 + 1,505 = = 2,240 d. Farmers might consider •

Possible future increases or further decreases in milk prices

•

Amount of owner time needed to develop artisan cheese market

•

Current value of cows

•

Possible future costs necessary to expand cheesemaking operations

•

Costs to maintain herd level at 25

Solutions Manual, Chapter 16

PROBLEMS P16-28. Differential analysis is used to solve this problem. a. Profit increase from reduced labor costs (12,000  $4) Profit decrease from increased variable overhead (12,000  $1) Profit decrease from increased fixed overhead Increase in monthly profit

$ 48,000 (12,000) (12,000) $ 24,000

b. Profit increase from increased sales if there were no changes in prices or costs (3,000  $75) Profit decrease from reduced selling price of all units (15,000  $5) Profit decrease from increase in fixed factory overhead Profit decrease from increase in fixed selling & admin costs Increase in monthly profit

$225,000 (75,000) (4,000) (1,800) $144,200

c. Profit decrease from increased cost of raw materials (12,000  $5) Profit increase from decrease in direct labor (12,000  $3) Profit increase from decrease in variable factory overhead (12,000  $1) Profit increase from decrease in fixed factory overhead Increase in monthly profit

$(60,000) 36,000 12,000 25,000 $ 13,000

d. Profit decrease from decreased sales if there were no changes in prices or costs (2,000  $75) Profit increase from increased selling price of all units (10,000  $5) Decrease in monthly profit

50,000 $ (100,000)

e. Profit decrease resulting from price change (see d) Profit increase from reduced labor costs (10,000  $4) Profit decrease from increased variable overhead (10,000  $1) Profit decrease from increased fixed overhead Decrease in monthly profit

$ (100,000) 40,000 (10,000) (12,000) $ (82,000)

$ 150,000)

Financial & Managerial Accounting for Decision Makers, 4th Edition

P16-29. Differential analysis is used to solve this problem. a. Increase in monthly profit [(1,500  $(2.00)]

$ 3,000

b. Increase from discontinuing A (see a) Decrease from lost sales of B (150  $4.00) Increase in monthly profit

$ 3,000 (600) $ 2,400

c. Increase from reduced sales of A with no change in price (250 x $2) Increase from increased selling price (1,250 x $5) Increase in monthly profit

$500 6,250 $ 6,750

d. Decrease from reduced sales of B with no change in prices (300  $4.00) $ (1,200) Increase from increased selling price of B [(1,200 − 300)  ($20.00 − $14.00)] 5,400 Decrease from increased sales of A [200  $2] (400) Increase in monthly profit $ 3,800 e. Contribution from new product D (1,500  $2) Former negative contribution of A (see a) Increase in monthly profit f.

$ 3,000 3,000 $ 6,000

Decrease from reduced sales of C with no changes in prices (350  $12) $ (4,200) Increase from increased selling price of C [(2,000-350)  [$35-$30)] 8,250 Increase from increased sales of B with no changes in prices (400  $4.00) 1,600 Decrease from reduced selling price of B [(1,200 + 400)  ($10.00 − $14.00)] (6,400) Decrease in monthly profit $ (750)

Solutions Manual, Chapter 16

P16-30. a. The president fell into the trap of being influenced by the sunk cost of the old machine. The book value of the old machine is the result of a past decision that cannot be changed. This $30,000 will show up as a deduction from revenues under both the keep and replace alternatives. In one case, it will be written off as depreciation over a number of years. In the other case, it will be written off as a loss on disposal. b. Differential Analysis of Replacement Decision: Six Year Totals

Annual operating costs: Old ($40,000 x 4) New ($20,000 x 4) Cost of new machine Total

(1)

(2)

(1) – (2)

Keep Old Machine

Replace with New Machine

Difference (Effect of Replacement on Income)

$160,000

$80,000 50,000 $130,000

$80,000 (50,000) $30,000

Advantage of replacement: $ 30,000 c. A limitation of the model presented in this Module is that it does not take into account the time value of money. This is actually a capital budgeting decision, which will be discussed in Module 25. That Module will discuss how to convert all future cash flows into current dollars (or present values), which will give an even more precise calculation of the net cost or benefits of replacing the machine. There is always a risk that the new equipment will not perform as claimed by the manufacturer, so the company may want to get some guarantees or assurances as to its performance. One way to deal with uncertainly is to calculate the model under multiple scenarios, where the savings is projected at pessimistic, expected, and optimistic levels to see how sensitive the outcome of the model is to variances in the projected benefits.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P16-31. a. Increase in revenues Increase in costs: Direct materials Direct labor Variable factory overhead Variable selling and administrative ($10  500) Increase in profits

$45,000 $11,850 8,500 3,950* 5,000

(29,300) $ 15,700

*Budgeted annual overhead is 75 percent fixed ($6,000,000/$8,000,000). The variable overhead associated with the 500 units is $3,950 ($15,800  0.25).

b. Fixed costs do not vary with volume, and in the absence of specific information, it is assumed that fixed costs do not vary between decision alternatives. Therefore, they are irrelevant, and should be omitted from the analysis. c. 1. An opportunity cost is the net benefit of the alternative action. The alternative action is to sell the scooters at a price of $57,840. With incremental costs of $29,300, this action would provide net benefits of $28,540. This is the opportunity cost. Regular selling price Incremental costs Opportunity cost

$57,840 (29,300) $ 28,540

2. With identical costs and a $12,840 lower selling price ($57,840 − $45,000), accepting Pulse Cycles’ offer will reduce profits by $12,840. Alternatively, this amount can be derived as follows: Profit on Pulse Cycles’ offer Less opportunity cost Increase (decrease) in profits

$ 15,700 (28,540) ($ 12,840)

d. Razor USA should be aware of possibly undercutting the price that other regular customers pay for the same product and how those customers might react, and it should be alert to possible violation of laws that regulate such practices.

Solutions Manual, Chapter 16

P16-32. Peterson’s management undoubtedly believes the promotion is good advertising and that it will have long-run benefits that are not easily quantified. The problem focuses on the shortrun net costs or benefits of the promotion under a variety of possible situations. Management might want this type of information to help them evaluate the desirability of continuing or modifying the promotion. a. Incremental revenues from coupon sales (600  $20) Incremental costs: Ice cream (600  25  $1.50) Coupons printing cost Loss

$ 12,000 $22,500 75

(22,575) $(10,575)

b. Each coupon redeemed cost Peterson’s $1.50. The sales of coupons will provide revenues to absorb this cost. The break-even point for coupon redemptions occurs when the cost of coupon redemptions absorbs all of the revenues from coupon sales. Incremental revenues from coupon sales (600  $20) Less printing cost of coupons Contribution assuming no coupons are redeemed Cost per redemption Coupon redemptions for break-even

$12,000 (75) $11,925 $1.50 7,950*

* 318 packages (7,950 / 25)

In effect, the break-even computation is being reversed. Instead of the normal: Break-even point = Fixed costs / Unit contribution margin, we have: Break-even point = Revenues / Unit loss of redemption Break-even redemption rate

= =

7,950 / 15,000 (600 pkgs.  25 coupons/pkg.) 0.53 or 53 percent

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. The sale of an additional cone with each redemption reduces the net loss per redemption, and this increases the number of coupons that can be redeemed before all coupon sales are absorbed. Loss per redemption: Loss on coupon redeemed Less contribution from addition sale ($2.00 − $1.50) Net loss per redemption Incremental revenues from coupon sales (600  $20) Less printing cost of coupons Contribution assuming no coupons are redeemed Net loss per redemption Coupon redemptions for break-even

$ 1.50 (0.50) $ 1.00 $12,000 (75) $11,925  $1.00 11,925

Break-even redemption rate = 11,925/15,000 coupons = 0.795, or 79.5 percent d. Incremental revenues from coupon sales (600  $20) Less cost of coupons Sixty percent of the coupons are redeemed:* One-fourth of which have no effect on sales: Cost of redemption (9,000* x 0.25 x $1.50) One-fourth of which result in additional sales of 2 single-scoop cones: Cost of redemption (9,000* x 0.25 x $1.50) Contribution of additional sales [9,000  0.25  2  ($2.00 − $1.50)] One-fourth of which result in additional sales of 3 single-scoop cones: Cost of redemption (9,000* x 0.25 x $1.50) Contribution of additional sales [9,000  0.25  3  ($2.00 − $1.50)] One-fourth of which come out of regular sales: Cost of redemption (9,000* x 0.25 x $1.50) Opportunity cost of lost sales [9,000  0.25  ($2.00 − $1.50)]

$12,000 (75)

(3,375) (3,375) 2,250

(1,125)

(3,375) 3,375

(3,375) (1,125)

(4,500) $2,925

*(600  25  0.60 = 9,000)

Solutions Manual, Chapter 16

P16-33. Unit selling price Unit variable costs Unit contribution margin

$310 (175) $135

a. Decrease from reduced sales if there were no changes in price or cost (2,000 x $135) Increase from increase in sales price [(15,000 – 2,000) x $50)] Increase in monthly profit b. Increase from additional sales if there were no changes in price or costs (6,000 units  $135.00) Decrease from reduced selling price of all units [(15,000 + 6,000 units)  ($310 x .10] Profit decrease from increased direct labor costs of the last 1,000 units [1,000 units  ($50  0.50)] Increase in monthly profit c. Increase in revenues (1,000 units  $250) Increase in costs: Direct materials (1,000  $80.00) Direct labor (1,000  $50.00) Factory overhead (1,000  $35.00) Additional selling and administrative Increase in profits d. Increase in revenues (6,000 units  $250.00) Increase in costs: Direct materials (6,000  $80.00) Direct labor (6,000  $50.00) Factory overhead (6,000  $35.00) Selling and administrative Opportunity cost of lost regular sales [(15,000 units + 6,000 units − 20,000-unit capacity)  $135.00] Increase in profits

$(270,000) 650,000 $ 380,000

$ 810,000 (651,000) (25,000) $ 134,000 $ 250,000

$ 80,000 50,000 35,000 750

(165,750) $ 84,250 $1,500,000

$480,000 300,000 210,000 1,000 135,000

(1,126,000) $ 374,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

e. Cost to Make Cost to buy (15,000 units  $10) Cost to make: Direct materials ($80.00  0.05  15,000 units) Direct labor ($50.00  0.05  15,000 units) Variable factory overhead ($35.00  0.05  15,000 units) Fixed factory overhead Opportunity cost Total Advantage of making f.

Cost to Buy $150,000

Difference (Effect of Buying on Income) $(150,000)

$ 60,000 37,500

60,000 37,500

26,250 5,000 4,000 $132,750

26,250 5,000 4,000 $ (17,250)

_______ $150,000

$17,250

Increase from reduction in variable costs (15,000 units  $5.00) Decrease from reduced sales price [15,000 x $310 - $290)] Increase from reduced fixed costs Advantage (disadvantage) of selling without inserts

$ 75,000 (300,000) 50,000 $(175,000)

P16-34. Tour selling price Tour variable costs Tour contribution margin

$100.00 (40.00) $60.00

a. Profit decrease from reduced tours if there were no changes in prices or costs (100 tours  $60.00) Profit increase from increase in selling price [(600 tours − 100 tours)  $10.00] Decrease in monthly profit b. Profit increase from increased tours with no changes in prices or costs (200 tours  $60.00) Profit decrease from reduced fee for all tours [(600 tours + 200 tours)  $10.00] Profit decrease from increased costs of the last 50 tours [50 tours  ($50 − $40)] Increase in monthly profit

Solutions Manual, Chapter 16

$ (6,000) 5,000 $ (1,000)

$ 12,000 (8,000) (500) $3,500

c. Increase in revenues (100 tours  $85) Increase in costs: Food (100 tours  $6) Guide salary (100 tours  $20) Supplies (100 tours  $4) Administrative Increase in profits

$8,500 $ 600 2,000 400 500

d. Increase in revenues (300 tours  $80) Increase in costs: Food (300 tours  $6) Guide salary (300 tours  $20) Supplies (300 tours  $4) Administrative Opportunity cost of lost regular sales (600 tours + 300 tours − 750 tour capacity)  $60] Increase in profits

(3,500) $ 5,000 $24,000 $ 1,800 6,000 1,200 500 9,000

(18,500) $ 5,500

e. Cost to Make Cost to buy (600 tours  $7) Cost to make: Food (600 tours  $6) Equipment rental ($5,000 − $3,800) Total Advantage of buying

$ 3,600 1,200 $ 4,800

Cost to Buy $4,200

Difference (Effect of Buying on Income) $(4,200)

$4,200

3,600 1,200 $ 600

$600

Here "buying" refers to accepting the offer of the Alberta outdoor supply company. f.

Increase in revenues: Full service (600 tours  $150) Current service (600 tours  $100) Additional costs Variable (600 tours  $30) Fixed Advantage of offering full-service tours

$90,000 (60,000) $ 18,000 5,000

$30,000

(23,000) $ 7,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

P16-35. a. Although there is not adequate information to give a definitive response, the president’s analysis is likely incorrect. All three divisions most likely share some common costs (such as the president’s salary) that are unavoidable in the short run, even if a section is eliminated. Also, the cataract section’s expenses may include depreciation on specialized equipment not easily sold if the section is discontinued. b. If the cataract section is not currently making a contribution toward covering common and fixed costs, profits should increase if that sector is dropped. c. If the cataract section is currently making a contribution toward covering common and fixed costs, profits may actually decline if the sector is dropped. It is also possible that the other sections obtain additional customers as a result of the existence of the cataract section. In any case, it is unlikely that profits will increase by $150,000 if the cataract sector is dropped. To determine the financially advantageous decision, management must perform a differential analysis of the relevant costs (and revenues) that will differ if the cataract section is discontinued.

Solutions Manual, Chapter 16

CASES and PROJECTS C16-35. a. By changing its sales strategy to increase emphasis on customer service, it is necessary for Ladbrecks to establish control systems that promote this behavior and reward employees who perform consistently with the new strategy. Setting up a compensation plan that creates incentive to provide increased customer support is a logical and effective management control mechanism. b. Figure 1 in the case indicates that sales increased approximately 8% beginning in month 25, compared with the previous months. Based on this assumption, and using the income statement for a typical store, the sales would have increased by $800,000, from $10,000,000 to $10,800,000. c. The increase occurred quite abruptly beginning in the month that the incentive plan was implemented. Although there was some fluctuation from month to month after the plan was rolled out, the fluctuation was around a significantly higher average sales amount. d. Wage expense increased from an average of about 8% of sales to about 10% of sales. e. As a percent of sales cost of sales was not affected. It remained at about 63% of sales. This suggests that the increased sales on average were for goods that had a markup approximately equal to the average sales prior to the incentive plan. f.

Figure 4 indicates that inventory turnover did not change significantly between the months prior to, and after, the rollout of the incentive plan. This means, indeed, that a higher level of inventory was required to support the higher level of sales.

g. With an inventory turnover of 4, the additional inventory needed by the typical store to generate sales of 800,000, with cost of sales of 63%, or $504,000, is $504,000 ÷ 4 = $126,000.

Financial & Managerial Accounting for Decision Makers, 4th Edition

h. Before Plan $10,000,000 6,300,000 3,700,000

After Plan $10,800,000 6,804,000 3,996,000

Change $800,000 504,000 296,000

Employee salaries Profit before fixed charges

800,000 2,900,000

1,080,000 2,916,000

280,000 16,000

Less implicit inventory costs* Profit after fixed charges

189,000 $2,711,000

204,120 $ 2,711,880

15,120 $ 880

Inventory costs calculation: Sales Cost of sales % Cost of sales $ Inventory turnover Total inventory Inventory fixed charge % Inventory fixed charge $

$10,000,000 63% $ 6,300,000 ÷4 $ 1,575,000 12% $ 189,000

$10,800,000 63% $ 6,804,000 ÷4 $ 1,701,000 12% $ 204,120

$800,000 63% $504,000 ÷4 $126,000 12% $ 15,120

Sales Cost of sales Gross profit

Using incremental analysis: Additional sales ($10,000,000*0.08) Additional cost of sales ($800,000*0.63) Additional gross profit Additional employee salaries On base sales (10,000,000*0.02) On new sales (800,000*0.10) Increased profit before fixed charges Less implicit inventory costs (126,000*0.12) Increased profit after fixed charge

Solutions Manual, Chapter 16

$800,000 (504,000) 296,000 (200,000) (80,000) 16,000 (15,120) $ 880

Workers with lower wages and tenure are receiving bonuses. The plan targeted sales for bonuses based on wage rate of employee, hours worked and a multiplier as follows: TARGET SALES = WAGE RATE x HOURS x 12.5 BONUS = 0.08 (ACTUAL SALES - TARGET) Therefore, workers with lower wage rates (wages had been based on seniority) have lower sales targets for receiving a bonus.

Employees getting bonus Employees not getting bonus

Avg. Wage Rate $ 5.65 $ 8.66

Avg. Years 7.87 18.12

One implication of this effect is that workers with many years of service are overpaid relative to their own productivity. Plan allows them to retain old high wages and boosts wages of lower paid employees. j.

Arguments for keeping the plan are: • Small profit increase • Large sales increase • Presumed increase in customer service • Future wages will be linked to productivity • Plan should encourage skilled employees to stay and encourage unskilled employees to leave. Arguments for discontinuing the plan are: • Many disgruntled employees- high turnover • Competition among employees • Huge increase in wages upon plan’s implementation • Plan consuming much time of administration

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 17 Product Costing: Job and Process Operations QUESTIONS Q17-1.

The importance of inventory costing is a function of the dollar size of inventories. Because merchandising and manufacturing organizations have larger inventory investments than most service organizations, inventory costing is more important to them. The complexity of inventory costing is a function of the number of major inventory categories and the difficulties encountered in assigning costs to each category. Because manufacturing organizations have three major inventory categories with many cost elements assigned to work-in-process and finished goods, inventory costing is more complex in manufacturing organizations than it is in service or merchandising businesses.

Q17-2.

Product costing is the process of assigning costs to inventories as they are converted from raw materials to finished goods. Service costing is the process of assigning costs to services.

Q17-3.

When costs are incurred in connection with manufacturing activities, they are product costs; when they are incurred in connection with other activities, they are period costs. The future service potential of manufacturing buildings and equipment is transformed into the future service potential of manufactured products. Depreciation on manufacturing buildings and equipment is absorbed by the product; hence, this depreciation is a product cost. The future service potential of office buildings and equipment expires with the passage of time. Depreciation on office buildings and equipment is not absorbed by products; hence, this depreciation is a period cost.

Solutions Manual, Chapter 17

Q17-4.

The three major product cost elements are direct materials, direct labor, and manufacturing overhead.

Q17-5.

A predetermined overhead rate is determined at the start of the year by dividing the predicted overhead costs for the year by the predicted activity for the year. Predetermined overhead rates are used to avoid delays in product costing and to avoid variations in cost assignments that might result from seasonal variations in costs or the overall volume of activity.

Q17-6.

In process production, a single product is produced on a continuous basis. Typical products produced on a continuous basis include beverages, electric wire, cotton yarn, and newsprint. In job production (also called job order production), products are produced in single units or in batches of identical units. Single unit jobs might include a house, a ship, or a satellite. Typical batch jobs include machine parts, clothing, and furniture.

Q17-7.

Engineering is primarily concerned with determining how a product should be produced. On the basis of an engineering analysis and with the aid of cost data, engineers develop manufacturing specifications for each product. Production scheduling personnel prepare a production order for each job. The production order assigns a unique identification number to a job and specifies such details as the quantity to be produced in the job, the total raw materials requirements of the job, the manufacturing operations to be performed on the job, and perhaps the time when each manufacturing operation should be performed.

Q17-8.

The job cost sheet is the most important record involved in the operation of a job cost system. Other records include raw materials, finished goods, bills of materials, operation lists, production orders, materials requisition forms, and work tickets.

Q17-9.

Purchased raw materials are recorded in the raw materials account, and incidental supplies are recorded as Manufacturing Supplies. Direct materials costs are transferred from Raw Materials to Work-in-Process. In labor-based operations, direct labor costs are added to Work-in-Process. As incurred, all other costs are accumulated in Manufacturing Overhead and periodically assigned to Work-inProcess. When products are completed, their accumulated product costs are transferred from Work-in-Process to Finished Goods Inventory. When finished goods are sold, their costs are transferred from Finished Goods Inventory to Cost of Goods Sold.

Q17-10.

Service organizations should maintain detailed job records to bill clients and to evaluate the profitability or contribution of individual jobs.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q17-11.

The four major elements of a cost of production report are: 1. A summary of units in process 2. A computation of equivalent units 3. A determination of the total costs in process and the cost per equivalent unit 4. Accounting for total costs

Q17-12.

Equivalent completed units are the number of completed units that are equal, in terms of production effort, to a given number of partially completed units.

Q17-13.

Equivalent units in process will be different for materials and conversion costs any time units in process are produced to a different percentage of completion for materials and conversion cost components.

Solutions Manual, Chapter 17

MINI EXERCISES M17-14. a. b. c. d. e. f. g. h.

Period Period Product, direct materials Product, conversion Period Product, direct materials Product, direct materials Product, conversion

i. Period j. Product, conversion k. Product, conversion l. Period m. Product, conversion n. Period o. Product, conversion

M17-15. a. Predetermined overhead rate per machine hour = $15,000,000 / 1,200,000 = $12.50 b. Applied overhead = $12.50  98,500 = $1,231,250 c. February overhead: Actual Applied Underapplied for February Overapplied overhead, February 1 Overapplied overhead, end of February

$1,238,500 (1,231,250) (7,250) 35,000 $ 27,750

M17-16. a. Process.

A continuous manufacturing process.

b. Process.

A continuous manufacturing process (may be job order if processed in batches for specific customers).

c. Job order.

Ordinarily manufactured in batches for particular combinations of size, style, and fabric. If batches are very large, process costing could be used.

d. Job order.

Ordinarily manufactured one at a time or in batches for a particular customer.

e. Job order.

Manufactured in batches.

Financial & Managerial Accounting for Decision Makers, 4th Edition

M17-17. a. Job order.

Each building is ordinarily a unique product.

b. Process.

A continuous manufacturing process (may be job order if processed in batches).

c. Job order.

Ordinarily manufactured in batches for particular combinations of size, color, style, etc.

d. Process.

Could use job order costing if processed in batches.

e. Job order.

Manufacturer would ordinarily track costs of large special orders.

M17-18. a. Units completed Cost per equivalent units Cost of goods transferred to finished goods inventory

12,000  $56 $672,000

b. Materials cost (5,000 units  $32) Conversion cost (5,000 units  0.10  $24) Ending work-in-process inventory

$160,000 12,000 $172,000

c. Beginning work-in-process plus current manufacturing costs equal total costs in process, which is also equal to the cost of goods transferred to finished goods plus ending workin-process. Cost of goods transferred to finished goods Plus cost of ending work-in-process Total costs (beginning work-in-process, plus current manufacturing costs)

Solutions Manual, Chapter 17

$672,000 172,000 $844,000

M17-19. Ending inventory = 1,200 BI + 3,000 PROD – 3,500 SOLD = 700 Absorption Costing Direct materials ($450  700) Variable overhead ($250  700) Fixed overhead ($550  700) Total

$315,000 175,000 385,000 $875,000

Variable Costing Direct materials ($450  700) Variable overhead ($250  700) Total

$315,000 175,000 $490,000

M17-20. Absorption Costing Beginning inventory Production Direct materials (3,000  $450) Variable overhead (3,000  $250) Fixed overhead (3,000  $550) Goods available for sale Less ending inventory ($3,750,000/3,000  700) Cost of goods sold

$ 1,500,000 $1,350,000 750,000 1,650,000

Variable Costing Beginning inventory Production Direct materials (3,000  $450) $1,350,000 Variable overhead (3,000  $250) 750,000 Goods available for sale Less ending inventory ($2,100,000/3,000  700) Cost of goods sold

3,750,000 5,250,000 875,000 $4,375,000

$ 840,000

2,100,000 2,940,000 490,000 $2,450,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E17-21. a. Raw Materials Inventory: Activity Beginning balance + Purchases = Total available − Raw materials used = Ending balance

Given Information $ 110,000 + ? ? (400,000) $ 105,000

b. Current manufacturing costs: Direct materials Direct labor Manufacturing overhead (200% of direct labor) Total Conversion costs Conversion costs

Direct labor

= = = = =

Solution $ 110,000 +395,000 505,000 (400,000) $ 105,000

$400,000 ? ? $850,000

$850,000 − $400,000 = $450,000 Direct labor + Manufacturing overhead Direct labor + 2 Direct labor 3 Direct labor $450,000 /3 = $150,000

c. Work-in-Process: Activity Beginning balance + Current mfg. costs = Total costs in process − Cost of goods mfg. = Ending balance

Given Information $ 75,000 +850,000 ? − ? $ 92,000

Solution $ 75,000 +850,000 925,000 (833,000) $ 92,000

d. Finished Goods Inventory: Activity Beginning balance + Cost of goods mfg = Cost of goods available for sale − Cost of goods sold = Ending balance

Solutions Manual, Chapter 17

Given Information $ 125,000 + ? 958,000 − ? $135,000

Solution $ 125,000 +833,000 958,000 (823,000) $135,000

E17-22. BRIDGEVIEW MANUFACTURING COMPANY Statement of Cost of Goods Manufactured August Current manufacturing costs: Cost of materials placed in production: Raw materials, 8/1 Purchases Total available Raw materials, 8/31 Direct labor Manufacturing overhead Work-in-process, 8/1 Total costs in process Work-in-process, 8/31 Cost of goods manufactured

$ 6,000 32,000 38,000 (6,500)

$31,500 22,000 38,600

$92,100 4,600 96,700 (5,800) $90,900

BRIDGEVIEW MANUFACTURING COMPANY Income Statement August Sales Cost of goods sold: Finished goods inventory, 8/1 Cost of goods manufactured Total goods available for sale Finished goods inventory, 8/31 Gross profit Selling and administrative expenses Net income

$250,000 $ 12,000 90,900 102,900 (15,000)

87,900 162,100 (98,600) $ 63,500

Financial & Managerial Accounting for Decision Makers, 4th Edition

E17-23. BLUE LINE PRODUCTS COMPANY Statement of Cost of Goods Manufactured For the Year Ending December 31 Current manufacturing costs: Direct materials Direct labor (5) Manufacturing overhead (6) Beginning work-in-process Total costs in process Ending work-in-process Cost of goods manufactured

$ 105,000 139,000 278,000

Analysis of Finished Goods Inventory: Finished goods, 1/1 (2) Cost of goods manufactured (4) Total goods available for sale Finished goods, 12/31 (3) Cost of goods sold (1)

$522,000 0 522,000 (0) $522,000

$ 116,000 522,000 638,000 (174,000) $464,000

Solution steps: (1) Cost of goods sold = [$580,000  (1.00 − 0.20)] (2) Beginning inventory = ($464,000  0.25) (3) Ending inventory = ($116,000  1.5) (4) Cost of goods manufactured = ($638,000 − $116,000) (5) Direct labor = [($522,000 − $105,000) / 3] (6) Manufacturing overhead = ($139,000  2)

Solutions Manual, Chapter 17

E17-24.

Sales Direct materials Direct labor Total direct costs Conversion cost Manufacturing overhead Current manufacturing costs Work in process, beginning Work in process, ending Cost of goods manufactured Finished goods inventory, beginning Finished goods inventory, ending Cost of goods sold Gross profit Selling and administrative expenses Net income

Case A $42,000 7,500 3,000 10,500 (a) 7,000 (b) 4,000 14,500 (c) 3,500 2,500 15,500 (d)

Case B $108,000 (b) 31,500 16,500 (c) 48,000 39,000 22,500 (d) 70,500 (e) 15,000 37,500 (f) 48,000

Case C $82,500 48,750 (f) 15,000 63,750 (e) 22,500 (g) 7,500 71,250 14,250 (d) 15,750 69,750 (c)

Case D $190,000 (b) 42,000 18,000 (c) 60,000 116,000 (g) 98,000 (f) 158,000 42,000 36,000 (e) 164,000

4,500

12,000

5,250

24,000

3,000 17,000 (e) 25,000 (f)

7,500 (g) 52,500 55,500 (a)

6,000 69,000 (b) 13,500

28,000 (d) 160,000 30,000

10,000 15,000 (g)

22,500 33,000

4,500 (a) 9,000

18,000 (a) 12,000

Within each independent case, the missing data was calculated in alphabetic order. Exhibit 17.6, p.168 and the WIP table on p.176 are helpful in determining the solutions. There are other correct solution approaches.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E17-25. a. The basic accounting problem that Adams and Walsh are arguing about stems from the use of actual overhead rates when there are wide fluctuations in the volume of activity. In periods of high activity, fixed overhead is spread over a large number of units, producing a relatively low per-unit cost assignment. In periods of low activity, fixed overhead is spread over a small number of units, producing a relatively high per-unit cost assignment. Mattoon should use a predetermined overhead rate to avoid variations in costs assigned to identical products because of seasonal variations in manufacturing overhead. In addition to the accounting problem, Mattoon Components Company also has a pricing problem. Cost-based pricing should be used as a guideline, not an inflexible rule. Management should adjust cost-based prices in response to market conditions. If competitors are lowering their prices, Mattoon should consider doing the same. Likewise, if competitors are raising their prices, Mattoon should consider the desirability of a similar action. In any case, management should strive to avoid frequent price changes. Finally, if the market for Mattoon’s products is highly competitive, management should use the market price as a starting point to determine allowable product costs, rather than basing prices on costs. This approach, known as target costing, is discussed in Chapter 20. b. Cost estimating equation for total manufacturing overhead: Variable costs = ($380,500 − $325,000) / (40,000 − 34,000) = $9.25 Fixed costs = $380,500 − (40,000  $9.25) = $10,500 Total costs = $10,500 + $9.25X c. Predetermined rate for next year: Predetermined Overhead rate = $10,500 + $9.25(35,000) = $9.55 per direct labor hour 35,000 d. Overapplied manufacturing overhead at the end of next year is $2,250: Actual overhead $341,550 Applied overhead (36,000  $9.55) (343,800) Overapplied overhead $ (2,250) e. The overapplied overhead may be: • Written off to Cost of Goods Sold. • Allocated among Work-in-Process, Finished Goods Inventory, and Cost of Goods Sold.

Solutions Manual, Chapter 17

E17-26. a.

Raw Materials Inventory Beg. Bal. 35,000 52,000 (2) (1) 60,000

Accounts Payable 62,000

(1)

Work-in Process Inventory Beg. Bal. 12,000 90,500 (8) (2) 52,000 (3) 18,000 (7) 25,000 End. Bal. 16,500

Wages Payable 24,500

(3)

Other Payables 8,500

(6)

Finished Goods Inventory Beg. Bal. 50,000 95,750 (9) (8) 90,500 End. Bal. 44,750

Manufacturing Supplies Beg. Bal 3,500 3,800 (4) (1) 2,000

Cost of Goods Sold 95,750

Manufacturing Overhead Beg. Bal. -0- 25,000 (7) (3) 6,500 (4) 3,800 (5) 11,000 (6) 8,500

(9)

Accumulated Depreciation – Factory Assets 11,000 (5)

b. The balances in Work-in-Process Inventory and Finished Goods Inventory are the amounts in their respective “T” accounts at the end of April: Work-in-Process Inventory, $16,500, and Finished Goods Inventory, $44,750.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E17-27. a.

Jobs-in-Process Beg. Bal. 200,000 622,000

(8)

(2) 150,000 (3) 225,000 (7) 250,000 End. Bal. 203,000 Other Payables 78,000

(8)

(6)

Cost of Jobs Completed 622,000

Job Supplies Inventory Beg. Bal. 10,000 2,200 (4) (1) 4,500

Accounts Payable 4,500 150,000

(1) (2)

Wages Payable 380,000

(3)

Production Overhead Beg. Bal. 2,850 250,000 (7) (3) 155,000 (4) 2,200 (5) 12,000 (6) 78,000

Accumulated Depreciation – Agency Assets 12,000 (5)

b. The cost incurred as of the end of the period for the uncompleted jobs in process is $203,000, the balance in the Jobs-in-Process account.

Solutions Manual, Chapter 17

E17-28. PORT TOWNSEND PAPER Cost of Production Report For the Month Ending October 31 Summary of units in process (tons): Beginning 0 Units started 20,000 In-process 20,000 Completed (19,000) Ending 1,000 Equivalent units in process: Units completed

Materials 19,000

Plus equivalent units in ending inventory Equivalent units in process

1,000 20,000

Total cost to be accounted for and cost per equivalent unit in process: Beginning work-in-process

Current costs Total cost in process Equivalent units in process Cost per equivalent unit in process

134,000 $134,000  20,000 $ 6.70

Conversion 19,000 750*

Total

19,750

0 355,500**

$355,500  19,750 $ 18.00

489,500 $489,500 $ 24.70

Accounting for total costs: Transferred out (19,000  $24.70) Ending work-in-process: Materials (1,000  $6.70) Conversion (1,000  75%  $18.00) Total cost accounted for

$469,300 $6,700 13,500

20,200 $489,500

1,000 units 75% converted ** Includes direct labor of $185,000 + [mfg. overhead of ($50 x 3,410 hrs.) = $170,500] = $355,500

Financial & Managerial Accounting for Decision Makers, 4th Edition

E17-29. HOWELL PAVING COMPANY Cost of Production Report For the Month Ending April 30 Summary of units in process (tons): Beginning 0 Units started 40,000 In-process 40,000 Completed (35,000) Ending 5,000 Equivalent units in process: Units completed

Materials 35,000

Plus equivalent units in ending inventory Equivalent units in process

5,000 40,000

Total cost to be accounted for and cost per equivalent unit in process: Beginning work-in-process

Current costs Total cost in process Equivalent units in process Cost per equivalent unit in process

440,000 $440,000  40,000 $ 11.00

Accounting for total costs: Transferred out (35,000  $28.50) Ending work-in-process: Materials (5,000  $11) Conversion (5,000  60%  $17.50) Total cost accounted for

Conversion 35,000 3,000*

Total

38,000

0 665,000**

$665,000  38,000 $ 17.50

1,105,000 $1,105,000 $

28.50

$ 997,500 $ 55,000 52,500

107,500 $1,105,000

5,000 units 60% converted ** Includes direct labor of $95,000 + [ applied mfg. overhead of (38,000 × $15) = $570,000] = $665,000

Solutions Manual, Chapter 17

E17-30. a.

Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($675,000 / 45,000 cases) Total unit cost

Absorption Costing $20 10 4

Variable Costing $20.00 10.00 4.00

15 $49

0.00 $34.00

b. SMUCKERS Absorption Costing Income Statement For the Third Quarter of the Year Sales (45,000  $85) Cost of goods sold (45,000  $49) Gross profit Selling and administrative expenses Net income SMUCKERS Variable Costing Income Statement For the Third Quarter of the Year Sales (45,000  $85) Variable cost of goods sold (45,000  $34) Contribution margin Fixed expenses: Manufacturing overhead $675,000 Selling and administrative 1,225,000 Net income

$3,825,000 (2,205,000) 1,620,000 (1,225,000) $ 395,000

$3,825,000 (1,530,000) 2,295,000

(1,900,000) $ 395,000

c. There is no difference in income because sales and production are the same. When this situation is maintained, the two methods yield the same net income.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E17-31. a. GLENVIEW COMPANY Functional (Absorption Costing) Income Statement For the year Sales (54,000  $20) $1,080,000 * Cost of goods sold (54,000  $12.25 ) (661,500) Gross profit 418,500 Other expenses: Variable selling and administrative (54,000  $1) $54,000 Fixed selling and administrative 185,000 (239,000) Net income $179,500 * Cost per unit: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($255,000 / 60,000 units) Total

$ 5.00 2.00 1.00 4.25 $12.25

b. GLENVIEW COMPANY Contribution (Variable Costing) Income Statement For the Year Sales (54,000  $20) Variable expenses:

$1,080,000

Cost of goods sold (54,000  $8.00*) Selling and adm. (54,000  $1) Contribution margin Fixed expenses: Manufacturing overhead Selling and administrative Net income * Cost per unit: Direct materials Direct labor Variable manufacturing overhead Total

Solutions Manual, Chapter 17

$432,000 54,000

255,000 185,000

(486,000) 594,000

(440,000) $154,000

$5.00 2.00 1.00 $8.00

E17-32. a. WRIGHT DEVELOPMENT Functional (Absorption Costing) Income Statements Comparative (in thousands, except site data) Sales: 95 sites  $150 250 sites  $150 Cost of sales: 95 sites  $55.5* 250 sites  $55.5* Gross profit Selling and administrative expenses: Variable (6% of sales price) Fixed

Year 1

Year 2

$14,250.0 $37,500.0 (5,272.5) (13,875.0) 23,625

8,977.5

$855.0 600.0

Net income

(1,455.0) $7,522.5

$2,250.0 600.0

(2,850) $20,775

*Cost per site: Land costs $7,500,000 / 200 sites Clearing costs Improvements Total site cost

Absorption $37,500 8,000 10,000 $55,500

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. WRIGHT DEVELOPMENT Functional (Absorption Costing) Income Statements Comparative (in thousands, except site data) Sales: 95 sites  $150 250 sites  $150 Variable costs: Cost of operations: 95 sites  $18* 250 sites  $18* Selling expenses (6% of sales price) Contribution margin Fixed expenses: Land Selling and administrative Net income

Year 1

Year 2

$14,250 $37,500

$ 1,710 $4,500 855

$7,500 600

(2,565) 11,685

(8,100) $3,585

2,250

$7,500 600

(6,750) 30,750

(8,100) $22,650

*Cost per site: Land costs $7,500,000 / 200 sites Clearing costs Improvements Total site cost

Solutions Manual, Chapter 17

Variable $ 0 8,000 10,000 $18,000

PROBLEMS P17-33. SAVOY COMPANY Statement of Cost of Goods Manufactured For the Month of July Current manufacturing costs: Cost of materials placed in production: Raw materials, 7/1 $25,000 Purchases 150,000 Total available 175,000 Raw materials, 7/31 (28,000) $ 147,000 Direct labor 105,000 Manufacturing overhead: Manufacturing supplies ($4,000 + $2,500 − $3,500) $ 3,000 Production employees’ fringe benefits 10,500 Depreciation on plant 12,000 Production supervisors' salaries 10,000 Plant maintenance 8,000 Plant utilities 7,500 Production equipment rent 4,000 55,000 Work-in-process, 7/1 Total costs in process Work-in-process, 7/31 Cost of goods manufactured

$307,000 18,000 325,000 (15,000) $310,000

Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

SAVOY COMPANY Income Statement For the Month Ending July 31 Sales Cost of goods sold: Finished goods inventory, 7/1 Cost of goods manufactured Total goods available for sale Finished goods inventory, 7/31 Gross profit Selling and administrative expenses: Office supplies ($1,500 + $1,000 − $1,000) Administrative salaries Sales salaries and commissions Depreciation on office Office utilities Office maintenance Office equipment rent Net income

$583,500 $ 90,450 310,000 400,450 (88,600)

1,500 46,000 45,000 3,000 2,500 4,200 1,000

(311,850) 271,650

(103,200) $ 168,450

P17-34. a. BAUER HOCKEY, LLC Statement of Cost of Goods Manufactured For the Month of April Current manufacturing costs: Cost of materials placed in production: Raw materials, 4/1 $ 50,350 Purchases 225,000 Total available 275,350 Raw materials, 4/30 (52,500) $222,850 Direct labor [(5,200 + 400)  $15] 84,000 Manufacturing overhead (125 percent of direct labor) 105,000 Work-in-process, 4/1 Total costs in process Work-in-process, 4/30 Cost of goods manufactured

$411,850 38,500 450,350 (40,200) $410,150

Continued

Solutions Manual, Chapter 17

BAUER HOCKEY, LLC Income Statement For the Month of April Sales Cost of goods sold: Finished goods inventory, 4/1 Cost of goods manufactured Total goods available for sale Finished goods inventory, 4/30 Gross profit Other expenses: Office supplies ($1,800 + $2,200 − $1,500) Administrative salaries Sales salaries Depreciation on office and office equipment Office utilities

$745,500 $

90,000 410,150 500,150 (88,000)

(412,150) 333,350

2,500 102,600 105,000 8,000 6,000

(224,100)

Net income

$ 109,250

b. Actual overhead: Manufacturing supplies ($6,200 + $12,000 − $7,400) Salaries of production supervisors Depreciation on plant and machinery Plant utilities Indirect labor (900  $15) Employee fringe benefits [($84,000 + $13,500)  0.20] Overtime premium (400  $15 x .50) Applied overhead Underapplied (overapplied) overhead

10,800 24,500 24,000 15,000 13,500 19,500 3,000

$110,300 (105,000) $ 5,300

Determined above Reclassification of employee fringe benefits ($84,000  0.20) Revised costs

Direct Labor $84,000

Manufacturing Overhead $110,300

16,800 $100,800

(16,800) $93,500

Financial & Managerial Accounting for Decision Makers, 4th Edition

P17-35. a. Analysis of Work-in-Process with actual overhead rate: Work-in-Process Beginning balance Current manufacturing costs: Direct materials Direct labor (450 x $20) Actual overhead Total costs in process Less cost of completed jobs Ending balance

$ $ 6,000 9,000 6,300*

*Actual manufacturing overhead Accumulated dep.: Bldg. & equipment Indirect labor Utilities Property taxes Insurance Total **Total costs in process: Direct materials Direct labor Overhead Less costs assigned to Job A06: Direct materials Direct labor Overhead (50  $14***) Cost of goods manufactured

21,300 $21,300 (17,800)** $ 3,500

$ 2,425 2,700 450 375 350 $6,300 $6,000 9,000 6,300 1,800 1,000 700

$21,300

(3,500) $17,800

***Overhead rate = $6,300 / 450 = $14 per direct labor hour

Solutions Manual, Chapter 17

b. Analysis of Work-in-Process with predetermined overhead rate: Work-in-Process Beginning balance Current manufacturing costs: Direct materials Direct labor Applied overhead (450  $15) Total costs in process Less cost of completed jobs: Ending balance *Total costs in process: Direct materials Direct labor Overhead Costs assigned to job A06: Direct materials Direct labor Overhead (50  $15) Cost of goods manufactured

$ $6,000 9,000 6,750

$6,000 9,000 6,750 1,800 1,000 750

21,750 $21,750 (18,200)* $ 3,550*

$21,750

(3,550) $18,200

At the end of January, overhead is overapplied by $450 ($6,300 actual minus $6,750 applied). This amount should be left in Manufacturing Overhead and allowed to accumulate throughout the year. If the predetermined rate is accurate, the year-end balance will be close to zero. c. Essential point illustrated in (c) and (d): high volume results in low overhead rates, and low volume results in high overhead rates during a given period. Fixed: Depreciation on plant and equipment Property taxes on building Insurance on building Total fixed Variable: Utilities Indirect labor Total variable Direct labor hours Variable overhead per direct labor hour (rounded)

$ 2,425 375 350 $3,150 $ 450 2,700 $3,150  450 $ 7.00

Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. continued

Direct labor hours Variable rate Variable overhead Fixed overhead Total overhead Direct labor hours Actual overhead rate Costs assigned to jobs similar to A06: Direct materials Direct labor Overhead (50 direct labor hours  $19.60) (50 direct labor hours  $11.20) Total

250 DLH 250  $7.00 $ 1,750 3,150 $ 4,900  250 $ 19.60

750 DLH 750  $7.00 $ 5,250 3,150 $ 8,400  750 $ 11.20

$ 1,800 1,000

980 ________ $3,780

560 $3,360

d. When reviewing the solutions to a, b, and c, there appears to be considerable variation in the cost assigned to identical jobs. This variation is a function of the overall volume of activities. During high-volume months, the costs assigned are low compared to lowvolume months. Predetermined overhead rates are preferred to avoid this fluctuation in the cost of identical jobs. Note: At this point, the instructor might also mention the timing issue. When actual overhead costs are assigned, it must be after the end of the period when total costs and total activity are known. This delay is unacceptable if prices are based on costs. It also causes wide fluctuation in bookkeeping activities.

