Solutions Manual for Financial Accounting 13th edition By William Thomas, Wendy Tietz by ACADEMIAMILL

SOLUTIONS MANUAL

Chapter 1 The Financial Statements Ethics Check (5-10 min.) EC 1-1 a. Objectivity and independence b. Due care c. Integrity d. Integrity

Chapter 1

The Financial Statements 1-1

Short Exercises (10 min.) S 1-1 a. Corporation,

limited

partners

Limited-liability

partnership (LLP) and Limited-liability company (LLC). If any of these businesses fails and cannot pay its liabilities, creditors cannot force the owners to pay the business’s debts from the owners’ personal assets. Creditors can go after the general partner of a limited liability partnership. b. Proprietorship. There is a single owner of the business, so the owner is answerable to no other owner. c. Partnership. If the partnership fails and cannot pay its liabilities, creditors can force the partners to pay the business’s

debts

from

their

personal

assets.

partnership affords more protection for creditors than a proprietorship because there are two or more owners to share this liability.

(5 min.) S 1-2 1. The entity assumption applies. 2. Application of the entity assumption will separate Osmond’s personal assets from the assets of Simple Treats, Inc. This will help Osmond, investors, and Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-2

lenders know how much assets, liabilities and equity the business has, and this knowledge will help all parties evaluate the business realistically. (5-10 min.) S 1-3 a.

Stable-monetary-unit assumption

Historical cost principle; $300 is the accounting value of the laptop

Historical cost principle; the sale price is the amount actually received from the sale

Entity assumption

(10 min.) S 1-4 Computed amounts in boxes Total Assets =

Total Liabilities

Stockholders’ Equity

$660,000

$300,000

$360,000

85,000

50,000

35,000

350,000

75,000

275,000

(5 min.) S 1-5 1. Liabilities = Assets − Owners’ Equity

Chapter 1

The Financial Statements 1-3

2. Owners’ Equity = Assets − Liabilities This way of determining the amount of owners’ equity applies to any company or your household. (5-10 min.) S 1-6 a. Land

g. Retained earnings

b. Accrued expenses payable L

h. Prepaid expenses

c. Supplies

i. Accounts payable

d. Equipment

j. Accounts receivable A

e. Notes payable f. Long-term debt

L L

k. Merchandise inventory A l. Common stock

(5-10 min.) S 1-7 1. Assets are the economic resources of a business that are expected to produce a benefit in the future.

Owners’ (stockholders’) equity represents the insider claims of a business, the owners’ interest in its assets. Assets and owners’ equity differ in that assets are

resources and owners’ equity is a claim to assets. Assets must be at least as large as owners’ equity, so equity can be smaller than assets.

Chapter 1

The Financial Statements 1-4

2. Both liabilities and owners’ (stockholders’) equity are

claims to assets. Liabilities are the outsider claims to the assets of a business; they are obligations to pay creditors. Owners’ equity represents the insider claims to the assets of the business; they are the owners’ interest in its assets. (5 min.) S 1-8 1. Revenues and expenses

2. Net income (or net loss)

(10 min.) S 1-9 a.

Salary expense

Dividends

Accounts payable

Net income

Common stock

Inventory

Interest revenue

Cash

Retained earnings

Long-term debt

Increase or decrease in cash

Net cash provided by operating activities

R, C B

I, R, C B B I

B, C R, B B

Chapter 1

C C

The Financial Statements 1-5

m. n.

Sales revenue

Net cash used for financing activities

(15-20 min.) S 1-10 a. Paying large dividends will cause retained earnings to be low. b. Heavy investing activity and paying off debts can result in a cash shortage even if net income has been high. c. The single best source of cash for a business is operating activities.

This source of cash is best because it results

from the core operations of the business. Operating activities should be the main source of cash for a business.

d. Borrowing, issuing stock, and selling land, buildings, and equipment can bring in cash even when the company has experienced losses.

Reducing accounts receivable and

inventory can also increase cash flow.

Chapter 1

The Financial Statements 1-6

(5 min.) S 1-11 a.

(5 min.) S 1-12 MacKensie Services, Inc. Income Statement Year Ended December 31, 2021

(millions)

Revenues .......................................

$394

Expenses........................................

171

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

$223

(5 min.) S 1-13 Journey Corporation Statement of Retained Earnings Year Ended December 31, 2021

(millions)

Retained earnings, December 31, 2020 Add: Net income ($460 − $380) ......

Chapter 1

$270 80

The Financial Statements 1-7

Less: Dividends declared................. Retained earnings, December 31, 2021

(64) $286

(10-15 min.) S 1-14 Jackson Corporation Balance Sheet December 31, 2021

(in millions)

ASSETS Current assets: Cash ........................................................

$ 52

Accounts receivable .................................

Total current assets .................................

Long-term assets .........................................

Total assets .................................................

$120

Chapter 1

$ 21

The Financial Statements 1-8

Total current liabilities .............................

Long-term liabilities: Long-term notes payable..........................

Total liabilities .............................................

STOCKHOLDERS’ EQUITY Common stock .............................................

Retained earnings ........................................

Total stockholders’ equity ............................

Total liabilities and stockholders’ equity .......

$120

Chapter 1

The Financial Statements 1-9

(10-15 min.) S 1-15 Sullivan Corporation Balance Sheet September 30, 2021 (in millions)

ASSETS Current assets: Cash ........................................................