Solutions Manual, Chapter 17

P17-36. (Note: all numbers except hourly rates are in thousands) Work-in-Process Beginning balance ($6,440 + $2,750) Current manufacturing costs: Direct materials Direct labor Applied overhead (3,325  $6.25) Total costs in process Less cost of completed jobs: 522 523 524 Ending balance

$ $28,050.00 83,125.00 20,781.25

11,127.50 35,737.50 56,377.50

9,190.00

131,956.25 141,146.25

(103,242.50) $37,903.75

Job # 522

Job # 523

Beg. Bal. $ 6,440.0 DM 0 DL 3,750.0 OH (150  6.25) 937.5 Total $11,127.5

Beg. Bal. $ 2,750.0 DM 3,300.0 DL 23,750.0 OH (950  $6.25) 5,937.5 Total $35,737.5

Job # 524

Job # 525

Beg. Bal. $ 0.0 DM 14,190.0 DL 33,750.0 OH (1,350  $6.25) 8,437.5 Total $56,377.5

Beg. Bal. $ -0DM 10,560.00 DL 21,875.00 OH (875  $6.25) 5,468.75 Total $37,903.75

Financial & Managerial Accounting for Decision Makers, 4th Edition

P17-37. Work-in-Process Beginning balance Current manufacturing costs: Direct materials $98,150 Direct labor 38,750 Applied overhead (DL  0.90) 34,875 Total costs in process Less cost of completed jobs (#365 - #370)* Ending balance

*Cost of goods manufactured and sold: Job 365 Job 366 Beg. bal. $40,000 $29,800 Cur. costs: Dir. mat. 1,600 Dir. lab. 2,450 7,600 Mfg. OH** 2,205 6,840 Total cost

$44,655

$45,840

$ 117,400

171,775 289,175 (259,275) $ 29,900

Job 367 $30,600

Job 368 $ 17,000

Job 369 $ 0

Job 370 $ 0

Job 371 $ 0

Total $ 117,400

2,400 6,500

3,050 8,300

40,100 5,850

26,800 5,050

24,200 3,000

98,150 38,750

5,850 $45,350

7,470 $35,820

5,265 $51,215

4,545 $36,395

2,700 $29,900

34,875 $289,175

**($405,000 / $450,000  Direct labor dollars = 90% of Direct labor dollars)

Solutions Manual, Chapter 17

P17-38. a. MINOT PROCESSING COMPANY: PROCESSING DEPARTMENT Cost of Production Report For the Month of November Summary of units in process: Beginning Units started In process Completed Ending

4,000 20,000 24,000 (21,000) 3,000 Materials

Conversion

Equivalent units in process: Units completed

21,000

Plus equivalent units in ending inventory Equivalent units in process

3,000 24,000

21,000 750*

Total cost to be accounted for and cost per equivalent unit in process: Beginning work-in-process Current cost Total cost in process Equivalent units in process Cost per equivalent unit in process

$ 34,000 350,000 $384,000  24,000 $16

Accounting for total costs: Transferred out (21,000  $33.00) Ending work-in-process: Materials (3,000  $16) Conversion (750  $17) Total cost accounted for

Total

21,750

$23,950 345,800+ $369,750  21,750 $17

$ 57,950 695,800 $753,750 $33

$693,000 $48,000 12,750

60,750 $753,750

* 3,000 units, 1/4 converted + Includes direct labor of $182,000 and applied manufacturing overhead of $163,800 (90% of direct labor cost)

b. Work-in-process: Beginning Current manufacturing costs: Direct materials Direct labor Applied overhead Total Cost of goods manufactured Ending © Cambridge Business Publishers, 2021 17-28

$ 57,950 $350,000 182,000 163,800

695,800 $753,750 (693,000) $ 60,750

Financial & Managerial Accounting for Decision Makers, 4th Edition

P17-39. a. JIF PEANUT BUTTER Cost of Production Report For the Month of September Summary of units in process: Beginning Units started In process Completed Ending

200,000 600,000 800,000 (575,000) 225,000 Materials

Equivalent units in process: Units completed

575,000

Equivalent units in ending inventory Equivalent units in process

225,000 800,000

Total cost to be accounted for and cost per equivalent unit in process: Beginning work-in-process

$182,000

Current cost Total cost in process Equivalent units in process Cost per equivalent unit in process

578,000 $760,000 800,000 $ 0.95

Conversion

Accounting for total costs: Transferred out (575,000  $2.15) Ending work-in-process: Materials (225,000  $0.95) Conversion (225,000  75%  $1.20) Total cost accounted for

Total

575,000 168,750* 743,750

$44,600 847,900+ $892,500 743,750 $ 1.20

$ 226,600 1,425,900 $1,652,500 $

2.15

$1,236,250 $213,750 202,500

416,250 $1,652,500

*225,000 units, 75% converted +Includes direct labor of $401,900 and manufacturing overhead of $446,000

b. JIF PEANUT BUTTER Statement of Cost of Goods Manufactured For the Month of September Current manufacturing costs: Direct materials Direct labor Manufacturing overhead Plus: Work-in-process, 9/1 Total costs in process Less: Work-in-process, 9/30 Cost of goods manufactured

Solutions Manual, Chapter 17

$578,000 401,900 446,000

$1,425,900 226,600 1,652,500 416,250 $1,236,250

P17-40. a. 6,000 equivalent units / 0.40 = 15,000 unfinished units b. 15,000 units x 0.25 complete = 3,750 equivalent units c. Conversion costs Equivalent units per intern Cost per equivalent unit of conversion d. Total conversion costs: Equivalent units in ending inventory per intern Units completed Total equivalent units of conversion Cost per equivalent unit of conversion Total conversion costs Correct computation of equivalent units: Units completed Equivalent units in ending inventory Total equivalent units of conversion Total conversion costs Equivalent units of conversion Cost per equivalent unit of conversion (rounded) e. Work-in-Process: ending Materials Conversion (3,750 x $5.71) Total f.

6,000 12,000 18,000 × $5.00 $90,000 12,000 3,750 15,750 $90,000 ÷ 15,750 $ 5.71

$30,000.00 21,412.50 $51,412.50

Work-in-Process: ending Stated Correct Overstatement of inventory and understatement of cost of goods manufactured

$ 30,000 ÷ 6,000 $ 5.00

$60,000.00 (51,412.50) $8,587.50

Financial & Managerial Accounting for Decision Makers, 4th Edition

P17-41. a. Absorption cost per unit: Variable cost Fixed: $288,000 / 12,000 $288,000 / 8,000 Total unit cost

January $25

February $25

24 _____ $49

36 $61

b. February sales had to absorb fixed cost of $288,000 plus fixed cost of finished goods beginning inventory of $48,000 (2,000*  $24.00) which were included in the January 31 ending finished goods inventory. January sales thus deferred fixed costs of $48,000. This $48,000 shift in fixed costs from January, (which increased January income by $48,000), to February, (which decreased February income by $48,000), explains the $96,000 (from +$75,000 to -$21,000) difference in the January and February net incomes. *(12,000 January units production – 10,000 January units sold)

c. OTABO Contribution (Variable Costing) Income Statements For the Months of January and February January $800,000

Sales Variable expenses: Cost of goods sold (10,000  $25) Selling and administrative Contribution margin Fixed expenses:

$250,000 20,000

Manufacturing overhead Selling and administrative Net income d. Variable costing income Plus fixed MOH deferred (2,000  $24) Less: fixed MOH released (2,000 x $24) Absorption costing net income

Solutions Manual, Chapter 17

288,000 215,000

(270,000) 530,000

(503,000) $ 27,000 January $27,000 48,000 0 $75,000

$250,000 20,000

288,000 215,000

February $800,000

(270,000) 530,000

(503,000) $ 27,000

February $27,000 (48,000) $(21,000)

P17-42. a. RED ARROW BLUEBERRIES Functional (Absorption Costing) Income Statement For the Summer Quarter (Last Year) Sales (7,000  $115) $805,000 Cost of goods sold: Variable costs (7,000  $75)* $525,000 Fixed costs Goods available Ending inventory (1,000  $24) Gross profit Operating expenses: Variable selling and administrative (7,000  $2) Fixed selling and administrative Net income (loss) * Variable manufacturing costs: Direct materials Direct labor Manufacturing overhead Total

192,000 717,000 (24,000)

$ 14,000 38,000

(693,000) 112,000

(52,000) $ 60,000

$ 25 40 10 $75

**$192,000 / 8,000 = $24

b. RED ARROW BLUEBERRIES Contribution (Variable Costing) Income Statement For the Summer Quarter (Last Year) Sales (7,000  $115) $ 805,000 Variable expenses: Manufacturing (7,000  $75) $525,000 Selling and administrative (7,000  $2) 14,000 (539,000) Contribution margin 266,000 Fixed expenses: Manufacturing overhead $192,000 Selling and administrative 38,000 (230,000) Net income (loss) $ 36,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. and d. Ending inventory Absorption $ 75 24 $99  1,000 $99,000

Variable costs Fixed costs Total unit cost Units in ending inventory Ending inventory value (rounded to dollar)

Variable $75 0 $75  1,000 $75,000

e. The difference in the ending inventory under absorption costing and variable costing is explained by the differing treatments of fixed manufacturing costs, which are assigned to inventory under absorption costing but not under variable costing. Absorption ending inventory Inventory units  Fixed unit costs (1,000  $24) Variable ending inventory

P17-43. a. Variable manufacturing costs Fixed manufacturing costs or

Total monthly manufacturing costs where: X = units produced

$99,000 (24,000) $ 75,000

= =

($1,540,000 − $1,470,000) / (40,000-35,000) $14 per unit

= = = =

$1,540,000 − $14(40,000) $980,000 per month $1,470,000 − $14(35,000) $980,000 per month

$980,000 + $14X

b. Because general & administrative expenses are identical at monthly volumes of 35,000 units and 40,000 units, they must be all fixed. Fixed costs: Manufacturing General & administrative Total Unit contribution margin: Selling price ($2,450,000 / 35,000) Variable costs Net

$980,000 650,000 $1,630,000 $70 (14) $56

Break-even point = $1,630,000 / $56 = 29,108 units (rounded UP)

Solutions Manual, Chapter 17

c. Sales volume for

$600,000

$600,000 after-tax income = $1,630,000 + $600,000/(1 - 0.21) = 42,670 units(rounded UP) $56 d. CHARGER COMPANY Contribution (Variable Costing) Income Statement For the month of January Sales revenue Variable costs: Cost of good sold (35,000 × $14) Contribution margin Fixed costs: Manufacturing General & administrative Net income before taxes Income taxes @ 0.21 Net income

$2,450,000 (490,000) 1,960,000 $980,000 650,000

(1,630,000) 330,000 (69,300) $ 260,700

e. The two income figures are identical because production and sales are equal.

Financial & Managerial Accounting for Decision Makers, 4th Edition

CASES and PROJECTS C17-44. a. For financial reporting, all costs incurred in manufacturing products are called product costs and carried in the inventory accounts until the product is sold, at which time they are recognized as the expense, cost of goods sold. At the Harman Greeting Card Company product costs include: • Batch setup $300 per setup • Materials $150 per 1,000 cards • Conversion $200 per 1,000 cards The cost of each card in a batch can be computed as the total cost of the batch divided by the number of units in the batch. This cost per unit can then be assigned to any ending inventory or to the cost of goods sold. There are two additional considerations: 1. Given the large number of cards manufactured, this approach might prove too complex. Harman Greeting might just determine the average cost of a card produced during a period and use this number for financial reporting purposes. Harman Greeting would, of course, want more detailed information for internal decision making. 2. It is unclear how to treat the product-level costs of designing a new card and preparing a production master. Theoretically, these costs should be assigned to all cards manufactured with a particular production master. The problem is that the final number of units to be manufactured with the master is unknown. There are at least four possible approaches: i

Expense these costs when incurred. This will understate the value of Harmon Greeting’s assets. If approximately the same number of designs and masters are developed each year, the income statement will be reasonably accurate. ii Amortize the masters over a number of years that represent the average life of a design and production master. iii Perform a different evaluation of the file of each design and master after obtaining information on initial sales. iv Retain the masters at their original cost and expense them when they are deemed to be worthless. Unfortunately, none of these alternatives directly assigns the costs of a specific design and production master to the cards produced with that master.

Solutions Manual, Chapter 17

b. The first step in evaluating the Walgreens proposal is to compare the incremental revenues with the incremental costs for the initial order. If the initial order is profitable, accepting the order will not affect current sales; if Harmon Greeting has excess capacity, the order should be accepted. Relevant costs for this analysis include: • • • • •

Product designs and production masters Batch setup Materials Conversion Shipping

$3,500 each $300 per setup $150 per 1,000 cards $200 per 1,000 cards $15 per batch

If the initial order would not be profitable, but accepting the order will not affect current sales and Harman Greeting has excess capacity, management might assess the probability of additional sales to Walgreens, making the relationship profitable. If accepting the Walgreens order would require giving up some current sales, an opportunity cost would have to be incorporated into the analysis. c. Only product costs were considered in the answer to (a) All manufacturing costs and shipping costs are considered in requirement (b). Also note that because the designs are exclusive for Walgreens, these costs are included in assessing the profitability of the order. Note: Although it is not required, you might ask the students to evaluate the initial Walgreens order. The analysis is as follows: Incremental revenues (10 designs  30,000 cards  $0.70) Incremental costs: Product design and production masters (10 designs  $3,500 each) Batch setup (10 designs X 3 batches  $300 each) Materials (10 designs X 30,000 cards per design X $150 per 1,000) Conversion (10 designs X 30,000 cards per design X $200 per 1,000) Shipping ($15 per batch  30 batches) Total Advantage of accepting

$210,000 35,000 9,000 45,000 60,000 450 (149,450) $ 60,550

*10 designs x 3 set-ups for each design (30,000 cards per design/10,000 cards per set-up)

Assuming there is available capacity, the order appears acceptable in the short run. Additional orders for the same designs will make the arrangement with Walgreens even more profitable. From a long-run viewpoint, any arrangement with Walgreens must also cover a portion of fixed costs.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C17-45. There are several acceptable ways to approach the analysis of Dart's two products. The method presented below simply restates the original gross profit financial reports, assigning overhead to the two products using departmental overhead rates per labor hour for the Fabrication and Assembly Departments, instead of using a plantwide overhead rate of $21 (calculated as [$393,750 + $126,000] / [18,750 hrs. + 6,000 hrs.]).

Sales units Sales dollars Cost of goods sold: Direct materials Direct labor Applied overhead: Fabrication Lion Tamers (3,000  1.5  $47*) Assembly Bear Detectors (7,500  2.5  $15.2222**) Lion Tamers (3,000  0.50  15.22222**) Total Gross profit *Fabrication overhead rate: Fixed overhead Variable overhead (3,000  1.5  $6) Total Labor hours (3,000  1.5) Overhead rate **Assembly overhead rate: Fixed overhead Variable overhead Bear Detectors (7,500  2.5  $12) Lion Tamers (3,000  0.50  $12) Total Labor hours [(7,500  2.5) + (3,000  0.50)] Overhead rate (rounded)

Bear Detector 7,500 $750,000

Lion Tamer 3,000 $450,000

165,000 281,250

97,500 90,000

211,500 285,417 _______ (731,667) $ 18,333

22,833 (421,833) $ 28,167

$184,500 27,000 $211,500  4,500 $ 47 $ 65,250

225,000 18,000 $308,250  20,250 15.22222

It appears that Lion Tamers are being cross-subsidized by Bear Detectors through the use of a single, plantwide overhead rate based on direct labor. When costs are broken into two overhead cost pools for fabrication and assembly, a very different picture emerges. Lion Tamers appear to be far less profitable that originally thought, while Bear Detectors now appear to be profitable. These results help explain why the Nittney competitor charges a higher selling price on Lion Tamers (assuming similar cost structures and production procedures). Continued

Solutions Manual, Chapter 17

Note: The instructor may ask the minimum price Dart Products could charge for each product without losing money or having a negative contribution margin. This would be each product’s unit variable cost, determined as follows:

Sales: Units Cost of goods sold: Direct materials Direct labor Variable overhead: Fabrication Lion Tamers (3,000  1.5  $6) Assembly Bear Detectors (7,500  2.5  $12) Lion Tamers (3,000  0.50  $12) Total Units Unit variable cost

Bear Detector

Lion Tamer

7,500

3,000

$165,000 281,250

$ 97,500 90,000

27,000 225,000 ________ $671,250  7,500 $ 89.50

18,000 $232,500  3,000 $ 77.50

Any amount in excess of $89.50 for Bear Detectors and $77.50 for Lion Tamers will provide a contribution toward covering fixed costs and providing for a profit. Care should be taken in using these numbers because of the high fixed costs of the Fabricating Department. In the long run, Dart Products must cover fixed as well as variable costs.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C17-46. While a definitive evaluation cannot be made without balance sheet information, it appears that the new management team has increased inventories by 50,000 units, doubled selling and administrative expenses (salaries?), and reduced Kluber's cash balance to pay for selling and administrative expenses and the 50,000-unit inventory increase. The reduction in the cost of goods sold and the increase in net income during the second half of the year is probably due to $1,000,000 in overapplied manufacturing overhead. In exchange for current profits the future consequence may include excess investments in inventory and increased risk of spoilage and/or obsolescence. While the inventory buildup may be in anticipation of increased sales, the fact that second and first-half sales are identical makes this unlikely. Kluber is heading for serious problems. The following analysis may be useful in explaining the results of the second half of the year: Estimated fixed costs for six months = $2,000,000 / 2 = $1,000,000 Analysis of fixed manufacturing overhead during the second six months: Actual Applied (200,000 units × $10) = Overapplied

$ $

1,000,000 (2,000,000) (1,000,000)

The $100,000 cash dividend is very questionable given the stock acquisition and the $400,000 increase in selling and administrative expenses. Are these higher management salaries? Using variable costing, these additional expenses would have resulted in a $400,000 INCREASE in net loss from the first half of the year.

Solutions Manual, Chapter 17

Chapter 18 Activity-Based Costing, Customer Profitability and Activity-Based Management QUESTIONS Q18-1.

The following two sentences summarize the concepts underlying activity-based costing: 1. Activities performed to serve customer needs cost money. 2. The cost of resources consumed by activities should be assigned to cost objectives on the basis of the units of activity consumed by the cost objective.

Q18-2.

Implementing the two-stage model requires: 1. 2. 3. 4. 5.

Q18-3.

Identifying activities. Assigning costs to activities. Determining the basis for assigning the cost of activities to cost objectives. Determining the cost per unit of activity. Reassigning costs from the activity to the cost objective on the basis of the cost objective's consumption of activities.

An activity cost pool consists of the total costs identified that relate to a given activity conducted as part of a process. An activity cost driver is the unit of measurement of the activity level that causes costs to be incurred. Cost per unit of activity is simply the total amount of the activity cost pool divided by the level of the activity cost driver.

18-1

Q18-4.

Cost Pool Maintenance

Possible Cost Drivers Number of maintenance hours Number of repair orders Number of machine hours

Materials movement

Number of movements Weight or volume of material Dollar value of material

Machine setup

Number of setups Number of setup hours Number of production runs

Inspection

Number of inspections Number of inspection hours Weight or volume of goods inspected

Materials purchases

Number of purchase orders Number of vendors Dollar value of purchases

Customer service

Number of customers Dollar value of sales to customers Number of customer service calls

Q18-5.

Activity-based costing is based on the premise that • activities drive costs and that • the cost of activities should be assigned to cost objectives on the basis of the activities they consume.

Q18-6.

Activity-based costing differs from traditional approaches to cost allocation in terms of the number of cost pools used, the assignment of costs to pools based on activities, the rejection of volume-based allocation that is not related to cost-causing activities, the need to understand the production process, and the frequent use of judgment.

Q18-7.

ABC often reveals product cross-subsidization problems if it produces costs for some products that are higher, and costs for other products that are lower, than costs produced by traditional costing methods. ABC often reveals that some products are undercosted and others are overcosted. This is referred to as cross- subsidization.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q18-8.

Customers make varying demands on companies with some customers requiring little support and others requiring substantial amounts of support. Using ABC companies can determine the amount of its various customer support activities, and their related costs that are incurred for the benefit of each customer, thereby determining customer profitability after taking into account these customer support costs.

Q18-9.

Activity-Based Management (ABM) is the identification and selection of activities to maximize the value of activities while minimizing their cost from the perspective of the final consumer. Whereas activity-based costing (ABC) is concerned with measuring the cost of activities used to produce a cost objective (e.g., a product or service), ABM is concerned with how to efficiently and effectively manage activities and processes to provide value to the final consumer.

18-3

MINI EXERCISES M18-10. 1. 2. 3. 4. 5.

i h f a j

6. d 7. b* 8. c 9. e 10. g

* (Note: (d) cannot be used because it is the most logical answer to item 6, and each answer can be used only once.)

M18-11. There is no single correct answer to this exercise. The purposes of the exercise are to develop skills in thinking about activities and to organize them sequentially. 1. Open cargo hatch 2. Unload aircraft 3. Move baggage to baggage sorting area 4. Sort baggage by outgoing flight numbers and/or destination 5. Move baggage for which hub is final destination to baggage claim area 6. Accumulate baggage for each outgoing flight 7. Move baggage to outgoing aircraft 8. Load aircraft 9. Secure baggage 10. Close cargo hatch

M18-12.

Assignment of salary: $150,000  0.60 portion teaching  0.50 Annual enrollment: Introductory course (60 students  2 semesters) Graduate course (30 students  2 semesters) Cost of instruction per student

Introductory Course

Graduate Course

$45,000

 120 _______ $375.00

 60 $750.00

Financial & Managerial Accounting for Decision Makers, 4th Edition

M18-13. The easiest way to solve this assignment is to classify each of the activities Christine performed as unit, batch, product, or facility level. Next, total the percentages in each category. Finally, multiply the percentages by Christine’s salary. Assignment of Salary Unit level: Supervising production Total Batch level: Job scheduling Supervising setup First unit inspection Total Product level: Product design Preparing bills of materials Preparing operations lists Total Facility level: Employee training Facility maintenance Attending professional meetings Total Grand total

25 percent 25

$28,750

12 percent 6 percent 7 percent 25

28,750

15 percent 5 percent 9 percent 29

33,350

8 percent 3 percent 10 percent 21 100

24,150 $115,000

M18-14. Sales revenue Less: Cost of goods sold Customer relations ($110  432) Selling expenses ($2,150,000  0.05) Accounting (3,220  $7.50) Warehousing (57,850  $0.60) Packing (57,850  $0.30) Shipping (1,250,000  $0.05) Profitability of June sales in Los Angeles

$2,150,000 $1,405,000 47,520 107,500 24,150 34,710 17,355 62,500

(1,698,735) $ 451,265

18-5

M18-15. Activity cost of converting raw materials into 125 fireplace inserts: Setup Movement: Batch ($15  4 moves) Weight ($0.10  125 units  50 lbs.  4 moves) Inspection ($2.00  3  125) Drilling ($6  8  125) Welding ($4.00  100  125) Shaping ($22  0.75  125) Assembly ($18  1  125) Total

$ $

60.00 2,500.00

120.00

2,560.00 750.00 6,000.00 50,000.00 2,062.50 2,250.00 $63,742.50

M18-16. Activity cost calculations: Machine setup cost = $750,000  18,750 setup hours = $40 per setup hour Material handling cost = $121,600  3,800 tons = $32 per ton of materials Machine operation = $552,500  16,250 = $34 per machine hour Product costs: Direct materials Direct labor Manufacturing overhead: Machine setups (6 setup hours  $40) Material handling (4 tons  $32) Machine operation (8 machine hours  $34) Total job costs Units produced Cost per unit produced

Stands $48,000 10,000

240 128 272 $58,640  100 $586.40

Charbroilers $125,000 30,000

(36 setup hours  $40) (14 tons  $32) (25 machine hours  $34)

1,440 448 850 $157,738  50 $3.154.76

Financial & Managerial Accounting for Decision Makers, 4th Edition

M18-17. Activity cost calculations: Machine setup cost = $210,000  3,500 setups = $60 per setup hour Material handling cost = $468,000  6,500 = $72 per material move Machine operation = $1,026,270  12,670 = $81 per machine hour Product costs:

Direct materials Direct labor Manufacturing overhead: Machine setups (24 setup hrs.  $60) Material handling (35 moves  $72) Machine operation (100 hours  $81) Total cost per batch Gallons produced Cost per gallon

Cashmere $282,940 5,000

Emerald $299,090 5,500

1,440 (26 setup hrs.  $60) 2,520 (40 moves  $72) 8,100 (120 hours  $81) $300,000  20,000

1,560 2,880 9,720 $318,750  25,000

12.75

M18-18. Activity Refinishes (@ $150) Touchups (@ $100) Communication (@ $30) Total support costs Gross Profit Customer profits

Brookside

Edgewater

Hillrose

$ 18,000 26,000 27,000 71,000 150,000 $ 79,000

$ 10,500 20,500 15,900 46,900 150,000 $ 103,100

$ 12,000 22,000 17,700 51,700 150,000 $ 98,300

The instructor may want to ask the students to comment on the usefulness of this type analysis and ask what reasonable actions Elite might take as a result of this analysis (see discussion below). Continued

18-7

This analysis is beneficial to Elite because it shows that the Brookside Company is a definite outlier among the three builders in terms of support services required. Brookside is a significantly larger consumer of activities for refinishes, touchups and communication. Note that Brookside requires 900 communications (calls, emails, etc.) for 380 refinishes and touchup procedures, or 2.4 communications per procedure; whereas, the ratios for Edgewater and Hillrose are 1.93 and 1.97, respectively. Elite should consider sharing some of these data with the Brookside Company to demonstrate to them that they are not in line with the other builder/customers in terms of the level of support required. If Brookside cannot be brought in line, Elite may consider replacing Brookside, possibly by seeking another builder as a third customer. Of course, despite Brookside’s poor performance as a customer, it is still quite profitable – this analysis may simply serve to help make it more profitable. Also, by determining the cost of each unit of activity for refinishes, touchups, and communications, Elite should assess its cost management of these activities and attempt to lower the cost per unit without reducing the level of effectiveness.

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E18-19. a. Activity Cost Pools Setup costs Materials handling costs Machine operating costs Packing costs Total indirect manufacturing costs

Cost $ 55,000 10,050 242,400 67,200

   

Cost Drivers 550 setups 670 material moves 20,200 machine hours 1,400 packing orders

= = = =

Cost per Unit of Activity $100 $15 $12 $48

$374,650

b. Manufacturing overhead cost of producing metal casements: Number of setups Number of materials moves Number of machine hours Number of packing orders Total manufacturing overhead cost Casements produced Cost per casement

45 112 2,400 195

   

$100 $15 $12 $48

= = = =

$ 4,500 1,680 28,800 9,360 $44,340  500 $ 88.68

The instructor may want to ask the students to comment on the adequacy of Thornton’s cost system (see below). Thornton’s cost system should provide an accurate measurement of manufacturing overhead because it recognizes the activities that go into making a product, and it assigns cost to the product based on the cost of performing the activities used to produce it.

18-9

E18-20. a. Plantwide manufacturing overhead

Total manufacturing overhead Total allocation base activity

Plantwide overhead rate based on machine hours = $600,000 / 20,000 machine hours = $30.00 per machine hour b

Plantwide manufacturing overhead rate based on direct labor hours = $600,000 / 4,000 direct labor hours = $150 per direct labor hour

c. Milling department overhead rate based on machine hours = $450,000 / 15,000 machine hours = $30.00 per Milling Dept. machine hour Finishing department overhead rate based direct labor hours = $150,000 / 2,000 direct labor hours = $75 per Finishing Dept. direct labor hour d. Milling department overhead rate based on direct labor hours = $450,000 / 2,000 direct labor hours = $225 per Milling Dept. direct labor hour Finishing department overhead rate based on machine hours = $150,000 / 5,000 machine hours = $30 per Finishing Dept. machine hour e. Part c. allocation rates, which use machine hours as the allocation base in the Milling Department and direct labor hours as the allocation base in the Finishing Department, are probably the best of the four alternatives illustrated, because they reflect the nature of the activity in the respective departments. The processes in the Milling Department are machine-activity intensive whereas the Finishing Department conducts processes that are direct-labor-activity intensive.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E18-21. a. Activity cost calculations: Setup cost: $125,000 / 2,500 setup hours = $50 per setup hour Production scheduling cost: $75,000 / 150 batches = $500 per batch Production engineering cost: $265,000 / 20,000 machine hours = $13.25 per MH Supervision cost: $85,800 / 4,000 direct labor hours = $21.45 per direct labor hour Machine operating cost: $49,200 / 1,025 repair requests = $48 per request b. Direct materials cost Direct labor cost Manufacturing overhead costs: Setup costs (2 hours  $50) Production scheduling (1 batch  $500) Production engineering (20 machine hours  $13.25) Supervision (20 direct labor hours  $21.45) Machine operations (1 maintenance request  $48) Total Job 845 cost

Job 845 $ 1,450 500 100 500 265 429 48 $3,292

c. Cost of Job 845 using a plantwide overhead rate based on machine hours:

Direct materials cost Direct labor cost Manufacturing overhead cost: (20 machine hours  $30*) Total Job 845 cost

Job 845 $1,450 500 600 $2,550

*See E18-20 a. for calculation.

d. Cost of Job 845 using departmental overhead rates based on machine hours in the Milling Department and direct labor hours in the Finishing Department

Direct materials cost Direct labor cost Manufacturing overhead cost Milling Department (15 machine hours  $30*) Finishing Department (15 labor hours  $75*) Total Job 845 cost

Job 845 $ 1,450 500 450 1,125 $3,525

18-11

d. continued The instructor may want to ask the students what additional data management will need for Job 845 to adequately evaluate its price and profitability. This problem takes into account only manufacturing costs, which are all that are allowed to be included in product costs for financial statement purposes; however, for managerial purposes, management will want to know what additional costs are incurred with respect to Job 845. This will include shipping, distribution, as well as service to the customer after the sale and delivery of the job.

E18-22. a. Overhead rate per direct labor dollar: $188,780 / $151,024 = 1.25 or 125%

Direct materials Direct labor Overhead (1.25 × direct labor) Total cost Units Unit cost (rounded)

Gas Cooker Charcoal Smoker $ 225,500.00 $108,500.00 100,683.00 50,341.00 125,853.75 62,926.25 $452,036.75 $221,767.25  4,000  3,500 $ 113.01 $ 63.36

Total $334,000.00 151,024.00 188,780.00 $673,804.00

(a) ÷ (b)

b. Rate per unit of activity cost driver: (a) Activity Materials acquisition and inspection

Cost

Cost Driver

(b) Cost Driver Quantity

$50,100

Direct materials cost

$334,000

0.15 per DM$

Product assembly

123,500

Machine hours

19,000

$6.50 per MH

Scheduling

15,180

Number of batches

115

$132 per batch

Rate

Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. continued

Total direct materials costs Total direct labor costs Overhead costs: Materials acquisition $225,500 & $108,500 @ 0.15/DM$ Product assembly 16,000 & 3,000 @ $6.50/MH Scheduling 80 & 35 @ $132/batch Total costs Units produced Unit cost (rounded)

Gas Cooker $ 225,500 100,683

Charcoal Smoker $ 108,500 50,341

Total $334,000 151,024

33,825

16,275

50,100

104,000 10,560 $474,568  4,000 $ 118.64

19,500 4,620 $199,236  3,500 $ 56.92

123,500 15,180 $673,804

E18-23. a. The solution to (b) using activity-based costing is more accurate. If the solution to (a) using traditional costing is followed, prices developed on the basis of costs will be inaccurate and result in lost profits and lost profit opportunities. In particular, the Gas Cooker, which is more complicated may be priced too low, resulting in lost revenues and profits. The Charcoal Smoker, which is less complicated may be priced too high, resulting in lost sales. Under traditional costing, Charcoal Smokers are subsidizing the cost of Gas Cookers because part of the cost of the Cookers is being assigned to the Smokers. b. Given the advancement of technology and automation, indirect costs tend to displace direct costs. As this pool of indirect costs becomes a more significant part of the overall product costs, department and plant wide rate allocation methods become less accurate and can even be misleading. Therefore, as manufacturing process continue to advance in terms of technology and automation; they will also tend to benefit more from the use of an ABC costing method. c. Subtracting product costs from revenues will yield the gross margin on the products, but to determine the net profitability of Cookers and Smokers, the costs incurred after the products are manufactured, for selling and distribution activities, must be determined. Because all customer types may not be equally profitable (due to variations in servicing demands), management may also want to determine the profitability for the various categories of customers (e.g., premium stores, discount stores, buying clubs, and specialty shops) that buy Smokers and Cookers from Cuisinart.

18-13

E18-24. a. Overhead rate per direct labor hour: $436,000 / 16,000 DLH = $27.25 Z205 X301 Direct materials $18,550 $18,550 Direct labor 5,000 5,000 Overhead ($27.25  200 hours each) 5,450 5,450 Total cost $29,000 $29,000 2,000 Units  2,000 Unit cost $14.50 $14.50 b. Rate per unit of cost driver: Activity Cost Assembly setups $ 124,000 Materials handling 57,000 Assembly 225,000 Maintenance 30,000

Driver Activity 4,000 600 12,500 1,200

Total direct materials costs Total direct labor costs Overhead costs: Assembly setup — 30 & 60 hours @ $31 per hour Materials handling — 75 & 150 moves @ $95 per move Assembly — 500 & 750 assembly hours @ $18/assembly hr Maintenance — 25 & 45 maintenance hours @ $25/hr Total costs Units produced Unit cost (rounded)

Rate $31/setup hour $95/move $18/assembly hour $25/maintenance hour X301 $18,550 5,000

Z205 $18,550 5,000

930 7,125 9,000 625 $41,230  2,000 $ 20.62

1,860 14,250 13,500 1,125 $54,285  2,000 $ 27.14

c. In (a), X301 and Z205 had the same total manufacturing cost because they have identical direct materials and direct labor costs, and because manufacturing overhead is assigned based on direct labor hours, which were also identical. However, in (b), using activity-based costing, the differences between the two products and the activities required to produce them are reflected in the total product costs. Z205 required more setup hours, more material moves, and more maintenance hours than X301, thus causing Z205 to have $6.52 per unit more cost than X301. d. A company like Panasonic operates in a highly competitive worldwide market that often forces companies to price products at levels that result in very low profit margins. In such cases, relying on product costs that include even small errors can result in bad pricing and product mix decisions. By undercosting both models, the Panasonic brand manager may not realize that neither product is profitable at the current sales price. Before raising prices, the brand manager would need to review prices of similar products sold by Panasonic competitors. ©Cambridge Business Publishers, 2021 18-14

Financial & Managerial Accounting for Decision Makers, 4th Edition

E18-25. a. Total overhead costs: Setup Ordering Assembly Finishing Direct machine hours Overhead cost per direct machine hour (rounded)

$ 175,000 120,000 910,000 208,000 $1,413,000 ÷ 14,000 $ 100.93

Job cost calculations:

Direct materials Direct labor Overhead ($100.93 × 200) and ($100.93 × 225) Units produced Cost per unit (rounded)

Job 201 $12,000.00 20,500.00 20,186.00 $52,686.00 ÷ 1,000 $52.69

Job 202 $14,000.00 40,000.00 22,709.25 $76,709.25 ÷ 850 $90.25

b. Calculation of activity costs: Setup costs Ordering costs Assembly Finishing

$175,000 / 1,750 setups $120,000 / 15,000 orders $910,000 / 14,000 machine hrs. $208,000 / 104,000 direct labor hrs.

= $100 per setup = $8 per order = $65 per machine hr. = $2 per kwh

Job cost calculations:

Direct materials Direct labor Setup cost ($100 × 15) and ($100 × 18) Ordering costs ($8 × 200) and ($8 × 100) Assembly ($65 × 200) & ($65 × 225) Finishing ($2 × 820) and ($2 × 1,600) Total job costs Units produced Cost per unit (rounded)

Job 201 $12,000 20,500 1,500 1,600 13,000 1,640 $50,240 ÷ 1,000 $50.24

Job 202 $14,000 40,000 1,800 800 14,625 3,200 $74,425 ÷ 850 $87.56

c. In addition to the manufacturing cost information provided by ABC, management will need to have additional information about non-manufacturing costs, such as distribution and customer service. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 18

18-15

d. The findings in the above requirements could have multiple implications for Ridgeland. The manager should be pleased that both Jobs 201 and 202 had ABC costs less than their costs under traditional overhead costing. However, what this also means is that traditional costing would have to be undercosting some other jobs. While it may be encouraging that the two jobs in this exercise are more profitable than previously thought, it should be of serious concern that other jobs are not as profitable as management previously thought. A full cost analysis of all jobs should be conducted before management can assess the full impact of failing to account for the actual activities used in producing the jobs.

E18-26.

E18-27. a. Dropping the three customers that have losses totaling $355,000 will not likely cause an immediate increase in profits of $355,000 because some of those costs are not avoidable. For example, some of those costs may be fixed costs that will continue, even if the three customers to which some of the costs are assigned cease to be customers. In the long run, the company should be able to use those costs to help serve new, hopefully profitable, customers, or possibly eliminate the costs. b. The benefit of this type analysis is that it clearly focuses management’s attention on the fact that not all customers are equally profitable because the activities consumed in serving customers are not equal for all customers. Without customer profitability analysis, management may not even be aware that some customers are unprofitable, and that the customers that produce the most sales revenue may not be producing the most profits.

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P18-28. a.

Purchasing and materials handling Setup Machine operations First unit inspection Packaging

Direct materials Direct labor Purchasing and handling: Product A ($0.50  175,000) Product B ($0.50  65,000) Specialty ($0.50  95,000) Setup: Product A ($150  150) Product B ($150  45) Specialty ($150  800) Machine operations: Product A ($110  1,200) Product B ($110  650) Specialty ($110  800) First unit inspection: Product A ($175  140) Product B ($175  50) Specialty ($175  400) Packaging: Product A ($0.50  35,000) Product B ($0.50  15,000) Specialty ($0.50  10,000) Total Units Unit cost

Budgeted Cost $475,000 225,000 1,540,000 280,000 100,000 Standard Product A $58,000 95,500

    

Budgeted Activity 950,000 1,500 14,000 1,600 200,000

= = = = =

Standard Product B $44,350 64,900

Cost per Unit of Activity $ 0.50 150.00 110.00 175.00 0.50 Specialty Products $27,000 45,000

87,500 32,500 47,500 22,500 6,750 120,000 132,000 71,500 88,000 24,500 8,750 70,000 17,500 ________ $437,500  35,000 $12.50

7,500 ________ $236,250  15,000 $15.75

5,000 $402,500  10,000 $40.25

18-17

b. The much higher unit cost of the specialty products due to the higher number of machine hours per unit and the small number of units in each batch: Standard Product A Standard Product B Specialty Products

35,000 units/140 batches = 15,000 units/50 batches = 10,000 units/400 batches =

250 units per batch 300 units per batch 25 units per batch

Consequently, setup costs and first unit inspection costs are averaged over a smaller number of units.

P18-29. a. Total cost of meals, facilities, and medical services / Annual resident days = ($4,927,500 + $2,591,500) / 36,500 = $206 cost per day For parts b and c: Calculation of meals & residential cost per resident day: Total cost of meals and residential space / Annual resident days = $2,591,500 / 36,500 = $71 cost per day b. Total cost of medical services / Annual assistance hours = Cost per hour = $4,927,500 / 73,000 = $67.50 per hour ABC cost per resident day based on annual assistance hours: Cost per resident day (medical services cost plus meals and residential cost): Class A: $67.50 × 9,100 = $614,250 / 18,000 = $34.13* + $71 = $105.13 Class B: $67.50 × 22,500 = $1,518,750 / 10,000 = $151.88* + $71 = $222.88 Class C: $67.50 × 23,000 = $1,552,500 / 5,500 = $282.27* + $71 = $353.27 Class D: $67.50 × 18,400 = $1,242,000 / 3,000 = $414.00 + $71 = $485.00 * rounded

c. Total cost of medical services / No. of assistance contacts = Cost per contact = $4,927,500 / 109,500 = $45.00 ABC cost per resident day based on number of assistance contacts: Cost per resident day (medical services cost plus meals and residential cost): Class A: $45 × 27,000 = $1,215,000 / 18,000 = $67.50 + $71 = $138.50 Class B: $45 × 31,000 = $1,395,000 / 10,000 = $139.50 + $71 = $210.50 Class C: $45 × 27,500 = $1,237,500 / 5,500 = $225.00 + $71 = $296.00 Class D: $45 × 24,000 = $1,080,000 / 3,000 = $360 + $71 = $431.00

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. Under the current costing system, the cost per resident day is $206 per day for all resident classifications. While classifications C and D account for the lowest number of resident days, they account for more than half of the assistance hours and almost half the assistance contacts as the other classifications. The best cost driver is the driver that has the greatest influence on cost. Intuitively, both assistance hours and contacts would seem to influence costs; however, since much of the cost is probably related to staff time, annual assistance hours would probably be a better cost driver.

P18-30. a. Activity cost per unit of activity: Taking applications: $306,000 / 3,600 hours = $85 per hour Conducting credit investigations: $378,000 / 5,400 hours = $70 per hour Underwriting: $405,000 / 5,400 hours = $75 per hour Preparing loan packages: $594,000 / 10,800 hours = $55 per hour Closing loans: $396,000 / 3,600 hours = $110 per hour b. Loan # 7023 Taking applications ($85 per hour × 2) Investigations ($70 per hour × 3) Underwriting ($75 per hour × 6) Loan packages ($55 per hour × 9) Closing loans ($110 per hour × 4)

Loan # 8955 Taking applications ($85 per hour × 4) Investigations ($70 per hour × 5) Underwriting ($75 per hour × 6) Loan packages ($55 per hour × 18) Closing loans ($110 per hour × 6)

$ 170 210 450 495 440 $1,765

$ 340 350 450 990 660 $2,790

c. Average cost per hour = $2,079,000/ 28,800 = $72.19 (rounded) Cost of loan #7023 ($72.19 × 24 hours) = $1,732.56 Cost of loan #8955 ($72.19 × 39 hours) = $2,815.41

18-19

d. Loan 7023 is undercosted and Loan 8955 is overcosted when using average cost compared with ABC: Loan #7023 Loan #8955 ABC cost $1,765.00 $2,790.00 Average cost - 1,732.56 - 2,815.41 Difference $32.44 $(25.41) Since individual jobs use different mixes of the various categories of labor, ABC accounts for these differences; whereas, the average method does not. ABC recognizes the unique combination of the various activities used to process each individual loan and provides a more accurate measure of cost.

P18-31. a. Costs assigned to machines 7 and 8: $66,200 / 10 = $6,620 b. Activity costs: Daily Trips Maintenance salaries ($3,500  2) Associate Cashiers' salaries: Routine visits ($3,000  2  0.75) Maintenance visits ($3,000  2  0.25) Head cashier's salary and office space: Routine visits [($6,000 + {$12,000/2}*)  0.60] Maintenance [($6,000 + {$12,000/2})  0.40] Supervisor's salary and office space: Routine visits [($8,000 + {$12,000/2})  0.20] Supervising maintenance employees [($8,000 + {$12,000/2})  0.80  2/5] Supervising head cashier: [($8,000 + {$12,000/2})  0.80  1/5  0.60] [($8,000 + {$12,000/2})  0.80  1/5  0.40] Supervising cashiers: [($8,000 + {$12,000/2})  0.80  2/5  0.75] [($8,000 + {$12,000/2})  0.80  2/5  0.25] Cashiers' service vehicle Maintenance service vehicle Total cost Total activity Activity cost per unit (rounded)

Maintenance Call Hours $7,000

$4,500 1,500 7,200 4,800 2,800 4,480 1,344 896 3,360 1,120 2,400 ________ 21,604  500 $ 43.21

4,800 24,596  190 $ 129.45

*One-half office costs.

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c. Cost assignments and reassignments:

Machine lease, space rent, and utilities Routine trips: (80  $43.21) (30  $43.21) Maintenance: (24  $129.45) (14  $129.45) Total

Machine 7 $2,000.00

Machine 8 $2,000.00

3,456.80 1,296.30 3,106.80 ________ $8,563.60

1,812.30 $5,108.60

d. Although determining accurate cost information is one of the primary benefits of activitycost systems, the greatest potential benefit is the basis it provides for evaluating the cost-benefit of activities performed. Often, when the true cost of an activity is determined, management will conclude that it is either not worth the cost to continue the activity, or possibly it is more cost-effective to outsource the activity to another organization. Calculating ABC costs is simply the first step in activity-based management, which should be the ultimate goal of any activity-based cost system

P18-32. a. $737,500 / (25,000 + 4,500) = $25.00 per direct labor hour b. Overhead cost for shafts: $25.00  25,000 hours = $625,000 $625,000/50,000 units = $12.50 per unit Overhead cost for gears: $25.00  4,500 hours = $112,500 $112,500/18,000 units = $6.25 per unit c. Setup activity cost based on number of production runs: 20 + 30 = 50 runs $40,000 / 50 runs = $800 per production run Machine activity cost based on number of machine hours: 43,000 + 6,500 =49,500 hours $198,000 / 49,500 hours = $4 per machine hour Continued

18-21

c. continued Purchasing and receiving activity cost based on number of orders processed: 50 + 98 = 148 $218,300 / 148 = $1,475 per order Engineering activity cost based on number of engineering hours: 2,500 + 2,500 = 5,000 hours $209,000 / 5,000 hours = $41.80 per hour Materials handling activity cost based on number of materials moves: 62 + 33 = 95 $72,200 / 95 = $760 per move Activity costs of shafts and gears: Setup (20 & 30 runs @ $800) Machine (43,000 & 6,500 hours @ $4) Purchasing (50 & 98 @ $1,475) Engineering (2,500 & 2,500 @ $41.80) Materials Handling (62 & 33 @ $760) Total ABC overhead cost Number of units produced ABC manufacturing overhead per unit (rounded)

Shafts $ 16,000 172,000 73,750 104,500 47,120 413,370  50,000 $8.27

Gears $ 24,000 26,000 144,550 104,500 25,080 324,130  18,000 $18.01

d. Using a plantwide manufacturing overhead rate of $25.00 per hour, Sterling assigned $12.50 of overhead cost to each shaft and $6.25 of overhead cost to each gear. By recognizing that shafts and gears make different demands on the activities of the manufacturing process, ABC produces an overhead cost of $8.27 for shafts and $18.01 for gears. This shows that Sterling is over-assigning costs to shafts by $4.23 per unit ($12.50 – $8.27), and it is under-assigning costs to gears by $11.76 per unit ($6.25 – $18.01). These cost assignment errors clearly explain why the company is having difficulty competing in the shafts market (because its product is overcosted by $4.23), and why it is cornering the market in the gears market (because its product is undercosted by $11.76).

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P18-33. a. ($ 000) Sales Cost of goods (80% of sales) Gross profit Less expenses: Sales commissions (@ 5% of sales) Sales visits (@1,000) Product adjustments (@ 1,600) Phone and other remote contacts (@ $100) Promotion and entertainment (@ $3,000) Corporate jet expense Customer profitability Net customer return on sales

A $19,000 -15,200 3,800

Customer B C D $14,000 $5,000 $6,000 -11,200 -4,000 -4,800 2,800 1,000 1,200

E $4,000 -3,200 800

950.0 90.0 16.0

700.0 105.0 32.0

250.0 95.0 28.8

300.0 30.0 12.8

200.0 30.0 6.4

16.0

20.0

10.0

3.50

2.50

60.0 51.0 32.0 8.0 $1,851.0 $ 557.20

36.0 0.0 $817.7

42.0 5.0 $514.1

13.6%

12.9%

D $817.7

E $514.1

242.4 _____

161.6

$575.3

$352.5

9.6%

8.8%

63.0 16.0 $2,649.0 13.9%

13.2%

11.1%

b. Customer ($ 000) A B C Customer profitability (before G&A exp.) $2,649.0 $1,851.0 $557.2 Less G&A expense*: 19/48 × (2,000 – 61) 767.5 14/48 × (2,000 – 61) 565.5 5/48 × (2,000 – 61) 202.0 6/48 × (2,000 – 61) 4/48 × [2,000 – 61) _______ _____ ______ Net customer profitability Net customer profitability / sales

$1,881.5 $1,285.5 $ 355.2 9.9%

9.2%

7.1%

*Corporate jet cost previously assigned to the customers is subtracted from total G&A overhead in this calculation.

18-23

c. The above analyses provide insight into how Remington’s Aeronautics is using its resources to generate sales and support customers. Although all five customers appear to be profitable before assigning corporate G&A expense, there is a wide variance in the percentage of “customer profitability,” ranging from 13.9% to 11.1%. This difference is attributable to differences in the amount of activity costs incurred for the benefit of the customers, because cost of goods sold (@ 80%) and sales commissions (@ 5%) are the same percentages for all customers. Although Customer C has more revenue than Customer E, there is significantly more activity cost incurred for the benefit of Customer C than for Customer E. This should provide an opportunity for management to assess the level of activity being expended for the benefit of Customer C, which has the lowest return-on-sales percentage. Management should be cautioned about placing too much reliance on the “Net Customer Profitability” calculations since G&A expenses (except for the cost of the corporate jet assigned to the customers) are allocated based on total sales, not based on activity incurred for the customers. There may be a temptation for management to consider dropping Customer C. However, unless the G&A costs allocated to Customer E could be eliminated, the total profits of the company would decline from such an action. On the other hand, the net profitability numbers provide some insight into how well the various customers are bearing what may be regarded as their reasonable share of corporate overhead. In that sense, one could conclude that Customer C is covering its share of overhead but adding less additional profit to the company.

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CASES and PROJECTS C18-34. a. One of the most difficult tasks in implementing an ABC system is assigning resource costs to the activity pools. This often involves significant subjective judgments and estimation. In this case, the vast majority of overhead costs are related to indirect labor, and these costs should readily be assignable to the four activity cost pools by asking each of the employees to estimate the amount of time they spend on each activity. For the membership manager and the controller, this should be very easy since virtually all of their time is probably spent, respectively, on maintaining the membership roster and maintaining the financial records. The general manager and the assistant manager will have to depend on best estimates of the use of their time. They may want to keep a log of time spent on the four activities for a typical month, and then use the data from that log as a basis for estimating the allocation of their time. Computers and information systems maintenance could also be assigned to the activity pools in the same proportion as the allocation of indirect labor cost, or possibly the controller could determine the amount of the computer cost that is related to supporting the financial system, and then allocate the remainder to the other activities in proportion to the indirect labor assigned to those activities. Postage is probably largely related to the activity of maintaining the membership roster and communicating with members, with some smaller amount related to the other activities. The controller should be able to use actual data to assign these costs to the four key activities. b. Some possible activity cost drivers are: Recruiting and providing orientation for new members • Number of new members recruited during the year • Number of new member recruiting packages sent out during the year • Number of existing members Maintaining the membership roster and communicating with members • Number of existing members • Maximum number of members approved for each category Planning, scheduling and managing club events • Number of events for each category of members • Number of event days for each category of members • Total cost spent on events for each category of members Maintaining the financial records and reporting for the club • Number of existing members • Maximum number of members approved for each category ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 18

18-25

c. The remaining overhead costs not mentioned in part a. fall into the category of “facility” level costs, and they would be difficult to assign to the activity cost pools. Generally, these types of costs are either not assigned to the cost objectives (in this case, the membership categories), or else they are assigned based on some relationship that the costs have to the cost objectives. Here, the best way to assign these costs to the three membership categories is probably on the basis of either the number of members or the number of member visits. For example, clubhouse maintenance and depreciation, liability insurance, and security could be assigned based on the number of members in the three categories, and utilities could be based on the number of visits to the Club. d. A golf and country club seems to be a reasonable situation for applying ABC. Even though it requires considerable judgment in determining the key activities, assigning resource costs to activity pools, and selecting activity cost drivers, it should provide results that are more reliable on some sort of direct cost allocation of overhead costs to the three membership categories. To ensure that the results are perceived by the members to be fair and reasonable, Dess Rosmond should form an implementation committee of staff, and possibly Club members. Hiring an ABC consultant who has worked on such implementations in various types of service organizations may also lead to more successful results.

C18-35. Traditional cost accounting allocated $5,100,000 of ATI's total overhead cost of $9,600,000 to "Published Advertising" and $4,500,000 to "Online,” based on Direct Labor Cost—53.1% of which must have been incurred by "Published" and 46.9% by "Online” ($5.1 million/$9.6 million = 53.1%, and $4.5 million/$9.6 million = 46.9%)." The following analysis shows that ABC results in a very different cost allocation: $8,263,125 to Published Advertising and only $1,336,875 to Online. The first step in the ABC analysis assigns the $9.6 million total overhead cost to the primary process activities related to the product lines. These were given in the problem: Selling Design Creative services Customer services

$4,200,000 1,700,000 2,950,000 750,000

Continued

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Next, we select an activity cost driver for each activity. Activity: Selling Design Creative services Customer services

Cost Driver: Salesperson days Art & design hours Subcontract hours No. of service calls

Calculations of activity costs per cost driver unit: Selling: Design: Creative services: Customer service:

$4,200,000/16,000 days = $262.50 per day $1,700,000/20,000 hours = $85 per hour $2,950,000/62,500 hours = $47.20 per hour $750,000/40,000 calls = $18.75 per call

ABC cost assignments: Published Selling: Publishing — 14,250 days × $262.50 = Online — 1,750 days × $262.50 = Design: Publishing — 17,500 hours  $85 = Online — 2,500 hours  $85 = Creative Services: Publishing — 50,000 hours × $47.20 = Online — 12,500 hours × $47.20 = Customer Service: Publishing — 36,000 calls × $18.75 = Online — 4,000 calls × $18.75 = Total ABC cost assignments Total production units ABC unit cost assignment (rounded) Traditional indirect cost assignments Difference

On-Line

$3,740,625 $ 459,375 1,487,500 212,500 2,360,000 590,000

675,000 _________ 8,263,125  100,000 82.63 51.00 $31.63

75,000 1,336,875 5,000,000 0.27 0.90 $(0.63)

Continued

18-27

Total ABC production costs: Published ($105 direct + $82.63 ABC) Online ($0.50 direct + $0.27 ABC)

$187.63 $0.77

Total Traditional Production Costs: Publishing ($105 direct + $51) Online ($0.50 direct + $0.90 indirect)

$156 $1.40

Questions: Should ATI give up trying to compete in the "Online" market? Probably not. Using ABC, it costs only $0.77 per unit and not $1.40 per unit to produce a minute of "Online" service. If it matches Tel-a-Ad’s price of $1 per minute it will still have a profit margin of 23%; whereas, if it switches to Publishing, at its current price of $210, its profit margin only 10.65%. Does the charge of predatory pricing seem valid? No! Predatory pricing involves selling below cost to try to drive the competition from the market. At a price of $1 per minute, Tel-a-Ad was probably making a profit almost 25%. Why are customers willing to pay a higher price to get publishing services? At a price of $210 per unit, there is not likely to be a great deal of competition because it produces a margin of only approximately 10.7%, compared to almost 25% in the "online" sector of the market. The closer the selling price is to total cost, the more likely the market will tolerate a price increase. Do traditional costing and ABC lead to similar conclusions? Obviously not. Inaccurate cost data will almost always lead a manager to incorrect conclusions. Of course, the greater the error, the greater the likelihood that the error will lead to bad decisions.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C18-36. a. When product costs are calculated using ABC, the costs are first assigned to the activities causing the costs and then to the products based on the activities they consume. The following illustrates how the factory overhead costs are assigned. Purchasing Department: The activity driving the purchasing department costs is the number of purchase orders. With 100 purchase orders and costs of $6,000, the cost per purchase order is $60. The final assignment of costs to products is then made based on the quantity of materials used in producing each product. For example, 10,000 square yards of leather were used in producing standard briefcases and 1,250 sq. yds. (0.5  2,500) were used in producing specialty briefcases. Using these quantities assigns 88.9 percent (10,000 / 11,250) of the purchasing department costs for leather to standard briefcases and 11.1 percent (1,250 / 11,250) to specialty. As shown in the following, similar calculations are used for the other materials.

Leather Fabric Synthetic

Standard $1,067 1,440 _____ $2,507

(20  $60  0.889) (30  $60  0.800)

(20  $60  0.111) (30  $60  0.200) (50  $60)

Specialty $ 133 360 3,000 $3,493

Receiving and Inspecting Materials: The activity driving the cost of receiving and inspecting materials is the number of deliveries. The receiving and inspection cost per delivery is $50 ($7,500/150). As with the purchasing department costs, the cost is then assigned to the products based on the materials used. The assignment is as follows:

Leather Fabric Synthetic

(30  $50  0.889) (40  $50  0.800)

Standard $1,333 1,600 _____ $2,933

Specialty (30  $50  0.111) $ 167 (40  $50  0.200) 400 (80  $50) 4,000 $4,567

Continued

18-29

a. continued Setting Up Production Line: The costs of setting up the production line are assigned to products based on the time spent performing the activity. Since there were 50 setups for the standard product and each requires one hour, a total of 50 hours relate to standard briefcases. Similarly, the 100 setups for the specialty briefcases each required two hours for a total of 200 hours. Thus, the cost per setup hour is $40 ($10,000 / 250). This results in $2,000 (50  $40) assigned to the standard line and $8,000 (200  $40) to the specialty line. Inspecting Finished Goods: The costs of inspecting the final products are assigned directly to the products based on the time spent on each product. The cost per hour is $20 ($8,000 / 400). Thus, the total inspection cost for the standard briefcases is $3,000 (150  $20) and for the specialty line, $5,000 (250  $20). Equipment-Related Costs: Although the equipment-related costs are caused by the process rather than a specific product, they must be allocated to determine the total costs for each product. The cost per machine hours is $0.60 ($6,000 / 10,000), and the cost assigned to each product is $3,000 (5,000  $0.60). Plant-Related Costs: Plant related costs are also allocated on the basis of machine hours. The cost is $1.30 ($13,000 / 10,000) per machine hour, and the cost assigned each product is $6,500 (5,000  $1.30).

Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

a. continued ABC Overhead Costs Summary: When costs are assigned to products using an ABC system, the factory overhead costs for each product differ from those calculated using a direct labor hour basis. The following summary shows the total manufacturing overhead assigned to each product using activity-based costing:

Purchasing Department: Leather Fabric Synthetic Receiving & Inspecting Materials: Leather Fabric Synthetic Other: Setup activities Inspecting final products Machine-related costs Plant-related costs Total costs

Standard

Specialty

$ 1,067 1,440 _____ 2,507

$ 133 360 3,000 3,493

1,333 1,600 ______ 2,933

167 400 4,000 4,567

2,000 3,000 3,000 6,500 14,500 $19,940

8,000 5,000 3,000 6,500 22,500 $30,560

18-31

b. With overhead costs assigned on the basis of activities as far as practicable, standard briefcases cost $27.99 per unit and specialty briefcases, $32.72:

Direct materials Direct labor Overhead Total

Standard $20.00 6.00 ($19,940 / 10,000) 1.99 $27.99

Specialty $17.50 3.00 ($30,560 / 2,500) 12.22 $32.72

If these ABC costs are compared with the traditional system’s product costs, the standard briefcase shows a lower cost while the specialty briefcase shows a higher cost. The differences in the unit costs using the two systems are: Product Costs Traditional ABC Difference Difference as a percent of traditional cost

Standard $30.49 27.99 $ 2.50 8.20%

Specialty $22.75 32.72 $(9.97) (43.82)%

c. With ABC costing, the standard briefcase line now shows a gross profit of $2.01 ($30.00 − $27.99) per unit while the specialty line shows a loss of $0.72 ($32.00 − $32.72) per unit. Thus, CarryAll is really making a profit on the product which shows the loss using a direct labor hour basis for allocating overhead and losing on the specialty line which appears profitable using traditional allocation procedures. The president was correct in being concerned about the profitability of the products, but the problem is with the specialty product line, not with the standard line. Traditional allocation using a volumebased measure results in the high-volume product subsidizing the low-volume product, affecting the profitability of each. When costs are traced to products based on the activity causing the costs, better costing data are available for evaluating the profitability of the various products. d. It is certainly important for CarryAll to determine that its traditional cost system was distorting the cost of its products; and this should lead to important strategic changes regarding the company’s product mix and efforts. However, a potentially greater benefit is that it can now move to the next level of using ABC to manage its activities better, and better control the cost of activities. By measuring the cost of key activities, CarryAll can determine whether all activities are adding value to the products and, if so, whether there may be ways to improve its processes so that the activities can be performed more efficiently and possibly more effectively. Alternatively, it may want to consider outsourcing some of its key activities, if it is determined that outsourcing can lead to more cost-effectiveness.

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Chapter 19 Additional Topics in Product Costing QUESTIONS Q19-1.

a. Direct product costs include direct materials and direct labor. These costs are classified as direct because they can be traced to specific products. Indirect product costs cannot be easily traced to specific products and are placed in a cost pool before being applied (or assigned) to products. b. Direct department costs are assigned to a department upon their incurrence. Indirect department costs are allocated to a department from another department or other cost objective.

Q19-2.

The primary distinction between direct and indirect costs is that indirect costs cannot be traced to a particular cost objective and are, thus, allocated from a cost pool, whereas direct costs are assigned directly to a cost objective without previous assignment to a cost pool.

Q19-3.

Although these terms are often used interchangeably in business, cost assignment generally refers to the assignment of costs to a cost objective, either by direct traceability or by allocation. Cost allocation almost always refers to an indirect assignment of costs that were previously assigned to another cost pool.

Q19-4.

A cost can be direct at one level and indirect at other lower levels. For example, the plant manager's office is a cost center for which costs are accumulated and measured, the plant manager’s salary is a direct cost with respect to the manager's office cost center, but it is an indirect cost with respect to the plant operating departments. The plant manager’s office costs would probably be allocated to the operating departments.

Q19-5.

The primary advantage of separate reassignment of fixed and variable costs is to more accurately assign costs on the basis of the factors that drive costs. This, however, will be achieved only if fixed costs are allocated on the basis of service capacity provided and if variable costs are allocated on the basis of actual services.

19-1

Q19-6.

Interdepartmental services are services provided by one service department to another service department. For example, the IT department provides services to virtually all other service departments by supporting their networks and computer equipment.

Q19-7.

Under the direct method, there is no recognition of interdepartmental services. Under the step method, some, but not all, interdepartmental services are accounted for. Under the linear algebra method, there is full recognition of interdepartmental services.

Q19-8.

Although service department costs are often allocated to production departments based on a single volume-based cost driver, the most precise method of allocating service department costs would be to identify the actual activity cost drivers that are influenced by the use of services by the production departments. For example, the IT department costs may be driven by multiple drivers, such as number of computers, hours of network time, troubleshooting hours, etc.

Q19-9.

Just-in-time (JIT), an approach to managing inventories and their production, emphasizes inventory reduction or elimination. JIT is typically found in a company that has adopted a lean production philosophy and is considered to be an integral part of that philosophy.

Q19-10.

A lean production process involves minimizing cycle time, eliminating waste, producing inventory only as needed, and ensuring the highest level of quality and efficiency. To achieve these results on a continuing basis, there is a strong emphasis on continuous improvement programs.

Q19-11.

In a lean organization, inventories are produced only as needed. The need for a product or component creates the demand to produce another item. The demand in one part of the process “pulls” the unit from the previous part of the process, as opposed to one part of the process producing and “pushing” units to the next part of the process, thus creating inventories. The “pull” approach to inventory production causes units or components to be produced “just in time” for the user, thereby eliminating the need for inventory buildup.

Q19-12. Computer technology has affected the way inventories are manufactured and handled through the use of robotics, fully computerized manufacturing and product handling systems and bar code identification systems. It is changing the way companies relate to other parties in the value chain. It has spawned worldwide use of alternative inventory production and management techniques and processes such as just-in-time (JIT) inventory management and lean production management.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q19-13.

Elements of JIT that contribute to the reduction of raw materials inventories include: (1) developing long-term relationships with a limited number of vendors, (2) selecting vendors on the basis of service and material quality as well as price, (3) establishing procedures for production employees to order raw materials for current production needs directly from approved vendors, and (4) accepting vendor deliveries directly to the shop floor.

Q19-14.

Cycle time is the total time required to produce a unit or batch. It is composed of setup time, processing time, movement time, waiting time, and inspection time. Of the five elements of cycle time, only processing time adds value to the product; hence, the goal of management is to minimize the other elements.

Q19-15.

A value-chain approach to management is one that seeks to achieve management’s goals for the company while helping vendors and customers to achieve their goals. JIT is a philosophy that requires a high level of trust, cooperation, and coordination between a company and its vendors and customers. Without this cooperation and coordination, the goals of JIT cannot be achieved.

Q19-16.

In a standard cost system, managers can avoid an unfavorable labor variance by using the labor force to produce inventory, even if the inventory is not needed. If managerial performance is evaluated based on such variances, managers have incentive to produce more inventory than is needed, which is not consistent with a lean production philosophy.

19-3

MINI EXERCISES M19-17. a. S1 1.

Based on number of employees: Direct department costs S1 allocations: $1,000,000  (50/80) $1,000,000  (30/80) Totals

$1,000,000 $2,000,000 (1,000,000) 625,000 _______ _________ $ 0 $2,625,000

$ 750,000

Based on production capacity: Direct department costs S1 allocations: $1,000,000  (75,000/95,000) $1,000,000  (20,000/95,000) Totals

$1,000,000 $2,000,000 (1,000,000) 789,494 _______ _________ $ 0 $2,789,474

$ 750,000

Based on space occupied: Direct department costs S1 allocations: $1,000,000  (57,600/80,000) $1,000,000  (22,400/80,000) Totals

$1,000,000 $2,000,000 (1,000,000) 720,000 _______ _________ $ 0 $2,720,000

$ 750,000

Based on 5-year average of services used: $1,000,000 $2,000,000 Direct department costs (1,000,000) S1 allocations: 600,000 $1,000,000  0.60 _________ _________ $1,000,000  0.40 $ 0 $2,600,000 Totals Based on estimated direct department costs: Direct department costs S1 allocation: $1,000,000  ($2,000,000/$2,750,000) $1,000,000  ($750,000/$2,750,000) Totals

$1,000,000 $2,000,000 (1,000,000) 727,273 _________ ________ $ 0 $2,727,273

375,000 $1,125,000

210,526 $ 960,526

280,000 $1,030,000

$ 750,000

400,000 $1,150,000

$ 750,000

272,727 $1,022,727

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. 1. Number of employees. A service department whose cost is driven primarily by factors related to the number of employees in the various producing departments might best be allocated to the producing departments based on the number of employees. Examples include payroll, health services, food service, and possibly personnel. The advantages in using this allocation base are that the data are readily available and it is simple to use. The disadvantage is that the cost incurred for the benefit of the producing department may not be closely correlated with the number of employees in the various departments. For example, all employees may not eat in the plant cafeteria, or the costs incurred by the personnel department may be driven primarily by hiring activity, or all departments may not be adding new employees at the same rate. 2. Production capacity in units. The advantages are that this method is easy to apply and the data doesn’t need to be reproduced from period to period unless the service capacity changes. The disadvantage is that this method normally may be used only to allocate fixed costs, since variable costs are incurred because of the use of capacity, not its availability. Certain costs may be incurred by just making the capacity available to perform the service, regardless of the actual service used. To keep the total service capacity available for use may require certain upkeep activities, even if some of the capacity is not used during the period. In those cases, such as with certain machine maintenance costs, it may be advantageous to use available capacity rather than the actual capacity used as the allocation base. 3. Space occupied. This is a very convenient and commonly used allocation base for assigning space utilization costs (such as utilities and custodial costs) to the various producing departments. The allocation model changes only when space utilization changes. A disadvantage of this allocation base is that it typically assumes that all space has an equal influence on costs incurred. In practice, some space is often more costly to heat or to keep clean than other space, so if the model treats all space the same, it will not accurately associate cost allocations with the factors that drive cost. 4. Five-year average percentage of S1 services used. The only advantage of using a moving average allocation base is that it causes the amount of cost allocated to the various producing departments to be smoothed over time (some would consider this to be a disadvantage rather than an advantage). The big swings in allocated cost in the short run associated with changes in the allocation base are eliminated by using a five-year average of S1 services used. The disadvantage of using this method is that the amount of cost allocated to a producing department is not determined only by the activity of the current period but by the activity of the previous four periods as well – hence it does not assign costs in a given period that accurately measure the services actually used during the current period. continued

19-5

b. continued 5. Estimated overhead cost. This is generally not considered to be a very accurate basis for allocating service costs to producing departments. A given producing department’s use of services from a service department is not likely to be closely correlated with the amount of direct overhead incurred. Direct departmental overhead data are readily available, so it is a convenient allocation base to use; however, it is likely to result in significant inequities in the allocation of service department costs to the various producing departments.

M19-18. a. Total

Melting

Molding

General Plant Management Allocation base (number of employees) Percent of total base Cost allocation

100 100% $200,000

60 60% $120,000

40 40% $80,000

Plant Security Allocation base (space occupied, sq. ft.) Percent of total base Cost allocation

100,000 100% $100,000

20,000 20% $ 20,000

80,000 80% $80,000

Melting $500,000

Molding $400,000

120,000 20,000 $640,000

80,000 80,000 $560,000

Melting $640,000

Molding $560,000

 1,056 _______ $ 615.43

 7,200 $77.78

b. Direct department costs Allocated costs (a): General plant management Plant security Total departmental overhead c. Total department overhead Total overhead activity base: Machine hours Direct labor hours Departmental overhead rate

Financial & Managerial Accounting for Decision Makers, 4th Edition

M19-19.

Service dept. costs S1 allocations: $150,000  (28/70) $150,000  (42/70) S2 allocations: $80,000  (52/80) $80,000  (28/80) S3 allocations: $106,000  (27/90) $106,000  (63/90) Total costs

Service Departments S1 S2 S3 $150,000 $ 80,000 $ 106,000 (150,000)

Producing Departments P1 P2 — — $60,000 $90,000

(80,000) 52,000 28,000 (106,000) ______ $ 0

______ $ 0

31,800 ______ $143,800

74,200 $192,200

Note that the direct method gives no recognition to interdepartmental services, which are potentially significant in this exercise.

M19-20. a. Cost of goods sold / Average inventory = Inventory turnover 2018: $6,725 / [($2,067 + $2,264) / 2] = 3.11 times 2019: $13,686 / [($2,264 + $3,113) / 2] = 5.09 times b. Gross margin return on inventory investment = Gross margin / Average inventory 2018: $1,810 / [($2,067 + $2,264) / 2] = 0.8358, or 83.6% 2019: $3,946 / [($2,264 + $3,113) / 2] = 1.468, or 146.8%

M19-21. a. Cost of goods sold / Average inventory = Inventory turnover 2018: $51,433 / [($2,538 + $2,678) / 2] = 19.72 times 2019: $57,889 / [($2,678 + $3,649) / 2] = 18.3 times b. Gross margin return on inventory investment = Gross margin / Average inventory 2018: $9,818 / [($2,538 + $2,678) / 2] = 3.765, or 376.5% 2019: $13,398 / [($2,678 + $3,649) / 2] = 4.235, or 423.5%

19-7

EXERCISES E19-22. The service department costs are allocated in the following order: 1st: 2nd: 3rd:

S1 (provided 30% of its services to other service departments); S2 (provided 20% of its services to other service departments); S3 (provided 10% of its services to other service departments). Service Departments S1 S2 S3 $ 150,000 $ 80,000 $ 106,000

Service dept. costs S1 allocations: $150,000  (10/100) $150,000  (20/100) $150,000  (28/100) $150,000  (42/100) S3 allocations: $95,000  (15/95) $95,000  (52/95) $95,000  (28/95) S2 allocations: $151,000  (27/90) $151,000  (63/90) Total allocated costs

Producing Departments P1 P2 —

—

(150,000) 15,000 30,000 $42,000 $ 63,000 (95,000) 15,000 52,000 28,000 (151,000) ______ $ 0

_______ $ 0

______ $ 0

45,300 ______ $139,300

105,700 $196,700

NOTE: If M19-19 is also assigned, it is interesting to note the difference in the results obtained using the direct and the step methods. The difference amounts to $4,500 ($143,800 – $139,300 or $192,200 – $196,700). It is difficult to evaluate the significance of this amount without knowing the total amount of the allocation base used in P1 and P2. The step method gives some, but not complete, recognition to interdepartmental services. Even though S2 and S3 provide 5% and 7%, respectively, of their services to S1, no S2 or S3 costs are allocated to S1.

Financial & Managerial Accounting for Decision Makers, 4th Edition

E19-23. a. Personnel services are measured based on number of employees; therefore, the percent of personnel services provided to the Payroll Department is computed as follows: # of employees in Payroll Department # of employees in all depts other than the Personnel Dept. =

5 = (5 + 12 + 20 + 10)

5 47

= 10.64%

b. Payroll services are measured based on gross payroll cost; therefore, the percent of payroll services provided to the Personnel Department is computed as follows: Gross payroll cost in Personnel Department Gross payroll cost in all depts. except Payroll =

$12,960 $126,720

= 10.23%

c. Personnel Department costs are allocated first since that department provides the highest percentage of interdepartmental services. Service Depts. Personnel Payroll Direct dept. costs $25,000 Cost allocations: Personnel Department (25,000) $25,000  (5/47) $25,000  (12/47) $25,000  (20/47) $25,000  (10/47) Payroll Department $33,000  ($36,000/$113,760) $33,000  ($43,200/$113,760) $33,000  ($34,560/$113,760) _____ Totals $ 0

Producing Depts. Housewares Clothing Toys

$30,340

$50,174

$60,830

$45,156

2,660 6,383 10,638 5,319 (33,000) 10,443 _____ $ 0

______ $67,000

12,532 ______ $84,000

10,025 $60,500

19-9

E19-24. a. 1. Using a traditional costing system (as discussed in Module 16), all of the production costs would be charged to the Work-in-Process account; therefore, the total cost charged during the most recent month would be the cost of components of $1,200,000 plus the cost of conversion of $1,850,000, for a total of $3,050,000. 2. Using a traditional costing system Cost of Goods Sold would be charged with the total cost transferred to customers. Since there was no beginning or ending inventory, all of the cost of $3,050,000 charged to Work-in-Process during the month would have been transferred to Cost of Goods Sold. b. 1. Assuming a lean production system and backflush costing, all of the cost would have been charged directly to Cost of Goods Sold, thereby eliminating any debits to the Work-in-Process account. In fact, there would not be a Work-in-Process account under backflush costing. 2. All of the costs incurred during the month of $3,050,000 would be charged directly to the Cost of Goods Sold account as incurred. Note: If there were an ending inventory, under backflush costing, the costs associated with those units would be backed out of Cost of Goods Sold and charged to the appropriate inventory account.

E19-25.

Scenario B

Gross Margin % (1) Gross profit (2) Sales (1) ÷ (2) Gross Margin %

$15,000 $50,000 30%

$40,000 $75,000 53.33%

$30,000 $60,000 50%

$15,000 $50,000 30%

Inventory Turnover (1) Cost of goods sold (2) Average inventory (1) ÷ (2) Inventory Turnover

35,000 $6,000 5.83

30,000 $6,000 5

35,000 $4,000 8.75

Gross Margin Return on Inventory Investment (1) Gross profit (2) Average inventory (1) ÷ (2) GMROI

$15,000 $40,000 $6,000 $6,000 250% 666.67%

$30,000 $6,000 500%

$15,000 $4,000 375%

Financial & Managerial Accounting for Decision Makers, 4th Edition

E19-26. a. Scenario B represents an increase in GMROI from 250% to 667% resulting from increasing the gross margin percent while holding the level of inventory unchanged. Scenario C represents an increase in GMROI from 250% to 500% as a result of increasing gross margin percent from 30% to 40% while holding inventory level constant and only slightly decreasing inventory turnover. Scenario D represents an increase in GMROI from 250% to 375% by lowering inventory level constant increasing the inventory turnover. b. From the above analyses, we can see that GMROI is driven by two factors: gross margin percent and inventory turnover. Gross margin percent is increased by either paying less for inventory, or by selling it at a higher price. Inventory turnover can be increased by increasing sales (and cost of sales) without increasing average inventory or by reducing average inventory while holding sales and cost of sales constant. In sum, to increase overall return on inventory investment, it is not sufficient to just increase gross margin percent – inventory levels must also be controlled.

E19-27. Students’ responses will vary for this question, however, should include those technical skills identified in Exhibit 19.5. •

Financial analysis

•

Budgeting, planning and forecasting

•

Operational analysis

•

Cost management

•

Technological acumen

•

Identifying data trends

•

Data mining and extraction

•

Statistical modeling and data analysis

•

Enterprise resource planning systems

•

Customer lifetime value

There tends to be a larger skills gap in the areas of technological acumen, identifying data trends, data mining and extraction, and statistical modeling and data analysis so evidence of these skills will likely be more difficult to find in the applicants. PepsiCo might be able to help a new finance professional develop these skills in house by offering in house training programs, reimbursement programs for employees to take classes at local universities or colleges or establishing mentor programs connecting those employees with these skills to new employees so new employees have a support network. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 19

19-11

E19-28. a. Cycle time = (3.75 + 2 + 0.75 + 0.5 + 1) = 8 b. Cycle efficiency = 3.75 (processing time) / 8 (cycle time) = 0.47 c. A first step might be to consider hiring additional employees to eliminate the downtime. Cycle efficiency would increase by almost 15% (from 0.47 to 0.54 (3.75/7). Assuming sufficient demand for scooters, the increase in revenue related to the increase in production should offset the increase in labor costs. Clarion might also look at rearranging equipment to reduce move time although the cost to move the equipment might be prohibitive. Quality control testing procedures should also be evaluated to see if there were ways to decrease the time needed to test the scooters.

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P19-29. a. Cost Pool Plant manager's exp. Cafeteria subsidy

Allocation Base Number of employees

Plant security Bldg depreciation

Space occupied

$ 6,000 20,000 $26,000

Nurse's expense

Number of visits

$ 7,000

Machine maintenance Equipment depreciation

Machine hours

$7,000 15,000 $22,000 $80,500

Total Cost in Pool $20,500 5,000 $25,500

b. Cost Pools 1

Producing Departments 3

Common costs $25,500 $26,000 $7,000 $22,000 Allocation of pool #1: (25,500) $25,500  (20/60) $25,500 (30/60) $25,500 (10/60) Allocation of pool #2: (26,000) $26,000  (12,000/24,000) $26,000  (6,000/24,000) $26,000  (6,000/24,000) Allocation of pool #3: (7,000) $7,000  (25/50) $7,000  (20/50) $7,000  (5/50) Allocation of pool #4: (22,000) $22,000  (1,500/3,000) $22,000  (600/3,000) $22,000  (900/3,000) _____ _____ _____ _____ Total $ 0 $ 0 $ 0 $ 0

$8,500 $12,750 $4,250 13,000 6,500 6,500 3,500 2,800 700 11,000 4,400 _____ ______ 6,600 $36,000 $26,450 $18,050

19-13

c. Based on direct labor hours: Total overhead costs Total direct labor hours (3,400 + 5,000 + 1,600) Cost per direct labor hour

$ 80,500 ÷ 10,000 $8.05

Allocated to department P1: $8.05 × 3,400 = Allocated to department P2: $8.05 × 5,000 = Allocated to department P3: $8.05 × 1,600 =

$ 27,370 40,250 12,880 $80,500

Based on machine hours: Total overhead costs Total machine hours (1,500 + 600 + 900) Cost per machine hour

$80,500 ÷ 3,000 $26.833

Allocated to department P1: $26.833 × 1,500 = Allocated to department P2: $26.833 × 600 = Allocated to department P3: $26.833 × 900 =

$40,250 16,100 24,150 $80,500

d. By allocating cost based on cost pools, the unique characteristics of various pools of cost can be reflected in the allocations – that is, different cost drivers can be used for each cost pool. If all costs are pooled together into a single plant-wide overhead rate, there is an implicit assumption that all of the costs are driven by a single cost driver, such as direct labor hours or machine hours. Therefore, using a multiple pool approach is likely to give a more accurate cost measurement.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P19-30. a. 1.

Total

Mixing

Packaging

IT costs: Allocation base (no. of employees) Percent of total base Cost allocations

60 100% $210,000

40 67.667% $140,000

20 33.333% $70,000

Maintenance costs: Allocation base (no. of hours) Percent of total base Cost allocations

2,500 100% $185,000

1,500 60% $111,00

1,000 40% $74,000

IT costs: Allocation base (no. of connections) Percent of total base Cost allocations

80 100% $210,000

50 62.5% $131,250

30 37.5% $78,750

Maintenance costs: Allocation base (no. of orders) Percent of total base Cost allocations

300 100% $185,000

120 40% $74,000

180 60% $111,000

b. All of the bases in (a) would be reasonable under certain circumstances. The objective in cost allocation is to try to relate the cost to the activity that generates the cost. In the case of IT costs, the availability and use of computer connections are the activities that generate costs, and the need for connections is related to the number of employees using the computers; however, if all employees are not using the computers equally, then a better allocation base would probably be the number of computer connections. Maintenance costs should be examined to determine whether they are more closely related to the time spent making the repairs or to the number of orders processed. Unless the maintenance procedures are very similar for both departments, the number of hours is probably the better basis for making the allocation.

19-15

P19-31. a. Administration costs are allocated based on number of employees and facilities costs are allocated based on space occupied. Administration costs should be allocated first since it provides a greater amount of interdepartmental services than does the Facilities Department.

Direct costs Cost allocations: Administration: $65,000  (4/16) $65,000  (8/16) $65,000  (4/16) Facilities: $47,000  (7,500/10,000) $47,000  (2,500/10,000) Total costs b.

Total department costs Total number of patient visits Cost per patient visit

Service Administration Facilities $ 65,000 $ 30,750

Producing Medical Ancillary $745,700 $350,000

(65,000) 16,250 32,500 16,250 (47,000) _______ $ 0

_______ $ 0

35,250 ________ $813,450 $813,450  7,975 $102

11,750 $378,000 $378,000  3,000 $126

Financial & Managerial Accounting for Decision Makers, 4th Edition

P19-32. a. Technical Support’s common costs are allocated first because it has more interdepartmental services than Administration. Technical Admin. Commercial Retail Body Fit Support Services Products Products & Healthy $500,000 $750,000 * * $7,152,500

Direct costs Cost allocations: Technical Support: $500,000  (690/4,600) $500,000  (1,840/4,600) $500,000  (1,610/4,600) $500,000  (460/4,600) Administrative Services: $825,000  (70/150) $825,000  (60/150) $825,000  (20/150) Total allocated costs

(500,000) 75,000 200,000 175,000 50,000 (825,000) 385,000 ________ ________ $ 0 $ 0

______ **

330,000 ______ 110,000 ** $7,312,500

* Information not available **Cannot be computed

b. Total budgeted cost of Body Fit & Healthy / Total budgeted output per period = $7,312,500 / 750,000 lbs. = $9.75 budgeted cost/pound Projected selling price

= = = =

Cost + (100%  cost) $9.75 + (100% x $9.75) $9.75+ $9.75 $19.50 per pound

19-17

P19-33. a. The company is using the direct method. Only services provided to producing divisions are considered in the cost allocations. Interdepartmental services are ignored. b. Using the step method, computer services costs would be allocated first. allocation computations are as follows:

(in thousands) Service department costs Cost allocations: Information Technology: $250,000  0.35 $250,000  0.25 $250,000  0.20 $250,000  0.20 Personnel: $247,500  0.40/0.90 $247,500  0.30/0.90 $247,500  0.20/0.90 Total cost allocations

Service Departments Computer Personnel $250,000 $160,000

The cost

Producing Divisions East Central West

(250,000) 87,500 $62,500 $50,000 $50,000 (247,500) 110,000 ______ $ 0

_______ $ 0

82,500 ______ ______ 55,000 $172,500 $132,500 $105,000

c. (in thousands) Income before allocations Less allocated costs Division income

Total $480,000 (410,000) $ 70,000

East $200,000 (172,500) $ 27,500

Central $170,000 (132,500) $ 37,500

West $110,000 (105,000) $ 5,000

d. The complaint made by the manager of the West Division was well founded. When indirect costs were allocated by the direct method, his division received an inequitable allocation. Recognition of interdepartmental services was necessary for an accurate allocation. The step method provided a more accurate recognition of services provided by the service departments.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P19-34. a.