$ 78

Accounts receivable .................................

Total current assets .................................

105

Property and equipment...............................

Other long-term assets.................................

Total assets .................................................

$153

LIABILITIES Current liabilities: Accounts payable .....................................

$ 34

Total current liabilities .............................

Long-term liabilities: Long-term notes payable..........................

Total liabilities .............................................

STOCKHOLDERS’ EQUITY Common stock .............................................

Retained earnings ........................................

71*

Total stockholders’ equity ............................

102

Total liabilities and stockholders’ equity .......

$153

Chapter 1

The Financial Statements 1-10

Or, total stockholders’ equity ($102) – common stock ($31) = $71

Chapter 1

The Financial Statements 1-11

(10-15 min.) S 1-16 Python Legal Services, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income ...............................................$115,000 Adjustments to reconcile net income to net cash provided by operating activities ..............................................

(9,000)

Net cash provided by operating 106,000 activities...................................................... Cash flows from investing activities: Purchases of equipment .......... $(20,000) Net cash used for investing activities.. (20,000) Cash flows from financing activities: Payment of dividends .............. $(15,000) Net cash used for financing activities.. (15,000) Net increase in cash ..................................... 71,000 Cash balance, December 31, 2020 .................

16,000

Cash balance, December 31, 2021 .................$ 87,000

Chapter 1

The Financial Statements 1-12

(10-15 min.) S 1-17 Solve in this order: a.

$82

$149

g. $182 h. $230 e. $230 d. $112

(5 min.) S 1-18 Ethics is a factor that should be included in every business and accounting decision, beyond the potential economic and legal consequences.

Ideally, for each decision,

honesty and truthfulness should prevail, considering the rights of others. The decision guidelines at the end of the chapter spell out the considerations we should take when making decisions.

Simply, we might ask ourselves three

questions: (1) Is the action legal? (2) Who will be affected by the decision? (3) How will the decision make me feel afterward?

Chapter 1

The Financial Statements 1-13

(10-15 min.) S 1-19 Asset (m)

Economic resources that are expected to produce a benefit

in the future Balance sheet (l)

Also called the statement of

financial Position Bookkeeping (k)

Mechanical part of accounting

Corporation (f)

Owned by stockholders whose liability is limited to the amount they have invested in the business

Equity (r)

Insider claims of a business

Ethical duties (d)

Responsibilities of the

members of society to each other Expenses (h)

Costs of doing business

Financial accounting (b) Provides information for decision makers outside of the organization

Chapter 1

The Financial Statements 1-14

Historical cost principle (j)States that assets should be recorded at their actual cost on the date of purchase Income statement (o)

Answers the question “How

well did the company perform during the period?” Investors and creditors (n)

Entities that provide

money to finance a company’s operations Liability (g)

A debt payable to an

outsider (continued) S 1-19

Managerial accounting (c) Provides information for managers of the organization Net income (a)

Total revenues minus total

expenses Partnership (q)

A business organization form

with

Chapter 1

The Financial Statements 1-15

two or more owners who are each personally liable for all of the business’s debts Proprietorship (i)

A business organization form with a single owner who is personally liable for all of the business’s debts

Revenues (e)

Inflows of resources resulting from delivering goods or services to customers

Statement of cash flows (p) Reports cash flows from operating, investing, and financing activities

(5-10 min.) S 1-20 1.

Insert Function dialog box 6. Artificial intelligence

Formula bar

Spreadsheet 3.

Spreadsheet

Data analytics

Machine learning 4.

Robotic process automation

Chapter 1

The Financial Statements 1-16

Active cell

10. Ribbon (5-10 min.) S 1-21

1. Active cell (J)

7. Column header letters

8. Zoom slider (A)

3. Row header numbers (G)

9. Ribbon tabs (H)

4. Worksheet tabs (K)

10. Quick Access toolbar

(E) 5. Ribbon (I)

11. Insert Function dialog box

(D) 6. File name (B)

12. Formula bar (L)

Chapter 1

The Financial Statements 1-17

Exercises (10-15 min.) E 1-22A Amounts in billions; (computed amounts in boxes)

Assets Smythe Real Estate Odessa Florals Hometown Bank

$73 26 29

Stockholders’ = Liabilitie + Equity s $41 $32 15 11 14 15

Odessa Florals appears to have the strongest financial position because its liabilities make up the smallest percentage of company assets ($11/$26 = .42). Stated differently,

Odessa

Florals’

equity

the

highest

percentage of company assets ($15/$26 = .58). Liabilities as a percent of total assets: Smythe Real Estate: $41/$73 = 0.56 Odessa Florals: $11/$26 = 0.42 Hometown Bank: $14/$29 = 0.48

(10-15 min.) E 1-23A

Req. 1

Chapter 1

The Financial Statements 1-18

(Amounts in millions)

Total

Assets $220 320 130 $670

Liabilities $160 380

Stockholders’ Equity

$540

$130

Req. 2 Resources Req. 3 to work with

Amount owed to creditors

Chapter 1

Req. 4

Actually owned by company stockholders

The Financial Statements 1-19

(10-20 min.) E 1-24A 1

Situation 2

(Millions)

Total stockholders’ equity, January 31, 2021 ($47 − $19) .......

$28

Add: Issuances of stock...................

-0-

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

13*

44*

84*

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

-0-

(75) (20)

Net loss ......................................

-0-

$52

Total stockholders’ equity, January 31, 2022 ($77 − $25) ....... _____ *Must solve for these amounts.

Chapter 1

The Financial Statements 1-20

(10-15 min.) E 1-25A a.

Income statement

Balance sheet

Statement of retained earnings, Statement of cash flows

Balance sheet, Statement of cash flows

Statement of cash flows

Income statement

Balance sheet, Statement of retained earnings

Income statement

Balance sheet

Income statement, Statement of retained earnings, Statement of cash flows

Balance sheet

Chapter 1

The Financial Statements 1-21

(10-20 min.) E 1-26A Landy Products Balance Sheet December 31, 2021 ASSETS Current assets: Cash ..........................................................

$ 24,000

Receivables................................................

18,000

Inventory ...................................................

80,000

Total current assets ...................................

122,000

Equipment......................................................

182,000

Total assets....................................................

$304,000

LIABILITIES Current liabilities: Accounts payable .......................................

$ 22,000

Total current liabilities ...............................

22,000

Long-term liabilities: Long-term notes payable ............................

172,000

Total liabilities ...............................................

194,000

STOCKHOLDERS’ EQUITY Common stock................................................

34,500

Retained earnings ..........................................

75,500*

Total stockholders’ equity...............................

110,000

Total liabilities and stockholders’ equity.......... _____ *Computation of retained earnings:

$304,000

Chapter 1

The Financial Statements 1-22

Total assets ($304,000) − current liabilities ($22,000) − long-term notes payable ($172,000) − common stock ($34,500) = $75,500

(10-20 min.) E 1-27A

Req. 1

Jill Carlson Realty Company Balance Sheet January 31, 2021

(Amounts in millions) ASSETS Cash

LIABILITIES $

Current liabilities 57.2

Receivables

0.5 Long-term liabilities

Investment assets (long-term)

79.4

Property and equipment, net Other assets (longterm)

Total liabilities

2.9 102.6 105.5

1.6 STOCKHOLDERS’

9.3

EQUITY Common stock

39.2

Retained earnings

3.3*

Total stockholders’ equity

42.5

Total liabilities and Total assets

$148 .0

stockholders’ equity $148. 0

_____ *Computation of retained earnings: Total assets ($148.0) − Total liabilities ($105.5) − Common stock ($39.2) = $3.3

Chapter 1

The Financial Statements 1-23

Chapter 1

The Financial Statements 1-24

(15-25 min.) E 1-28A

Req. 1 Jill Carlson Realty Company Income Statement Year Ended January 31, 2021

(Amounts in millions)

Total revenue ............................................

$25.7

Expenses: Salary and other employee $13.7 expenses................................................... Other expenses ..................................... 7.6 Interest expense ................................... 1.5 Total expenses ......................................

22.8

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

$2.9

Req. 2 The statement of retained earnings helps to compute dividends, as follows: Jill Carlson Realty Company Statement of Retained Earnings Year Ended January 31, 2021

(Amounts in millions)

Retained earnings, beginning of year ..................

$2.6

Add: Net income for the year (Req. 1)..................

2.9

Subtotal

5.5

Less: Dividends declared**..................................

2.2

Retained earnings, end of year (from Exercise 127A)...................................................................

$3.3

Chapter 1

The Financial Statements 1-25

**($5.5 – $3.3 = $2.2)

Chapter 1

The Financial Statements 1-26

(15-20 min.) E 1-29A

Req. 1

Giada Coffee Roasters Corp. Income Statement For the Month Ended August 31, 2022

Revenue: Service revenue .............................

$278,70 0

Expenses: Salary expense .............................. $78,50 0 Utilities expense ............................

5,100

Rent expense ................................. 1,800 Total expenses............................... 85,400 Net income........................................

$193,30 0

Giada Coffee Roasters Corp. Statement of Retained Earnings For the Month Ended August 31, 2022 Retained earnings, August 1, 2022 ...........

Add: Net income for the month ................

193,300

Subtotal

193,300

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

-0-

(2,800)

Retained earnings, August 31, 2022 ......... $190,500

Chapter 1

The Financial Statements 1-27

(15-20 min.) E 1-30A

Req. 1 Giada Coffee Roasters Corp. Balance Sheet August 31, 2022 Assets Liabilities Cash ..................... $ Accounts payable ............. $ 5,300 8,800 Office supplies ...... 7,400 Equipment ............ 201,50 Stockholders’ Equity 0 Common stock .................. 14,900 Retained earnings ............ 190,500 Total stockholders’ equity 205,400 Total liabilities and Total assets ..........

$214,2 00

stockholders’ equity ......

Chapter 1

$214,20 0

The Financial Statements 1-28

(15-20 min.) E 1-31A

Req. 1 Giada Coffee Roasters Corp. Statement of Cash Flows For the Month Ended August 31, 2022 Cash flows from operating activities: Net income ........................................... $193,30 0 Adjustments to reconcile net income to net cash provided by operating activities... 1,400 Net cash provided by operating activities .................................................

194,700

Cash flows from investing activities: Acquisition of equipment ...................... $(201,500 ) Net cash used for investing activities.