Total Plant Total direct departmental overhead costs for producing and service departments Total direct labor hours Plant-wide overhead rate (per direct labor hour) (rounded) Cost of jobs Direct materials Direct labor (100 hours @ $50) Manufacturing overhead (100 hours @ $161.67) Total job cost

$4,365,000  27,000 $161.67 A1 $ 3,000 5,000 16,167 $24,167

A2 $ 3,000 5,000 16,167 $24,167

b. Direct method Service Department Allocations: Service Depts. Human Resources Facilities Direct costs Cost allocations: Human Resources: $150,000  (60/150) $150,000  (90/150) Facilities: $450,000  (225,000/300,000) $450,000  (75,000/300,000) Total cost allocations

$150,000

$450,000

Producing Depts. Cutting

Welding

$2,662,500 $1,102,500

(150,000) 60,000 90,000 (450,000) _______ $ 0

Overhead allocation base (direct labor hours) Departmental overhead rates (per direct labor hour) Cost of jobs Direct materials Direct labor (100 hours @ $50) Manufacturing overhead: Cutting (75 hrs. and 25 hrs. @ $255) Welding (25 hours and 75 hours @ $87) Total job cost

_______ $ 0

337,500 _________ 112,500 $3,060,000 $1,305,000

 12,000

 15,000

$255.00

$87.00

$ 3,000 5,000

19,125 2,175 $29,300

6,375 6,525 $20,900

19-19

c. Human Resource services provided to Facilities, Cutting, and Welding: (20 + 60 + 90) = 170 20/170 = 11.76% 60/170 = 35.29% 90/170 = 52.94% Facilities services provided to Human Resources, Cutting, and Welding: (15,000 + 225,000 + 75,000) = 315,000 15,000/315,000 = 225,000/315,000 = 75,000/315,000 =

4.76% 71.43% 23.81%

Summary: Services Provided to Services Provided from Human Resources Facilities

Human Resources — 4.76%

Facilities 11.76% —

Cutting 35.29% 71.43%

Welding 52.94% 23.81%

The Facilities Department provides the greatest amount of interdepartmental services between Facilities and Human Resources; therefore, Facilities is allocated first when using the Step Method. Step Method Service Department Allocation:

Direct costs Cost allocations: Facilities: $450,000  (15,000/315,000) $450,000  (225,000/315,000) $450,000  (75,000/315,000) Human Resources: $171,428  (60/150) $171,428  (90/150) Total

Service Depts. Human Facilities Resources 450,000 $150,000

Producing Depts. Cutting Welding $2,662,500 $1,102,500

(450,000) 21,428* 321,429* 107,143* (171,428) ______ $ 0

______ $ 0

68,571* _______ 102,857* $3,052,500 $1,312,500

*Rounded

Overhead allocation base (direct labor hours) Departmental overhead rates (per direct labor hour)

 12,000 $254.38*

 15,000 $87.50

Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. continued Cost of jobs Direct materials Direct labor (100 hours @ $50) Manufacturing overhead: Cutting (75 hrs. and 25 hrs. @ $254.38) Welding (25 hours and 75 hours @ $87.50) Total job cost

$ 3,000 5,000

19,079 2,187 $29,266

6,359 6,563 $20,922

d. In producing a given job, departmental overhead rates better reflect the actual cost incurred in each department than does a plantwide overhead rate. If various products are worked on disproportionately in the two production departments as we see in this problem, using a plantwide rate will lead to cost cross-subsidization between the products, where Job A2 is subsidizing the cost of Job A1 – i.e., A1 is allocated more cost and A2 is allocated less cost under a plantwide rate than under departmental rates. To reduce cost cross-subsidization, departmental overhead rates should be used. From the standpoint of both pricing and profitability, using a plantwide manufacturing overhead allocation method could lead to serious mistakes. It will likely cause Job A1 to be underpriced and Job A2 to be overpriced. The plant-wide rate makes it appear that the company is indifferent between the two jobs from a cost and profitability standpoint; hence, it will lead to mistakes in pricing the current jobs and in making decisions regarding future opportunities to do jobs like A1 and A2. In this particular case, it made virtually no difference whether direct or step service department cost allocation was used, because the amount of service department cost was relatively small compared with total production department costs, although the amount of interdepartmental services provided between the two service departments differed (11.76% versus 4.76%). Though, because the total service department costs were small in comparison to total production department costs, it would still matter little whether or not the Human Resources or Facilities was allocated first under the step allocation method.

19-21

P19-35. a. Charged to Cost of Goods Sold: Raw materials purchased Factory wages Factory supervision Facilities cost Factory supplies Depreciation Total charged to Cost of Goods Sold b. Balance in Raw Materials in Process:

$500,000 100,000 25,000 75,000 15,000 35,000 $750,000

150 units  $30 = $4,500

Balance in Finished Goods Inventory:

250 units  ($30 + $ 60) = $22,500

Balance in Cost of Goods Sold:

$750,000 − $4,500 − $22,500 = $723,000

c. Two issues that affect the accuracy of CNN Systems’ inventories balances are (1) using standard or budgeted cost valuations in inventory accounts instead of actual cost valuations, and (2) assigning only raw materials cost to inventory units in process at the end of the period, thereby excluding conversion costs from cost measurements for units in process. For convenience, companies often use standard costs to account for inventory balances, with any variances between standard and actual being charged to Cost of Goods Sold. When the variance is material, for external reporting purposes, it is necessary to adjust Inventories and Cost of Goods Sold to actual. Since we do not know how many units were produced during the period, it is not possible to determine the significance of the variance between standard and actual costs. Companies that have a JIT philosophy of inventory management often use a backflush inventory accounting system such as CNN Systems’ in which they assign only raw materials costs to Raw Materials in Process. To the extent that these units have been partially processed, inventory costs are understated. However, if units in process represent only a small number of units, the effect on total assets and total expenses will be small. In this case, there were only 50 units 40% converted (an equivalent of 20 units in process at year-end) with standard conversion costs of $60 per unit, or $1,200. Assigning only raw materials costs to units in process caused Raw Materials in Process to be understated by $1,200 and Cost of Goods Sold to be overstated by $1,200. This represents only.17% (or $1,200  $723,000) of the balance in Cost of Goods Sold, which would probably be considered immaterial by CNN Systems’ managers.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P19-36. a. Year Year 1 Year 2 Year 3 Year 4 Year 5 Current year

Quantity Used 10,000 15,000 17,500 12,500 18,000 14,500

Average Inventory 1,500 2,500 3,000 2,500 2,250 2,900

Inventory Turnover 6.7 6 5.83 5 8 5

Purchase Price Variance $ 1,500 F 10,500 F 12,000 F 20,000 U 8,000 F 9,500 F

The unfavorable purchase price variance in Year 4 appears to be associated with a decrease in inventory turnover followed by an increase in inventory turnover and a drop in quantity used. In all years except Year 4 there were favorable purchase price variances. Decreases in inventory turnover are a possible signal of the buildup of excess inventory (Year 3). Excess inventory will reduce return on investment directly by increasing the denominator and indirectly by decreasing the numerator through storage and obsolescence costs. This was followed by an increase in inventory turnover and an increase in quantity used in Year 5. b. To achieve quantity discounts and favorable materials price variances, a purchasing agent may order excess inventory, thereby increasing subsequent storage, obsolescence, and handling costs. To obtain a low price, a purchasing agent may order from a supplier whose goods have not been certified as meeting quality specifications, thereby causing subsequent inspection, rework, and spoilage costs, and perhaps, dissatisfied customers. c. While financial performance reports are useful management tools, they should not be used exclusively, especially for first-line managers. Nonfinancial performance measures are of equal and sometimes greater value at this level. Inventory turnover is one example of a useful nonfinancial performance measure. Another problem results from trying to artificially divide an organization into segments and ignoring interactions between segments. Purchasing as well as production should be concerned with spoilage. These two areas should also work together to devise methods of reducing raw materials inventories, perhaps with direct deliveries of small quantities of raw materials to the shop floor. Purchasing, production, and accounting should work together to develop procedures that minimize bookkeeping costs for purchases while still safeguarding assets. Perhaps purchasing should not be overly involved with the placement of individual orders. Instead, they should be involved with the selection of qualified vendors, the negotiation of standing purchase agreements with qualified vendors, the development of purchasing and delivery procedures, and monitoring relationships with vendors.

19-23

P19-37. a. Total actual Maintenance Department costs incurred: $750,000 + $75 (35,000 + 15,000) = $4,500,000 Rooms Department allocation: 35,000 hrs. / (35,000 hrs. + 15,000 hrs.) = 70% × $4,500,000 F&B Department allocation: 15,000 hrs. / (35,000 hrs. + 15,000 hrs.) = 30% × $4,500,000 Total

$3,150,000

1,350,000 $4,500,000

b. Fixed cost allocation rate: $750,000 / (35,000 hrs. + 25,000 hrs.) = $12.50 per hour of estimated hours Rooms Department allocation: (35,000 hrs. × $12.50) + (35,000 × $75) = $3,062,500 F&B Department allocation: (25,000 hrs. × $12.50) + (15,000 × $75) = 1,437,500 Total $4,500,000 c. The allocation in part b. is more equitable because it does not allow the managers to manipulate the allocation of fixed costs. In this problem, basing the allocation on actual usage versus planned usage, the F&B Department was able to shift $87,500 of its cost allocation to the Rooms Department. It was not fair for the Rooms Department to have $87,000 of additional cost just because the F&B department decided to reduce its maintenance program. d. If a user charge were established, it should be based on a level of usage that would not allow the Rooms and F&B Departments to manipulate the results. If the rate were based on expected usage, there would be incentive for the managers to overestimate their usage so as to minimize the hourly charge for the fixed cost portion. One possible way to avoid this sort of manipulation would be to use the average hours used for the past one, two, or three years as a basis for establishing the rate.

Financial & Managerial Accounting for Decision Makers, 4th Edition

CASES and PROJECTS C19-38. Switching to a materials pull system can help solve Data Storage's space problems by reducing the space required to produce current products. This would be accomplished by reducing the inventories located between workstations. Under a materials pull system, employees at each station work to replenish the inventories used by employees at subsequent stations. The buildup of excess inventory is strictly prohibited. If the number of completed units at a workstation reaches a specified limit, work at the station stops until workers at the next station pull a unit from the in-process storage area. Hence, the pull of inventory by a subsequent station authorizes production to continue. In addition to reducing space requirements, the implementation of a materials pull system can improve quality and reduce cycle time. Quality is likely improved because low inventory levels often result in more immediate identification of quality problems. Low inventory levels also require the immediate correction of quality problems. Indeed, all operations may occasionally cease until a quality problem is corrected. The related pressure of stopping operations leads to an emphasis on doing it right the first time. Hence, there is a reduced need for separate inspection activities. Cycle times are reduced because of the significant reduction in waiting times and the time required for separate inspection activities. Management’s attitude toward inventory and efficiency will have to change to make a materials pull system work. Management must accept the notion that inventory is an enemy that increases costs and production times and hides quality problems. They must also accept the notion that it is better to have employees idle than to have them building excess inventory. Finally, they must shift their emphasis from performance at each workstation to an emphasis on the performance of the entire operation. This will require careful planning and active employee involvement in decision making.

19-25

C19-39. a. Wearwell’s value chain consists of all activities related to suppliers of goods and services, activities performed within Wearwell to provide a product, as well as those activities related to marketing and selling the product, and activities for providing service to customers after the sale. Examples of activities that comprise the value chain are: 1.

Establishing sources for yarn and other goods and services.

Establishing arrangements with manufacturers to tuft the carpet.

Establishing arrangements with the transport company to transport the yarn and finished carpet.

Processing orders of yarn, following up on such orders, and paying yarn suppliers.

Processing manufacturing services from manufacturing contractors, scheduling delivery of yarn and finished carpet, and paying for services.

Resolving any problems related to quality, cost, and service with vendors of yarn and manufacturing services.

Creating a marketing plan with appropriate literature, samples, etc., to support the sale of the product.

Establishing dealer relationships in major markets with dealers whose business strategy is consistent with that of Wearwell.

Engaging in sales and marketing programs with dealers and establishing appropriate levels of inventory for dealers.

10. Processing sales orders from dealers and coordinating with manufacturers, the transport company, and Wearwell’s own warehouse staff to make sure that orders are filled in a timely fashion. 11. Processing sales invoices, collecting payments, and following up on delinquent accounts. 12. Dealing with dealers, and where appropriate, with retail customers on customers’ service issues, quality problems, warranty claims, etc. b. For financial reporting purposes, all costs related to manufacturing are considered to be part of the cost of the product. This would include the cost of yarn and its delivery to the carpet mills, as well as the cost of the finished carpet and its delivery to Wearwell’s warehouse. All other costs are considered to be period expenses, not costs of the product for financial accounting and reporting purposes.

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. For managerial decision-making purposes, such as pricing, determining product mix, profitability analysis, etc., all costs that can be assigned to the product equitably are considered to be product costs. This obviously includes all the manufacturing costs identified in (b) above, but it also includes any costs incurred down the value chain in dealing with dealers who sell the carpet and the ultimate retail buyers. By including these costs, management is better able to assess the overall cost and profitability of its various products. On a manufacturing cost basis alone, plush carpet may appear to be the more profitable; but because it is a more fragile type of carpet, it may require substantially more customer service activities than Berber and textured styles. Hence, after adding all costs incurred in the value chain, plush carpet may not be very profitable compared to the other products. Having this information enables the company to make better decisions in developing its marketing, sales, and pricing strategies. d. To limit its cost of maintaining inventories without reducing sales, Wearwell can take some measures to minimize its inventory levels. By limiting its product to three styles and three colors, at any given time only 9 different product categories are in inventory. By close coordination with the yarn manufacturers, the tufting mill contractors, and the ten dealers, Wearwell should be able to limit its investment in inventory. Ideally, Wearwell would like to receive orders from dealers before buying yarn or having it tufted into carpet. By establishing incentive prices, Wearwell may be able to achieve this goal. However, industry norms as well as the cyclical nature of the carpet business may make it difficult to completely avoid holding carpet in inventory. Wearwell should monitor its inventory levels and turnover for each style and each color to identify products that may not be turning over quickly enough. Style and color trends must be anticipated to avoid having large amounts of obsolescent stock on hand. e. On first glance, this does not appear to be an ideal context for applying ABC because it does not involve significant manufacturing activity. However, there are differences in the company that may suggest a need for activity-based costing analysis. For example, the company makes inventory in 9 different combinations of style and color. This constitutes 9 different products. It sells these products through 10 different dealers and possibly uses a variety of selling and promotional strategies in marketing its products. To the extent that these different products, customers, and marketing approaches have different demands on the activities of the business, they have different costs. ABC attempts to measure these differences.

19-27

Chapter 20 Pricing and Other Product Management Decisions QUESTIONS Q20-1.

A value chain is composed of processes, and each process is composed of activities.

Q20-2.

The goal of every organization along a value chain should be to maximize the value while minimizing the cost of a product or service to final customers.

Q20-3.

The goal of using a value-added perspective is to maximize value added (the difference between selling price and costs) by the organization. To do this, the focus is primarily on internal activities and costs. Under a value chain perspective, the goal is to maximize value and minimize costs to final customers, often by developing linkages or partnerships with suppliers and customers.

Q20-4.

Economic models assume a goal of profit maximization and known cost and revenue functions. Most for-profit organizations attempt to achieve a target profit rather than a maximum profit. One reason for this is an inability to determine the single set of actions out of all possible actions that will lead to profit maximization. Furthermore, managers are more apt to strive to satisfy a number of goals (such as profits for investors, job security for themselves and their employees, and being a “good” corporate citizen) than to strive for the maximization of a single profit goal. In any case, to maximize profits, a company’s management would have to know the cost and revenue functions of every product the firm sells. For most firms, this information either cannot be developed or cannot be developed at a reasonable cost.

20-1

Q20-5.

Three reasons why cost-based approaches to pricing have been important are: 1. Cost data are available. When hundreds of different prices must be set in a short time, cost may be the only feasible basis for product pricing. 2. Cost-based prices are defensible. Managers threatened by legal action or public scrutiny feel secure using cost-based prices. They can argue that prices are set in a manner that provides a “fair” profit. 3. Revenues must exceed costs if the firm is to remain in business. In the long run, the unit selling price must exceed the full cost of each unit.

Q20-6.

Cost-based pricing has four major problems: 1. Cost-based pricing requires accurate cost assignments. If costs are not accurately assigned, some products may be priced too high, losing market share to competitors, and other products may be priced too low, gaining market share but being less profitable than anticipated. 2. The greater the portion of unassigned costs, the greater the likelihood of overpricing and underpricing individual products. 3. Cost-based pricing assumes goods or services are relatively scarce and customers who want a product or service are, generally, willing to pay the price. 4. In a competitive environment, cost-based approaches increase the time and cost of bringing new products to market.

Q20-7.

Cost-based pricing starts with cost and adds a markup to achieve a desired profit. Target costing starts with a price and then subtracts a desired profit to determine a target cost.

Q20-8.

While a formula may be used to determine a markup on cost, it is not possible to develop a formula indicating how to achieve a target cost. Hence, while cost-based pricing is a technique, target costing is more of a philosophy or an approach to pricing and cost management. Target costing takes a proactive approach to costs, reflecting a belief that costs are best managed by decisions made during product development. This contrasts with the more passive cost-plus belief that costs result from design, procurement, and manufacture.

Q20-9.

The marketing life cycles of household electronic equipment is considerably shorter than the life cycles of household paper products. Because of shorter product life cycles, life-cycle costing is more important to manufacturers of household electronic equipment than to manufacturers of household paper products.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q20-10.

Continuous improvement costing begins where target costing ends. While target costing takes a proactive approach to cost management during the conception, design, and preproduction stages of a product’s life, continuous improvement costing takes a proactive approach to cost management during the production stage of a product’s life.

Q20-11.

From the seller’s viewpoint, life-cycle costs include costs associated with initial conception through design, preproduction, production, and after-production support of a product. From the buyer’s perspective, life-cycle costs include all costs associated with a purchased product or service, including initial acquisition costs and subsequent costs of operation, maintenance, repair, and disposal.

Q20-12.

Benchmarking against competitors only tells you what you need to do to catch up. Benchmarking against best practices across all industries tells you how to outdistance competitors.

20-3

MINI EXERCISES M20-13. Note: The solutions to this assignment will vary. The purpose of the assignment is to stimulate thinking about value chain concepts. Farm

Transport

Wholesale Distributor

Packaging

Processing

Cafeteria

Final Customer

M20-14. Note: The solutions to this assignment will vary. The purpose of the assignment is to stimulate thinking about value chain concepts. Focal Point of Analysis

Upstream

Timber Company

Lumber Processor

Wholesale Distributor

Downstream

Furniture Mfg Co

Wholesale Distributor

Retailer

Final Customer

M20-15. a. b. c. d. e.

Marketing and sales Inbound logistics Outbound logistics Support Support

f. g. h. i. j.

Operations Operations Operations Service Support

f. g. h. i. j.

Inbound logistics Support Service Support Operations

M20-16. a. b. c. d.

Operations Operations Marketing and sales Marketing and sales (An argument can also be made for support.) e. Support

Financial & Managerial Accounting for Decision Makers, 4th Edition

M20-17. Profit $ 9,000,000 $ 9,000,000 $ 58,567,500 X

Revenues – Costs 950,000X − [$16,317,500 + (950,000  $35) + (0.10  950,000X)] 950,000X – $49,567,500 – 95,000X 855,000X $68.50 = Price per case

= = = = =

M20-18. Variable costs: Ice cream Franchise fee Total per unit variable cost Total revenue Price × 130,000 Price × 130,000 Price

= = = =

$1.50 0.20 $1.70

Fixed costs + Variable costs + Profit $144,500 + ($1.70 × 130,000) + $125,000 $490,500 $3.77 (rounded) per cone

M20-19. a. It was a tongue-in-cheek comment implying that Hotel Klingerhoffer’s announcement did not capture the reality of what was happening. All room rates were increasing whether the rooms were occupied or vacant. b. Hotel Klingerhoffer’s reasoning was probably economic although accounting could have played a role because of the relationship of fixed and variable costs. One aspect of economics is to raise revenue if you need to meet rising expenses. However, as related to supply and demand, if you raise prices you reduce demand. From an accounting perspective, the basics of cost-volume-profit is that you increase prices to cover lower volume because variable costs stay the same per unit (room in this case) while the fixed cost per unit (room) go up when volume goes down. Because of the large amount of fixed costs in operating a hotel the concept of contribution margin is critical when the breakeven point is approached. Raising prices increases the contribution margin per room and pushes the breakeven point lower.

20-1

M20-20. Possible means of benchmarking the development and production of the new product include: 1. Examining similar products of competitors. 2. Evaluating the potential price range based on competing or complementary products. 3. Experimenting with production procedures and with new production combinations. 4. Developing prototypes and testing extensively for quality. 5. Examining production methods of companies in other industries that have similar production procedures—even if they produce different types of products.

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E20-21. a. Current variable manufacturing costs per unit ($1,275,000/15,000) Expected increase per unit Expected variable manufacturing costs per unit Current and expected variable selling and administrative cost per unit ($150,000/15,000) Expected variable costs Current fixed manufacturing overhead Expected increase Expected fixed manufacturing overhead Current and expected fixed selling and administrative costs Expected fixed costs

$85 10 95 10 $105 $ 685,000 30,000 715,000 330,000 $1,045,000

Revenue = Fixed costs + Variable costs + Profit Price × 15,000 = $1,045,000 + ($105 × 15,000) + $185,000 Price = ($1,045,000 + 1,575,000 + $185,000) / 15,000 Price = $187.00 b. Selling price Variable costs Contribution margin

$165 (105) $ 60

Expected total contribution ($60 × 18,000) Less fixed costs Expected profit (loss)

$1,080,000 (1,045,000) $ 35,000

The increase in sales volume does not cover the reduction in selling price. (Loss of $150,000 in profit ($185,000 - $35,000)). A larger expected increase in sales volume might make a sales price reduction desirable but management would need to consider the speculative nature of any expected volume increase before lowering the price. c. Required sales volume = ($1,045,000 + $200,000) / $60 = 20,750

20-3

E20-22. a. Profit $250,000 18,000X X

= = = =

Total revenues − Total costs 18,000X − [$830,000 + 18,000 ($40)] $830,000 + $720,000 + $250,000 $100 = Price per hour

b. Markup on variable costs

= = =

(Fixed costs + Profit) / Variable costs ($830,000 + $322,000) / (18,000  $40) 1.60 or 160 percent

c. 1. Markup to cover unassigned costs

= = =

Fixed costs / Variable costs $830,000 / (18,000  $40) 1.15 or 115 percent (rounded)

2. Markup to cover desired profit

= = =

Profit / Variable costs $100,000 / (18,000  $40) 0.14 or 14 percent (rounded)

E20-23. a. Markup on variable costs

= = =

(Fixed costs + Profit) / Variable costs [$900,000 + ($7,500,000  0.10)] / ($250,000 + $250,000) 3.30 or 330 percent

Markup on manufacturing costs = (Selling and administrative costs + Profit) / Total manufacturing costs = ($250,000 + $550,000 + $750,000) / $600,000 = 2.583 or 258.3 percent (rounded) b. Markup to cover unassigned costs

= = =

Unassigned costs / Manufacturing costs $800,000 / $600,000 1.333 or 133.3 percent (rounded)

Markup to cover desired profit

= = =

Profit / Manufacturing costs ($7,500,000  0.08) / $600,000 1.00 or 100 percent

Combined rate is calculated as follows: Markup on manufacturing costs = (Unassigned costs + Profit) / Total manufacturing costs = ($800,000 + [$7,500,000 x 8%]) / $600,000 = 2.333

Financial & Managerial Accounting for Decision Makers, 4th Edition

E20-24. a. Profit $450,000

= =

$1,150,000X $1,150,000X X DVDs = DVDs =

= = =

Total revenue – Total costs 150,000X + 500,000(2X) – ($4,000,000 + $2,000,000 + $1,560,000 + $2,052,500) $4,000,000 + $2,000,000 + $1,560,000 + $2,052,500 + $450,000 $10,062,500 $8.75 the price of CDs

Price of CDs (200%) $8.75 × 2 = $17.50

b. Profit = CDs = CDs = = =

Total revenue – Total costs Sales units (Sale Price) - 25% of material cost – 10% of other cost 150,000 ($8.75) − 0.25 ($5,560,000) − 0.10 ($4,052,500) $1,312,500 − $1,390,000 − $405,250 $(482,750)

DVDs = DVDs = = =

Sales units (Sale Price) - 75% of material cost - 90% of other cost 500,000 ($17.50) − 0.75 ($5,560,000) − 0.90 ($4,052,500) $8,750,000 − $4,170,000 − $3,647,250 $932,750

E20-25. Cost-based pricing requires accurate cost assignments. The company should verify the costs being assigned to the CDs before deciding to stop production. To satisfy customers, it may need to sell both products. If CDs are dropped, do all of the variable costs cease, and what part of the other costs can be avoided? Another issue may be to change the target price relationships, perhaps increasing the selling price of the CDs. What evidence does the company have to support the 90/10 split between the two products when assigning nonmaterials costs? Any change in the split would cause a change in how the products are priced.

20-5

E20-26. Predicted annual sales ($1,200  7,500) Less: Catalog company fees: Fixed Variable ($75  7,500) Desired return ($9,000,000  0.30) Raw materials ($200  7,500) Target cost for conversion and administration Number of units Target conversion and administrative cost per unit

$9,000,000

12,000 562,500 2,700,000 1,500,000

(4,774,500) $4,225,500  7,500 $

563.40

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P20-27. = = =

Assets  Percent return $6,000,000  0.35 $2,100,000

Markup on variable costs

= = =

(Fixed cost + Target profit) / Total variable costs ($2,600,000 + $2,100,000) / $400,000 11.75 or 1,175%

Variable cost per hour

= =

$400,000/40,000 hours $10

Variable cost for WPD

= =

15,000 hours  $10 $150,000

WPD Revenue

= =

$150,000 + ($150,000  1,175%) $1,912,500

Variable cost for ICS

= =

25,000 hours  $10 $250,000

ICS Revenue

= =

$250,000 + ($250,000  1,175%) $3,187,500

WPD Revenue per hour

= =

$1,912,500 / 15,000 $127.50

ICS Revenue per hour

= =

$3,187,500 / 25,000 $127.50

a. Target profit

20-7

b. Markup

= =

$2,100,000 / $3,000,000 0.70 or 70%

Total cost per hour

= =

$3,000,000 / 40,000 hours $75.00

WPD Total cost

= =

15,000 hours  $75.00 $1,125,000

WPD Revenue

= =

$1,125,000 + ($1,125,000  0.70) $1,912,500

ICS Total cost

= =

25,000 hours  $75.00 $1,875,000

ICS Revenue

= =

$1,875,000 + ($1,875,000  0.70) $3,187,500

*Rounded

c. The total revenue for both methods is predetermined to be $5,100,000 and the cost is allocated between the two products using the same predicted hours (15,000 & 25,000) for both parts a. and b. Therefore, the total revenue is the same for both methods. d. The primary advantage of using a cost-based pricing model is that it is relatively easy and convenient; however, it assumes that reliable cost data are available. If the cost data are erroneous, then the price will not be a true cost-based price, meaning that if costs are overstated, then price will be overstated accordingly, and vice versa. Another advantage is that it may be the only available basis for establishing a price for a new product for which there are no comparables in the marketplace. The primary disadvantage is that it does not take into account the market demand for the product or service. Cost-based pricing is a good starting point in setting price, and then, if market price data are available, one can readily see how profits are likely to deviate from the profit percentage factored into the cost-based price.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P20-28. a. Sales ($65,000  400) Profit ($26,000,000  0.12) Total costs allowed Less fixed costs Variable costs allowed

$26,000,000 (3,120,000) 22,880,000 (8,000,000) $14,880,000

b. Sales ($65,000  400) Profit ($26,000,000  0.15) Total costs allowed Less fixed costs Variable costs allowed

$26,000,000 (3,900,000) 22,100,000 (8,000,000) $14,100,000

c. The primary advantage is that, if the cost targets are met, there should be no surprises when the product is taken to market, because the price that the market is likely to support has already been anticipated in the design and manufacture of the product. What the customer wants in terms of features and quality, and what the customer is willing to pay for those specifications, have already been factored into the decision to produce the product. Also, there should be no surprises about what the actual profitability of the product will be when it is introduced in the market.

P20-29. a. Item Direct materials: Plastic case Lens set Electrical set Film track Direct labor Indirect mfg: Variable costs Fixed costs

Year 1 Base

× 90%

Year 2 Target

Year 2 Actual

Variance

$ 5.10 12.00 8.30 10.50 48.00

0.90 0.90 0.90 0.90 0.90

$ 4.59 10.80 7.47 9.45 43.2

$ 4.75 10.90 7.00 10.05 45.00

$0.16 0.10 0.47 0.60 1.80

U U F U U

5.60 16.00

0.90 0.90

5.04 14.40*

5.00 12.75

0.04 F 1.65 F*

*If 120,000 were used to adjust the Year 1 base, the target would be $12 [(100,000 × $16 × 0.90) / 120,000], providing for a variance of $0.75 U ($12.00 − $12.75).

continued

20-9

a. continued The company made progress during Year 2 with favorable variances for 3 of the 7 components. The unfavorable lens items may require more consideration since they are vendor purchased. Maybe new vendors can be found, or else current vendor contracts may be renegotiated. Variable costs have come down nearly 7.6% from Year 1 levels. Fixed costs have come down over 20%. Direct labor is the largest per unit component cost. It came down 6.25%. The decrease was due entirely to the decrease in hours per unit (1.6 to 1.5 hours per unit). The rate per hour remained the same $30 ($48 / 1.6 or $45 / 1.5) which would be reasonable. Hourly pay rates would normally not be expected to decrease from year to year. The fixed manufacturing costs should be reviewed. The total fixed costs decreased from $1,600,000 (100,000 × $16) to $1,530,000 (120,000  $12.75). If they are fixed, why did they decrease? Did increased production or other factors cause the decrease? If it was volume driven, maybe some of the costs are not fixed. b. First, a 10% cost reduction is a reasonable Kiazen costing goal. If Kaizen costing is going to be seriously implemented, the goal must be challenging, but achievable. To be successful, Kaizen must be embraced by everyone who has influence on costs, and pursuing the goal must be seen as a team effort. If management merely lays down a cost reduction goal without input from the managers, it is likely to fail. Also, if a goal is not completely achieved, it should not be viewed as a failure, but as an opportunity for future cost reductions. Kaizen should be seen as a challenge to find design improvements, possibly new vendors, ideas from vendors, etc., all of which can contribute to future cost reductions.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P20-30. a. GE CAPITAL Consumer Loan Department Budget For Upcoming Years ($ millions) Loan processing* Customer relations Printing, mailing & postage Total

Current (base) Year $12,500.00 2,800.00 550.00 $15,850.00

Year 1 $12,960.00 2,903.04 570.24 $16,433.28

Year 2 $13,436.93 3,009.87 591.22 $17,038.02

*Sample computation: 12,500  1.08  0.96 = $12,960.00 and 12,960 x 1.08 x 0.96 = $13,436.93

b. There are two possible major sources of cost reductions that GE Capital might be able to exploit: (1) internal sources, and (2) external sources. Internally, management can always find better, more efficient ways to perform essential activities, or find non-value added activities that can be eliminated. Externally, to the extent that GE is using vendors (inspectors, appraisers, processors, etc.), there should be opportunities to work with those vendors to improve their efficiencies, and have some of the cost savings from those improvements shared with GE. c. The benefit of a successful Kaizen costing program is that the company operates more efficiently and with lower costs. When they do that, they should reward those who have helped to achieve the success. As a company succeeds with its Kaizen program it becomes more “lean” and able to be more competitive in the marketplace, and more profitable to its shareholders. The potential downside of Kaizen is that management uses it as a stick, rather than as a carrot to motivate managers and employees to lower costs. Also, if employees are not properly trained on the Kaizen philosophy, they will likely not be motivated to seek lasting ways to lower costs and improve processes, or they may pursue cost reductions that compromise quality.

20-11

P20-31. a. Variable costs markup = ($1,018,200 + $300,000) / $507,000 = 2.6 or 260% b. Direct materials Direct labor Variable manufacturing overhead Variable selling and administrative costs Total variable costs

$ 8 4 3 4 $19

Selling price = $19 + ($19 × 2.6) = $68.40 c. Variable costs Markup to cover fixed costs ($1,018,200/$507,000) × $19 Markup to provide for a profit ($300,000/$507,000) × $19 Suggest selling price

$19.00 38.16* 11.24* $68.40

Any price in excess of $19 increases short-run profits. However, all products must have an average markup of 200.83 percent ($1,018,200 / $507,000) if Tech Com is to remain profitable in the long run. Using this guideline, the suggested markup is at least $38.16 ($19 x 2.0083). To achieve target profits, all products must have an additional average markup of 59.17 percent ($300,000 / $507,000). Using this guideline, the suggested additional markup is $11.24 ($19 x 0.5917). d. Variable Fixed Total

Manufacturing Costs $405,000 424,200 $829,200

Selling and Administrative Costs $102,000 594,000 $696,000

Manufacturing cost markup = ($300,000 + $696,000)/$829,200 = 1.201* *Rounded

Financial & Managerial Accounting for Decision Makers, 4th Edition

e. Suggested selling price = $21 + ($21 × 1.201) = $46.22 Note: The suggested selling prices are different in (b) and (e). This will occur whenever a specific product has a different mix of variable and fixed costs than the company’s other products. This difference is shown in the following optional analysis:

Variable Fixed Total

Total Manufacturing Costs $405,000 424,200 $829,200

Total Cost Mix $405,000 / $829,200 = 0.488* $424,200 / $829,200 = 0.512* 100% or 1.000

Variable Fixed Total

Unit Manufacturing Costs —Flash Drive $15 6 $21

Unit Cost Mix $15 / $21 = 0.714* $6 / $21 = 0.286* 100% or 1.000

* Rounded

The manufacturing cost base indiscriminately mixed fixed and variable costs in the base and in the markup. If the variable selling and administrative expenses can be identified with individual products, they should be included in the base rather than in the markup. Conversely, the nonvarying nature of fixed manufacturing costs and the difficulty of accurately associating them with individual products suggest that they should be included in the markup rather than in the base. Perhaps the best approach is to use the variable cost markup with the markup broken down into two parts: one for fixed costs and one for profit. Note: If the fixed costs are associated with specific products, they should be figured into the required markup with that product rather than placed in a common cost pool or objective to be covered by all products.

20-13

P20-32. a. 1. Manufacturing costs Selling and administrative costs Full costs

$580,000 420,000 $1,000,000

Full cost markup = $250,000 / $1,000,000 = 0.25 2. Manufacturing costs Variable selling and administrative costs Total

$580,000 55,000 $635,000

Manufacturing costs plus variable selling and administrative costs markup = ($365,000 + $250,000) / $635,000 = 0.969* 3. Manufacturing cost markup = ($420,000 + $250,000) / $580,000 = 1.155* 4. Variable manufacturing costs Variable selling and administrative costs Total

$335,000 55,000 $390,000

Fixed manufacturing costs Fixed selling and administrative costs Total

$245,000 365,000 $610,000

Variable cost markup = ($610,000 + $250,000) / $390,000 = 2.205* 5. Fixed manufacturing costs Total selling and administrative costs Total

$245,000 420,000 $665,000

Variable manufacturing cost markup = ($665,000 + $250,000) / $335,000 = 2.731* * Rounded

b. The cost base used in the computations determines the size of the markup percentage. All costs appear in either the numerator or the denominator. The smaller the denominator, the larger the numerator and the larger the markup percentages. Because the denominators become progressively smaller between a.1. and a.5., the numerators and the markup percentages become progressively larger.

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c. Initial selling price using the mfg. cost markup = $250 + ($250 × 1.155) = $538.75 Initial selling price using the var. mfg. cost markup = $145 + ($145 × 2.731) = $541.00* Note: The initial selling prices are very close. This occurs whenever a specific product has a similar mix of variable and fixed costs to the company’s other products. This is illustrated in the following optional analysis:

Variable Fixed Total

Total Manufacturing Costs $335,000 245,000 $580,000

Total Cost Mix $335,000 / $580,000 $245,000 / $580,000

Variable Fixed Total

Unit Manufacturing Costs, TW Irons $145 105 $250

Unit Cost Mix $145 / $250 $105 / $250

= 0.578* = 0.422* 1.000 or 100 %

= 0.580 = 0.420 1.000 or 100 %

* Rounded

d. The controller’s approach to product pricing is systematic, and it does recognize the need for selling prices to exceed costs. He also recognizes the need to consider cost-based formula prices to meet competition and take advantage of market opportunities. In highly competitive markets, however, it might be better to systematically determine an appropriate selling price and then subtract an allowance for profit to arrive at a target cost, which will then serve as a basis for product design. This proactive approach to cost management will help ensure the long-run competitiveness and profitability of Pipestem Golf Inc.

20-15

CASES and PROJECTS C20-33. There is no correct answer to this question. The objective of the question is to stimulate a classroom discussion of pricing issues. The following comments are intended to assist in guiding the classroom discussion. The arguments presented by the representative of the cable TV company are based on a short-run analysis of costs and revenues. Assuming that there is no alternative use of the space, in the short run, any fee represents incremental income to the pole owners. However, over time the presence of a third set of wires is likely to increase the maintenance costs of the poles, electric wires, and telephone cables. The arguments of the cable TV representative do not consider these costs. The arguments presented by the representative of the electric company are primarily long-run in nature. The electric company representative is considering the potential future opportunity costs associated with alternative ways of using the space. The problem is to estimate this opportunity cost. There are other interested parties. Owners of local TV stations and customers of the electric company should be interested in the rental charge. The local TV company should be concerned with subsidized competition and offer arguments similar to those presented by the railroad industry concerning the use of public roads by trucks. Because electric rates are set by regulatory commissions on the basis of a target return on investment, the rates they charge customers will be affected by the pole rental rates. The following factors should be considered in determining the pole rental fee: •

Opportunity costs, if any

•

Avoidable costs, such as incremental maintenance costs

•

Social and legal factors, such as “fairness”

We do not know the actual average annual cost of pole maintenance and depreciation. If we knew this cost, the pole rental fee might be set at one-half of the full cost, plus a negotiated return on investment. This would be a long-run approach to pricing based on “fairness.” In practice, the electric and telephone companies may set a high rate to encourage equal pole ownership. This suggests a low initial fee with annual increases to encourage the cable TV company to own one-third of the poles they utilize.

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C20-34. The foreign competitor probably designed its product and production procedures to meet a target cost based on a target selling price less a desired profit. The competitor’s proactive cost management during these preproduction stages resulted in minimizing nonvalue-added activities and in selecting low-cost materials and design and manufacturing alternatives. Unless legal action can be taken on the basis of patent infringement or the government is willing to impose significant import duties on the competitive product or take some other action to keep it out of the country, Houston Electronics is left with the options of (1) significantly reducing the price of the HE Versatile CVD or (2) withdrawing from the market. The best advice for the president concerning the HE Versatile CVD is to see if process reengineering and partnerships with vendors and distributors can allow Houston Electronics to continue to produce the product and profitably market it at a significantly lower price. Houston Electronics should immediately start work on the Enhanced HE Versatile CVD, or some other similar product, to regain its technological lead. It should, however, follow a different strategy in developing and marketing this next generation of products. Management’s fundamental problem was failing to recognize the intensity of worldwide competition. The premium pricing strategy attracted competitors looking for new ways to make money. These competitors probably purchased a few of the HE Versatile CVDs, performed reverse engineering, and determined how to make a better product at a lower cost. It is likely that the competitor also selected a selling price to achieve maximum market penetration in the shortest period of time, recognizing that if it did not quickly grab a significant share of the market at a low price, other competitors would be encouraged to enter the market. Management of Houston Electronics should price products to achieve significant market penetration, rather than follow a market skimming strategy. They should then determine a target cost for the product and design the product and manufacturing procedures so that products can be produced for no more than the target cost. They should also form partnerships with vendors and suppliers to obtain the ideas of others and to encourage all entities along the product’s value chain to recognize that they are in business together.

20-17

Chapter 21 Operational Budgeting and Profit Planning QUESTIONS Q21-1.

Planning is the process of forecasting future operating activities, whereas budgeting places the plans in financial terms based upon the related revenues and expenses. Control relates to evaluating the plans and budgets in comparison with the actual activities.

Q21-2.

Except in small organizations, budgeting requires formal planning because of the need to coordinate the budget among various levels of the organization. Advantages of formal planning include: improved communication and coordination, provides a guide to action, and provides a basis for performance evaluation.

Q21-3.

Advantages of the incremental approach stem from the fact that this approach simplifies the budget process, reduces the time to prepare the budget, focuses on changes from the previous budget or previous actual results, and is easy to implement. The disadvantages include not detecting previous inefficiencies in the budget and a tendency to use the previous budget as a base for the next budget.

Q21-4.

The minimum level approach establishes a base amount for budget items and requires explanation of justification for any budgeted amount above the minimum.

Q21-5.

A cost objective’s budget is predicted based on the anticipated consumption of cost drivers.

Q21-6.

The continuous improvement budgeting concept establishes a budget that has improvements built-in throughout the budgeting period. For a given cost category, the expenditures to provide that cost may be reduced each month of the budget period.

21-1

Q21-7.

The cash budget tends to bring together all of the other budgets. Every budget affects either cash receipts or disbursements directly or indirectly. While not all budget schedules tie directly to cash, somewhere in the system the economic transaction interfaces with either cash inflows or outflows.

Q21-8.

The sales, purchases, selling expense, general and administrative expense, and special budgets normally support the cash budget. Cash budgets aid in the creation of the budgeted income statement and balance sheet, which begin with a forecast of sales and how the sales will be collected.

Q21-9.

Budgeted statements are projections of the impact of planned or possible activities on future financial statements. They reflect what the results will be if all plans in the budget occur as scheduled.

Q21-10.

The production and the manufacturing cost budgets are part of the master budget of a manufacturing organization but not part of the budget of a merchandising organization.

Q21-11.

The top-down approach begins with top management deciding on the primary goals and objectives for the entire organization, which are then passed down to successive levels. The bottom-up approach allows all managers to establish, within limits, their goals and to participate in the actual decision process.

Q21-12.

Budgetary slack is not desirable because it undermines the budgeting process. It is difficult to prevent, but it can be reduced if the budgeting process adequately reflects an understanding of human behavior, provides a proper model for evaluations and control, allows inputs at each budget level (but with proper oversight), and holds each manager accountable for the results.

Q21-13.

Annual budgets are not desirable when operating cycles do not occur at regular twelve-month intervals although they may be necessary because of various reporting requirements of lines of credit, lease agreements, or government contracts. Alternatives are life-cycle and continuous budgets.

Q21-14.

Continuous budgeting is based on a moving time frame that extends over a fixed period. As each budgeting segment ends, a month for example, another month is added to the budget. At any given time, the budget is always for the same time period into the future.

Q21-15.

Other forecasts include: cash collections, uncollectible receivables, cost of materials and supplies, employee turnover, length of activity times, interest rates, development time of new products, and others peculiar to a given organization.

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Q21-16.

Motivational considerations help prevent or minimize employee feelings of ill will, disrespect of budget process, and disunity. Participation in the budget process encourages adherence to the budget, enhances self-pride in achieving the budget, and increases employee loyalty to the organization. It also emphasizes the need for top management to get involved with supporting the budget activity, not just preparing the activity. Ways to use budgets to motivate employees include: a. emphasize importance of budgets to organization, b. encourage participation, c. emphasize that top management supports budgeting process, d. allow flexibility in changes to the budget, e. use budget results to reward good performance, and f.

educate employees about the budgeting process in the organization.

21-3

MINI EXERCISES M21-17. VINYARD CLINIC Output/Input Budget For the Month of October Examining supplies ($50 × 500) Labor: Nursing services ($35 × 0.50 × 500) Physician services ($90 × 0.25 × 500) Variable overhead (.75 × 500 × $15] Fixed overhead Total budget

$ 25,000 $8,750 11,250

20,000 5,625 8,000 $58,625

M21-18. WOOD COUNTY DEPARTMENT OF MOTOR VEHICLES Incremental Budget For Next Year

Supplies Temporary and seasonal wages Wages of full-time employees Supervisor salaries Rent Insurance Utilities Miscellaneous Contingencies and equipment Total

Current Year Budget $ 12,000 32,000 200,000 60,000 48,000 16,000 10,000 9,600 25,000 $412,600

Increment 0.025 0.03 0.03 0.03 0.00 0.04 0.02 0.025 balance 0.025

Next Year Budget $ 12,300 32,960 206,000 61,800 48,000 16,640 10,200 9,840 27,238* $424,978

*$424,978 less $376,900, total of other items, = $27,238.

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M21-19. THUNDER ROAD GUITARS Purchases Budget January - May January

February

March

15 6 21 (7) 14

12 8 20 (6) 14

16 9 25 (8) 17

Purchase units: Budgeted sales Plus desired end. inv.* Total inventory needs Less beginning inv. Purchases

April

May

18 11 29 (9) 20

22 10 32 (11) 21

* For example, 50% of the following month's sales, [12 (Feb. budgeted sales) × 0.50 = 6] for January.

Purchase dollars: Budgeted cost of. sales Plus desired end. inv.* Total inventory needs Less beginning inv. Purchase dollars

January

February

March

April

May

$12,000 4,800 16,800 (5,600) $11,200

$ 9,600 6,400 16,000 (4,800) $11,200

$12,800 7,200 20,000 (6,400) $13,600

$14,400 8,800 23,200 (7,200) 16,000

$ 17,600 8,000 25,600 (8,800) $16,800

* For example, 50% of the following month's sales, [$14,400 (April budgeted sales) x 0.50 = $7,200] for March.

M21-20. PATRICK'S RETAIL COMPANY Cash Budgets February, March, and April Cash balance, beginning Cash receipts: 75% of current month's sales 25% of previous month's sales Total receipts Cash available Budgeted disbursements: 70% of previous month's sales Operating expenses Total disbursements Cash balance, ending

February $ 55,000

March $ 80,000

April $ 97,500

262,500 62,500 325,000 380,000

300,000 87,500 387,500 467,500

281,250 100,000 381,250 478,750

175,000 125,000 (300,000) $ 80,000

245,000 125,000 (370,000) $ 97,500

280,000 125,000 (405,000) $73,750

21-5

M21-21. PE RUG COMPANY Production Budget For the Months of July, August, & September Budgeted sales - sq. yards Plus desired ending inventory* Total inventory requirements Less beginning inventory Budgeted production – sq. yards

July 50,000 21,000 71,000 (35,000) 36,000

August September 35,000 42,000 25,200 28,800 60,200 70,800 (21,000) (25,200) 39,200 45,600

October 48,000

*60 percent following month’s sales

PE RUG COMPANY Purchases Budget For the Months of July & August Current needs for production (7 lb/sq. yard) Plus desired ending inventory* Total requirements Less beginning inventory Purchases in pounds

July 252,000 109,760 361,760 (100,000) 261,760

August 274,400 127,680 402,080 (109,760) 292,320

September 319,200

*40 percent of following month’s production requirements.

M21-22. CAROLINA TABLE Manufacturing Cost Budget From the Month of April Production

250 units

Direct materials Wood (production x 24 sq. feet x $35) Hardware kits (production x 1 kit x $20) Direct labor (production x 0.75 hours x $40) Variable overhead (production x $25) Fixed manufacturing overhead Total manufacturing costs

$210,000 5,000

$215,000 7,500 6,250 91,250 $320,000

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EXERCISES E21-23. a. HIGHLANDS INDUSTRIES Activity-Based Manufacturing Cost Budget For the Month of February Unit-level costs: Direct materials: 3 lbs. × 25,000 × $6 Assembly: 1/4 × 25,000 × $20 Manufacturing overhead: $8 × 25,000 Batch-level costs: Setup: $100 × 25 batches (25,000 / 1,000) Inspection: $40 × 25 batches Product-level costs: Product development Facility-level costs: Factory administration Budgeted manufacturing costs

$450,000 125,000 200,000

$775,000

2,500 1,000

3,500 50,000 145,000 $973,500

b. The development of an effective budget is a difficult job. It is also a necessary one. Organizations that do not plan are likely to wander aimlessly and ultimately succumb to the swirl of current events. The formal development of a budget helps to ensure both success and survival. Budgeting compels planning; it improves communications and coordination among organizational elements; it provides a guide to action; and it provides a basis of performance evaluation. Budget models are also used to analyze and prepare for various business risks.

21-7

E21-24. JONAH FREIGHT Loading Department Activity-Based Budget For the Month of November Activities: Cleaning: Trucks [(20 days × 25 trucks × 30 minutes) / 60 minutes] Docks [(20 days × 25 trucks × 15 minutes) / 60 minutes] Total cleaning time Loading: Instructions [(20 days × 25 trucks × 15 minutes)/60 minutes] Loading trucks (20 days × 25 trucks × 1 hour) Total loading time Budget: Cleaning: Labor (375 hours × $25) Overhead ($12,000 × 0.30) Supervision ($6,000 × 0.15) Loading: Labor (625 × $25) Overhead ($12,000 × 0.65) Supervision ($6,000 × 0.35) Total

250.00 hours 125.00 hours 375.00 hours

125.00 hours 500.00 hours 625.00 hours

$ 9,375 3,600 900 15,625 7,800 2,100

$ 13,875

25,525 $39,400

Financial & Managerial Accounting for Decision Makers, 4th Edition

E21-25. a. Activity cost budget Reception: Out-patients Admitted Total

9,200 × $20 = 8,800 × $20 =

$ 184,000 176,000 $ 360,000

Treatment: Out-patients Admitted Total

4,600 × $175 = 2,200 × $175 =

$ 805,000 385,000 $ 1,190,000

Cleaning: Out-patients Admitted Total

4,500 × $30 = 3,000 × $30 =

$ 135,000 90,000 $ 225,000

b. The cleaning activity base might be adjusted for a cost per person-hour rather than a cost per person. The number of forms and aliments probably would not need to be changed. c. It requires the managers to predict a realistic level for each activity rather than just adjusting the dollars for an overall predetermined percentage increase.

21-9

E21-26. a. Average quarterly sales basis HONOLULU SHIRT SHOP Sales Budget Quarterly – Upcoming Year

Winter

Quarter Spring Summer

Fall

Year Totals

Units: Children's* Women's Men's

231 252 189

924 1,008 756

Dollars: Children's** Women's Men's Totals

$2,310 3,780 3,402 $9,492

$ 9,240 15,120 13,608 $37,968

* Example of Winter Quarter Computation: 880 annual sales × 1.05 (i.e. 5% growth) ÷ 4 quarters = 231 ** Example of Winter Quarter Computation: 231 × $10 = $2,310

b. Actual quarterly sales basis Quarter – Upcoming Year Fall

Year Totals

Winter

Spring

Summer

Units: Children's* Women's Men's

84 84 147

189 126 168

525 630 273

126 168 168

924 1,080 756

Dollars: Children's** Women's Men's Totals

$840 1,260 2,646 $4,746

$1,890 1,890 3,024 $6,804

$5,250 9,450 4,914 $19,614

$1,260 2,520 3,024 $6,804

$ 9,240 15,120 13,608 $37,968

* Example of Winter Quarter Computation: 80 quarterly sales × 1.05 (i.e. 5% growth) = 84 ** Example of Winter Quarter Computation: 84 × $10 = $840

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c. Using average quarterly sales smooths the investment in inventory throughout the year and reduces the possibility of being out of stock in most quarters unless sales change substantially from the previous period. This method also simplifies the purchasing of inventory by making it the same every quarter. Using actual quarterly sales minimizes the investment in inventory during low-sales quarters. However, if sales are expected to increase by 5 percent, the low-sales quarters might increase more than the high-sales quarters, thereby causing out-of-stock situations. An alternative might be to use actual sales for items that fluctuate widely and average sales for those items that have little change.

E21-27. HOLIDAY EVENTS Partial Cash Budgets For the Months of October, November, and December Cash balance, beginning Collections on sales Cash available for operations Disbursements for operations Ending cash before borrowings or replacements Short-term finance: New loans Repayments Interest Cash balance, ending

Oct. $25,000 100,000 125,000 (115,000)

Nov. $12,000 90,000 102,000 (110,000)

Dec. $12,000 140,000 152,000 (115,000)

Total $ 25,000 330,000 355,000 (340,000)

10,000

(8,000)

37,000

15,000

2,000

20,000 (22,000) (240)* $14,760

22,000 (22,000) (240) $14,760

$12,000

*[($2,000 × 0.01 × 2 months) + ($20,000 × 0.01 × 1 month)]

21-11

E21-28. MTC WHOLESALERS Purchases Budget For the Months of July, August, and September Inventory required, current sales* Desired ending inventory** Total inventory needs Less beginning inventory*** Purchases****

July $156,000 72,000 228,000 (78,000) $150,000

August $144,000 81,000 225,000 (72,000) $153,000

September $162,000 82,500 244,500 (81,000) $163,500

* 60 % of sales revenue ** 50 % of following month's cost of sales *** 50% current month’s cost of sales **** Paid in following month

MTC WHOLESALERS Cash Budget For the Months of July, August, and September Cash balance, beg. Cash receipts: 60% of current month's sales 30% of previous month's sales 10% of sales two months prior Total receipts Cash available Cash disbursements: Purchases Operating costs Total disbursements Cash balance, end.

July $125,000

August $118,500

September $118,000

156,000 67,500 25,000 248,500 373,500

144,000 78,000 22,500 244,500 363,000

162,000 72,000 26,000 260,000 378,000

160,000 95,000 (255,000) $118,500

150,000 95,000 (245,000) $118,000

153,000 95,000 (248,000) $130,000

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E21-29. ANDREW INC. Schedule of Budgeted Cash Collections Quarterly by Months May $150,000

Sales Cash receipts: 60% of current month's sales Less 2% discount Net collections in month of sale 20% of previous month's sales 15% of two months' previous sales Total receipts

June $175,000

July $160,000

Total $485,000

$ 90,000 $ 105,000 ( 1,800) (2,100) 88,200 102,900 30,000* 30,000

$96,000 $291,000 (1,920) (5,820) 94,080 285,180 35,000 95,000

18,750** 22,500*** $136,950 $155,400

22,500 $151,580

63,750 $443,930

* April sales: $60,000 / 0.40 = $150,000; May collections: $150,000 × 0.20 = $30,000 ** March sales: $25,000 / 0.20 = $125,000; May collections: $125,000 × 0.15 = $18,750 *** June collections of April sales: $150,000 × 0.15 = $22,500

E21-30. STIMSON LUMBER Schedule of Cash Disbursements April, May, and June Budgeted sales

April $440,000

May $520,000

June $480,000

Lumber purchases* Wages** Operating expenses*** Lease payment Total disbursements

$312,000 88,000 21,000 10,000 $431,000

$288,000 104,000 22,000 10,000 $424,000

$336,000 96,000 26,000 10,000 $468,000

* 60% of following month's sales, $560,000 × 0.60 of July sales for June purchases ** 20% of sales *** 5% of preceding month's sales, $420,000 × 0.05 for April

21-13

E21-31. RINGWOOD MANUFACTURING Schedule of Cash Disbursements For the Months of July and August July Accounts payable: (0.6 × $70,000) + (0.4 × $80,000) (0.6 × $85,000) + (0.4 × $70,000) Payroll: (0.5 × $50,000) + (0.5 × $40,000) (0.5 × $45,000) + (0.5 × $50,000) Loan payments Total

August

$ 74,000 $ 79,000 45,000 15,000 $134,000

47,500 15,000 $141,500

E21-32. QUALITY WOOL COMPANY Budgeted Income Statement For the Year Ending December 31 Sales ($1,200,000 × 1.03 × 1.05) Less bad debts ($1,297,800 × 0.02) Collected sales Cost of goods sold ($780,000 × 1.02 × 1.05) Profit before operating expenses Operating expenses* ([$206,000 - $15,000] × 1.04) + $15,000 Income before tax

$1,297,800 (25,956) 1,271,844 (835,380) 436,464 (213,640) $ 222,824

*Assuming depreciation is based on historical cost, the $15,000 of depreciation is not subject to the 4 percent price increase.

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E21-33. a. BARNES & NOBLES Budgeted Income Statement Next Year Sales Cost of goods sold ($2,000,000 × 0.70) Gross margin Sales and administrative expenses: Depreciation Wages and salaries Advertising Other operating costs Net income before taxes Income taxes (20%) Net income (loss)

$2,000,000 (1,400,000) 600,000 $ 36,000 375,000 12,000 15,000

( 438,000) 162,000 (32,400) $ 129,600

b. Required sales volume = [$438,000 + ($150,000 / (1 – 0.20))] / (1 – 0.70) = $2,085,000

E21-34. a. COMFY CUSHIONS Production Budget For the Months of October and November October November December Unit sales 11,000 12,000 10,000 Desired ending inventory (30% next mo. production) 3,600 3,000 Finished goods requirements 14,600 15,000 Less beginning inventory (3,400) (3,600) Production requirements 11,200 11,400 b. COMPANY CUSHIONS Purchases Budget For the Month of October Production requirements (4 lbs. each) Desired ending inventory (20% next mo. production) Raw materials requirements Less beginning inventory Purchase requirements (units) Purchase requirements (At $1.10 per pound)

October 44,800 9,120 53,920 (8,500) 45,420 $49,962

November 45,600

21-15

E21-35. a. ADVANCE DRAINAGE SYSTEMS Production Budget For the Months of September, October, and November Sept. 3,000 750 3,750 (850) 2,900

Nov. 1,500 150 1,650 (450) 1,200

Dec. 500

Sept.

Oct.

Nov.

Units (in pounds): Production requirements* Plus desired ending inventory** Total inventory needs Less beginning inventory Budgeted purchases in pounds

203,000 61,600 264,600 (60,000)# 204,600

154,000 33,600 187,600 (61,600) 126,000

Dollars: Budgeted purchases ($1.50 per pound)

$306,900

$189,000

Budgeted sales Plus desired ending inventory* Total inventory requirements Less beginning inventory Budgeted production

Oct. 2,500 450 2,950 (750) 2,200

*30% of the following month’s sales.

b. ADVANCE DRAINAGE SYSTEMS Purchases Budget For the Months of September and October

84,000

* 70 pounds per unit ** 40% of the following month's production needs. # September beginning inventory given in problem

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PROBLEMS P21-36. a. OFFICE DEPOT Schedule of Cash Receipts July, August, and September Cash sales (44% of total sales) 50% of current month's credit sales 35% of last month's credit sales 15% of two months' prior credit sales Total cash receipts

July $ 19,800 12,600 8,232 3,360 $43,992

Aug. $ 22,880 14,560 8,820 3,528 $49,788

Sept. $26,400 16,800 10,192 3,780 $57,172

Aug. $25,500 9,150 34,650 (7,650) $27,000

Sept. $30,500 10,500 41,000 (9,150) $31,850

b. OFFICE DEPOT Purchases Budget July, August, and September Budgeted cost of goods sold Plus desired ending inventory* Total inventory needs Less beginning inventory Budgeted purchases

July $23,500 7,650 31,150 (7,600) $23,550

*30% of the following month's cost of goods sold, $35,000 × 0.30 for Sept.

OFFICE DEPOT Schedule of Cash Disbursements for Purchases July, August, and September Current month (50%) Previous month (50%) Total cash disbursements

July $ 11,775 12,000 $23,775

Aug. $ 13,500 11,775 $25,275

Sept. $ 15,925 13,500 $29,425

21-17

c. OFFICE DEPOT Cash Budget Third Quarter Cash balance, beginning Cash receipt Cash available

July $ 10,000 43,992 $ 53,992

Aug. $ 10,017 49,788 $ 59,805

Sept. $ 10,030 57,172 $ 67,202

Cash disbursements: Purchases Other expenses (less depreciation) Equipment note Total disbursements Balance before borrowing or repayment Borrowings Loan repayments** Cash balance, ending

$ 23,775 11,600 10,000 $(45,375) $ 8,617 1,400 _______ $ 10,017

$ 25,275 15,000 10,000 $(50,275) $ 9,530 500 _______ $ 10,030

$ 29,425 13,500 — $(42,925) $ 24,277 (1,926) $ 22,351

**The loan payment plus interest is determined by trial-and-error with $100 payment increments plus interest but ending cash balance must stay above $10,000. Borrowings from: Principal paid Interest Total payment

July $1,400 21 $1,421

Aug. $500 5 $505

Repaid in Sept. $1,900 26 $1,926

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P21-37. a. WILLIAMS SUPPLY COMPANY Schedule of Cash Collections For the Month of July Current month's sales ($295,000 × 0.60 × 0.98) Previous month's sales ($240,000 × 0.25) Two months' prior sales ($175,000 × 0.12) Total cash collections

$173,460 60,000 21,000 $254,460

WILLIAMS SUPPLY COMPANY Schedule of Cash Payments for Purchases For the Month of July Current month's purchases* ($122,000 × 0.50) Beginning accounts payable (given) Total cash payments

$61,000 47,200 $108,200

*Cost of purchases: July sales units ($295,000 July sales / $50 selling price) Plus desired ending inventory [($320,000 August sales/$50 selling price) × 0.4] Total units needed Less beginning inventory ($47,200 Value/$20 cost per unit) July purchases Cost per unit Cost of purchases

5,900 2,560 8,460 (2,360) 6,100 × $20 $122,000

c. WILLIAMS SUPPLY COMPANY Schedule of Selling and Administrative Expenses and Cash Disbursements For the Month of July Total Selling and administrative expenses: Fixed [($1,200,000 × 0..75) / 12 months] $75,000 Cash payment ($75,000 - $3,000*) Variable {[($1,200,000 × 0.25) / $3,000,000] × $295,000} 29,500 Total expenses and cash disbursements $104,500

Cash

$ 72,000 29,500 $101,500

*Monthly depreciation = $36,000 / 12 = $3,000

21-19

d. WILLIAMS SUPPLY COMPANY Cash Budget For the Month of July Cash receipts Cash disbursements: Merchandise Selling and administrative Excess receipts (disbursements)

$254,460 $108,200 101,500

(209,700) $44,760

P21-38. a. WAUCONDA MEDICAL CENTER OUTPATIENT CLINIC Supplies Purchases Budget For June, July, and August Required for patient visits Desired ending inventory (0.10 following month with $4,000 minimum) Total requirements Less beginning inventory Purchases

June $60,000

July $70,000

August $90,000

Total $220,000

7,000 67,000 (5,000) $62,000

9,000 79,000 (7,000) $72,000

4,000 4,000 94,000 224,000 (9,000) (5,000) $85,000 $219,000

b. WAUCONDA MEDICAL CENTER OUTPATIENT CLINIC Revenue and Expense Budget For June, July, and August June July August Patient visits 3,000 3,500 4,500 Average bill per patient × $75 × $75 × $75 Total revenues $225,000 $262,500 $337,500 Expenses: Bad debts (0.10 total revenues)* 22,500 26,250 33,750 Disallowed claims*** 33,750 39,375 50,625 Supplies ($20 per patient) 60,000 70,000 90,000 Salaries** 42,000 49,000 63,000 Facility costs (includes dep. of $2,500 per month) 15,000 15,000 15,000 Total expenses (173,250) (199,625) (252,375) Revenues less expenses $ 51,750 $ 62,875 $85,125

Total 11,000 × $75 $825,000 82,500 123,750 220,000 154,000 45,000 (625,250) $199,750

* An alternative is to deduct these items in a computation of net revenues. ** July patient visits require an additional staff at $7,000. August patient visits require two additional staff at $7,000 each. ***Disallowed claims (0.50 covered by insurance x 0.10 disallowed x Total patient revenues) ©Cambridge Business Publishers, 2021 21-20

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. WAUCONDA MEDICAL CENTER OUTPATIENT CLINIC Cash Budget For June, July, and August Beginning cash Cash receipts Services paid in cash (0.40) Insurance receipts (2 months previous × 0.50 × 0.70) Total cash receipts

June $15,000

July August Total (11,500) $ (40,000) $ 15,000

90,000

105,000

135,000

0 90,000

0 105,000

78,750 213,750

408,750

Total cash available

105,000

93,500

173,750

423,750

Cash disbursements: Purchases Salaries Facilities less depreciation Total cash disbursements Ending balance per computations

62,000 42,000 12,500 (116,500) $(11,500)

72,000 49,000 12,500 (133,500) $ (40,000)

85,000 63,000 12,500 (160,500) (410,500) $13,250 $ 13,250

d. The cash budget is not feasible because the clinic does not have adequate cash for June and July operations. This is because of the delay in receiving reimbursements from insurance companies, with June reimbursements not received until August and so forth. Note that there will be cash receipts from insurance companies in September and October for July and August services, respectively. Management needs to obtain more initial funding, perhaps from a loan or additional investments by the medical center. Alternatively, management might try to arrange faster payments from insurance companies, although that is unlikely to be successful.

21-21

P21-39. a. NORDSTROMS Monthly Purchase Budget (in thousands) Quarter Ending June 30 Cost of sales for month Desired ending inventory* Total inventory needs Less beginning inventory Budgeted purchases

April $2,160 3,420 5,580 (3,400) $2,180

May $2,280 3,150 5,430 (3,420) $2,010

June $2,100 2,880 4,980 (3,150) $1,830

Total $ 6,540 9,450 15,990 (9,970) $6,020

*150% of the following month's cost of sales, ($3,200 × 0.60) × 1.50 for June

b. NORDSTROMS Schedule of Monthly Cash Receipts (in thousands) Quarter Ending June 30 50% of current month's sales 30% of last month's sales 20% of sales two months prior Total cash receipts

April $1,800 900 540 $3,240

May $1,900 1,080 600 $3,580

June $1,750 1,140 720 $3,610

Total $ 5,450 3,120 1,860 $10,430

c. NORDSTROMS Schedule of Monthly Cash Disbursements (in thousands) Quarter Ending June 30 Purchases of prior month Current operating expenses** Dividends Total cash disbursements

April $2,400* 1,155 710 $4,265

May $2,180 1,155 ______ $3,335

June $2,010 1,155 _____ $3,165

Total $ 6,590 3,465 710 $10,765

* From March 31 Accounts Payable ** $750 wages and salaries + $55 advertising + $350 other costs

Financial & Managerial Accounting for Decision Makers, 4th Edition

d. NORDSTROMS Monthly Cash Budget (in thousands) Quarter Ending June 30 Cash balance, beginning Receipts Disbursements Excess receipts over disb. Balance before borrowings Borrowings Loan repayments Cash balance, ending

April $ 2,525 3,240 (4,265) (1,025) 1,500 500 0 $ 2,000

May $ 2,000 3,580 (3,335) 245 2,245 0 (204) $ 2,041

June $ 2,041 3,610 (3,165) 445 2,486 0 (309) $ 2,177

Total 2,525 10,430 (10,765) (335) 2,190 500 (513) $ 2,177

e. NORDSTROMS Budgeted Monthly Income Statements (in thousands) Quarter Ending June 30 April May June Sales $3,600 $3,800 $3,500 Cost of sales (2,160) (2,280) (2,100) Gross profit 1,440 1,520 1,400 Operating expenses: Wages and salaries 750 750 750 Depreciation 75 75 75 Advertising 55 55 55 Other costs 350 350 350 Insurance 30 30 30 Interest* 5 5 3 Total expenses (1,265) (1,265) (1,263) Pre-tax income $ 175 $ 255 $ 137

Total $10,900 (6,540) 4,360 2,250 225 165 1,050 90 13 (3,793) $ 567

*Computation of monthly interest expense: April, $500 × 0.01 = $5 May, $500 × 0.01 = $5 June, $300 × 0.01 = $3

21-23

f. NORDSTROMS Budgeted Balance Sheet (in thousands) June 30 Assets Cash Accounts receivable* Inventory Prepaid insurance** Fixtures*** Total assets

$ 2,177 2,510 2,880 60 2,775 $10,402

*Accounts Receivable 50% of June sales 50% X 40% of May sales Total

Liabilities and Equity Merchandise payable Dividend payable

$ 1,830 710

Stockholders' equity**** Total liabilities & equity

7,862 $10,402

$1,750 760 $2,510

**Prepaid Insurance $150/ 5 months = $30 per month $30 × 3 months = $90 insurance expense $150 - $90 = $60 insurance balance 6/30 ***Fixtures March 31 balance Less depreciation ($75 per month × 3 months) June 30 balance ****Stockholders' Equity Beginning equity Plus income Less dividends Ending equity

$3,000 (225) $2,775

$8,005 567 (710) $7,862

Financial & Managerial Accounting for Decision Makers, 4th Edition

P21-40. a. CUBS INCORPORATED Production Budget For the Months of January and February January February Requirements for current sales 12,000 11,500 Desired ending inventory (40 % following month’s sales) 4,600 5,000 Total requirements 16,600 16,500 Less beginning inventory (40 % current month’s sales) (4,800) (4,600) Production requirements 11,800 11,900

March 12,500

b. CUBS INCORPORATED Purchases Budget For the Month of January Current requirements (units) Desired ending inventory (20% following month’s production requirements) Total requirements Less beginning inventory (20 % current month’s requirements) Purchases (units) Purchases (dollars at $15 each)

January February 11,800 11,900 2,380 14,180 (2,360) 11,820 $177,300

c. CUBS INCORPORATED Manufacturing Cost Budget For the Month of January Variable costs Direct materials (11,800 × $15) Direct labor (11,800 × $5) Variable manufacturing overhead (11,800 × $7) Total variable costs Fixed manufacturing overhead Total manufacturing costs

$177,000 59,000 82,600 318,600 150,000 $468,600

21-25

d. CUBS INCORPORATED Cash Budget For the Month of January Beginning balance Receipts: December sales (10,000 × $75 × 0.50) January sales (12,000 × $75 × 0.50) Total cash available Disbursements: Purchases Direct labor Variable manufacturing overhead Fixed manufacturing overhead (exclude depreciation) Variable selling and administrative (12,000 × $3) Fixed selling and administrative Dividend Ending Balance

$ $375,000 450,000

177,300 59,000 82,600 135,000 36,000 160,000 15,000

10,000

825,000 835,000

(664,900) $170,100

e. CUBS INCORPORATED Budgeted Contribution Income Statement For the Month of January Sales (12,000 × $75) Less variable costs: Cost of goods sold [12,000 × ($15 + $5 + $7] Selling and administrative (12,000 × $3) Contribution Less fixed costs Manufacturing overhead Selling and administrative Net income

$900,000 $324,000 36,000

150,000 160,000

(360,000) 540,000

(310,000) $230,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

P21-41. As illustrated in the following revised cash budget, Jacobs does not have enough cash to purchase one-hundred thirty percent of February’s production needs. CUBS INCORPORATED Cash Budget with Additional Purchases of Raw Materials For the Month of January Beginning balance Receipts: December sales (10,000 × $75 × 0.50) January sales (12,000 × $75 × 0.50) Total cash available Disbursements: Purchases * Direct labor Variable manufacturing overhead Fixed manufacturing overhead (exclude depreciation) Variable selling and administrative (12,000 × $3) Fixed selling and administrative Dividend Ending Balance NOT FEASIBLE

$375,000 450,000

409,350 59,000 82,600 135,000 36,000 160,000 15,000

825,000 835,000

(896,950) ($ 61,950)

Inadequate cash

* Current requirements Revised ending inventory (11,900 x 150%) Total requirements Beginning inventory Purchases Purchases at $15 each

$ 10,000

11,800 units 17,850 units 29,650 units (2,360) units 27,290 units $409,350

Being aware of this cash shortage in advance, management has time to consider alternatives actions that will alleviate the possible cash shortage. Possible actions include: •

Conserve cash by slower payments of bills. Perhaps they do not have to pay all debts in the month incurred.

•

Delay the cash dividend.

•

“Encourage” customers to pay cash at the time of sale.

•

Invest more cash in the business. For the size of the operations there may be inadequate owner investment.

•

Secure a line of credit with the bank.

21-27

P21-42. a. ELECTRIC MONKEY COMPUTER ACCESSORIES Sales Budget For the Year Ending December 31 Unit sales Sales revenue

First Second Third Fourth 4,400 4,600 4,500 4,800 $990,000 $1,035,000 $1,012,500 $1,080,000

Total 18,300 $4,117,500

b. ELECTRIC MONKEY COMPUTER ACCESSORIES Production Budget For the Year Ending December 31 Unit sales Desired ending inventory* Finished goods requirements Less beg inv. Production requirements

First 4,400 1,380 5,780 (1,500) 4,280

Second 4,600 1,350 5,950 (1,380) 4,570

Third 4,500 1,440 5,940 (1,350) 4,590

Fourth 4,800 1,600 6,400 (1,440) 4,960

Total 18,300 1,600 19,900 (1,500) 18,400

*30% of following quarter’s sales

c. ELECTRIC MONEY COMPUTER ACCESSORIES Purchases Budget For the Year Ending December 31 First Second Purchases in units Required for production Desired ending inventory* Total requirements Less beginning inventory Purchase requirements (units) Purchase requirements (dollars)

4,280 914 5,194 (950) 4,244

4,570 918 5,488 (914) 4,574

Third

Fourth

Total

4,590 992 5,582 (918) 4,664

4,960 1,000 5,960 (992) 4,968

18,400 1,000 19,400 (950) 18,450

$318,300 $343,050$349,800

$372,600 $1,383,750

*20% of following quarter’s production

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d. ELECTRIC MONKEY COMPUTER ACCESSORIES Manufacturing Cost Budget For the Year Ending December 31 First Production requirements: 4,280 Manufacturing resource requirements: Direct materials (1 kit) 4,280 Direct labor hours (0.5 LH) 2,140 Variable manufacturing costs: Direct materials $321,000 Direct labor 64,200 Manufacturing overhead 10,700 Total variable costs 395,900 Fixed manufacturing costs 125,000 Total manufacturing costs $520,900

Second 4,570

Third 4,590

Fourth 4,960

Total 18,400

4,570 2,285

4,590 2,295

4,960 2,480

18,400 9,200

$342,750 68,550 11,425 422,725 125,000 $547,725

$344,250 $372,000 $1,380,000 68,850 74,400 276,000 11,475 12,400 46,000 424,575 458,800 1,702,000 125,000 125,000 500,000 $549,575 $583,800 $2,202,000

e. ELECTRIC MONKEY COMPUTER ACCESSORIES Selling and Administrative Expense Budget For the Year Ending December 31 Unit sales Sales Revenue Variable costs: Bad debts Other Total Fixed costs Total selling and admin.

First Second Third Fourth Total 4,400 4,600 4,500 4,800 18,300 $990,000 $1,035,000 $1,012,500$1,080,000 $4,117,500

9,900 $ 10,350 35,200 36,800 45,100 47,150 157,500 157,500 $202,600 $204,650

$ 10,125 $ 10,800 36,000 38,400 46,125 49,200 157,500 157,500 $203,625 $206,700

$ 41,175 146,400 187,575 630,000 $817,575

21-29

f. ELECTRIC MONKEY COMPUTER ACCESSORIES Cash Budget For the Year Ending December 31 First Second Third Fourth Total Beginning balance $ 75,000 $ 296,470 $ 598,145 $ 883,620 $ 75,000 Operating cash receipts: Current quarter's sales (0.70) 693,000 724,500 708,750 756,000 2,882,250 Previous quarter's sales (0.29) 245,000 287,100 300,150 293,625 1,125,875 Total operating receipts 938,000 1,011,600 1,008,900 1,049,625 4,008,125 Total available for operations 1,013,000 1,308,070 1,607,045 1,933,245 4,083,125 Cash disbursements: Purchases: Current quarter (0.60) 190,980 205,830 209,880 223,560 830,250 Previous quarter (0.40) 125,000 127,320 137,220 139,920 529,460 Direct labor 64,200 68,550 68,850 74,400 276,000 Var. manufacturing overhead 10,700 11,425 11,475 12,400 46,000 Fixed manufacturing overhead 110,000 110,000 110,000 110,000 440,000 Variable selling and admin. 35,200 36,800 36,000 38,400 146,400 Fixed selling and admin. 150,000 150,000 150,000 150,000 600,000 Interest* 450 0 0 0 450 Total disbursements (686,530) (709,925) (723,425) (748,680) (2,868,560) Available before borrowing or repayment 326,470 598,145 883,620 1,184,565 1,214,565 Borrowing 0 0 0 0 0 Repayment* (30,000) 0 0 0 (30,000) Ending balance $296,470 $598,145 $883,620 $1,184,565 $1,184,565 * Repayment: Principal paid Interest

1st Qtr. $30,000 $450 = ($30,000 x 0.015)

Financial & Managerial Accounting for Decision Makers, 4th Edition

g. ELECTRIC MONKEY COMPUTER ACCESSORIES Pro Forma Contribution Income Statement For the Year Ending December 31 Sales revenue

First Second Third Fourth Total $990,000 $1,035,000 $1,012,500 $1,080,000 $4,117,500

Less variable costs: Cost of goods sold Selling and admin. Total variable costs Contribution margin

395,900 45,100 (441,000) 549,000

422,725 47,150 (469,875) 565,125

424,575 458,800 1,702,000 46,125 49,200 187,575 (470,700) (508,000) (1,889,575) 541,800 572,000 2,227,925

Less fixed costs: Manufacturing overhead Selling and admin. Total fixed costs Operating income Less interest expense* Net income (loss)

125,000 157,500 (282,500) 266,500 (450) $266,050

125,000 157,500 (282,500) 282,625 0 $282,625

125,000 125,000 500,000 157,500 157,500 630,000 (282,500) (282,500) (1,130,000) 259,300 289,500 1,097,925 0 0 (450) $259,300 $289,500 $1,097,475

$30,000

*Borrowing at start of quarter

21-31

CASES and PROJECTS C21-43. Participative budgeting allows all managers who operate under some aspect of a budget to have input into the budget's process. This process is known as bottom-up because the firstline managers have input into the budget. Imposed budgeting, known as the top-down approach, passes goals and objectives down the organizational ladder without input from those affected by the budget. Ms. Jones appears to favor participative budgeting because of her belief in increased responsiveness when employees have input in important aspects of the company. Mr. Dobbs believes that managers should manage and not spend time in activities that do not contribute directly to the operations of their departments.

C21-44. a. A participative approach may have the following behavioral implications for budgetary planning and budgetary control: 1. The process fosters greater awareness of organizational goals and, thus, a greater opportunity for goal congruence. Therefore, employees are likely to construct realistic budgets consistent with the financial resources available. 2. The process fosters higher motivation to achieve company goals because they are congruent with the goals of the subunit. 3. Participation will increase motivation to achieve goals and accept budgetary control because the employees are more committed. b. His imposed budgetary approach relies on unilateral, top-down communications from higher to lower levels within the organization with little or no lateral communications across organizational lines. The participative budgetary approach requires more interaction because it relies on bilateral communications between levels and lateral communications across levels. The unilateral communication in the imposed budgetary approach tends to create resentment toward the budget, increase tension, and reduce motivation. The bilateral communication in the participative approach fosters goal congruence, increases motivation, and improves morale.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C21-45. a. 1. This will contribute to slack unless the average of all workers in her department are in the top quartile of wages and salaries. This can be especially troublesome if she knows the average wages and salaries of her department are near the lower end of the range. However, this is also something that could be easily detected through variance analysis of the labor rate variance. The amount of slack will depend on the known difference between the actual average and the top quartile average. 2. If the optimistic operating range has a reasonable chance of being achieved this would not be considered an unethical base. Evaluation variances with a static budget normally do not detect volume differences, and this could easily result in budgetary slack. 3. Using the worst performance periods as a base for the coming year would provide for slack in the budget unless the poor performance tends to repeat itself from time to time. 4. If replacement values are used for planning, then replacement values would have to be used for evaluation purposes. If used consistently according to generally accepted accounting principles, this would not generate slack. 5. If the fixed costs are discretionary, it is appropriate to use the current amount with adjustments for inflation. However, committed fixed costs, such as a ten-year lease of equipment, would create budgetary slack and would be an unethical practice. 6. If the department's employees normally experience a learning curve in their production activities, it would create slack if most of the department's employees have already achieved relatively high levels of job skills. However, if the department has high employee turnover or if most of the department's employees are new, this would not be an unreasonable assumption. b. No, anything that purposefully distorts the results of operations cannot be justified. If the managers are not being fairly evaluated with the static budget, they should recommend to the top executives that the system be changed. Just because they have always used a static budget approach does not mean that it cannot be changed. c. Ms. Bailey could recommend several measures to top management that would improve the reporting system. These include: 1. Change from a static to a flexible budgeting system. 2. Allow the department managers to have input into the planning process with appropriate justifications for the amounts submitted. 3. Separate variance analysis into fixed and variable categories. 4. Separate variance analysis into controllable and uncontrollable categories. 5. Have investigations of all variances outside a certain range such as plus or minus two percent. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 21

21-33

C21-46. a. 1. The reasons that Atkins and Granger use budgetary slack include: •

These employees are hedging against the unexpected (reducing uncertainty and risks).

•

The use of budgetary slack allows employees to exceed expectations or show consistent performance. This is particularly important when performance is evaluated on the basis of actual results versus budget.

•

Employees are able to blend personal and organizational goals through the use of budgetary slack as good performance generally leads to higher salaries, promotions, and bonuses.

2. The use of budgetary slack can adversely affect Atkins and Granger for the following reasons: •

It limits the usefulness of the budget as a motivator for employees.

•

It affects their ability to identify trouble spots and take appropriate, corrective action.

•

It reduces their credibility in the eyes of management.

Also, the use of budgetary slack may affect management decision making as the budgets will show lower contribution margins (lower sales, higher expenses). Decisions regarding the profitability of product lines, staffing levels, incentives, etc., could have an adverse effect on Atkins' and Granger's departments. b. The use of budgetary slack, particularly if it has a detrimental effect on the company, may be unethical. In assessing the situation, the specific standards of Statements on Management Accounting No. 1C that should be considered are: •

Competence—Clear reports using relevant and reliable information should be prepared.

•

Integrity - Any activity that subverts the legitimate goals of the company should be avoided. Favorable as well as unfavorable information should be communicated.

•

Objectivity - Information should be fairly and objectively communicated. relevant information should be disclosed.

•

Confidentiality - The standards of confidentiality do not apply.

All

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 22 Standard Costs and Performance Reports QUESTIONS Q22-1.

Responsibility accounting is the structuring of performance reports addressed to individual or group members of an organization in a manner that emphasizes the factors controllable by them. Noncontrollable costs should be excluded from performance reports because, if included, they would distract managers' attention from controllable costs and, thereby, dilute efforts to deal with controllable items. Lower-level managers may also become frustrated with the entire performance reporting system if they believe upper-level managers expect them to control costs they cannot influence.

Q22-2.

Because the managers have so much pressure to perform at certain levels, they often resort to unethical practices to compensate for unfavorable results. These actions eventually end in results unfavorable to the organization.

Q22-3.

Responsibility accounting reports must be expanded to include the nonfinancial areas of productivity, quality, and innovative assessments. Examples of nonfinancial areas include: machine-hours run per batch, customers served per hour, warranty claims per 1,000 units sold, and defective units per batch.

Q22-4.

A cost center is a responsibility center whose manager is responsibility for managing costs. Examples might include: manufacturing department, manufacturing plant, repair activities, accounting, personnel department, shipping activities, computer center.

Q22-5.

A cost center is different from either an investment center or a profit center in that it does not recognize revenues nor compute any type of income figure.

22-1

Q22-6.

The use of tight standards often causes planning and behavioral problems. Management expects to use more of the budgeted inputs than the standards allow; accordingly, tight standards should not be used to budget input requirements or cash flows. If employees find that a second set of standards are used in the real budget or if they are constantly subjected to unfavorable performance reports, they may come to distrust the entire budgeting and performance evaluation system, or they may quit trying to achieve any of the organization's standards.

Q22-7.

A standard cost variance is the computed difference between an actual cost number and the related standard cost number. The objective of variance analysis is to identify standard cost variances and to explain the reason(s) for their occurrence.

Q22-8.

A price variance is caused by a difference between the actual price of inputs and the standard price of inputs. A quantity variance is caused by a difference between the actual quantity of inputs used and the allowed quantity of inputs.

Q22-9.

1. Possible causes for favorable materials price variances are: a. Quantity discounts b. Bargain purchases c. Purchasing from a distressed seller d. Purchasing lower quality materials than required 2. Possible causes for unfavorable materials price variances are: a. Last minute or rush purchases b. Purchasing higher quality materials than required c. Vendors on strike, making sources scarce d. Unexpected rises in inflation, driving up prices of goods 3. Possible causes for favorable materials quantity variances are: a. Higher machine efficiency than anticipated b. Higher worker efficiency than anticipated c. Higher quality of materials than anticipated d. Improved processing procedures 4. Possible causes for unfavorable materials quantity variances are: a. Lower machine efficiency than anticipated b. Lower worker efficiency than anticipated c. Lower quality of materials than anticipated d. Poor working conditions due to unexpected causes (i.e., weather) e. New workers without proper training or experience f. New products or procedures that workers are not use to

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q22-10.

Standard labor time is determined by evaluating how long it takes an employee to perform an activity. It can be determined by either the engineering or empirical observation approach. The first is the use of time and motion studies to evaluate how long it takes to perform an activity. The second is the use of long-run observations while operating under normal conditions. The average of the long-run observations is used to set the standard time.

Q22-11.

When a new labor contract is negotiated, the standards should be adjusted accordingly. Otherwise, the managers will be held responsible for actual labor cost charges for which they have no control.

Q22-12.

The revenue variance is the difference between budgeted sales and actual sales. The sales price variance is the difference between the budgeted sales price and the actual sales price times the actual sales volume.

Q22-13.

The net sales volume variance is computed as the difference between the actual and the budgeted sales volumes times the budgeted unit contribution margin. It is also equal to the sales volume variance less the differential standard costs. Its components are the actual sales volume, the budgeted sales volume, and the budgeted unit contribution margin.

Q22-14.

The actual costs are simply the total actual costs of all the items that make up the overhead category. The standard cost of actual inputs is found by multiplying the actual overhead base activity level by the standard cost of each unit of activity (cost driver).

Q22-15.

The net sales volume variance measures the expected variance from budgeted contribution margin caused by a variance in sales volume from the budgeted sales volume. The net sales volume variance is used in evaluating the performance of the sales department in a company when the department is treated as a profit center.

22-3

MINI EXERCISES M22-16. a. The performance report inappropriately compares the actual costs of manufacturing 50,000 units with the budgeted costs of manufacturing 46,000 units. The result is a series of unfavorable variances for variable manufacturing costs. The actual variable costs of manufacturing 50,000 units are expected to exceed the budgeted variable costs for 46,000 units. This is because variable costs change in proportion to changes in volume. b. A comparison should be made between the actual costs of manufacturing 50,000 units and the costs allowed in a flexible budget drawn up for this level of activity. Prior to developing such a budget, the standard variable costs per unit must be determined. Budget $124,200 105,800 69,000

Direct materials Direct labor Variable overhead

÷ ÷ ÷

Units 46,000 46,000 46,000

= = =

Standard Variable Costs $2.70 2.30 1.50

NOWWHAT COMPANY Production Department Performance Report For the Month of January Flexible Budget Formula Volume Manufacturing costs: Direct materials Direct labor Variable overhead Fixed overhead Total

$2.70/unit 2.30/unit 1.50/unit 252,000

Actual 50,000

Flexible Budget 50,000

$130,500 118,000 72,000 252,000 $572,500

$135,000 115,000 75,000 250,000 $575,000

Flexible Budget Variance

$4,500 3,000 3,000 2,000 $2,500

F U F U F

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M22-17. Materials price variance

= = = =

AQ used (AP − SP) 17,500 lbs. × ($4.25 − $4.00) 17,500 lbs. × $0.25 $4,375 U

Materials quantity variance

= = = =

SP × (AQ used − SQ) $4.00 × [17,500 − (6,000 × 3)] $4.00 × (17,500 − 18,000) $2,000 F

M22-18. a. Standard quantity allowed × Standard price = Flexible budget 18,000 oz* x $12 = $216,000.00 *(3 oz. x 6,000 units)

b. Actual quantity x Actual price = Actual cost 17,750 oz. x $12.25 = $217,437.50 Difference between (a) and (b) = $1,437.50 U Total materials variance c. Materials price variance

= = = =

AQ (AP - SP) 17,750 x ($12.25 − $12.00) 17,750 x $0.25 $4,437.50 U

d. Materials quantity variance

= = = =

SP (AQ − SQ) $12.00 x (17,750 oz. − 18,000 oz.) $12.00 x 250 oz. $3,000.00 F

Total materials variance = $4,437.50 U + $3,000.00 F = $1,437.50 U

22-5

M22-19. a. Actual cost of labor inputs (given) Standard cost of actual inputs (64,000 hours × $20.00) Labor rate variance

$1,248,000 (1,280,000) $ 32,000 F

b. Standard cost of actual inputs (above) Flexible budget cost (250,000 × 1/4 × $20.00) Labor efficiency variance

$1,280,000 (1,250,000) $ 30,000 U

c. Total actual direct labor cost Total std. direct labor cost (250,000 units × 1/4 × $20.00) Total flexible budget labor variance

$1,248,000 (1,250,000) $ 2,000 F

M22-20. Management's conclusion may not be correct. We do not know the actual level of production. If it is not the same as the level called for in the master budget, there is a labor variance. For purposes of performance evaluation, a flexible budget (adjusted to the actual level of production) should be used. Even if actual and budgeted production are equal, there may be offsetting labor rate and efficiency variances.