(201,500 )

Cash flows from financing activities: Issuance (sale) of stock to owners ......... Payment of dividends ...........................

$ 14,900 (2,800)

Net cash provided by financing activities .................................................

12,100

Net increase in cash .................................

$ 5,300

Chapter 1

The Financial Statements 1-29

Cash balance, August 1, 2022 ................... 0 Cash balance, August 31, 2022 .................

Chapter 1

$ 5,300

The Financial Statements 1-30

(10-15 min.) E 1-32A TO:

Owner of Giada Coffee Roasters Corp.

FROM:

Student Name

SUBJECT: Your

Opinion of net income, dividends, financial position, and cash flows first

month

operations

was

successful.

Revenues totaled $278,700 and net income was $193,300. These operating results look very strong. The company was able to pay a $2,800 dividend, and this should make you happy with so quick a return on your investment. Your financial position looks secure, with assets of $214,200 and liabilities of only $8,800. Your stockholders’ equity is $205,400. Operating activities generated cash of $194,700, which is outstanding. Operating activities are the main source of cash, which is expected for a thriving company. You ended the month with cash of $5,300. Based on the above facts, I believe you should stay in business.

Student responses may vary.

Chapter 1

The Financial Statements 1-31

(20-25 min.) E 1-33A

Req. 1

Edwin Company Income Statement For the Year Ended December 31, 2021

(million s)

Revenue: Revenues.......................................

$150

Expenses: Salary expense ..............................

$34

Rent expense .................................

Utilities expense ............................

Total expenses...............................

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

$ 77

Req. 2 Edwin Company Statement of Retained Earnings Year Ended December 31, 2021 Retained earnings, December 31, 2020

(millions) $ 73

Add: Net income ($150 − $73) ........

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

(16)

Retained earnings, December 31, 2021

Chapter 1

$134

The Financial Statements 1-32

(continued) E 1-33A

Req. 3 Edwin Company Balance Sheet December 31, 2021

(in millions)

ASSETS Current assets: Cash ........................................................

$185

Accounts receivable .................................

Total current assets .................................

255

Property and equipment...............................

Other long-term assets.................................

Total assets .................................................

$312

LIABILITIES Current liabilities: Accounts payable .....................................

$ 56

Total current liabilities .............................

Long-term liabilities: Long-term notes payable..........................

Total liabilities .............................................

STOCKHOLDERS’ EQUITY Common stock .............................................

96*

Retained earnings ........................................

134

Total stockholders’ equity ............................

230

Total liabilities and stockholders’ equity .......

$312

Chapter 1

The Financial Statements 1-33

*Common stock = Total stockholders’ equity ($230) – Retained earnings ($134) = $96

Chapter 1

The Financial Statements 1-34

(10-15 min.) E 1-34B

Amounts in billions; (computed amounts in boxes)

Water Street Bank Pufferbelly Restaurant Blake Gift Shop

Assets = $78 30

Liabilities $43 7

Stockholders’ + Equity $35 23 27

Blake Gift Shop appears to have the strongest financial position because its liabilities make up the smallest percentage of company assets ($7/$34 = .21). Stated differently,

Blake

Gift

Shop’s

equity

the

highest

percentage of company assets ($27/$34 = .79). Liabilities as a percent of total assets: Water Street Bank: $43/$78 = 0.55 Pufferbelly Restaurant: $7/$30 = 0.23 Blake Gift Shop: $7/$34 = 0.21

(10-15 min.) E 1-35B

Req. 1 (Amounts in millions)

Total

Assets $240 390 130 $760

Liabilities $100 360

Stockholders’ Equity

$460

$300

Chapter 1

The Financial Statements 1-35

Req. 2 Resources Req. 3 to work with

Amount owed to creditors

Chapter 1

Req. 4

Actually owned by company stockholders

The Financial Statements 1-36

(10-20 min.) E 1-36B

Total stockholders’ equity, January 31, 2021 ($49 − $17) ...... Add: ......................Issuances of stock Net income................................. Less: Dividends declared ................... Net loss ..................................... Total stockholders’ equity, January 31, 2022 ($72 − $23) ......

Situation 2

$32 3

$32 -0-

$32 20

14* -0-0-

21* (4) -0-

5* (8) -0-

$49

Millions

_____ *Must solve for these amounts.

Chapter 1

The Financial Statements 1-37

(10-15 min.) E 1-37B a.

Balance sheet, Statement of cash flows

Statement of cash flows

Balance sheet

Income statement, Statement of retained earnings, Statement of cash flows

Income statement

Balance sheet

Income statement

Balance sheet

Statement of cash flows

Income statement

Balance sheet

m. Statement of retained earnings, Statement of cash flows n.

Balance sheet, Statement of retained earnings

Chapter 1

The Financial Statements 1-38

(10-20 min.) E 1-38B Patterson Products Balance Sheet December 31, 2021 ASSETS Current assets: Cash ..........................................................

$ 20,000

Receivables................................................

17,600

Inventory ...................................................

78,000

Total current assets ...................................

115,600

Equipment......................................................

186,000

Total assets....................................................

$301,600

LIABILITIES Current liabilities: Accounts payable .......................................

$ 22,000

Total current liabilities ...............................

22,000

Long-term liabilities: Long-term notes payable ............................

173,000

Total liabilities ...............................................

195,000

STOCKHOLDERS’ EQUITY Common stock................................................