M22-21. a. Actual variable overhead cost Standard variable overhead costs for actual machine hours [($4,972,500/585,000) × 575,000] Variable overhead spending variance b. Standard variable overhead costs for actual machine hours (from above) Standard allowed (given) Variable overhead efficiency variance

$5,002,500 (4,887,500) $ 115,000

$4,887,500 (4,972,500) $ 85,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

M22-22. Revenue variance

= = =

(AQ × AP) − (BQ × BP) (650 × $38) − (600 × $40) $700 F

Sales price variance

= = =

(AP − BP) × AQ ($38 − $40) × 650 $1,300 U

Sales volume variance

= = =

(AQ − BQ) × BP (650 − 600) × $40 $2,000 F

M22-23. a. Actual fixed overhead cost Budgeted fixed overhead cost Fixed overhead budget variance

$10,115,000 (9,900,000) $ 215,000 U

b. Fixed overhead rate = $9,900,000/6,000,000 = $1.65/ barrel Budgeted fixed overhead cost Applied fixed overhead (5,950,000 × $1.65/ barrel) Volume variance

$9,900,000 (9,817,500) $ 82,500 U

M22-24. BLACK SUPPLY COMPANY Reconciliation of Budgeted and Actual Contribution Income For the month of November Budgeted income $35,000 Sales department variances: Sales price variance $13,000 U Net sales volume variance 6,000 F Variable expenses 2,600 U Fixed expenses 500 F 9,100 U Administration department variances 2,000 F Production department variances 11,500 F Actual income $39,400 Note: The important point is to leave out the sales volume variance and to properly consider the impact of favorable and unfavorable variances on income. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 22

22-7

EXERCISES E22-25. Rate per Unit Direct materials Direct labor Variable overhead Fixed overhead Total

a. $4.00 d. $1.50 $2.00

5,000 $20,000 e. 7,500 g. 10,000 j. 65,000 m. $102,500

Units 7,500 b. $30,000 11,250 h. 15,000 k. 65,000 n. $121,250

10,000 c. $40,000 f. 15,000 i. 20,000 l. 65,000 $140,000

Fixed overhead is the most difficult item to determine. It is determined after computing the total of all variable cost items for 10,000 units and subtracting that amount from $140,000.

E22-26.

Actual Standard hours/unit Actual hours (total) Standard rate/hour Actual rate Flexible budget Labor rate or variable overhead spending variance Efficiency variances Total flexible budget variance

a. b.

c. d. e.

Direct Labor $306,000 0.50 12,000 $25.00 25.50 $312,500 $6,000 U $12,500 F $6,500 F

Variable Overhead f. $192,500 b. 0.50 12,000 $15.00 $187,500 g. h.

$12,500 U $7,500 F $5,000 U

a. Actual direct labor = 12,000 AH × $25.50 AR = $306,000 b. Standard hours per unit is the most difficult computation in the exercise: 25,000 units × SH × $25 = $312,500 25,000 × SH × $15 = $187,500 or SH = $312,500/(25,000 × $25) = 0.50 SH = $187,500/(25,000 × $15) = 0.50 c. Labor rate variance = ($25.50 - $25.00) × 12,000 = $6,000 U d. Labor eff. variance = $25.00 × [12,000 AH – (25,000 × 0.50)SH] = $12,500 F e. $6,000 U - $12,500 F or $306,000 - $312,500 = $6,500 F f.

$187,500 flexible budget + $5,000 U total flexible budget variance = $192,500

g. Variable overhead spending variance = $192,500 – (12,000 × $15) = $12,500 U h. Variable overhead efficiency variance = $15 × [12,000 - (25,000× 0.50)] = $7,500 F ©Cambridge Business Publishers, 2021 22-8

Financial & Managerial Accounting for Decision Makers, 4th Edition

E22-27. 1.

a and g

e (some students may argue for efficiency also)

a, d, e, and f

c and d and possibly b if there’s more material spoilage with inexperienced workers

b, d, and f and possibly g over the long run

10. c Note: Be careful not to let the students include every variance for each situation. Try to get them to see the more direct relationships rather than every possibility.

E22-28. Revenue variance

= = = =

(AQ × AP) − (BQ × BP) (525,000 × $50) − (500,000 × $100) $26,250,000 – $50,000,000 $23,750,000 U

Sales price variance

= = =

(AP − BP) × AQ ($50 − $100) × 525,000 $26,250,000 U

Sales volume variance

= = =

(AQ − BQ) × BP (525,000 − 500,000) × $100 $2,500,000 F

Net sales volume variance

= = =

(AQ – BQ) × BCM (525,000 – 500,000) × ($100 - $35) $1,625,000 F

22-9

E22-29. a. Actual fixed overhead cost Budgeted fixed overhead cost Fixed overhead budget variance

$122,000 (125,000) $ 3,000 F

b. Budgeted fixed overhead cost Fixed overhead cost applies based on produced ($125,000/25,000 × 24,000 units) Fixed overhead volume variance

$125,000 (120,000) $ 5,000 U

c. No, the budget variance was not related to operating below the normal operating level. As long as the operating level is within the relevant range, variations in activity should have no effect on fixed costs. The budget variance resulted from spending factors such as paying less than expected for fixed-cost items or purchasing a smaller quantity of fixed-cost items. d. The volume variance resulted from the company operating at an output level different from the normal, or budgeted, level. At a budgeted level of output of 25,000 units, the standard fixed overhead cost per unit is $5.00 ($125,000/25,000). Because 24,000 units were produced, $5,000 of fixed costs for 1,000 fewer units than budgeted was applied to the production department. The volume variance is useful to management to provide an easy measure of the volume of activity for the period relative to the normal volume.

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P22-30. CASE PRODUCTS Manufacturing Activities Performance Report For the Month of July Flexible Budget Formula Volume: Regular Deluxe Variable costs: Direct materials: Lumber: Regular Deluxe Assembly kits: Regular Deluxe Total Direct labor: Regular Deluxe Total Variable overhead: Regular Deluxe Total Fixed overhead Total

Actual

Flexible Budget

8,000 3,500

Flexible Budget Variance

$36.00/unit 60.00/unit

$288,000 210,000

5.00/unit 5.00/unit $ 561,300

40,000 17,500 555,500

5,800 U

130,800

80,000 52,500 132,500

1,700 F

34,625 48,150 $774,875

20,000 13,125 33,125 46,000 $767,125

1,500 U 2,150 U $7,750 U

10.00/unit 15.00/unit

2.50/unit 3.75/unit

22-11

P22-31. a. Material A variances:

AQ AP

Actual Cost 6,430 × $7.80 $50,154

Standard Cost of Actual Inputs AQ 6,430 SP × $8 $51,440

Materials price variance $1,286 F

Flexible Budget Cost SQ (2,000×3) 6,000 SP × $8 $48,000

Materials quantity variance $3,440 U

Total Material A price variance $2,154 U

Material B variances:

AQ AP

Actual Cost 3,950 × $4.50 $17,775

Standard Cost of Actual Inputs AQ 3,950 SP × $4 $15,800

Materials price variance $1,975 U

Flexible Budget Cost SQ (2,000×2) 4,000 SP × $4 $16,000

Materials quantity variance $200 F

Total Material B price variance $1,775 U

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. Labor variances: AH AR

Actual Cost 4,100 × $15.50 $63,550

Standard Cost of Actual Inputs AH 4,100 SR × $15 $61,500

Labor rate variance $2,050 U

Flexible Budget Cost SH (2,000×2 hrs.) 4,000 SR × $15 $60,000

Labor efficiency variance $1,500 U

Total labor variance $3,550 U

P22-32. a. Materials price variance (usage basis)

= = = =

AQ × (AP − SP) 4,850 yds. × ($14.50 − $15.00) 4,850 yds. × $0.50 $2,425 F

Materials price variance (purchase basis)

= = = =

AQ × (AP − SP) 6,500 yds. × ($14.50 − $15.00) 6,500 yds. × $0.50 $3,250 F

Materials quantity variance

SP × (AQ - SQ) = $15.00 × (4,850 − 4,800*) = $15.00 × 50 = $750 U

or Purchase basis not introduced in text:

*SQ = 1,200 tents × 4 yards per tent = 4,800

Labor rate variance

= = = =

AH × (AR − SR) 1,850 × ($19.50 − $20.00) 1,850 × $0.50 $925 F

Labor efficiency variance

= = = =

SR × (AH − SH) $20 × (1,850 − 1,800*) $20 × 50 $1,000 U

22-13

b. Direct materials price variance: Buying in larger quantities, resulting in discounts; buying lower quality goods than standard; using competitive bids. Direct materials quantity variance: Inefficient workers on machines; old, inefficient machines; inferior raw materials. Labor rate variance: Lower paid workers than in budget, using different skilled workers than in budget. Labor efficiency variance: Unskilled workers, using inferior quality materials, new workers. Note: A possible explanation for any of the variances could be incorrect standards. c.

Direct materials Direct labor Total standard variable cost for 1,200 tents

Standard Cost per Unit $60 30*

× ×

Units Produced 1,200 1,200

Total Standard Cost = $ 72,000 = 36,000 $108,000

*(1.5 hours × $20)

Financial & Managerial Accounting for Decision Makers, 4th Edition

P22-33. a. Actual Cost $4.51

Direct materials ($2,255/500 bags) (10,000 lbs. / 500 bags × $0.25) Direct labor ($231/500 bags) (16 hrs. / 500 bags × $15.00) Variable overhead ($215 / 500 bags) (10 hrs. / 500 bags × $20.00) Total variable costs per bag

$5.00 0.462 0.48 0.43 ______ $5.402 = = = =

Actual cost − (AQ × SP) $2,255 − (10,250 × $0.25) $2,255 − $2,562.50 $307.50 F

Materials quantity variance

= = = =

SP × (AQ − SQ) $0.25 × (10,250 − 10,000) $0.25 × 250 $62.50 U

Labor rate variance

= = = =

Actual costs − (AH × SR) $231 − (15 × $15) $231 − $225 $6 U

Labor efficiency variance

= = =

SR × (AH − SH) $15 × (15 − 16) $15 F

Variable overhead spending variance

= = = =

Actual cost − (AH × SR) $215 − (9.5 hrs. × $20) $215 − $190 $25 U

Variable overhead efficiency variance

= = =

SR × (AH − SH) $20 × (9.5 − 10) $10 F

b. Materials price variance

Standard Cost

0.40 $5.88

22-15

c. Materials price variance: materials quality below standard, purchased in larger than standard quantities, bargain purchases. Materials quantity variance: material quality below standard, higher than normal waste, lower-skilled labor, inefficient machinery. Labor rate variance: use of higher-skilled workers, rate changes not reflected in standards. Labor efficiency variance: use of high-quality materials, higher machine efficiency, higher worker efficiency. Variable overhead spending variance: excessive prices paid for variable overhead items and/or excessive consumption of variable overhead items. Variable overhead efficiency variance: efficient machinery resulting from recent maintenance or more efficient use of machinery by workers. Note: A possible explanation for any of the variances could be incorrect standards.

P22-34. a. Standard cost per unit

= =

(Standard cost allowed for units produced) / units $9,600 / 1,000 = $9.60

Standard number of pounds per unit

= =

(Standard materials cost per unit) (Standard materials cost per pound) $9.60 / $3.20 = 3 pounds

b. Actual quantity in units

= = =

Standard quantity + Quantity variance in units (1,000 × 3) + ($704/$3.2) 3,000 + 220 = 3,220 pounds

c. Materials price variance

= = =

Actual cost − Standard cost of actual quantity $10,626 − ($3.20 × 3,220) $10,626 − $10,304 = $322 U

Financial & Managerial Accounting for Decision Makers, 4th Edition

d. Total standard labor cost allowed (1,000 units × 2.5 hrs. × $12.00) Less: Favorable labor efficiency variance Total standard cost of actual hours Actual hours

= =

(Total standard cost of actual hours) / (Standard cost per hour) $29,856 / $12 = 2,488 hours

Total actual cost

= =

Actual hours × Actual rate per hour 2,488 × $12.25 = $30,478

e. Labor rate variance

$30,000 144 $29,856

= =

Total actual cost −Total standard cost of actual hours $30,478 − $29,856 = $622 U

Because variable overhead is based on direct labor hours, the standard number of hours of variable overhead is 2.5, the same as the standard labor hours per unit.

g. VOH spending variance

h. Var. overhead eff. variance

= = =

Actual cost − Standard cost for actual hrs. $10,600 − ($4 ×2,488) $10,600 − $9,952 = $648 U = = = =

Standard cost × (Actual hours − Standard hours) $4 × [2,488 − (1,000 units × 2.5 hrs.)] $4 × (2,488 − 2,500) $4 × 12 = $48 F

P22-35. a. Account Shower Supplies ($0.50 × 4 bottles × 8,000 room nights) Towels ($4.00 × 1 × 8,000 room nights) Laundry ($0.25 × 8 lbs. × 8,000 room nights) Labor ($15 × 0.75 hours × 8,000 room nights) Variable overhead ($3 × 0.75 labor hours × 8,000 room nights) Fixed overhead ($10 × 8,000 room nights) Total

Actual

Budget

Variance

$ 14,620 32,121 20,898 91,504

$ 16,000 32,000 16,000 90,000

$1,380 F 121 U 4,898 U 1,504 U

19,565 82,000 $260,708

18,000 80,000 $252,000

1,565 U 2,000 U $8,708 U

22-17

b. The cost center performance report presented to Kathy is not useful in evaluating the performance of housekeeping. Most housekeeping costs vary with room nights. Because actual room nights exceeded budgeted room nights by 600 units, the budget should have been adjusted to the actual, higher level of activity. The many unfavorable variances are the expected result of basing the performance report on too low a level of activity. c. Flexible Budget

Account Actual Shower Supplies ($0.50 × 4 bottles × 8,600 room nights) $ 14,620 $ 17,200 Towels ($4.00 × 1 × 8,600 room nights) 32,121 34,400 Laundry ($0.25 × 8 lbs. × 8,600 room nights) 20,898 17,200 Labor ($15 × 0.75 hrs. × 8,600 room nights) 91,504 96,750 Variable overhead ($3 × 0.75 labor hrs. × 8,600 room nights) 19,565 19,350 Fixed overhead* 82,000 80,000 Total $260,708 $264,900

Total Variance

Price/Rate/ Quantity/ Spending Efficiency Variance† Variance‡

$ 2,580 F

$ 3,655 F $ 1,075 U

2,279 F

1,161 U

3,440 F

3,698 U

3,483 U

215 U

5,246 F

1,204 U

6,450 F

215 U 2,000 U $4,192 F

1,505 U

1,290 F

*The fixed overhead rate of $10 was based on 8,000 room nights. Hence, the fixed overhead is $80,000. †Actual cost minus (actual inputs × standard price or rate) Shower supplies = 36,550 × $0.50 = $18,275 Towels = 7,740 × $4.00 = $30,960 Laundry = 69,660 × $0.25 = $17,415 Labor = 6,020 × $15 = $90,300 Variable overhead = 6,020 × $3 = $18,060 ‡(actual inputs × standard price or rate) minus Flexible budget

d. From the perspective of financial performance, housekeeping exceeded expectations with net favorable variances of $4,192. Particularly noteworthy is the favorable variance for labor efficiency, which suggest employees worked faster than normal to complete housekeeping activities on time, and the favorable quantity variance for towels, which indicates fewer new towels were placed into service than anticipated. Hopefully that variance reflects towels holding up better rather than a reuse of poor quality towels. e. Management might also want to consider non-financial performance measures such as: the number and type of complaints from guests, the availability of rooms on a timely basis, and the quality of housekeeping for things such as neatness, cleanliness, and so forth. These qualify factors might be measured by periodic inspections by the hotel manager or someone appointed by the manager. ©Cambridge Business Publishers, 2021 22-18

Financial & Managerial Accounting for Decision Makers, 4th Edition

P22-36. a. Units completed Equivalent units in ending inventory Equivalent units of production

Materials 2,000 250 a 2,250

Conversion 2,000 125 b 2,125

a 500 units × 0.50 complete b 500 units × 0.25 complete b. EVANSTON COMPANY Performance Report For the Month of July

Direct materials (2,250 × 3 sq. meters × $12.00) Direct labor (2,125 × 2 hr. × $22) Manufacturing overhead [$80,450 + (2,125 × 2 hr. × $5.00)] Total

Actual $ 80,525

Flexible Budget

Variance

$ 81,000

$ 475 F

93,500

1,750 U

101,700 $276,200

535 F $ 740 U

95,250 101,165 _______ $276,940

c. Separate production cost information is not available for the variable and fixed elements of overhead. Hence, the overhead variance combined both of these elements. With two or more past observations it is possible to estimate the fixed and variable elements of overhead. It may not be possible to separately identify the fixed and variable overhead components for a single period. This problem illustrates such a situation.

22-19

P22-37. 1. Increase in labor rate Total hours worked Effect on labor rate variance

$2.00 × 175 $350 U

2. Increase in price ($125 × 0.10) Number of components purchased per month Effect on materials price variance Decrease in bad units Standard price Effect on materials quantity variance 3. Increased labor rate Number of hours paid Effect on labor rate variance

$12.50 × 1,200 $15,000 U 50 × $125 $6,250

$2.15 × 360 $ 774 U

Hours of inefficiency (12*/36 × 360) Standard labor rate Effect on labor efficiency variance

120 × $11.00 $ 1,320 U

*36 - 24 = 12

Or: Allowed hours = 360 actual hours × (24/36) units = 240 Labor eff. var. = $11 × (360 actual hours − 240 allowed hrs.) = 4. Excess rate paid ($0.60 -$0.40) Number of bundles inspected [(2,100 – 1,500) / $0.60] Effect on variable overhead spending variance Budgeted base salary Actual base salary Effect on fixed overhead budget variance

$1,320 U $0.20 × 1,000 $ 200 U $2,000 (1,500) $500 F

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5. Number of units purchased Price savings per unit Effect on materials price variance Number of defective units [5,000 × (3 times x 0.06)] Normal number of defective units (5,000 × 0.06) Excess defective units Standard price per unit Effect on materials quantity variance Good units produced (5,000 – 900)

5,000 × $20 $100,000

900 (300) 600 × $200 $120,000 U 4,100

Additional labor rate for handling defective units Number of units handled Effect on labor rate variance

$0.50 × 5,000 $ 2,500

Actual hours required to install good units (4,100/16) Std. hours required to install good units (4,100/20) Excess hours required Standard labor rate Effect on labor efficiency variance

256.25 (205.00) 51.25 × $12.00 $615.00 U

Increased use of electricity (hours) Cost of electricity Effect on variable overhead spending variance

25 × $2.00 $50

Excess labor hours required (see above) Variable overhead standard rate per labor hour Effect on variable overhead efficiency variance

51.25 × $6.00 $307.50

P22-38. a. Standard fixed overhead rate = Budgeted fixed cost / Normal activity = $420,000 / 30,000 direct labor hours = $14.00 per direct labor hour b. Fixed overhead assigned = Standard hours allowed × Std. fixed overhead rate = (5,800 units × 5 hours) × $14.00 = 29,000 × $14.00 = $406,000 c. Fixed overhead = Actual fixed overhead − Budgeted fixed overhead = $425,000 − $420,000 = $5,000 U

22-21

P22-39. There are three profit center variances we can compute for Bach-Tunes: a sales price variance, a net sales volume variance, and a variance for operating costs. Sales price variance = ($12.50 − $12.00) × 7,500 = $3,750 F The budgeted contribution margin is $6.25 per album: Budgeted selling price Variable royalty cost Budgeted contribution margin

$12.00 per album (5.75) per album $ 6.25 per album

Net sales volume variance = (7,500 − 8,000) × $6.25 = $3,125 U The operating costs are all fixed, so the only variance for operating costs is the difference between budget and actual. Operating cost variance = $34,700 actual − $35,000 budget = $300 F BACH-TUNES Reconciliation of Budgeted and Actual Contribution For the Month of September Budgeted contribution to corporate costs and profits Sales price variance Net sales volume variance Operating cost variance Actual contribution to corporate costs and profits

$15,000 $3,750 F 3,125 U 300 F

925 F $15,925

The favorable sales price and operating cost variances were more than enough to offset the unfavorable net sales volume variance. The most likely explanation is a significant shift in the mix to higher-priced quality albums.

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P22-40. a. 1. Sales price variance = ($4.50 – $4.25) x 26,000 = 6,500 F Net sales volume variance = [$4.25 – ($0.50 + $0.60)] x (26,000 – 24,000) = $6,300 F 2. Food price variance = $14,820 – (7,800 x $2.00) = $780 F Food quantity variance = [7,800 used – (1/4 x 26,000)] x $2.00 = $2,600 U 3. Labor rate variance = [$19,240 – (1,300 x $15.00)] = $260 F Labor efficiency variance = [1,300 – (26,000 x 1/25)] x $15.00 = $3,900 U b. FALAFEL, INC. - GEORGETOWN Reconciliation of Budgeted and Actual Profit For the Month of April Budgeted profit Sales variances: Sales price variance Net sales volume variance Food variances: Food price variance Food quantity variance Labor variances: Labor rate variance Labor efficiency variance Occupancy variance Actual profit

$68,100 $ 6,500 F 6,300 F

12,800 F

780 F 2,600 U

1,820 U

260 F 3,900 U

3,640 U 300 F $75,740

c. In the original performance report the revenue variance focused entirely on the top line, revenues. In the reconciliation the net sales volume variance is used rather than the gross sales volume variance. By looking at the net profit impact of sales volume, using the budgeted unit contribution margin, rather than the budgeted selling price, the implications of the sales increase are smaller. The input quantities variable cost items in the original performance report were based on a sales volume of 24,000 units rather than the actual sales volume of 26,000 units. As a consequence, the budgeted costs for food and labor were smaller than they should have been. Using the correct flexible budget amounts, the unfavorable food and labor variances are smaller. Because the occupancy costs are all fixed the occupancy cost variance remains the same as in the original performance report.

22-23

P22-41. a. INSTANT COMPUTING Production Performance Report For the Month of October Flexible Budget Formula Volume Manufacturing costs: Direct materials Direct labor Variable overhead Fixed overhead Total

$60/unit $40/unit $20/unit $160,000/mo.

Actual 2,250

Flexible Budget 2,250

$139,500 85,500 43,875 168,000 $436,875

$135,000 90,000 45,000 160,000 $430,000

Flexible Budget Variance

$4,500 U 4,500 F 1,125 F 8,000 U $6,875 U

b. INSTANT COMPUTING Selling and Distribution Performance Report For the Month of October Flexible Budget Formula Volume Selling and Distribution: Variable Fixed Total

$45/unit $75,000/mo.

c. Budgeted selling price Standard variable costs: Direct materials Direct labor Factory overhead Selling Budgeted unit contribution margin

Actual 2,250

Flexible Budget 2,250

$105,750 74,600 $180,350

$101,250 75,000 $176,250

Flexible Budget Variance

$4,500 U 400 F $4,100 U

$400 $60 40 20 45

(165) $235

Sales price variance = ($385 − $400) × 2,250 = $33,750 U Net sales volume variance = (2,250 − 2,000) × $235 = $58,750 F

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d. INSTANT COMPUTING Selling and Distribution Performance Report For the Month of October Sales price variance $33,750 U Net sales volume variance 58,750 F Selling and distribution expense variance 4,100 U Net sales department variance $20,900 F e. Administration variance: $135,000 actual − $125,000 budget = $10,000 U (over budget) f. INSTANT COMPUTING Reconciliation of Budgeted and Actual Net Income For the Month of October Budgeted net income $110,000 Sales Department variances $20,900 F Production Department variances 6,875 U Administration Department variances 10,000 U 4,025 F Actual net income (loss) $114,025

22-25

CASES and PROJECTS C22-42. a. Because there does not appear to be any clearly defined relationship between effort and accomplishment, the Consumer Products Research Department should be classified as a discretionary cost center. Because a relationship between effort and accomplishment is absent, the financial performance of a discretionary cost center cannot be evaluated with the aid of a flexible budget. Indeed, it is difficult to evaluate the financial performance of a discretionary cost center by any means. The best monetary evaluation is based on a comparison of the actual and budgeted costs for a period, identifying the difference as either over-budget or under-budget. b. It is difficult to compare the performance of Lopez and Garcia. Whereas Lopez's efforts may have led to the development and introduction of several important new products, he failed to maintain effective cost control. When it became apparent that CPR was exceeding its budget, Lopez should have taken one of two actions: (1) requested additional funds or (2) notified his superior of the need to reduce activities. Yet, the blame for poor cost control should not be placed only on Lopez. There is no indication of whether the matter of poor cost control was brought to Lopez's attention by upper management before the end of his second year. TruckMax's financial control system should have been set up so that the next level of management became immediately aware of any excess spending in CPR. CPR should have been prevented from spending more than its budget without upper management's approval. If this were done, Lopez may have quickly learned the importance of proper financial controls. Although Garcia did maintain adequate financial controls, it appears that she was too concerned with short-run financial performance. CPR's "favorable" financial performance under Garcia's leadership may have come at a high price if the activities she scaled back were important to the long-run success of the company. Upper management should have inquired how the favorable variances were achieved. This exercise is a classic example of the problem of evaluating the financial performance of discretionary cost centers. It also indicated the need to use nonmonetary performance measures. Such measures would help put the financial performance measures in perspective.

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C22-43. a. The engineers' recommendation is based on the manufacturer's published production specifications. Manufacturers’ estimates of machinery output tend to be unrealistic and reflect output under unusually efficient conditions. Such a standard tends to be extremely difficult to achieve and, thus, generally produces unfavorable variances. A strength of this standard is that it is objectively determined by an outside party. The accounting department's recommendation is based on the minimum materials and labor usages observed over the last period. This standard meets the desired objective of achievement; however, because each element was achieved only once in eight observations, managers may actually perceive it as not achievable and, thus, may not be motivated by the standard. It should be observed that the recommended standards for materials and labor were not achieved at the same time. There may be an inherent conflict in the two standards. The production supervisors' recommendation is from the standpoint of cost control. An average of past performance is a poor standard if it is unduly influenced by occasional extremes (highs or lows). A better approach is to eliminate the extreme observations and then to use the remaining observations as a basis for developing the standards. The production workers' recommendation is from the standpoint of motivation. This may be the most realistic recommendation. The workers are likely to accept it as being realistic and achievable with reasonable effort. However, it is likely that the workers' recommendation incorporates slack, making it easy to achieve favorable performance reports. b. The engineers' recommendation should produce the greatest amount of cost control because it has the tightest standard and requires explanation of more unfavorable variances. However, it may focus too much attention on costs that are difficult to reduce. The workers' recommendation is likely to be accepted more readily by the workers as equitable. Therefore, the workers are likely to be motivated to achieve this standard. An empirically derived standard from past observation with abnormal observations deleted from the analysis is probably the best alternative. This, in conjunction with a continuous improvement costing model (Kaizen), should begin to provide long-term benefits for the company.

22-27

C22-44. This problem illustrates many of the practical complexities–and even the political aspects−of using standard cost performance evaluation systems. To some extent, the views of the plant, accounting, and personnel managers are all correct. The plant manager's argument is valid with regard to its insistence on realistic standards. Standards that reflect unrealistic, ideal conditions generally have a demoralizing effect on workers. The argument that standards should be based on past averages is not as defensible. Such an approach may lead to mediocre performance if prior performance did not reflect a reasonably high level of efficiency. The controller's observations have merit, but the approach requires a high level of communication so that workers will know that variances will always require some adjustment factor to determine the real variance for a given manager. This method of standard setting always sets a very high standard for managers to aim for but accepts as reasonable some amount of unfavorable variances. To be successful, this approach requires a sophisticated team of managers who understand its nuances and complexities. The human resources director's point is well taken. Normally, to provide maximum positive motivation to managers, standards should be regarded as challenging but achievable with reasonable effort. As the human resources director suggests, properly established standards, which are understood by managers, can be a powerful and positive influence on the behavior of managers. Recommendation: If Merit Inc. is going to realize more positive performance and behavioral results from its standard cost performance evaluation system, it should evaluate and revise the standards so that they will represent reasonably achievable goals of performance, which will lead to favorable variances when performance is acceptable and to unfavorable variances when performance is unacceptable. Upper management should reinforce the reporting system by providing appropriate feedback to managers based on the nature of the variances. This may take the form of a bonus or other reward for favorable variances or some sort of penalty (or withholding of a bonus) for unfavorable variances.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C22-45. a. The performance report is used to evaluate three departments: Production, Sales, and Administration. In each case, the original static budget is compared to the actual results. This comparison is appropriate for the Administration Department; it contains only fixed costs. However, such a comparison is inappropriate for Production, which should be evaluated as a standard cost center. The Production Department produced 9,000 units. Its performance should be evaluated with the aid of a flexible budget drawn up for this level of activity. Also, the Sales Department appears to be evaluated as a revenue center, but it is not assigned a responsibility for the standard variable costs associated with the higher-than-budgeted sales volume. It is likely that the Sales Department's performance would be less favorable if these costs were assigned to it. b. The Production Department should be evaluated with the aid of a flexible budget drawn up for the actual level of activity. Prior to developing a flexible budget, we must determine the standard variable manufacturing cost per unit. Budgeted manufacturing costs for 7,500 units Less budgeted fixed manufacturing overhead Budgeted variable manufacturing costs for 5,000 units Budgeted volume Standard variable manufacturing costs per unit

$242,500 (160,000) $ 82,500 ÷ 7,500 $ 11

We can now evaluate the performance of the Production Department by comparing the actual and the allowed manufacturing costs. Actual manufacturing costs Allowed in a flexible budget: Variable ($11 × 9,000) Fixed Production department variances

$254,200 $ 99,000 160,000

(259,000) $ 4,800 F

It appears that Mr. Chandler and the Production Department did a good job.

Continued

22-29

b. continued Administration Department: The Administration Department's variances are correctly computed in the performance report to be $4,785 U, or over budget. Sales Department: The Sales Department's operating costs are all fixed. Consequently, they are correctly classified in the budget as $2,750 U. To compute the sales price variance, the budgeted and the actual unit selling price must be determined: Budgeted selling price: $450,000/7,500 = $60 unit Actual selling price: $526,500/9,000 = $58.50 unit Sales price variance = ($58.50 − $60) × 9,000 = $13,500 U Net sales volume variance = (9,000 − 7,500) × ($60 − $11) = $73,500 F Summarizing the sales department's performance: Sales price variance Net sales volume variance Sales expense variances Sales department variances

$13,500 U 73,500 F 2,750 U $57,250 F

Reconciliation: DICKENS COMPANY LIMITED Reconciliation of Budgeted and Actual Net Income For the Year Budgeted net income $107,500 Production department variances $ 4,800 F Administration department variances 4,785 U Sales department variances 57,250 F 57,265 F Actual net income $164,765

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 23 Segment Reporting, Transfer Pricing, and Balanced Scorecard QUESTIONS Q23-1.

Segment reports are income statements that show operating results for portions or segments of a business, while product reports are only for product lines of the business. Product reports are a type of segment reports.

Q23-2.

A reporting objective is an identified segment of a business that management has defined as precisely as possible so that only related revenues and expenses are assigned to it for reporting purposes.

Q23-3.

If a company wants to evaluate its operations from different perspectives, it may have more than one first-level set of statements. For example, it may want its product lines segregated as first-level segments and also its divisions segregated as first-level segments. Both first-level segment statements may have other defined segments as second-level segment statements.

Q23-4.

A first-level segment statement is the primary reporting of operations within the company (an example being territories). A second-level segment statement is a means of further defining a first-level statement. If territories are first-level statements, each one of them can be further divided into second-level statements with characteristics such as product lines, sales personnel, or type of customers (wholesale, retail, etc.).

Q23-5.

Direct segment costs are often defined negatively as the costs that would not be incurred if the segment being evaluated were discontinued. Common, or indirect, segment costs are related to more than one segment, and all or some of these costs would remain if the segment were discontinued. Indirect segment costs, also referred to as common segment costs, are related to more than one segment and are not directly traceable to a particular segment.

23-1

Q23-6.

Management needs segment reports about the product or characteristic under consideration, a correct defining of direct and indirect costs of the segment, and an evaluation of the importance of the segment to the overall operations of the business.

Q23-7.

Transfer prices are normally used in decentralized operations when products or services are exchanged between divisions to determine whether organizational objectives are being achieved in each division regarding costs and profits.

Q23-8.

Transfer pricing problems include: the selling division wanting the highest possible price and the buying division wanting the lowest possible price; suboptimization when prices are set that are not in the best interest of the overall organization; transfers where there are no external markets for comparison; and conflicts between managers that may interfere with other decision-making activities, thereby causing further conflicts.

Q23-9.

Suboptimization occurs when the parts of an organization maximize their own performance measures even if it is to the detriment of the entire organization. It can be minimized by proper training and goal setting within the organization. The reward system also influences the amount of suboptimization that takes place. It usually cannot be eliminated because individual managers tend to be self-survivors and, in doing so, tend to always help themselves first and the company second.

Q23-10.

ROI measures the earnings of an investment and is used to evaluate the utilization of the resources, the effectiveness and efficiency of the managers in control of the resources, and comparisons of investments both within the organization and with other organizations. This measure is often preferred over net income because net income does not take into consideration the amount of resources used to generate the income.

Q23-11.

Advantages of residual income and economic value added over return on investment include: 1. Encourages managers to make profitable investments above the minimum rate of return, even when they are below the current ROI level. 2. Results are measured in dollars rather than percentages.

Q23-12.

Residual income is the excess of investment center income over the minimum rate of return set by top management, whereas EVA uses the organization’s weighted average cost of capital, net assets, and after-tax income.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Q23-13.

The balanced scorecard helps with the evaluation process by including multiple categories to be evaluated, the most common of which are financial, customers, employees, productivity, and growth and innovation.

Q23-14.

By structuring the balanced scorecard around the company’s strategic goals, it measures how well managers are performing in terms of the company’s strategic goals. The balance scorecard will always include basic financial performance measures, but it should also score performance on key strategic objectives.

23-3

MINI EXERCISES M23-15. a. A single-level segment report might show the total income statement broken down into the four different lines of computer devices. Another possibility would be to segment the total income statement broken down by the company’s three plants. Still another possibility is to show the total income statement broken down by the five regions. b. Note: Several schematics are possible and two examples are provided. Scheme 1 First-level Second-level Third-level

Product lines Sales region Plant location

Product line is chosen as the first level because this is the most important reporting aspect to top management. This is often used when the products are highly competitive and each one needs careful monitoring. Scheme 2 First-level Second-level Third-level

Sales region Product line Plant location

Sales region is chosen to emphasize the need for different regions to compete against each other. This is especially beneficial when the regions have about the same potential sales levels.

Financial & Managerial Accounting for Decision Makers, 4th Edition

M23-16. PENTEL OF AMERICA, LTD. Territory and Company Income Statements For the Month of September

Sales: Pens Pencils Total sales Variable costs: Pens (27/60 × sales dollars) Pencils (27/60 × sales dollars) Total Contribution margin Direct fixed expenses Territory margin Common fixed expenses: Pens Pencils Home office Total Net income

West

East

Company Totals

$35,000 20,000 55,000

$25,000 40,000 65,000

$ 60,000 60,000 120,000

15,750 9,000 (24,750) 30,250 (5,500) $24,750

11,250 18,000 (29,250) 35,750 (6,500) $29,250

27,000 27,000 (54,000) 66,000 (12,000) 54,000 16,000 14,000 3,500 (33,500) $ 20,500

23-5

M23-17. FRANCISCO CONSULTING FIRM Product and Company Income Statements For the Month of July Nursing Hospitals Physicians Care Variable cost as a percent of sales* 0.75 0.65 0.70 Sales $340,000 $205,000 $275,000 Variable costs (255,000) (133,250) (192,500) Contribution margin 85,000 71,750 82,500 Direct fixed expenses (36,500) (8,500) (18,750) Product margin 48,500 63,250 63,750 Less allocated common costs (8,500) (2,500) (4,000) Product income $ 40,000 $ 60,750 $ 59,750 Less unallocated common expenses: Selling and administrative Service** Total Net income

Company Totals $820,000 (580,750) 239,250 (63,750) 175,500 (15,000) 160,500 70,400 6,850 (77,250) $83,250

* Variable Cost as percent of Sales =100%-CM% ** Fixed Service expenses less direct allocations $85,600 – ($36,500 + $8,500 + $18,750) – ($8,500 + $2,500 + $4,000) = $6,850

M23-18. a. Variable cost per wheel: Direct materials Direct labor Variable overhead Total Offer from Van Division Variable cost per wheel Contribution margin

$20 12 8 $40 $80 (40) $ 40

Since the Wheel Division is not at capacity, it should sell the Van Division up to 80,000 wheels at $80 each. This will increase the Wheel Division's total profits by $40 for each wheel transferred. b. The internal sale would be beneficial because the internal variable manufacturing costs of $40 per wheel are less than the external price paid by the Van Division of $95. However, caution should be taken as the internal sales force total production nears the 400,000 level. The company probably will not want the Wheel Division to give up any outside sales at $100. ©Cambridge Business Publishers, 2021 23-6

Financial & Managerial Accounting for Decision Makers, 4th Edition

M23-19. The proposal should be accepted because it makes a contribution to fixed costs and profits of $25,000 [10,000 ($ 5.50− $3.00)]. As shown in the following optional analysis, spreading the fixed costs over more units results in the current products becoming even more profitable ($5.00 versus $4.50). Karakomi Cameras Inc. Disposables Division Unit Margins Current Sales Sales (40,000 units) Variable costs Contribution margin Fixed costs: ($100,000/40,000) Net income

Per Unit $10.00 (3.00) 7.00

Total $400,000 (120,000) 280,000

(2.50) $ 4.50

(100,000) $180,000

New Sales Proposed Sales Sales Variable costs Contribution margin Fixed costs: ($100,000/50,000) Net income

Current Sales Adjusted $10.00 (3.00) 7.00

Per Unit $5.50 (3.00) 2.50

(2.00) $ 5.00

(2.00) $(0.50)

Total $55,000 (30,000) $ 25,000

Grand Total $455,000 (150,000) 305,000 (100,000) $205,000

23-7

M23-20. a. No.

Selling price Variable costs Unit contribution margin Unit sales Contribution margin

Current Sales $44 (30) $14  150,000 $2,100,000

Proposed Sales $20 (30) $ (10)  50,000 $(500,000)

Currently, the division is making $450,000 on 150,000 prints ($2,100,000 − $1,650,000 fixed costs); but under the proposal, with a $500,000 negative contribution, it would revert to an overall loss: Current contribution margin Fixed costs Loss on special order Net income

$2,100,000 $1,650,000 500,000

(2,150,000) $ (50,000)

As a general rule, a project should never be undertaken if the contribution margin is negative. b. What the Retail Division does with the prints after receiving them is of no concern to the Print Division. Hence, the Print Division would still object to a transfer price of $20. However, for the company, the proposal does have a contribution of $5 per unit ($40 − $30 − $5). Consequently, the order is desirable from the viewpoint of the company. c. If the company believes in autonomous divisions, it should not require the Print Division to sell, nor should it dictate a higher transfer price. On the other hand, the company may want to create incentives to encourage (but not require) the two division managers to reach some compromise transfer price that would increase the contribution and profits of both divisions.

Financial & Managerial Accounting for Decision Makers, 4th Edition

M23-21. a. Return on investment = $805,000/$3,500,000 = 0.23 b. Residual income: Net income Minimum level ($3,500,000  0.20) Residual income

$805,000 (700,000) $105,000

c. 1. ROI = ($805,000 + $165,000) / ($3,500,000 + 800,000) = 0.226 2. Residual income: Net income ($805,000 + $165.000) Minimum level ($3,500,000 + $800,000)  0.20 Residual income

$970,000 (860,000) $110,000

M23-22. Eastern Division: ROI = Return-on-sales ratio  Investment turnover 0.20 = 0.05  Investment turnover Investment turnover = 4 Return-on-sales ratio = Income / Sales 0.05 = $250,000 / Sales Sales = $5,000,000 Investment turnover = Sales / Operating assets 4 = $5,000,000 / Operating assets Operating assets = $1,250,000 Western Division: Return-on-sales ratio

= =

$600,000 / $8,000,000 0.075

Investment turnover = Return on investment / Return-on-sales ratio = 0.15 / 0.075 = 2.0 Operating assets

Solutions Manual, Chapter 23

23-9

Southern Division: Sales = Investment turnover  Operating assets = 6  $3,000,000 = $18,000,000 ROI

= = =

Return-on-sales ratio  Investment turnover 0.06  6 0.36

M23-23. a. Financial performance indicators: 1. Income/loss per member per year 2. Income/loss per employee per year 3. Income/loss for memberships 4. Income/loss for subscriptions 5. Income/loss per country/language 6. Income/loss per professional meeting or for all meetings 7. Budget versus actual comparisons for revenues and expenses 8. Revenue/costs versus benchmarks set by top management b. Customer performance indicators: 1. Number of member complaints 2. Membership turnover 3. Percent of members participating in continuing education seminars 4. Ratio of outside subscriptions to membership Operating performance indicators: 1. Members per employee 2. Revenue growth versus employee growth 3. Increase in costs of given activities versus their outputs; for example, employee cost per run of monthly journal versus that of last year. 4. Cost savings ideas per employee which resulted in implementation

Financial & Managerial Accounting for Decision Makers, 4th Edition

EXERCISES E23-24. a. OLAM INTERNATIONAL LIMITED Peanut Division Gross Profit Sales: Internal (75,000  $35) External (105,000  $35) Cost of goods sold: Var. costs (180,000  $15)* Fixed costs (180,000  $10) Gross profit

$2,625,000 3,675,000 2,700,000 1,800,000

$6,300,000

(4,500,000) $1,800,000

*Variable costs ($9 + $4 + $2)

b. OLAM INTERNATIONAL LIMITED Peanut Division Gross Profit Sales: Internal (75,000  $25) External (105,000  $35) Less cost of goods sold (see above) Gross profit

$1,875,000 3,675,000

$5,550,000 (4,500,000) $1,050,000

c. Since the Peanut Division has an annual excess capacity of 55,000 bushels but the Peanut Butter Division requires 75,000 bushels. each year, step transfer prices might lead to the best action by the manager of the Peanut Butter Division. The first 55,000 bushels, which have no opportunity cost, could be transferred at $35 per lb. The remaining 20,000 bushels have an opportunity cost of $25 per pound and could be transferred at this price. This approach follows the variable cost plus opportunity cost rule that leads to the maximization of corporate profits.