28,500

Retained earnings ..........................................

78,100*

Total stockholders’ equity...............................

106,600

Total liabilities and stockholders’ equity.......... _____ *Computation of retained earnings:

$301,600

Chapter 1

The Financial Statements 1-39

Total assets ($301,600) − current liabilities ($22,000) − long-term notes payable ($173,000) − common stock ($28,500) = $78,100

(10-20 min.) E 1-39B

Req. 1

Mary Burke Realty Company Balance Sheet March 31, 2021

(Amounts in millions) ASSETS Cash Receivables Investment assets Property and equipment, net Other assets

LIABILITIES $

1.6 Current liabilities .1 135.1

2.7

Long-term liabilities 102.3 Total liabilities

105.0

1.4 STOCKHOLDERS’ 10.3

EQUITY Common stock 27.9 Retained earnings 15.6* Total stockholders’ equity

43.5

______ Total liabilities and Total assets

$148.5

stockholders’ equity

$148 .5

_____ *Computation of retained earnings: Total assets ($148.5) − Total liabilities ($105.0) − Common stock ($27.9) = $15.6

Chapter 1

The Financial Statements 1-40

Chapter 1

The Financial Statements 1-41

(15-25 min.) E 1-40B

Req. 1 Mary Burke Realty Company Income Statement Year Ended March 31, 2021

(Amounts in millions)

Total revenue ...........................................

$40. 4

Expenses: Salary and other employee expenses.....

$ 15.2

Other expenses ....................................

6.6

Interest expense ..................................

0.4

Total expenses ..................................... 22.2 Net income ...............................................

$18. 2

Req. 2 The statement of retained earnings helps to compute dividends, as follows: Mary Burke Realty Company Statement of Retained Earnings Year Ended March 31, 2021 (Amounts in millions) Retained earnings, beginning of year………………………..

$17.2

Add: Net income for the year (Req. 1)………………………..

18.2

Subtotal

35.4

Chapter 1

The Financial Statements 1-42

Less: Dividends declared**…………………………………….

19.8

Retained earnings, end of year (from Exercise 139B)……

$15.6

**($35.4 – $15.6 = $19.8)

Chapter 1

The Financial Statements 1-43

(15-20 min.) E 1-41B

Req. 1

Island Coffee Roasters Corporation Income Statement For the Month Ended August 31, 2022

Revenue: Service revenue ………………………...

$279,30 0

Expenses: Salary expense ………………………….

$78,10 0

Utilities expense ………………………..

5,800

Rent expense ……………………………

1,800

Total expenses ………………………….

85,700

Net income ……………………………………...

$193,60 0

Island Coffee Roasters Corporation Statement of Retained Earnings For the Month Ended August 31, 2022 Retained earnings, August 1, 2022............

-0-

Add: Net income....................................... 193,600 Subtotal 193,600 Less: Dividends declared .......................... (2,700) Retained earnings, August 31, 2022 .......... $190,900

Chapter 1

The Financial Statements 1-44

(15-20 min.) E 1-42B

Req. 1

Island Coffee Roasters Corporation Balance Sheet August 31, 2022 Assets Liabilities

Cash.................

$ Accounts payable.......... $ 8,900 6,000

Office supplies ..

7,500

Equipment ........

200,00 Common stock .............. 0

Stockholders’ Equity 13,700

Retained earnings......... 190,900 Total stockholders’ 204,600 equity .......................... Total liabilities and Total assets ......

stockholders’ equity .. $213,5 00

$213,50 0

Chapter 1

The Financial Statements 1-45

(15-20 min.) E 1-43B

Req. 1

Island Coffee Roasters Corporation Statement of Cash Flows For the Month Ended August 31, 2022 Cash flows from operating activities: Net income .......................................... Adjustments to reconcile net income to net cash provided by operations ........ Net cash provided by operating activities Cash flows from investing activities: Acquisition of equipment...................

$193,60 0 1,400 195,000

$(200,00 0) Net cash used for investing activities..............................................

Chapter 1

(200,00 0)

The Financial Statements 1-46

Cash flows from financing activities: Issuance (sale) of stock to owners .....

$ 13,700

Payment of dividends........................ (2,700) Net cash provided by financing activities.. Net increase in cash .............................

11,000 $ 6,000

Cash balance, August 1, 2022 ............... 0 Cash balance, August 31, 2022 .............

Chapter 1

$ 6,000

The Financial Statements 1-47

(10-20 min.) E 1-44B TO:

Owner of Island Coffee Roasters Corporation

FROM:

Student Name

SUBJECT:

Opinion of net income, dividends, financial position, and cash flows

Your first month of operations was successful. Revenues totaled $279,300 and net income was $193,600. These operating results look very strong. The company was able to pay a $2,700 dividend, and this should make you happy with so quick a return on your investment.

Your financial position looks secure, with

assets of $213,500 and liabilities of only $8,900. Your stockholders’ equity is $204,600. Operating activities generated cash of $195,000, which is respectable. Operating activities are the main source of cash, which is expected for a thriving company. You ended the month with cash of $6,000. Based on the above facts, I believe you should stay in business.

Student responses may vary.

Chapter 1

The Financial Statements 1-48

Chapter 1

The Financial Statements 1-49

(20-25 min.) E 1-45B

Req. 1

Brewster Company Income Statement For the Year Ended December 31, 2021

(million s)

Revenue: Revenues.......................................

$146

Expenses: Salary expense ..............................

$28

Rent expense .................................

Utilities expense ............................

Total expenses...............................

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

$76

Req. 2

Brewster Company Statement of Retained Earnings Year Ended December 31, 2021

Retained earnings, December 31, 2020

(millions) $ 76

Add: Net income ($146 − $70) ........

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

(15)

Retained earnings, December 31, 2021

$137

Chapter 1

The Financial Statements 1-50

Req. 3

(continued) E 1-45B Brewster Company Balance Sheet December 31, 2021

(in millions)

ASSETS Current assets: Cash ........................................................

$175

Accounts receivable .................................

Total current assets .................................

260

Property and equipment...............................

Other long-term assets.................................

Total assets .................................................

$324

LIABILITIES Current liabilities: Accounts payable .....................................

$ 56

Total current liabilities .............................

Long-term liabilities: Long-term notes payable..........................

Total liabilities .............................................

STOCKHOLDERS’ EQUITY Common stock .............................................

98*

Retained earnings ........................................

137

Total stockholders’ equity ............................

235

Total liabilities and stockholders’ equity .......

$324

Chapter 1

The Financial Statements 1-51

*Common stock = Total stockholders’ equity ($235) – Retained earnings ($137) = $98

Quiz Q1-46

Q1-47

Q1-48

Q1-49

Q1-50

Q1-51

a Assets = Equity + $83,000 = + $60,000

Q1-52

Q1-53

Q1-54

Q1-55

Q1-56

Q1-57

Liabilities

Stockholders’ +

+ $23,000

[$260,000 − $185,000 − $81,000 − $28,000 =

$(34,000)] Q1-58

Q1-59

Q1-60

Q1-61

($300,000 + $200,000 − $55,000 = $445,000)

Beg.

Assets = $149,00 = 0

Changes

Liabilities $27,000*

Stockholders’ + Equity + $122,000

+ 69,000

Chapter 1

The Financial Statements 1-52

End.

$236,00 = 0*

$96,000*

$140,000

_____ *Must solve for these amounts.

Quiz (continued) Q1-62

Assets − Liabilities = Stockholders’ equity Beg. bal. $350,000 − $23,000 $327,000 = + Net + X income − − 75,000 Dividends End. bal. $530,000 − $36,000 $494,000 =

$327,000 + X – $75,000 = $494,000; X = $242,000

Q1-63

Chapter 1

The Financial Statements 1-53

Problems (30 min.) P 1-64A Computed amounts in boxes.

Kennedy Corp. BALANCE SHEET

Caring Co.

Childress, Inc.

(Millions)

Beginning: Assets ............................... Liabilities........................... Common stock ................... Retained earnings ..............

$76 51 7 18

$30 21 7 2

$17 1 6 10

Assets ............................... Liabilities........................... Common stock ................... Retained earnings ..............

$86 53 7 26

$48 32

$20

INCOME STATEMENT Revenues........................... Expenses ........................... Net income ........................

$227 218 $ 9

$165 157 8

18 $ 4

STATEMENT OF RETAINED EARNINGS Beginning RE ..................... + Net income ........................ − Dividends declared............. = Ending RE ..........................

$18 9 (1) $26

$ 2 8 (6) $ 4

$ 10 4 (2) $ 12

Ending:

Chapter 1

0 8

12 4

$22

The Financial Statements 1-54

(continued) P 1-64A

Net income .......... % of net income to revenues .....

Kennedy Corp.

Caring Co.

Millions

Highest $9 $227

= 4.0%

$8 $165

Chapter 1

= 4.8%

Childress, Inc. $4 $4 $22

= 18.2%

Highest

The Financial Statements 1-55

(20-25 min.) P 1-65A

Req. 1 City News, Inc. Balance Sheet May 31, 2021 ASSETS Cash

LIABILITIES $ 10,000 Accounts payable

$ 6,500

Accounts receivable

2,600 Note payable

50,000

Notes receivable

15,800 Total liabilities

56,500

Office supplies

700

STOCKHOLDERS’

Land

81,000

EQUITY

Equipment

35,600 Stockholders’ equity

89,200*

Total liabilities and Total assets

$145,700

stockholders’ equity

$145,700

_____ *Total assets ($145,700) − Total liabilities ($56,500) = Stockholders’ equity ($89,200).

Req. 2 City News, Inc. is in better (not worse) financial position than the erroneous balance sheet reports. Total assets ($145,700) are $7,800 higher than originally reported ($137,900), liabilities are $14,700 lower than originally reported, and stockholders’ equity is $22,500 higher than reported originally.

Req. 3

Chapter 1

The Financial Statements 1-56

The following accounts are not reported on the balance sheet because they are expenses. These accounts are reported on the income statement. Utilities expense Advertising expense Salary expense Interest expense

Chapter 1

The Financial Statements 1-57

(20-25 min.) P 1-66A

Req. 1 Brandon Hilton Realtor, Inc. Balance Sheet June 30, 2022 ASSETS Cash Office supplies

LIABILITIES

$ 55,000

Accounts payable

$ 16,000

8,000

Note payable

112,000

Land

165,000

Total liabilities

128,000

Furniture

30,000

STOCKHOLDERS’

Franchise

20,000

EQUITY Common stock 65,000 Retained earnings 85,000* Total stockholders’ equity

150,000

Total liabilities and Total assets

$278,000

stockholders’ equity

$278,000

_____ *Total assets ($278,000) − Total liabilities ($128,000) − Common stock ($65,000) = Retained earnings ($85,000).

Req. 2 It appears that the business can pay its debts. Total assets exceed total liabilities.