23-11

E23-25. a. Variable costs Fixed costs ($2,250,000/1,000,000) Total unit cost

$3.75 2.25 $6.00

b. Since the Foundry Division will still have a contribution margin of $1.75 ($5.50 − $3.75) and since it is already at its maximum sales to outsiders, the $5.50 price should be accepted. If the outside supplier is accepted, the Foundry Division will lose over half of its total current sales. The manager is not in the best negotiating position. c. No, not if fixed costs are still allocated on the basis of unit sales. Sales (insider) (600,000  $5.50) Variable costs Contribution margin Fixed costs Net loss

$3,300,000 (2,250,000) 1,050,000 (1,350,000) $ (300,000)

However, if the Assembly Division buys outside, the Foundry Division will lose the $1,050,000 contribution margin to cover its fixed costs, and it will then report an overall loss of $150,000 ($2,100,000 − $2,250,000), rather than an overall profit of $900,000 ($1,200,000 − $300,000).

E23-26. a. ATHENS COMPANY Divisional Income Statement Alpha Delta Sales: External* Internal** Total Variable costs: Incurred*** Transferred in**** Total Contribution margin Fixed costs Net income * Alpha 60,000  $40; Delta 200,000  $20 ** Delta 60,000 X $12 X 1.50

Company

$2,400,000 0 2,400,000

$4,000,000 1,080,000 5,080,000

$6,400,000 0 6,400,000

660,000 720,000 (1,380,000) 1,020,000 (380,000) $640,000

3,120,000 0 (3,120,000) 1,960,000 (575,000) 1,385,000

3,780,000 0 (3,780,000) 2,620,000 (955,000) $ 1,665,000

*** Alpha 60,000  $11; Delta 260,000  $12 **** Alpha 60,000 x $12

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. Overall company income is less because the internal sales of Delta do not equal the transferred-in costs of Alpha. However, the divisional income statements are strictly for internal evaluation purposes and do not reflect the absolute financial transactions of the organization.

E23-27. a. Return on investment: Trucking:

ROI

$525,000/ $3,750,000 =

Seafood:

ROI

$116,000 / $580,000

Construction:

ROI

$385,000 / $1,750,000

0.14 0.20 =

0.22

b. Residual income:

Net operating income Minimum level (Operating assets  0.15) Residual income

Trucking $525,000 562,500 $ (37,500)

Seafood $116,000 87,000 $ 29,000

Construction $385,000 262,500 $122,500

E23-28. The manager of the Construction Division is doing the best job based on ROI because it has the highest return. The Construction Division manager is also doing best with dollar returns of residual income of $122,500. The Seafood Division, however has the next highest residual income, and it is earned with substantially less assets ($580,000 versus $1,750,000) than Construction. Although the Trucking Division generates the most profit at $525,000, it does not meet the minimum desired 15% ROI.

23-13

E23-29. a. Division

Based on Book Value

Based on Current Value

Software

ROI = $35,000 / $250,000 = 0.14

ROI = $37,200 / $310,000 = 0.12

Consulting

ROI = $37,000/ $185,000 = 0.20

ROI = $38,500 / $175,000 = 0.22

Venture Cap.

ROI = $63,000 / $700,000 = 0.09

ROI = $43,200 / $720,000 = 0.06

Book Value

Software

Consulting

Venture Capital

Income Target return (10%)* Residual income

$35,000 (25,000) $10,000

$37,000 (18,500) $18,500

$63,000 (70,000) $(7,000)

* Software Consulting Venture Capital

$250,000  0.10 $185,000  0.10 $700,000  0.10

Current Value

Software

Consulting

Venture Capital

Income Target return (10%)* Residual income

$37,200 (31,000) $ 6,200

$38,500 (17,500) $21,000

$43,200 (72,000) $(28,800)

Consulting

Venture Capital

* Software Consulting Venture Capital

$310,000  0.10 $175,000  0.10 $720,000  0.10

c. Book Value

Software

Income after tax (20%)* Cost of capital employed (8%)# Economic value added * Software Consulting Venture Capital # Software Consulting Venture Capital

$28,000 (17,600) $10,400

$29,600 (13,200) $16,400

$ 50,400 (50,800) $ (400)

$35,000  0.80 $37,000  0.80 $63,000  0.80 ($250,000 - $30,000)  0.08 ($185,000 - $20,000)  0.08 ($700,000 - $65,000)  0.08 Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. continued Current Value

Software

Income after tax (20%)* Cost of capital employed (8%)# Economic value added * Software Consulting Venture Capital # Software Consulting Venture Capital

$ 29,760 (22,400) $ 7,360

Consulting $30,800 (12,400) $18,400

Venture Capital $ 34,560 (52,400) $(17,840)

$37,200  0.80 $38,500  0.80 $43,200  0.80 ($310,000 - $30,000)  0.08 ($175,000 - $20,000)  0.08 ($720,000 - $65,000)  0.08

d. Because it reflects current costs, current value is generally better than book value. Using this basis, consulting is the most successful division. It had the highest ROI, residual income, and EVA for the period.

E23-30. a. Financial information: Total Revenues Total Costs Journal advertising ROI: ($7,636,000 / $84,100,000) ($6,106,000 / $87,230,000) Residual Income: Income Minimum return (6% of net capital assets) Residual income Customer information: Course attendance Technical reports sold Operating criteria: Average cost per technical report Average cost per magazine Other personnel costs vs. salaries: ($7,000,000 / $28,000,000) ($5,872,000 / $28,050,000)

Planned

Actual

$54,436,000 $46,800,000 $ 450,000 0.091

$50,702,000 $44,596,000 $ 500,000 0.07

$7,636,000 (5,046,000) $ 2,590,000

$ 6,106,000 (5,233,800) $ 872,200

30,000 25,000

29,400 30,000

$36 $48

$36 $50

0.25 0.209

23-15

b. Success areas: 1. More reports were sold 2. Other personnel costs were much less in relation to salaries 3. Advertising revenue went up 4. Total costs decreased Failure areas: 1. Total revenues decreased 2. ROI decreased significantly 3. Residual income decreased significantly 4. Slightly fewer people took courses 5. Magazine costs went up Answer for this part depends upon the items used in (a) and there can be mixes as to the success or failure of the organization. c. It appears that the organization experienced declining membership resulting in lower revenues. Although most of the administrative costs decrease, per unit publication costs for the magazine were higher than expected.

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P23-31. a. WORLDWIDE COMMUNICATIONS, INCORPORATED Product and Company Income Statements For the Month of July Handset Switchboard Automated Sales: (6,500 × $25) (1,500 × $1,900) (2,500 × $3,500) Variable expenses: (6,500 × $15) (1,500 × $850) (2,500 × $1,950) Contribution margin Direct fixed expenses Product margin Common fixed expenses: Depreciation and supervision Other factory overhead Administrative Selling Total Net income

Company

$ 162,500 $ 2,850,000 $ 8,750,000 $11,762,500 (97,500) (1,275,000) 65,000 (60,000) $ 5,000

(4,875,000) 1,575,000 3,875,000 (175,000) (275,000) $ 1,400,000 $ 3,600,000

(6,247,500) 5,515,000 (510,000) 5,005,000 75,000 650,000 1,045,000 880,000 (2,650,000) $ 2,355,000

23-17

b. WORLDWIDE COMMUNICATIONS, INCORPORATED Territory and Company Income Statements For the Month of July Europe Asia Americas Sales:* Handset Switchboard Automated Total Variable expenses:** Handset Switchboard Automated Total Contribution margin Direct fixed expenses: Administrative Selling Total Territory margin Common fixed expenses: Depreciation and supervision Other manufacturing overhead Administrative ($1,045,000 − $845,000 allocated) Total Net income

Company

65,000 997,500 875,000 1,937,500

56,875 997,500 1,312,500 2,366,875

40,625 855,000 6,562,500 7,458,125

162,500 2,850,000 8,750,000 11,762,500

39,000 446,250 487,500 (972,750) 964,750

34,125 446,250 731,250 (1,211,625) 1,155,250

24,375 382,500 3,656,250 (4,063,125) 3,395,000

97,500 1,275,000 4,875,000 (6,247,500) 5,515,000

350,000 155,000 (505,000) $ 459,750

275,000 175,000 (450,000) $ 705,250

220,000 845,000 550,000 880,000 (770,000) (1,725,000) $2,625,000 $3,790,000 585,000 650,000 200.000 (1,435,000) $2,355,000

*Sales: Handset: Europe Asia Americas

**Variable Expenses: Handset: $97,500 × 0.40 $97,500 × 0.35 $97,500 × 0.25

$162,500 × 0.40 $162,500 × 0.35 $162,500 × 0.25

Switchboard: Europe Asia Americas

$2,850,000 × 0.35 $2,850,000 × 0.35 $2,850,000 × 0.30

Switchboard: $1,275,000 × 0.35 $1,275,000 × 0.35 $1,275,000 × 0.30

Automated: Europe Asia Americas

$8,750,000 × 0.10 $8,750,000 × 0.15 $8,750,000 × 0.75

Automated: $4,875,000 × 0.10 $4,875,000 × 0.15 $4,875,000 × 0.75

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. WORLDWIDE COMMUNICATIONS, INCORPORATED Product Line within the Americas Territory For the Month of July Sales* Variable expenses* Product margin Common fixed expenses: Administrative Selling Total Territory Income

Handset $ 40,625 (24,375) $ 16,250

Switchboard $855,000 (382,500) $472,500

Automated $6,562,500 (3,656,250) $2,906,250

Americas $7,458,125 (4,063,125) 3,395,000

220,000 550,000 (770,000) $2,625,000

*From part b.

d. Parts a. and b. illustrate single-level segment reporting where a company’s overall performance is segmented based on one or more criteria. In part a., the overall company performance is segmented into product segments, and in part b., the overall company performance is segmented into sales territories. These two parts provide two different ways of viewing the overall company performance. Part c. illustrates a multilevel segment report where a segment report based on territories is further broken down into product segment reports. Multilevel reports are particularly useful in diagnosing problem areas in an organization. If a particular segment based on one criterion is having difficulty, it is useful to be able to break that segment down into lower-level segments to help identify and address the source of the problem. As discussed in the module, as segmentation of performance reports goes deeper and deeper, more costs become common costs. As illustrated in part c., $770,000 of costs that are attributable to product lines, become common costs when preparing territory statements, broken down into products.

23-19

P23-32. a. THE ESSENTIAL BAKING COMPANY Territory and Company Income Statements For the Month of March (in thousands) Seattle Sales $8,400 Variable expenses: Baking * $4,005 Selling** 1,300 (5,305) Contribution margin 3,095 Direct fixed selling expenses (860) Territory margin $2,235 Common fixed expenses: Baking Administrative Total Net income

Portland $6,800 $3,260 1,035

(4,295) 2,505 (580) $1,925

Company $15,200 $7,265 2,335

(9,600) 5,600 (1,440) 4,160 1,425*** 1,135 (2,560) $ 1,600

*Variable baking expenses: Seattle: Loaves $3,800 × 0.50 = Baguettes 2,650 × 0.50 = Rolls 1,950 × 0.40 = Total

$1,900 1,325 780 $4,005

Portland: Loaves Baguettes Rolls Total

$3,250 × 0.50 = 2,150 × 0.50 = 1,400 × 0.40 =

$1,625 1,075 560 $3,260

**Variable selling expenses: Seattle: Loaves $3,800 × 0.10 = Baguettes 2,650 × 0.20 = Rolls 1,950 × 0.20 = Total

$ 380 530 390 $1,300

Portland: Loaves Baguettes Rolls Total

$3,250 × 0.10 = 2,150 × 0.20 = 1,400 × 0.20 =

$ 325 430 280 $1,035

*** $565 + $450 + $410 = $1,425

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. THE ESSENTIAL BAKING COMPANY Product and Company Income Statements For the Month of March (in thousands) Sales: Seattle Portland Total Variable expenses:* Baking Selling Total Contribution margin Fixed baking expenses Product margin Common fixed expenses: Selling Administrative Total Net income

Loaves

Baguettes

Rolls

Company

$3,800 3,250 7,050

$2,650 2,150 4,800

$1,950 1,400 3,350

$ 8,400 6,800 15,200

3,525 705 (4,230) 2,820 (565) $2,255

2,400 960 (3,360) 1,440 (450) $ 990

1,340 670 (2,010) 1,340 (410) $ 930

7,265 2,335 (9,600) 5,600 (1,425) 4,175 1,440 1,135 (2,575) $ 1,600

* Sales x 50%, 50%, 40% for Baking Sales x 10%, 20%, 20% for Selling

23-21

c. If the Rolls product line is dropped, net income decreases by $1,340, which is the amount of the contribution margin of the Rolls product line. The other two product lines would have to absorb the product fixed costs of the Rolls product line, at least in the short run. Long run, the company may be able to eliminate some of those product fixed costs. THE ESSENTIAL BAKING COMPANY Product and Company Income Statements For the Month of March (in thousands) Sales: Seattle Portland Total Variable expenses: Baking Selling Total Contribution margin Fixed baking expenses* Product margin Common fixed expenses: Selling Administrative Total Net income * Loaves Baguettes

Loaves

Baguettes

Company

$3,800 3,250 7,050

$2,650 2,150 4,800

$ 6,450 5,400 11,850

3,525 705 (4,230) 2,820 (793) $2,027

2,400 960 (3,360) 1,440 (632) $ 808

5,925 1,665 (7,590) 4,260 (1,425) 2,835 1,440 1,135 (2,575) $ 260

(565/1,015) × $1,425 = $793 (450/1,015) × $1,425 = $632

d. As parts a. and b. show, the Portland territory is not doing as well as the Seattle territory, and the Rolls product line is not doing as well as Loaves and Baguettes. It may be useful to do a second-level analysis by segmenting the territories by product lines and/or to segment the product lines by territories. These analyses should give additional insight into why these two segments (Portland and Rolls) are not doing as well as the other segments.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P23-33. a. BUSINESS BOOKS PUBLISHERS INC. Professional Division: Segment and Divisional Income Statements For the Month of May

Sales Variable manufacturing* Manufacturing margin Other variable expenses** Contribution margin Total direct costs #: Direct fixed expenses Allocated common fixed expense Total Product margin Unallocated common fixed expenses Professional division income (loss)

Professional Accounting Executive Management Division $105,000 $105,000 $97,500 $307,500 (63,000) (42,000) (48,750) (153,750) 42,000 63,000 48,750 153,750 (5,250) (5,250) (4,875) (15,375) 36,750 57,750 43,875 138,375

(37,500) (3,000) (40,500)

(55,100) (1,500) (56,600)

(37,500) (4,500) (42,000)

(130,100) (9,000) (139,100)

$ (3,750)

$ 1,150

$ 1,875

(725) (10,900) $ (11,625)

* Variable cost ratios (% of sales): Accounting 0.60 Executive 0.40 Management 0.50 ** 5% of sales # Total direct costs: $150,000 Less direct to: Accounting (37,500) Executive (55,100) Management (37,500) Total Less allocated to: Accounting (3,000) Executive (1,500) Management (4,500) Total Allocated fixed expenses Unallocated common fixed expenses

(130,100)

(9,000) (139,100) $ 10,900

23-23

b. BUSINESS BOOKS PUBLISHERS INC. Professional Division Market Income Statements: Accounting Books Segment For the Month of May Accounting Books Segment Sales Variable manufacturing (60% of sales) Manufacturing margin Other variable expenses* Contribution margin Direct fixed expenses Market margin Allocated common fixed expenses Market income Unallocated common fixed expenses** Accounting market income (loss)

Auditors Market $ 22,500 (13,500) 9,000 (1,125) 7,875 (11,250) (3,375) (1,125) $ (4,500)

Controllers Market $82,500 (49,500) 33,000 (4,125) 28,875 (22,500) 6,375 (1,500) $ 4,875

Total $105,000 (63,000) 42,000 (5,250) 36,750 (33,750) 3,000 (2,625) 375 (4,125) $ (3,750)

* 5% of sales ** Accounting segment direct fixed expenses Accounting Segment allocated common fixed expenses Less direct costs to Auditors & Controllers Markets Less allocated to Auditors & Controllers Markets Unallocated common cost to Accounting segment

$ 37,500 3,000 (33,750) (2,625) $ 4,125

c. In the short run, the Professional Division loss will be less if it discontinues the Auditors Market because that market has a negative market margin as a result of its direct fixed expenses exceeding its contribution margin. By eliminating the Auditors Market net income should increase by the amount of the negative market margin of $3,375, reducing the total net loss from $3,750 to $375, all of which is attributable to the Controllers Market. d. Even if the Auditors Market is discontinued, the Accounting Books Segment will still be in a loss situation in the short run and the long run unless other actions are taken. The Professional Division should consider shutting down the entire Accounting Books Segment. However, if the capacity costs allocated to the Auditors Market can either be eliminated or assigned to another product, it may be advisable to continue the Controllers Market since it has a positive Market Margin and Market Income.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P23-34. a. ALL THINGS GREEK INC. Division and Company Income Statements For the Month of August

Sales Cost of sales Division overhead Division expenses Division contribution Corporate overhead Division income

Alpha $250,000 139,500 39,000 (178,500) 71,500 (43,800) $ 27,700

Beta $300,000 165,000 45,000 (210,000) 90,000 (52,600) $ 37,400

Gamma $220,0001 124,1502 27,7503 (151,900) 68,1004 (38,600) $ 29,500

Company $770,000 428,650 111,750 (540,400) 229,600 (135,000) $ 94,600

$275,000 - $55,000 = $220,000 $158,250 - $34,100 = $124,150 3 $41,250 - $13,500 = $27,750 4 $75,500 - $7,400 = $68,100 2

The Gamma Division does not improve from dropping the marginal product lines. Division contribution dropped from $75,500 to $68,100, and division income dropped from $30,500 to $29,500. It now has the middle income figure for the period. The responses of the other managers will be unfavorable because their divisional incomes also decline with the additional corporate overhead assigned to them. For the Alpha Division, its income not only dropped, but it is also now the lowest-income-reporting division. b. The best way to improve the company's reporting process is to not allocate the corporate overhead to the divisions when they have no control over its occurrence. The division managers should be evaluated on division margin, not division income. The dysfunctional behavior of the managers caused by the arbitrary allocation of such costs renders ineffective any benefits of such allocations. It should be noted that any allocations that affect multiple divisions should be used carefully. In this case, the actions of one manager, Gamma, caused changes in the financial results of the other two divisions, even when their managers took no action. Allocations of such costs should be made using methods that cannot be manipulated by those who have no control over them. Allocations based on planned or budgeted outputs should be used to avoid the shifting of costs among divisions without justification.

23-25

P23-35. a. ROI = Operating income / Operating assets Current operations:

ROI

= =

$250,000 / $2,500,000 0.10

New investment:

ROI

= =

$30,000* / $400,000 0.075

ROI

= =

$280,000 / $2,900,000 0.097

*$625,000 × (1 − 0.6) − $220,000

Operations with new investment

Accepting the new product line will reduce the division's ROI from 10 percent to 9.7 percent. With this reduction, division management may be reluctant to invest in the project. b. Yes. Income Minimum level ($400,000 × 0.06) Residual income

$30,000 (24,000) $ 6,000

ROI = $30,000 / $400,000 = 0.075 > .06 This would encourage the division to accept the investment because the project's residual income is positive even though ROI is only 7.5%, which is below the current 10% ROI of the company. c. Income after tax (20%)* Cost of capital employed (6%)** Economic value-added

$24,000 (22,920) $ 1,080

* $30,000 × (1.0 − 0.20) = $24,000 **($400,000 − $18,000) × 0.06 = $22,920

Yes, because EVA is positive and this indicates that the company is not only recovering its cost of capital, but that it is also creating additional economic value.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P23-36. a. ROI ROI

= =

Division Income / Division Assets $12 / $75 = 16%

Residual Income

EVA = = = b. ROI

Division Income – (Division Assets × Capital Charge) $12 – ($75 × 0.10) $4.5 million

After-tax Div. Income – ([Div. Assets – Current Liabilities × Cost of Cap.) $12 (1 - 0.20) – [(75 – 5) × 0.06] $5.4 million $12 / $115 =

Residual Income

EVA = =

= = =

= =

10.4% (rounded) $12 – ($115 × 0.10) $0.5 million

12 (1 – 0.20) – [(115 – 5) × 0.06] $3.0 million

c. Either book value or replacement cost can be used effectively when measuring performance with ROI, Residual Income, or EVA; however, when there has been significant inflation and, hence, a significant difference between book value and replacement cost, it is best to use replacement cost if that information is available. Replacement cost essentially makes managers responsible for the value of the assets entrusted to them, not their depreciated book value. When book value is used to value assets, all measures of performance are artificially raised. A disadvantage of using book value is that managers will often delay replacing assets because they do not want to have to use the higher asset values in calculating performance measures. Also, comparative performances of division managers with assets of different ages will be difficult since the managers with newer, inflated asset costs will almost invariably appear less successful than those with older, low-cost assets. One point of clarification is that if replacement cost is used to value assets, then net income should be adjusted to convert cost-based depreciation to replacement cost-based depreciation. Sufficient data were not provided in this problem to be able to make the conversion.

23-27

P23-37. a. The $3.50 price would be the best because that is the current market price for largevolume purchases. However, since the new division has excess capacity, it could lower the price even more. The variable costs are currently $1.90, which would be the lowest acceptable transfer price. b. ELISE CARPETS INC. Backing Division Income Statements Sales: External (1,000,000 × $3.75) Internal (350,000 × $3.50) Total sales Variable costs* Contribution margin Fixed costs** Net income

Current

Proposed

$3,750,000 0 3,750,000 (1,900,000) 1,850,000 (850,000) $1,000,000

$3,750,000 1,225,000 4,975,000 (2,565,000) 2,410,000 (850,000) $1,560,000

Net income increase: $560,000 * Current Proposed

1,000,000 × $1.90 = $1,900,000 1,350,000 × $1.90 = $2,565,000

** Fixed costs

1,000,000 X $0.85 = $850,000

Or: Current cost to buy outside Variable cost to make inside Profit increase to company

(350,000 × $3.50) (350,000 × $1.90)

$1,225,000 (665,000) $ 560,000

If fixed costs are assumed not to change, the internal profit increase for the company will be $560,000, which is also the increase in the Backing Division profits. c. ROI will increase for the Backing Division because net income, see part (b), went up and the investment amount did not increase. d. ROI for the Tufting Division should not change. Its activity level and costs remain unchanged. The only change is the source of rubber backing.

Financial & Managerial Accounting for Decision Makers, 4th Edition

e. A transfer price of $3.75 is recommended. Since Backing is at full capacity, all internal sales have an opportunity cost equal to the net benefits of outside sales ($3.75 − $1.90) or $1.85. Variable cost plus opportunity cost totals $3.75 ($1.90 + 1.85). However, if there are some quantity discounts allowed, then Tufting would have reason to argue for the $3.50 price. If Backing can sell for $3.75 and Tufting can buy from someone else for $3.50, then Tufting should be allowed to purchase outside. f. Sales (350,000 units) Variable costs (350,000 × $1.90) Contribution margin

$3.75 Price $1,312,500 (665,000) $ 647,500

$3.50 Price $1,225,000 (665,000) $ 560,000

Decrease in internal profits: $87,500 OR Change in price × volume = ($3.75 − $3.50) × 350,000 = $87,500

P23-38. a. Redmond Division should consult with the Seattle Division to determine actual costs. This would be shown as follows: Selling price per unit Variable costs: Seattle Division Redmond Division Contribution margin

$750 $150 550

(700) $ 50

The combined contribution margin total of $50 for both divisions is a very small amount. Unless the company needed the order just to keep production moving, it probably should reject it. Ignoring the breakdown from Seattle, the Redmond Division would lose $175 ($750 revenue − $925 variable costs), assuming fixed costs would not be affected by the sale. b. If both divisions have excess capacity, the company as a whole would be gaining a contribution to fixed costs and profits of $25,000 ($50 × 500 units). However, the decision to sell the units at $750 should consider the effect on other customers. Will they react in a negative fashion if they become aware of the preferential price? Will they renegotiate price or seek other sources? On balance, management must consider a total $25,000 contribution (versus the normal contribution of $800 ($1,500 – $150 – $550) per unit or $400,000 for the order) a risky proposition for such a low return.

23-29

c. If Seattle Division does not have excess capacity, it is going to be reluctant to reduce its transfer price for any reason. Therefore, Redmond Division would show a loss on the sale of the 500 units. Selling price per unit Variable costs: From Seattle Division Other variable costs Contribution margin per unit Size of order in units Disadvantage of accepting order

$ 750 $375 550

(925) $(175) × 500 $(87,500)

d. It needs to know the fixed and variable components of all goods received from related divisions. Also helpful is the current operating level of each division and the market price, if any, of any goods received.

P23-39. a. Suggested possible key performance indicators are provided below in parentheses for each of the performance areas. These are just some of the possibilities among the many others that students may suggest. 1. Financial Perspective - Maintain and grow the bank financially a. Increase customer deposits (number of new depositors, average deposit of new depositors, dollar amount of increase in deposits, % increase in deposits) b. Manage financial risk (dollar amount of allowance for bad accounts, the ratio of the allowance for bad accounts to total receivables, number of accounts written off in current period, the percentage of accounts receivable written off in current period, amount of capital versus capital requirements.) c. Provide profits for the stockholders (total revenue and total revenue percentage increase, total return and % return on equity, ROI, EVA) 2. Customer Perspective – Maintain and grow the customer base a. Increase customer satisfaction (survey satisfaction rating, number of accounts closed, number of customer complaints, percent of customers filing complaints) b. Increase number of depositors & customer retention (number of new depositors and percent of new depositors to total number of depositors, number of accounts closed, number of referrals of new customers by existing customers) c. Increase quality of deposits (number and change in number of service calls from depositors, turnover of deposit balances, average depositor balance, average interest paid on depositor balances) Continued

Financial & Managerial Accounting for Decision Makers, 4th Edition

a. continued 3. Internal Perspective – Improve internal processes a. Achieve best practices for processing transactions (Industry quality ratings, bank reputations ratings, benchmark performance ratings, number of errors in processing transactions, percentage of erroneous transactions to total transactions) b. Improve employee satisfaction (employee satisfaction survey ratings, employee turnover, number of employee complaints/grievances, number of new employee applications) c. Improve employee promotion opportunities (number of employees promoted, employee turnover, average tenure of employees promoted, number of promotion opportunities 4. Learning and Innovation – Improve market differentiation a. Beat competitors in introducing new products (number of innovative products introduced, number of new products introduced emulated by competition, number of recent new products discontinued) b. Become first mover in establishing customer benefit for customers (number of innovative customer benefit programs initiated for all customers such as free checking or free ATM withdrawals (number of recent innovative customer benefit programs discontinued, number of customer complaints regarding customer service options) c. Become recognized as an innovator in the industry (performance in industry ratings reports, number of industry awards and recognitions received) b. Balanced scorecard performance evaluation systems can be implemented at only the top level of the organization, or they can be used at lower levels, or even throughout the organization. Companies often implement them at the upper echelon of management initially and after the system is fairly well defined, it is implemented down to lower levels of management. Ideally, a well-defined balanced scorecard will permeate an organization to create a high level of goal congruence within the organization toward the achievement of its overall goals and strategies.

23-31

CASES and PROJECTS C23-40. a. If the Consulting Division is viewed by top management and division management as a serious competitor to the major systems consulting firms, it needs to be able to recommend the equipment that is best suited for its clients’ needs. Since there are some systems designs where the consultants may feel a competitor’s products are better suited than IBM’s equipment for the situation, it would be best if the Consulting Division were not required to recommend only IBM equipment. If it is the company’s strategy to make its Consulting Division one of the largest in the industry, it should be able to compete on an equal basis with its competitors who can recommend equipment from any equipment vendor, otherwise the Consulting Division will be viewed in the market and in the company as a sales division for the Computer Equipment Division. b. Since both the Consulting Division and the Computer Equipment Division are investment centers, it is important for IBM to be able to evaluate the performance of these two divisions as though they were independent companies. To be able to do this requires IBM to establish transfer prices on any equipment purchased by the Consulting Division from the Computer Equipment Division. If IBM wanted to avoid the transfer pricing problem, it could arrange for the Consulting Division’s clients to purchase equipment directly from the Computer Equipment Division, with the Consulting Division getting a commission on the sale. If the equipment is actually purchased by the Consulting Division, then the best transfer price is probably market price, since IBM has a ready market price for all of its computer products. The downside of market transfer prices is that if the Consulting Division can buy comparable equipment from a competitor of IBM, it may do so, depriving the Computer Equipment Division of a sale and depriving the company of the profit on the sale. This would be especially significant if the Computer Equipment Division were operating with excess capacity. c. To avoid the problem described above, top management could require the Consulting Division to buy from the Computer Equipment Division, if the Computer Equipment Division can meet the comparable price of its competitors. If the Computer Equipment Division is operating at full capacity, it does not matter whether the Consulting Division buys from the Computer Equipment Division. Also, if the Consulting Division purchases from the Computer Equipment Division, any cost savings of the Computer Equipment Division from selling internally should be passed on to, or shared with, the Consulting Division.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C23-41. a. Before evaluating the decision, the current outlay costs should be considered as follows: Proposed process: Variable costs ($24 × 40,000) New lease Current process: Variable costs ($24 × 40,000) Savings of current process

$960,000 400,000

$1,360,000 (960,000) $400,000

If most of the fixed costs are depreciation and supervision which cannot be eliminated, the proposal should be rejected by the company. Note, however, that the lease would increase the Sign Division's income while reducing Molding Division's income by the amount of any fixed costs that cannot be reduced. [Some students will argue that the avoidability of the fixed costs is not clear and that if fixed costs of more than $200,000 ($600,000 − $400,000) can be avoided, the company should lease.] b. There is no easy way to establish a transfer price that will preserve divisional autonomy and maximize corporate profit. If there is no alternative use for the Molding Division’s capacity, a transfer price based on variable costs will lead the Sign Division to take the action (reject the proposal) that is in the best interest of the corporation. However, this transfer price will deprive Molding Division of the opportunity to cover its fixed costs and earn a profit. Perhaps, if the Molding Division sells only to the Sign Division, both divisions should be combined into a single profit or investment center.

23-33

C23-42. a. Roper Division management's attitude at the present time should be positive to each of these prices in decreasing order because Roper apparently has unused capacity. Roper Division management performance is evaluated based on return on investment (ROI), and each of these prices exceeds variable costs, which will increase Roper's ROI. At the time when all existing capacity is being used, Roper Division management would want the intercompany transfer price to generate the same amount of profit as outside business in order to maximize division ROI. b. Negotiation between the two divisions is the best method to settle on a transfer price. MBR Inc. is organized on a highly decentralized basis, and each of the four conditions necessary for negotiated transfer prices exists. These conditions are: 1. An outside market exists that provides both parties with an alternative. 2. Both parties have access to market price information. 3. Both parties are free to buy and sell outside the corporation. 4. Top management supports the continuation of the decentralized management concept. c. No, the management of MBR should not become involved in this controversy. The company is organized on a highly decentralized basis, which top management must believe will maximize long-term profits. Imposing corporate restrictions will adversely affect the current management evaluation system because division management would no longer have complete control of profits. Also, the addition of corporate restrictions could have a negative impact on division management who are accustomed to an autonomous working environment.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 24 Capital Budgeting Decisions QUESTIONS Q24-1.

Because capital budgeting involves the planning for cash flows over several years, capital budgeting is part of long-range planning. Short-range planning involves only single-year cash flows.

Q24-2.

The capital budgeting committee provides guidance to managers in the formulation of capital expenditure proposals. The committee also reviews, analyzes, and approves or rejects major capital expenditure proposals.

Q24-3.

Post-audits of an approved capital expenditure proposal help to keep the project on target, help to identify the need to reevaluate the project if the initial analysis was in error or significant environmental changes occur, and help improve the quality of investment proposals. Post-audits also help the capital budgeting committee identify the biases of individual managers; identify additional factors that should be considered in evaluating proposals; and avoid the routine approval of projects that appear desirable themselves but are related to larger projects that are not meeting management’s expectations.

Q24-4.

A project's cash flows are organized into three phases: initial investment, operation, and disinvestment. The investment phase includes all cash expenditures necessary to begin operations. The operation phase includes cash receipts from sales or rendering services as well as normal cash expenditures for materials, labor, and other operating expenses. The disinvestment phase occurs at the end of the project's life when assets are disposed of and any initial investment in working capital is recovered.

Q24-5.

The internal rate of return is (1) the discount rate that equates the present value of a project's cash inflows with the present value of the project's cash outflows; (2) the minimum rate that could be paid for the money invested in a project without losing money; and (3) the discount rate that results in a project's net present value equaling zero.

24-1

Q24-6.

Investing in a project that has an internal rate of return equal to the cost of capital should not affect the market value of a firm's securities. Investing in a project that has a return greater than the cost of capital should increase the market value of a firm’s securities. If, however, a firm invests in a project that has a return of less than the cost of capital, the market value of the firm's securities may fall.

Q24-7.

When used as the sole investment criterion, the payback period has a fatal flaw in that it fails to consider cash flows after the payback period. Investments are made to earn a profit. Hence, what happens after the payback period is just as important as the payback period itself.

Q24-8.

The basic problem with the accounting rate of return is that it fails to consider the timing of cash flows. All cash flows within the life of an investment proposal are treated equally, despite the fact that cash flows occurring early in a project's life are more valuable than cash flows occurring late in a project's life. Furthermore, the accounting rate of return model uses profits, rather than cash flows, in its analysis.

Q24-9.

The net present value and the internal rate of return models are superior to the payback and accounting rate of return models because they consider the time value of money and project profitability.

Q24-10.

There are two basic differences between the net present value and the internal rate of return models that often lead to differences in the evaluation of competing investment proposals: 1. The net present value model gives explicit consideration to investment size. The internal rate of return model does not. 2. The net present value model assumes all net cash inflows are reinvested at the discount rate, while the internal rate of return model assumes all net cash inflows are reinvested at the project's internal rate of return.

Q24-11.

In making the final decision to accept or reject a capital expenditure proposal that has passed the initial screening, nonquantitative factors are apt to play a decisive role. Very important at this point are management's attitudes toward risk and financing alternatives, their confidence in the professional judgment of managers making investment proposals, their beliefs about the future direction of the economy, and their evaluation of alternative investments.

Q24-12.

Although depreciation does not require the use of cash, depreciation reduces the net cash payments for income taxes. This reduction in cash payments for income taxes increases operating cash flows from what they would be without depreciation.

Financial & Managerial Accounting for Decision Makers, 4th Edition

MINI EXERCISES M24-13. a. fv

pv(1 + r)

= =

$5,000(1 + 0.04) $5,408 or $5,000 / 0.92456 = $5,408

= =

$15,000  0.68301 $10,245

c. pva = =

$2,500  3.60478 $9,012

d. a

= =

$69,845 / 5.74664 $12,154

Year 1 2 3 Total

Cash Flow $20,000 25,000 30,000

b. pv

x x X

Present Value at 6 Percent 0.94340 0.89000 0.83962

Present value of an annuity for 12 years at 8 percent ($3,000 x 7.53608) Present value of an annuity for 9 years at 8 percent ($3,000 x 6.24689) Present value of the deferred annuity or $3,000 x (7.53608 − 6.24689) = $3,868*

Present Value Amount $18,868 22,250 25,189 $66,307

= = =

$22,608 (18,741) $ 3,867

*dollar difference due to rounding

24-3

M24-14. a. fv

pv(1 + r)

= =

$8,900(1 + 0.06) $10,600 or $8,900 / 0.83962 = $10,600

= =

$12,000  0.74726 $8,967

c. pva = =

$25,000  3.31213 $82,803

d. a

= =

$66,200 / 4.35526 $ 15,200

Year 1 2 3 Total

Cash Flow $ 10,000 7,500 5,000

b. pv

x x x

Present Value at 14 Percent 0.87719 0.76947 0.67497

Present value of an annuity for 10 years at 16 percent ($15,000  4.83323) Present value of an annuity for 7 years at 16 percent ($15,000  4.03857) Present value of the deferred annuity or $15,000  (4.83323 − 4.03857) = $11,920*

= = =

Present Value Amount $ 8,772 5,771 3,375 $17,918

$72,498 (60,579) $ 11,919

*dollar difference due to rounding

Financial & Managerial Accounting for Decision Makers, 4th Edition

M24-15. a.

Initial investment Operation Net present value of all cash flows

Predicted Cash Inflows (Outflows) (A) $(30,723) 5,000

Year(s) of Cash Flows (B) 0 1-10

8% Present Value Factor (C) 1.000 6.71008

Present Value of Cash Flows (A) x (C) $(30,723) 33,550 $ 2,827

b. Present value factor for an annuity of $1 = $30,723 / $5,000 = 6.1446 In the row for 10 periods, 6.1446 corresponds most closely to an internal rate of return of 10 percent. c. A discount rate equal to the internal rate of return of 10 percent would produce a net present value of zero.

M24-16. a.

Initial investment Operation Net present value of all cash flows

Predicted Cash Inflows (Outflows) (A) $(294,800) 67,750

Year(s) of Cash Flows (B) 0 1-6

12% Present Present Value of Value Factor Cash Flows (C) (A) x (C) 1.000 $(294,800) 4.11141 278,548 $ (16,252)

b. Present value factor for an annuity of $1 = $294,800 / $67,750 = 4.35129 In the row for six periods, 4.35129 corresponds most closely to an internal rate of return of 10 percent. c. A discount rate equal to the internal rate of return of 10 percent would produce a net present value of zero.

24-5

M24-17. a. Initial investment Annual operating cash flows Payback period in years

$74,250 ÷ 16,500 4.5

b. Annual operating cash flows Average annual depreciation ($74,250/5) Average annual increase in net income Initial investment Accounting rate of return on initial investment

$16,500 (14,850) $1,650 ÷74,250 0.022

c. Average annual increase in net income Average investment ($74,250/2) Accounting rate of return on average investment

$ 1,650 ÷ 37,125 0.044

M24-18. a. Initial investment Annual operating cash flows Payback period in years

$227,500 ÷ 32,500 7.0

b. Annual operating cash flows Average annual depreciation [($227,500 - 22,750)/10] Average annual increase in net income Initial investment Accounting rate of return on initial investment

$ 32,500 (20,475) $ 12,025 ÷ 227,500 0.053

c. Average annual increase in net income Average investment [($227,500 +22,750)/2] Accounting rate of return on average investment

$ 12,025 ÷ 125,125 0.096

Financial & Managerial Accounting for Decision Makers, 4th Edition

M24-19. a. Initial Investment: Depreciable assets Working capital Annual operating cash flows Payback period in years

$100,000 20,000

$120,000 ÷ 24,000 5.0

b. Annual operating cash flows Average annual depreciation [($100,000 – $20,000) / 5] Average annual increase in net income Initial investment Accounting rate of return on initial investment

$ 24,000 (16,000) $ 8,000 ÷ 120,000 0.067

c. Average annual increase in net income Average investment [($100,000 + $20,000) + ($20,000 + $20,000) / 2 Accounting rate of return on average investment

$ 8,000 ÷ 80,000 0.10

24-7

EXERCISES E24-20. a.

Initial investment Operation: Year 1 Year 2 Year 3 Net present value of all cash flows

Predicted Cash Inflows (Outflows)

Year(s) of Cash Flows

10% Present Value Factor

Present Value of Cash Flows

(A) $(160,000)

(B) 0

(A) x (C) $(160,000)

42,000 95,000 65,000

1 2 3

0.90909 0.82645 0.75131

38,182 78,513 48,835 $5,530

b. With unequal annual net cash inflows, a trial-and-error approach is required to determine a project's internal rate of return. If the results of a trial-and-error approach produce a positive net present value, a larger discount rate should be selected for the next trial. If the results of a trial produce a negative net present value, a smaller discount rate should be selected for the next trial. The internal rate of return will produce a net present value of zero. Presented below is the final trial:

Initial investment Operation: Year 1 Year 2 Year 3 Net present value of all cash flows

Predicted Cash Inflows (Outflows)

Year(s) of Cash Flows

12% Present Value Factor

Present Value of Cash Flows

(A) $(160,000)

(B) 0

(A) x (C) $(160,000)

42,000 95,000 65,000

1 2 3

0.89286 0.79719 0.71178

37,500 75,733 46,266 $(501)*

* Difference is not $0, due to rounding. The investment proposal's internal rate of return is 12 percent (11.83 percent using spreadsheet software).

Financial & Managerial Accounting for Decision Makers, 4th Edition

E24-21. a. Predicted Cash Inflows (Outflows) (A) Initial investment $(85,000) Operation: Year 1 30,500 Year 2 60,000 Year 3 31,000 Net present value of all cash flows

Year(s) of Cash Flows

12% Present Value Factor

Present Value of Cash Flows

(B) 0

(A) x (C) $(85,000)

1 2 3

0.89286 0.79719 0.71178

27,232 47,831 22,065 $12,128

Predicted Cash Inflows (Outflows)

Year(s) of Cash Flows

20% Present Value Factor

(A) $(85,000)

(B) 0

(A) x (C) $(85,000)

30,500 60,000 31,000

1 2 3

0.83333 0.69444 0.57870

25,417 41,666 17,940 $23*

Initial investment Operation: Year 1 Year 2 Year 3 Net present value of all cash flows

Present Value of Cash Flows

* Difference is not $0, due to rounding. The investment proposal's internal rate of return is 20 percent (20.02 percent using spreadsheet software).

24-9

E24-22. a. Payback period

= =

$210,000 / $70,000 3.0 years

b. Factor for internal rate of return

= =

$210,000 / $70,000 3.0

For 4 periods a factor of 3.0 corresponds to a time value of money of 12 percent. Hence, the internal rate of return is approximately 12 percent. c. Initial investment = Annual net cash inflows x Factor for 4 years at 14 percent $210,000 = Annual net cash inflows x 2.91371 Annual net cash inflows = $210,000 / 2.91371 = $72,073

E24-23. a. Hershey utilized a single-period model for a multi-period problem. This fails to consider the time value of money. All the analysis accomplished was to make sure the initial investment was paid back through operations. b. No. It has a negative net present value of $40,061 Total annual contribution margin (200,000  $0.65) Fixed costs (excluding depreciation) Annual cash flow Present value of an annuity of $1 for 4 periods at 8% Present value of operating cash flows Initial investment Net present value

$ 130,000 (48,500) $81,500  3.31213 $269,939 (310,000) $ (40,061)

c. At the time-adjusted break-even point, the following relationship holds: Initial investment = Present value of yearly contribution − Present value of yearly fixed costs $310,000 = $310,000 = $2.15288X =

$0.65X (3.31213) − $48,500 (3.31213) $2.15288X − $160,638 $470,638

X = 218,609 required annual sales in units to break even on a time-adjusted basis

Financial & Managerial Accounting for Decision Makers, 4th Edition

E24-24. At the time-adjusted break-even point with income taxes, the following relationship holds: Initial investment $310,000 $310,000 $310,000 $1.7223X X =

= = = =

Present value factor

Annual before tax cash flows

−

Annual tax payments

3.31213 [$0.65X − $48,500 − 0.20 ($0.65X − $48,500− $62,000*)] 3.31213 ($0.52X − $26,400) $1.7223X − $87,440 $397,440

230,761 required annual sales in units to break even on a time-adjusted basis with income taxes

*Depreciation

E24-25. a. Payback period = $17,700,000 ÷ $4,420,000 = 4 years b. Solution approach - determine the proposal’s IRR and compare this to the interest rate. Factor for project = $17,700,000 ÷ $4,420,000 = 4.00 years In TABLE 24A-2, for seven periods, the closest discount rate is 16 percent. This is the project’s internal rate of return, the minimum rate that can be paid for the money invested in the project without losing money. Using spreadsheet software, the IRR is 16.29 percent. Because the IRR of the investment in LEDs is 320% (16% ÷ 5%) the interest rate, the City should make the investment, other things being equal.

24-11

E24-26. a. Annual savings in cost of gasoline: Cost with regular [(15,000 / 30) × $2.60] Cost with hybrid [(15,000 / 40) × $2.60] Annual savings

$1,300.00 (975.00) $ 325.00

Payback period = $2,200 / $325.00 = 6.77 years Note: This is longer than Hermione plans to own the car. b. Annual savings Discount rate, 6 percent, six years Present value of future savings Initial investment Net present value

$ 325.00 × 4.91732 $ 1,598.13 (2,200.00) $ (601.87)

The investment does not meet the NPV criteria. c. Incremental cost Desired payback period in years Annual cash savings for three-year payback period Annual gasoline savings: Consumption with regular (15,000 / 30 mpg) Consumption with hybrid (15,000 / 40 mpg) Savings in gallons Cost of gasoline for four-year payback ($550.00 / 125.00)

$ 2,200 ÷ 4 $550.00

500.00 gallons (375.00) gallons 125.00 gallons $4.40 gallons

Note: In some parts of the U.S, the cost of gasoline can exceed $4.40 per gallon. d. Annual cash savings for a four-year payback Per gallon cost of gasoline Required savings in gallons of gasoline

$550.00 ÷ 4.00 137.50

Consumption with regular Required savings Maximum consumption with hybrid

500.00 gallons (137.50) gallons 362.50 gallons

Required mpg for a four-year payback: Annual mileage Maximum consumption Required mpg

15,000 ÷ 362.50 41.38

Financial & Managerial Accounting for Decision Makers, 4th Edition

E24-27. a. Annual savings in cost of gasoline: Cost with LX [(15,000 ÷ 30) × $2.50] Cost with Hybrid [(15,000 ÷ 48) × $2.50] Annual savings

$1,250.00 (781.25) $ 468.75

Payback period: Incremental investment

$2,000

The payback period would be 4.27 years ($2,000 / $468.75). This is longer than Li plans to keep the car. Savings through 4 years Li plans to keep car ($468.75 × 4) Incremental resale value of Hybrid ($12,500 - $9,000) Payback through life of car

b. Initial investment Operations Annual savings PV 4-yr annuity at 8 percent Present value of future savings Disinvestment: Incremental resale value PV of $1 in 4 yrs at 8 percent Net present value

$1,875 3,500 $5,375

$(2,000.00) $ 468.75 × 3.31213 1,552.56 $3,500.00 × 0.73503

2,572.61 $2,125.17

The investment meets the NPV criteria. c. Incremental cost Desired payback period in years Annual cash savings for 2.5 year payback period

$2,000 ÷ 2.5 $ 800

Annual gasoline savings: Consumption with LX (15,000 ÷ 30 mpg) Consumption with Hybrid (15,000 ÷ 48 mpg) Savings in gallons

500.00 gallons (312.50) gallons 187.50 gallons

Cost of gasoline for 2.5 year payback ($800 ÷ 187.50)

$4.27 / gallon

24-13

d. Other considerations include: •

Reliability and cost of repair for the Hybrid in comparison with the LX.

•

Future cost of gasoline. The higher the cost of gasoline, the more attractive an investment in a hybrid becomes.

•

Future changes in mpg of hybrids and non-hybrid vehicles. It is possible that by delaying her purchase a year or two, more attractive alternatives will become available.

Author’s observations: The instructor can modify this exercise in a variety of ways. One possibility is to hold the mpg and the price of gasoline constant and ask for the break-even cost premium of a hybrid, or the break-even annual mileage. This exercise is revised from an earlier version to incorporate the higher mileage of current conventional and hybrid-powered vehicles. The model was originally presented in Barker, Clouse, Stout, and Stout, "The Economics of Buying a More Fuel Efficient Automobile: An Interactive Analysis," Journal of Financial Planning, June 2009, pp. 62-71. This model was significantly more sophisticated than the situation presented in this exercise. Students interested in the topic should be referred to that article.

Financial & Managerial Accounting for Decision Makers, 4th Edition

PROBLEMS P24-28. a. Payback period: Accounting rate of return: Total increase in income before depreciation Total depreciation Total increase in income Life in years Average annual increase in net income Initial investment Accounting rate of return

Proposal A 2 years

Proposal B 2.5 years

Proposal C 0.91 year

$135,000 (100,000) $35,000  3 $ 11,667 100,000 0.1167

$110,000 (100,000) $10,000  1 $ 10,000 100,000 0.10

Net present value at 12 percent: Year 1 2 3 Total Initial investment Net present value Rankings: Payback Accounting rate of return Net present value

Factor 0.89286 0.79719 0.71178

Present Values $ 53,572 $ 22,322 $ 98,215 31,888 31,888 24,912 49,825 ________ 110,372 104,035 98,215 (100,000) (100,000) (100,000) $ 10,372 $ 4,035 $ (1,785)

2 1-2 1

3 1-2 2

1 3 3

b. While the accounting rate of return and the net present value criteria consider profitability, payback considers only the time required to recover the investment. Proposal C provides for the shortest payback; hence, it ranks first using the payback criterion even though Proposal C does not meet the expected 12 percent return. Proposals A and B have identical total cash flows over their lives; hence, they have identical accounting rates of return. However, the timing of their cash flows differs. Because Proposal A has higher early-period cash flows, its net present value is higher than that of Proposal B. Of the three criteria used, only net present value considers both profitability and the timing of cash flows. ©Cambridge Business Publishers, 2021 Solutions Manual, Chapter 24

24-15

P24-29. a. Annual cost of discharge into sewer [(350,000 / 1,000)  $6 per thousand liters  300 days] Annual operating cost of proposed system Annual cost savings Present value of an annuity of $1 (n = 10; r = 0.14) Present value of operating cost savings Present value of salvage ($100,000  0.26974) Initial investment Net present value of investment

630,000 (280,000) $ 350,000 x 5.21612 $ 1,825,642 26,974 (1,500,000) $ 352,616

b. The net present value is a large positive amount at 14 percent, so the IRR must be larger than 14 percent. Net present value at 20 percent: Present value of annual cost savings and salvage: $350,000  4.19247 $100,000  0.16151 Initial investment Net present value

$ 1,467,365 16,151 (1,500,000) $ (16,484)

The project’s internal rate of return is about 20%. (19.63% using spreadsheet function.) c. Initial investment / Annual operating cost savings = Payback period $1,500,000 / $350,000 = 4.286 years

Financial & Managerial Accounting for Decision Makers, 4th Edition

P24-30. Straight-line depreciation: Annual depreciation ($200,000/5 years) Tax rate Annual depreciation tax shield Present value of an annuity of $1 (n = 5, r = 0.20) Present value of straight-line tax shield

$40,000 0.21 $ 8,400  2.99061 $25,121 (rounded) 

Double-declining balance depreciation with a switch in Year 4:

Year

1 2 3 4 5

Dep. Base

Annual Rate

Annual Dep.

Tax Rate

Tax Shield

20% PV Factor

Present Value

(A)

(B)

(D)

2/5* 2/5 2/5 1/2 balance

(E) (C) x (D) $16,800 10,080 6,048 4,536 4,536

(F)

$200,000 120,000 72,000 43,200 21,600

(G) (E) x (F) $14,000 7,000 3,500 2,187 1,823

0.21 0.21 0.21 0.21 0.21

0.83333 0.69444 0.57870 0.48225 0.40188

Present value of double-declining balance tax shield

$28,510

*With a five-year life, the straight-line rate is 1/5 per year and the double-declining balance rate is twice the straight-line rate, or 2/5 per year.

Present value of double-declining balance tax shield Present value of straight-line tax shield Advantage of double-declining balance depreciation

$28,510 (25,121) $ 3,389

P24-31. a. Operating cost savings (12,000 hours  $65) Operating costs of CAD/CAM system Before-tax cash savings Income taxes without tax shield at 21 percent Depreciation tax shield [($200,000/5 years)  0.21] Relevant annual after-tax cash flows

$780,000 (600,000) 180,000 (37,800) 8,400 $150,600

b. 1. Initial investment / Annual operating cost savings = Payback period $200,000 / $150,600 = 1.33 years 2. Present value of after-tax cash flows ($150,600  3.43308) Initial investment Net present value

$517,022 (200,000) $317,022

24-17

P24-32.

Initial investment Operations: Annual taxable income without depreciation Taxes on income ($180,000  0.21) Depreciation tax shield* Year 1 Year 2 Year 3 Year 4 Year 5 Net PV of all cash flows

Predicted Year(s) 14% Cash Inflows of Cash Present (Outflows) Flows Value Factor (A) (B) (C) $(200,000) 0 1.00000

Present Value of Cash Flows (A)  (C) $(200,000)

180,000

1-5

3.43308

617,954

(37,800)

1-5

3.43308

(129,770)

$16,800 10,080 6,048 4,536 4,536

1 2 3 4 5

0.87719 0.76947 0.67497 0.59208 0.51937

14,737 7,756 4,082 2,686 2,356 $319,801

*Computation of depreciation tax shield+: Year

Depreciation Base (A)

Annual Rate (B)

Annual Depreciation Tax Rate Tax Shield (C) (D) (E) (A)  (B) (C)  (D) 1 $200,000 2/5 $80,000 0.21 $16,800 2 120,000 2/5 48,000 0.21 10,080 3 72,000 2/5 28,800 0.21 6,048 4 43,200 1/2 21,600 0.21 4,536 5 21,600 balance 21,600 0.21 4,536 +The depreciation base is reduced by the amount of any previous depreciation. The annual rate is twice the straight-line rate.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P24-33. a. Total cost evaluation of keeping old compressor:

Operations Repairs Disinvestment Net present value of operating costs

Predicted Cash Inflows (Outflows) (A) $(130,000) (75,000) 6,000

Year(s) of Cash Flows (B) 1-5 1 5

16% Present Value Present of Value Factor Cash Flows (A)  (C) (C) 3.27429 $(425,658) 0.86207 (64,655) 0.47611 2,857 $(487,456)

Total cost evaluation of purchasing new compressor:

Initial investment: Purchase of new Sale of old Net Operation Disinvestment Net present value of costs

Predicted Cash Inflows (Outflows) (A)

Year(s) of Cash Flows (B)

$(200,000) 60,000 $(140,000) (107,500) 20,000

0 1-5 5

16% Present Value Present of Value Factor Cash Flows (A)  (C) (C)

1.00000 3.27429 0.47611

$(140,000) (351,986) 9,522 $(482,464)

Mitsubishi should purchase the new compressor because it has a time-adjusted cost advantage of $4,992 ($487,456 − $482,464).

24-19

b. Differential analysis of predicted cash flows: Keep Old Compressor (A) Initial investment: Cost of new compressor Disposal value of old Net initial investment Annual operating savings Repairs on old machine Disinvestment: Old New

$130,000 75,000

Replace with New Compressor (B)

Difference (Effect of Replacement on Cash Flows) (A) − (B)

$(200,000) 60,000

$(200,000) 60,000 $(140,000) $ 22,500 $ 75,000

107,500

6,000 20,000

$ 14,000

Net present value analysis of differential cash flows:

Initial investment: Operations Repairs on old Disinvestment Net present value of costs

Predicted Cash Inflows (Outflows) (A) $(140,000) 22,500 75,000 14,000

Year(s) of Cash Flows (B) 0 1-5 1 5

16% Present Value Present of Value Factor Cash Flows (A)  (C) (C) 1.00000 $(140,000) 3.27429 73,672 0.86207 64,655 0.47611 6,666 $

4,993

Mitsubishi should purchase the new compressor because it has a time-adjusted cost advantage of $4,993*. * Dollar difference from part a due to rounding.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P24-34. a. Total cost evaluation of keeping old system:

Operations Overhaul Disinvestment Net present value of operating costs

Predicted Cash Inflows (Outflows) (A) $(60,850) (25,000) 4,500

Year(s) of Cash Flows (B) 1-5 0 5

16% Present Value Present of Value Factor Cash Flows (A)  (C) (C) 3.27429 $(199,241) 1.00000 (25,000) 0.47611 2,142 $(222,099)

Total cost evaluation of purchasing new system:

Initial investment: Purchase of new Sale of old Net Operations Disinvestment Net present value of costs

Predicted Cash Inflows (Outflows) (A)

Year(s) of Cash Flows (B)

$(90,000) 12,000 $(78,000) (40,200) 10,000

0 1-5 5

16% Present Value Present of Value Factor Cash Flows (A)  (C) (C)

1.00000 3.27429 0.47611

$ (78,000) (131,626) 4,761 $(204,865)

Pinstripes should purchase the new system because it has a time-adjusted cost advantage of $17,234 ($222,099 − $204,865).

24-21

b. Differential analysis of predicted cash flows:

Keep Old System (A) Initial investment: Cost of new system Disposal value of old Net initial investment Annual operating savings Overhaul on old system Disinvestment: Old New

Replace with New System (B) $(90,000) 12,000

$60,850 25,000

Difference (Effect of Replacement on Cash Flows) (A) − (B)

40,200 0

$(90,000) 12,000 $(78,000) $20,650 $25,000

10,000

$ 5,500

4,500

Net present value analysis of differential cash flows:

Initial investment: Operations Overhaul of old Disinvestment Net present value of costs

Predicted Cash Inflows (Outflows) (A) $(78,000) 20,650 25,000 5,500

Year(s) of Cash Flows (B) 0 1-5 0 5

16% Present Value Present of Value Factor Cash Flows (A)  (C) (C) 1.00000 $(78,000) 3.27429 67,614 1.00000 25,000 0.47611 2,619 $ 17,233

Pinstripes should purchase the new system because it has a time-adjusted cost advantage of $17,233*. * Dollar difference from part a due to rounding.

Financial & Managerial Accounting for Decision Makers, 4th Edition

P24-35. Differential analysis of predicted cash flows: Keep Old Equipment (A) Initial investment: Cost of new equipment Removal costs of old equip. Disposal value of old equip. Net initial investment Annual operating savings: Direct labor: Old (500,000  0.15) New (500,000  0.08) Overhead Total

Replace with New Equipment (B)

Difference (Effect of Replacement on Cash Flows) (A) − (B)

$320,000 10,000 (70,500)

$320,000 10,000 (70,500) $259,500

$ 40,000 42,500

$ 35,000 42,100 $ 77,100

$75,000 84,600

Net present value analysis of differential cash flows:

Initial investment: Operations Net present value of costs

Predicted Cash Inflows (Outflows) (A) $(259,500) 77,100

Year(s) of Cash Flows (B) 0 1-10

14% Present Value Present of Value Factor Cash Flows (A)  (C) (C) 1.00000 $(259,500) 5.21612 402,163 $142,663

Dusseldorf should purchase the new equipment because it has a differential net present value of $142,663.

24-23

CASES and PROJECTS C24-36. Basic computations: Total revenues Annual revenues (75-year life) Annual profit and cash flow before dep. and taxes [$154,666,667 x (1.0 - 0.20)] Annual taxes without tax shield (0.34 tax rate) Initial investment Annual depreciation (75-year life) Depreciation tax shield ($15,333,333 x 0.34) Annual profit after depreciation without taxes Annual after-tax cash flow with tax shield ($123,733,334 – 42,069,333 + 5,213,333)

$11,600,000,000 $ 154,666,667 $ 123,733,334 $ 42,069,333 $ 1,150,000,000 $ 15,333,333 $ 5,213,333 $ 108,400,001 $

86,877,334

a. Payback period without taxes: $1,150,000,000 / $123,733,334 = 9.29 years b. Accounting rate of return on initial investment without taxes: $108,400,001 / $1,150,000,000 = 9.426 percent c. Accounting rate of return on initial investment with taxes: ($108,400,001 – 42,069,333 + 5,213,333) / $1,150,000,000 = 6.221 percent d. Internal rate of return in the absence of taxes: Cash flow time zero ($1,150,000,000) Cash flow n=1 through 75 123,733,334 IRR 10.754 percent e. Internal rate of return with taxes: Cash flow time zero Cash flow n=1 through 75 IRR

($1,150,000,000) 86,877,334 7.522 percent

Financial & Managerial Accounting for Decision Makers, 4th Edition

Strictly from the viewpoint of the preceding financial analysis, it appears that the receipt of $1.15 billion in 2008 is consistent, on a time-adjusted basis, with revenues of $11.6 billion over a period of 75 years. A 7.5% internal rate of return would normally be considered reasonable. It is also worth noting that the partnership’s investment has a payback period of more than nine years. Of course, the future revenues are subject to uncertainty. If the partnership has the right to increase hourly rates, increase the hours requiring fees, and shrink the size of parking spaces to increase the number of parking slots, the future profitability of the lease could be significantly enhanced at a significant cost to city residents. It is not clear if the city lost the right to make street renovations that might increase or reduce the number of parking spaces. Relinquishing this right could severely handicap urban development and renovation. It is also not clear if there are restrictions on any actions the city might take to increase the number of available parking spaces, perhaps by building one or more parking garages. Perhaps the biggest criticism of arrangements such as this is the use of a “one-shot” deal to balance the current budget of a government body. Recall that such budgets are based primarily on balancing cash receipts and disbursements rather than on accrual concepts used by business. This allows a government unit to relinquish future revenues in exchange for a current lump-sum receipt and identify the receipt as a “revenue” for budget purposes.

C24-37. a. Possible lease payments with the given residual values, interest rate, and down payment are as follows: Note: The down payment reduces PV in all computations. Lease Period 2 years 3 years 4 years 5 years

Monthly Payment $481.17 414.96 388.12 381.99

The 4 and 5 year lease terms meet the desired maximum down payment of $500 and the desired maximum monthly payment of $400. Continued

24-25

a. continued Visual of spreadsheet model:

b. Possible lease payments with a $1,000 down payment. Lease Period 2 years 3 years 4 years 5 years

Monthly Payment $457.86 398.52 375.09 370.98

With a $1,000 down payment, the three, four, and five-year lease meet the maximum monthly payment criterion. c. Payments with a $500 payment and a $1,000 increase in residual value: Lease Period 2 years 3 years 4 years 5 years

Monthly Payment $444.46 391.97 371.95 369.87

With a $1,000 increase in residuals, the three, four, and five-year lease models meet both the down payment and payment maximums.

Financial & Managerial Accounting for Decision Makers, 4th Edition

d. Payments with a $1,000 increase in residual value and a $1,000 down payment. Lease Period 2 years 3 years 4 years 5 years

Monthly Payment $421.16 375.53 358.91 358.86

Here, all combinations other than the two year lease meet the maximum payment requirement. However, all options are above the desired maximum down payment. The recommended solution is to offer four and five-year lease options with $500 down payment requirements. The case states that Challengers are increasing in popularity. And the analysis indicates that if the residual value increases by $1,000, they could also offer a 3 year lease. However, if the residual estimates are too high, Avant-Garde might lose money on the leases. The cost of the Challenger included in the lease computations is based on the average resale price of a new car. From a long-run perspective, this seems reasonable. In the short run, this assumes all cars can be sold at the stated resale price. The stated resale price is the opportunity cost. If there are excess cars available, the cost of the car, delivered to a lease, might be a better cost basis. No cost information is given in the problem. It would be an interesting exercise to “run” the numbers with some other present values. At this point, the instructor can easily move into a review of relevant costs, the economics of auto leasing, and the wisdom of automobile manufacturers who use out-ofpocket costs in lease computations. The instructor can also review transfer pricing.

24-27

C24-38. This case is based on “Upgrades That Pay,” by Ron White in the November 1994 issue of PC Computing, pp. 196-215. It has been modified to recognize the increase in standard monitor size. The instructor might wish to discuss the reasonableness of the set of tasks and whether or not the productivity gain will be realized. You might even have students perform similar experiments with other computer components such as modems. They will have to determine the tasks, the pay rates, the cost of the modems, possible savings in connect time, and so forth. If the dollars involved seem too small, it is easy to “factor them up” by assuming that you are making a decision for an entire organization and the purchase will involve hundreds of computers. The case is interesting because it helps get students thinking about issues in predicting costs for an investment decision to which they can relate. a. Additional information required to find the payback period includes: •

The incremental cost of the monitor and card

•

The pay rate for a manager

•

The amount of time a manager would have spent using the computer without the larger monitor and faster video card

b. The following amounts were assumed in the magazine article: •

The incremental cost of the monitor and card, $1,200

•

The pay rate for a manager, $50 per hour

•

The amount of time a manager would have spent using the computer without the larger monitor and faster video card, 60 hours per month

Value of annual productivity gain = 60 hours x 12 months x $50 per hour x 0.09 = $3,240 Investment = $1,200 Payback = $1,200/$3,240 = 0.37 years, or about 4.4 months. Note: With a payback period of 4.4 months and a life expectancy of several years, there is no need to use more complex capital budgeting models.

Financial & Managerial Accounting for Decision Makers, 4th Edition

C24-39. a. The project is acceptable because it has an IRR greater than 16 percent and a positive net present value when discounted at 16 percent. Increase in yearly cash receipts (600,000 / 2) x $9.00 Increase in yearly cash disbursements: Variable [(600,000 / 2) x $5] $1,500,000 Fixed ($175,000 x 5) 875,000 Increase in annual operating cash inflows

$ 2,700,000

(2,375,000) $ 325,000

Internal rate of return: Factor = $1,000,000 / $325,000 = 3.07692 For n = 5, this factor provides an internal rate of return slightly greater than 18% (18%: 3.12717 and 20%: 2.99061).

Initial investment: Operations Net present value

Predicted Cash Inflows (Outflows) (A) $(1,000,000) 325,000

Year(s) of Cash Flows (B) 0 1-5

16% Present Value Present Value of Factor Cash Flows (A)  (C) (C) 1.000 $(1,000,000) 3.27429 1,064,144 $ 64,144

b. While the project is desirable using capital budgeting models, the project will not produce a return of 16 percent on fixed assets during the first year of operations, a year that is critical for Mr. Light’s promotion. Annual cash flows Annual depreciation $1,000,000/5 Net income

$325,000 (200,000) $125,000

First year return on fixed assets = $125,000 / 1,000,000 = 12.5% This is an example of a situation where performance measures may lead to dysfunctional results.

24-29

C24-40. a. Bayside should comply with the new federal regulations. Treating the initial investment as a sunk cost, the net present value of making the additional investment exceeds the proceeds from selling the plant. Present value of selling the plant, using the end of the year as time zero: Cash from sale of plant Tax shield of loss on sale: Selling price Book value ($910,000 − 162,000 dep.) Loss Tax shield Proceeds from selling plant

$350,000 $ 350,000 (748,000)* $ 398,000 x 0.21

83,580 $433,580

*Total initial investment in fixed assets ($810,000) and working capital ($100,000); depreciation is $810K/5 years)

Present value of making additional investment, using the end of the current year as time zero:

Initial investment: Fixed assets Operations: Annual taxable income without depreciation Taxes on income ($310,000  0.21) Dep. tax shield – original Dep. tax shield - additional* Disinvestment: Site restoration Tax shield of restoration ($80,000  0.21) Working capital Net present value of all cash flows *Computation of additional depreciation tax shield: Annual straight-line depreciation ($300,000 / 4) Tax rate Depreciation tax shield

Predicted Cash Inflows (Outflows)

Years of Cash Flows

12% Present Value Factor

Present Value of Cash Flows

$(300,000)

1.00000

$(300,000)

310,000 (65,100) 34,020 15,750

1-4 1-4 1-4 1-4

3.03735 3.03735 3.03735 3.03735

941,579 (197,731) 103,331 47,838

(80,000)

0.63552

(50,842)

16,800 100,000

4 4

0.63552 0.63552

10,677 63,552 $618,404

$75,000 x 0.21 $15,750

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. Bayside should not have accepted the proposal if they were aware of the forthcoming regulations. In this case, with the amount of the initial investment treated as a relevant cost, the project has a negative net present value. Present value of investment and meeting regulations using the end of Year 1 as time zero: Predicted Cash Inflows (Outflows) Initial investment: Fixed assets Working capital Additional investment Operations: Annual taxable income without depreciation Taxes on income ($310,000  0.21) Original Dep. tax shield Additional Dep. tax shield Disinvestment: Site restoration Tax shield of restoration ($80,000  0.21) Working capital Net present value of all cash flows

Year(s) of Cash Flows

12% Present Value Factor

Present Value of Cash Flows

$(810,000) (100,000) (300,000)

0 0 1

1.00000 1.00000 0.89286

$(810,000) (100,000) (267,858)

310,000

1-5

3.60478

1,117,482

(65,100) 34,020 15,750

1-5 1-5 2-5

3.60478 3.60478 (3.60478 − 0.89286)

(234,671) 122,635 42,713

(80,000)

0.56743

(45,394)

16,800 100,000

5 5

0.56743 0.56743

9,533 56,743 $(108,817)

c. The project’s net present value could be increased by using accelerated depreciation for tax purposes. From a policy perspective, the government could institute an investment tax credit for investments in equipment to reduce pollution. This would also increase the project’s net present value.

24-31

C24-41. a. Anthony should accept the proposal because it has a net present value of $29,842. Predicted Cash Inflows (Outflows)

Year(s) of Cash Flows

14% Present Value Factor

Present Value of Cash Flows

$(350,000) (75,000)

0 0

1.00000 1.00000

$(350,000) (75,000)

125,000 60,000

1-3 4-6

2.32163 (3.88867−2.32163)

290,204 94,022

80,000 75,000

6 6

0.45559 0.45559

36,447 34,169 29,842

Initial investment: Facilities Working capital Operations: 20X1-20X3 20X4-20X6 Disinvestment: Facilities Working capital Net present value

b. Given the currently available information, the proposal should not have been accepted. It has a negative net present value of $82,938. Predicted Cash Inflows (Outflows)

Year(s) of Cash Flows

14% Present Value Factor

Present Value of Cash Flows

$(250,000)

1.00000

$(250,000)

(150,000) (75,000) $(225,000)

0.87719

(197,368)

$150,000 125,000 60,000

2 3 4-6

0.76947 0.67497 (3.88867−2.32163)

115,421 84,371 94,022

80,000 75,000 $ 155,000

0.45559

70,616 $ (82,938)

Initial investment: 20X0: Facilities 20X1: Facilities Working capital Total Operations: 20X2 20X3 20X4-20X6 Disinvestment: Facilities Working capital Net present value

Financial & Managerial Accounting for Decision Makers, 4th Edition

c. The project should be continued because it has a positive net present value of $74,340. As of January 1, 20X1 the $250,000 spent in 20X0 on the project is a sunk cost and not relevant to decisions about the future. The only relevant costs are future costs that differ depending on the actions of management. The current salvage value is a relevant cost.

Initial investment: Current salvage value 20X1: Facilities Working capital Total Operations: 20X2 20X3 20X4-20X6 Disinvestment: Facilities Working capital Net present value

Predicted Cash Inflows (Outflows)

Year(s) of Cash Flows

14% Present Value Factor

Present Value of Cash Flows

$(95,000)

1.00000

$ (95,000)

$(150,000) (75,000) $(225,000)

0.87719

(197,368)

$150,000 125,000 60,000

2 3 4-6

0.76947 0.67497 (3.88867−2.32163)

115,421 84,371 94,022

$ 85,000 75,000 $ 160,000

0.45559

72,894 $ 74,340

24-33

C24-42. a. 1. Current annual net cash inflow: Net income Depreciation Net cash inflow

$ 15,400 66,000 $ 81,400

2. Predicted annual net cash inflow:

Sales Expenses: Cost of food Supplies Employee expenses: Variable Fixed Utilities: Variable Fixed Property taxes Insurance Advertising Total Net cash inflow

Current $495,000

Adjustment 1.30

Predicted $643,500

165,000 22,000

x x

1.40 1.40

231,000 30,800

77,000 77,000

x x

1.40 1.00

107,800 77,000

15,400 15,400 22,000 11,000 8,800 (413,600) $ 81,400

x x x x +

1.40 1.00 1.00 1.00 $10,000

21,560 15,400 22,000 11,000 18,800 (535,360) $ 108,140

b. Present value of cash flows for 15 years at 12 percent $108,140 x 6.81086 Present value of demolition costs $88,000 x 0.18270 Maximum payment for restaurant

$736,526 (16,078) $720,448

c. Projected net cash inflow Effect of error in sales projection ($643,500 x 0.08) Effect of raise [($107,800 + $77,000) x 0.10] Actual cash flow

$ 108,140 (51,480) (18,480) $ 38,180

Present value of cash flows for 15 years at 12 percent ($38,180 x 6.81086) Present value of demolition costs ($88,000 x 0.18270) Maximum payment for restaurant

$260,039 (16,078) $243,961

Based on the actual cash flows, the investment decision was not a wise one. Ron should not have paid more than $243,961 for the restaurant.

Financial & Managerial Accounting for Decision Makers, 4th Edition

d. The alternatives under consideration are to: (1) sell the restaurant or (2) keep it and increase the annual marketing expenditures. A third option, keeping the restaurant but not making additional marketing expenditures, is not under consideration. In this part of the problem, the $450,000 Ron paid for the restaurant is a sunk cost. The $350,000, however, is an opportunity cost associated with keeping the restaurant. It can be viewed as similar to an initial investment. Projected net cash inflow Effect of raise [($107,800 + $77,000) x 0.10] Effect of increase in advertising expenditures Revised projection

$108,140 (18,480) (25,000) $ 64,660

Present value of cash flows for 15 years at 12 percent ($64,660 x 6.81086) Present value of demolition costs ($88,000 x 0.18270) Present value of restaurant

$440,390 (16,078) $424,312

Ron should keep the restaurant and make the additional expenditures. The net present value of keeping the restaurant exceeds the $350,000 offer.

24-35

Appendix A Compound Interest and the Time-Value of Money EXERCISES EA-1. a. Future value, 4%, 6 years: $4,000 x 1.26532 = $5,061.28 b. Future value, 6%, 6 years: $4,000 x 1.41852 = $5,674.08 c. Future value, 8%, 6 years: $4,000 x 1.58687 = $6,347.48

EA-2. a. Future value, 12%, 4 years: $7,500 x 1.57352 = $11,801.40 b. Future value, 3%, 16 quarters: $7,500 x 1.60471 = $12,035.33 c. Future value, 1%, 48 months: $7,500 x 1.61223 = $12,091.70 The last calculation relies on a future value factor that is not in the table at the end of Appendix A. The solution can be determined using a financial calculator or using Excel. The Excel calculation is as follows:

A-1

EA-3. Present value, 1% per quarter, 8 quarters: $14,000 x 0.92348 = $12,929.

EA-4. Present value, 6%, 4 years: $24,000 x 0.79209 = $19,010.

Financial & Managerial Accounting for Decision Makers, 4th Edition

EA-5. PV annuity, 1%, 36 months: $12,500/30.10751 = $415.18

EA-6.

The interest for the first month would be $12,500 x .01 = $125. The remaining $290.18 would go to reduce the loan balance.

EA-7. a. PV annuity, 2%, 24 quarters: $40,000 / 18.91393 = $2,114.84.

b. Approximate number of payments it would take paying $1,500 per month is 39.0 quarterly payments. ©Cambridge Business Publishers, 2021 Solutions Manual, Appendix A

A-1

EA-8. This problem requires computation as the future value of an annuity. This can be calculated from Table 1 as follows: Future value, 6%, 5 years ………. Future value, 6%, 4 years ………. Future value, 6%, 3 years ………. Future value, 6%, 2 years ………. Future value, 6%, 1 years ………. Total ………………………………...

1.33823 1.26248 1.19102 1.12360 1.06000 5.97533

Annual deposit x Future value factor = Future value Deposit x 5.97533 = $20 million; $20 million / 5.97533 = $3,347,095.47 per year.

EA-9. PV of an Annuity, 9%, 7 years: $60,000 x 5.03295 = $301,977.

2019 Revenue: In 2019 Ott, Inc. would recognize the present value of $301,977 as sales revenue, plus interest income for eight months (May 1 through December 31. Interest income would be equal to $18,119 ($301,977 x 9% x 8/12). 2020 Revenue: in 2020, Ott would recognize interest income of: ($301,977 x 9% x 4/12) + {[$301,977-($60,000 - $301,977x9%)] x 9%x8/12} = $25,209.

Financial & Managerial Accounting for Decision Makers, 4th Edition

EA-10. First, we must compute the payment due on December 1, 2021: Future value, 5%, 3 years: $10,000 x 1.15763 = $11,576.30. Next, we compute the present value of that payment at the market interest rate of 8%: Present value, 8%, 3 years: $11,576.30 x 0.79383 = $9,189.61. Finally, we compute the interest from December 1 through December 31, 2018: $9,189.61 x 0.08/12 = $61.26 Thus, in 2018, Rex Corporation would recognize sales revenue of $9,189.61 and interest income of $61.26.

EA-11. Present value, 12%, 10 years: $50,000 x 0.32197 = $16,099. PV annuity, 12%, 10 years: $200,000 x 5.65022 = $1,130,044. Maximum price Rye Company should be willing to pay is $1,130,044 + $16,099 = $1,146,143. Using Excel:

A-1

EA-12. If Debra Wilcox chooses 26 payments, she will receive $7 million/26 = $269,230.77 per year for 26 years, with the first payment due today. This is an annuity due. Equivalently, this can be structured as an annuity in arrears by recognizing that the present value factor for the first payment is 1.0. Thus, the annuity factor is 1.0 plus the present value of an annuity for 25 payments. a. PV annuity due, 8%, 25+1 payments: $269,230.77 x (1 + 10.67478) = $3,143,210.01 b. PV annuity due, 4%, 25+1 payments: $269,230.77 x (1 + 15.62208) = $4,475,175.40 c. If her opportunity cost of capital is 8%, Debra Wilcox should choose the lump sum of $3,500,000 rather than take the annuity. On the other hand, if her discount rate is 4%, the annuity gives a higher present value. One way to examine this problem is to ask what opportunity cost of capital (or discount rate) would make her indifferent between the two options. This is answered by solving for the rate at which the present value of the annuity is equal to $3,500,000. Using the rate function in Excel:

So, the rate at which Debra Wilcox would be indifferent between $3,500,000 as a lump sum payment and an annuity due of $269,230.77 for 26 payments is approximately 6.68% per year.

Financial & Managerial Accounting for Decision Makers, 4th Edition

EA-13. The answer depends on Ms. Reed’s opportunity cost of capital (discount rate). To determine the rate at which she would be indifferent between these two options, we divide the present value by the future value and consult Table 2: $60,000/$100,000 = 0.60000. From Table 2, the present value of $1 received five years in the future discounted at 10% is 0.62092. At 11%, the present value is 0.59345. Thus the discount rate at which she would be indifferent is between 10% and 11%. Alternatively, we can use the rate function in Excel:

The rate at which she would be indifferent is 10.76%. So, if her discount rate is higher than that, she should accept the $60,000 today. If her rate is less than 10.76%, she should choose the deferred payment of $100,000.

A-1

EA-14. This calculation (and the calculation in A13) can be done with either the present value or future value tables, depending on which value is placed in the numerator and which is in the denominator. Using the present value tables: $400,000/$955,000 = 0.41885 The present value factor for 11%, 8 years is 0.43393. The present value factor for 12%, 8 years is 0.40388. Hence, the required rate of return on the investment is between 11% and 12%. Using Excel, we can determine the exact rate:

Financial & Managerial Accounting for Decision Makers, 4th Edition

EA-15. This question can be answered by adding the future values at 12%:

Date: July 1, 2019 …………….. June 30, 2020 ………….. June 30, 2021 ………….. June 30, 2022 ………….. June 30, 2023 ………….. Value on June 30, 2023

Amount Deposited

Future Value Factor

$360,000 60,000 60,000 60,000 60,000

1.57352 1.40493 1.25440 1.12000 1.00000

Future Value $566,467 84,296 75,264 67,200 60,000 $853,227

EA-16. a. Present value of an annuity, 5% per half-year, 20 half-years: Payment = $10,000,000/12.46221 = $802,425.89 b. $10,000,000 x 5% = $500,000. c. Present value of an annuity, 5% per half-year, 10 half-years: $802,425.89 x 7.72173 = $6,196,116.07

EA-17. a. (i) Present value 2%, 10 periods: $200,000 x 0.82035 = $164,070 PV annuity, 2%, 10 periods: ($200,000x.05/2) x 8.98259 = $44,913 $164,070 + $44,913 = $208,983.

continued next page

A-1

(ii) Present value 3%, 10 periods: $200,000 x 0.74409 = $148,818 PV annuity, 3%, 10 periods: ($200,000x.05/2) x 8.53020 = $42,651 $148,818 + $42,651 = $191,469.

Financial & Managerial Accounting for Decision Makers, 4th Edition

b. Present value 4%, 6 periods: $200,000 x 0.79031 = $158,062 PV annuity, 4%, 6 periods: ($200,000x.05/2) x 5.24214 = $26,211 $158,062 + $26,211 = $184,273.

A-1

EA-18. a. PV annuity, 9%, 20 years: $450,000 x 9.12855 = $4,107,847.50

b. PV annuity due, 9%, 19+1 years: $450,000 x (1+ 8.95011) = $4,477,549.50

Financial & Managerial Accounting for Decision Makers, 4th Edition

EA-19. a. A: 1 + PV annuity, 5%, 5 years: $8,000 x (1 + 4.32948) = $42,635.84 B: PV annuity, 5%, 5 years: $9,000 x 4.32948 = $38,965.32 PV annuity, 5%, 2 years: $2,000 x 1.85941 = $3,718.82 $38,965.32 + $3,718.82 = $42,684.14 at 5% interest. Alternative A appears to be the cheaper alternative. b. A: 1 + PV annuity, 7%, 5 years: $8,000 x (1 + 4.10020) = $40,801.60 B: PV annuity, 7%, 5 years: $9,000 x 4.10020 = $36,901.80 PV annuity, 7%, 2 years: $2,000 x 1.80802 = $3,616.04 $36,901.80 + $3,616.04 = $40,517.84. Alternative B appears to be the cheaper alternative at 7% interest.

EA-20. A: PV annuity 2%, 24 quarters: $3,000 x 18.91393 = $56,741.79 B: PV annuity 8%, 5 years: $14,300 x 3.99271 = $57,095.75 Payment alternative A appears to be cheaper at an 8% discount rate. However, this is misleading because the effective discount rate is higher in alternative A. If the same discount rate (2% compounded quarterly) is used for both calculations, the annuity factor for alternative B would be lower. To compute the appropriate discount rate, add the present value of a single payment for each of the five payments as follows: 2%, 4 quarters 2%, 8 quarters 2%, 12 quarters 2%, 16 quarters 2%, 20 quarters Total

0.92385 0.85349 0.78849 0.72845 0.67297 3.96725

$14,300 x 3.96725 = $56,731.68, hence, alternative B is slightly cheaper.

A-1

EA-21 a. The future value factor from Table 4 for 40 periods and 4% interest is 98.8265, so the future value of Samuel’s $2,400 annual contributions would be $237,183.60. b. If Samuel waits 10 years, then the accumulation will only be over 30 years, which has a future value factor of 58.3283 in Table 4. Therefore, the accumulation will be $139,987.92, almost $100,000 less. c. If Samuel can earn 5% per year on his investments, then Table 4 shows a future value factor of 126.8398, which would turn the $2,400 investments into $304,415.52.

EA-22 The Table 4 future value factor for 36 periods at 1% interest per period is 43.5076, so Janice Utley’s $1,000 monthly investments would accumulate to $43,507.60 after 36 months.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Appendix B Data Analytics and Blockchain Technology EXERCISES EB-1. Using Microsoft Excel for descriptive analytics (LO1, 2) a. Mean salary: $34,419.57 b. Median salary: $28,875 c. Minimum salary: $15,750 d. Maximum salary: $135,000 e. Number of observations: 474

EB-2. Using the Microsoft Excel PivotTable function for descriptive analytics (LO1, 2) a. While not the case in all observations, in general there appears to be a very pronounced upward trend in average salaries with higher education levels. This trend is more pronounced for males (gender = 1) than females (gender = 0). b. At nearly every education level males earn a higher average salary than females. c. For nearly every education level, non-minorities (minority = 0) earn higher average salaries than minorities (minority = 1). This holds for both genders. d. The overall average salary for the entire population is $34,419.57. For males the average salary is $41,441.78 and for females the average salary is $26,031.92. The overall average salary for male minorities is $32,246.09 and for female minorities the average salary is $23,062.50.

B-3

EB-3. Using Microsoft Excel for diagnostic analytics (LO1, 2) a. The reported adjusted R-squared of 0.50 indicates that 50 percent of the variation in average salaries is explained by the three variables, gender, minority status, and education level. b. All three variables had t Stats greater than 2, and therefore generally considered significant. Gender and education had positive t Stats, indicating that males with more education earn higher average salaries. The minority indicator variable had a negative value indicating that minority status is associated with lower average salaries.

EB-4. Using Tableau to create summary statistics (LO1, 2) a. The average salary of males exceeds the average salary for females for both minorities and non-minorities. In addition, the average salary of Caucasians exceeds the average salary of minorities for both males and females. b. In general, although not in every instance, higher levels of education are associated with higher average salaries for both genders and minority status. c. Consistent with the findings for average salaries, higher levels of education are generally, but not in every instance, associated with higher average salaries for both genders and minority status.

EB-5. Using Tableau to calculate a visualization (LO1, 2) The visualization provides an easier to visualize graphic of the association between education levels and both gender and minority status. In general, although not in every instance, higher levels of education are associated with higher average salaries for both genders and minority status.

EB-6. Using Tableau to forecast future values (LO1, 2) At 100 months of Job time, the forecast of average salary for males of $42,085 exceeds the average salary for females of $26,711 by $15,374.

EB-7. Public accounting firms and data analytics (LO1, 2) Students’ answers will vary depending on the item chosen.

Financial & Managerial Accounting for Decision Makers, 4th Edition

EB-8. Public accounting firms and data analytics (LO1, 2) Students’ answers will vary depending on the item chosen.

EB-9. Public accounting firms and data analytics (LO1, 2) Students’ answers will vary depending on the item chosen.

EB-10. Public accounting firms and data analytics (LO1, 2) Students’ answers will vary depending on the item chosen.

EB-11. Public accounting firms and blockchain technology (LO3, 4) Students’ answers will vary depending on the item chosen.

EB-12. Public accounting firms and blockchain technology (LO3, 4) Students’ answers will vary depending on the item chosen.

EB-13. Public accounting firms and blockchain technology (LO3, 4) Students’ answers will vary depending on the item chosen.

EB-14. Public accounting firms and blockchain technology (LO3, 4) Students’ answers will vary depending on the item chosen.

B-3