Chapter 1

The Financial Statements 1-58

a. Personal cash ($15,000) b. Personal account payable ($3,400) g. Personal residence ($334,000) and mortgage payable ($182,000)

Chapter 1

The Financial Statements 1-59

(30-45 min.) P 1-67A

Req. 1 Oak Hill Garden Supply, Inc. Income Statement Year Ended December 31, 2021 Revenue Service revenue ...............

$452,600

Expenses Salary expense ................

$108,40 0

Rent expense ...................

41,200

Interest expense ..............

10,300

Utilities expense ..............

8,800

Property tax expense .......

7,400

Total expenses.................

176,100

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

$276,500

Req. 2 Oak Hill Garden Supply, Inc. Statement of Retained Earnings Year Ended December 31, 2021 Retained earnings, December 31, 2020 .... $ 364,600 Add: Net income ....................................

276,500

Subtotal

641,100

Less: Dividends declared ......................... (107,000) Retained earnings, December 31, 2021 .... $ 534,100

Chapter 1

The Financial Statements 1-60

(continued) P 1-67A

Req. 3

Oak Hill Garden Supply, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Cash

$ Accounts payable 44,000

$ 26,000

Accounts receivable

84,900 Interest payable

2,700

Supplies

6,300 Note payable 99,600

Land

25,000 Total liabilities

Building

406,00 0

STOCKHOLDERS’

Equipment

110,00 0

EQUITY Common stock

128,300

13,800

Retained earnings 534,100 Total stockholders’ equity

547,900

Total liabilities and Total assets

$676,2 stockholders’ 00 equity

$676,20 0

Chapter 1

The Financial Statements 1-61

b. Retained earnings increased $364,600 to $534,100. c. Stockholders’ ($128,300).

equity

$169,500

—

from

($547,900)

exceeds

liabilities

The stockholders have a greater claim against Oak Hill Garden Supply’s assets than do the company’s creditors.

Chapter 1

The Financial Statements 1-62

(20 min.) P 1-68A

Req. 1

Mitchell Company Statement of Cash Flows Year Ended March 31, 2022

Millions

Cash flows from operating activities: Net income ..............................................

$ 3,020

Adjustments to reconcile net income to net cash provided by operating activities ............ 2,420 Net cash provided by operating activities.....................................................

5,440

Cash flows from investing activities: Purchases of property, plant, and equipment ..................................................

$(2,6 40)

Sales of property, plant, and equipment ...

Other investing cash payments................. (195) Net cash used for investing activities .... (2,810 ) Cash flows from financing activities: Issuance of common stock ........................ Payment of dividends ............................... Net cash used for financing activities ....

Chapter 1

$ 190 (265) (75)

The Financial Statements 1-63

Net increase in cash ....................................

$ 2,555

Cash, beginning .......................................... 220 Cash, ending ...............................................

$ 2,775

Req. 2 Operating activities provided the largest amount of cash. This signals financial strength because operations should be the main source of cash. (40-50 min.) P 1-69A INCOME STATEMENT Revenues ................................................ 13,92 0 Cost of goods sold ...................................

2022 = $ k (11,100 )

2021 $14,75 0 A

(1,300)

(1,200) 1,870

= (11,680 )

Other expenses ....................................... Income before income taxes .................... 1,520 Income taxes (35% tax rate) .................... Net income..............................................

532

988

STATEMENT OF RETAINED EARNINGS Beginning balance ................................... 3,825

Net income.............................................. Dividends declared ..................................

988

Ending balance........................................ 4,721

BALANCE SHEET Assets: Cash ................................................ 1,020

Property, plant and equipment.......... Other assets..................................... 11,95

Chapter 1

(655) l $ m

$ n o

$ b

= 1,215

$ 2,680 C = 1,215 (70)

(92) $ p

$ d

= 3,825

$ q 1,547

$ e 1,316

= 1,180

The Financial Statements 1-64

9 Total assets ............................... 14,52 6 Liabilities: Current liabilities.............................. 4,815

Long-term debt ................................ Other liabilities ................................ Total liabilities ........................... Stockholders’ Equity: Common stock.................................. Retained earnings ............................ 4,721 Other stockholders’ equity................ Total stockholders’ equity .......... 5,326

r $ s

11,104 $13,60 0

$ t 4,350 35 9,200

$ 5,660 3,370 180 F

= 9,210

$ 425 u

$ 425 G

= 3,825

180

140 4,390

= v

Total liabilities and stockholders’ equity.................. 14,52 6 STATEMENT OF CASH FLOWS ................... Net cash provided by operating activities................................................. Net cash used for investing activities................................................. Net cash used for financing activities................................................. Increase (decrease) in cash ........

630

$ w

$ h

= 13,60 0

$ x (270)

$ 875 (425)

(520)

(520) I =

(70)

(160) Cash at beginning of year ................. 1,180 = Cash at end of year........................... 1,020 =

y $ z

1,250 $ j

= 1,180

(30 min.) P 1-70B Computed amounts in boxes Babble Co.

Chapter 1

Floralties, Inc.

Millions

Drake Co.

The Financial Statements 1-65

Balance Sheet

Beginning: Assets ........................

$ 79

$ 35

$ 13

Liabilities....................

Common stock ............

Retained earnings .......

Assets ........................

$ 88

$ 53

$ 15

Liabilities....................

Common stock ............

Retained earnings .......

Revenues ....................

$227

$163

$ 27

Expenses ....................

218

153

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

$ 9

$ 10

$ 4

Beginning RE ..............

$ 27

$ 15

$ 6

+ Net income .................

− Dividends declared......

(1)

(11)

(4)

= Ending RE ...................

$ 35

$ 14

$ 6

Ending:

INCOME STATEMENT

STMT. OF RETAINED EARNINGS

(continued) P 1-70B

Babble Co.

Chapter 1

Floralties, Inc.

Drake Co.

The Financial Statements 1-66

Millions Net income ............

% of net income to revenues.........

$9 = $227 4.0%

$10

$10 = $163 6.1%

$4 = $27 14.8%

Highest

Chapter 1

Highest

The Financial Statements 1-67

(20-25 min.) P 1-71B

Req. 1 Parker Design, Inc. Balance Sheet March 31, 2021 ASSETS Cash

LIABILITIES $ 8,000 Accounts payable

Accounts receivable

3,900 Note payable

Notes receivable

13,000 Total liabilities

3,500 53,000 56,500

Office supplies

1,400

STOCKHOLDERS’

Land

86,000

EQUITY

Equipment

39,000 Stockholders’ equity

94,800*

Total liabilities and Total assets

$151,300

stockholders’ equity

$151,300

_____ *Total assets ($151,300) − Total liabilities ($56,500) = Stockholders’ equity ($94,800).

Req. 2 Parker Design, Inc. is in a better financial position than the erroneous balance sheet reports. Assets are $9,800 greater and liabilities are $16,300 less than originally reported, and equity is $26,100 greater than reported originally.

Req. 3

Chapter 1

The Financial Statements 1-68

The following accounts are not reported on the balance sheet because they are expenses. Expenses are reported on the income statement. Utilities expense Advertising expense Salary expense Interest expense

Chapter 1

The Financial Statements 1-69

(20-25 min.) P 1-72B

Req. 1 Hudson Alvarez Realtor, Inc. Balance Sheet June 30, 2022 ASSETS Cash Office supplies

LIABILITIES

$ 44,000 Accounts payable

$ 9,000

4,000 Note payable 102,000

Land

162,000 Total liabilities 111,000

Furniture

17,600

STOCKHOLDERS’

Franchise

16,000

EQUITY Common stock

75,000

Retained earnings 57,600*

Total assets

$243,600

Total stockholders’ equity

132,600

Total liabilities and stockholders’ equity

$243,600

_____ *Total assets ($243,600) − Total liabilities ($111,000) − Common stock ($75,000) = Retained earnings ($57,600).

Req. 2 It appears that Hudson Alvarez’s business can pay its debts. Total assets far exceed total liabilities.

Chapter 1

The Financial Statements 1-70

b. Personal account payable ($6,500) g. Personal residence ($419,000) and personal mortgage ($179,000)

Chapter 1

The Financial Statements 1-71

(30-45 min.) P 1-73B

Req. 1 Full Moon Products, Inc. Income Statement Year Ended December 31, 2021 Revenue: Service revenue ..............

$451,600

Expenses: Salary expense................ $108,900 Rent expense ..................

41,000

Interest expense .............

10,000

Utilities expense ............. 8,100 Property tax expense ......

7,300

Total expenses ................ 175,300 Net income .............................

$276,300

Req. 2 Full Moon Products, Inc. Statement of Retained Earnings Year Ended December 31, 2021 Retained earnings, December 31, 2020 .... $364,80 0 Add: Net income .................................... 276,300 Subtotal 641,100 Less: Dividends declared ......................... Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-72

(108,000 ) Retained earnings, December 31, 2021 ....

Chapter 1

$533,10 0

The Financial Statements 1-73

(continued) P 1-73B

Req. 3

Full Moon Products, Inc. Balance Sheet December 31, 2021 ASSETS Cash

LIABILITIES $ 46,000Accounts payable

$ 25,000

Accounts receivable

85,000 Interest payable

2,800

Supplies

6,200 Note payable 99,200

Land

29,000 Total liabilities 127,000

Building

405,000

STOCKHOLDERS’

Equipment

115,000

EQUITY Common stock

26,100

Retained earnings 533,100 Total stockholders’ equity

559,200

Total liabilities and Total assets

$686,200 stockholders’ equity

$686,20 0

Req. 4 a. Full Moon Products was profitable; net income was $276,300.

Chapter 1

The Financial Statements 1-74

b. Retained earnings increased $364,800 to $533,100.

$168,300

—

from

c. Total equity ($559,200) exceeds total liabilities ($127,000). Therefore, the stockholders have a greater claim against the company’s assets than do the creditors.

Chapter 1

The Financial Statements 1-75

(20 min.) P 1-74B

Req. 1

Tidal Wave Company Statement of Cash Flows Year Ended March 31, 2022

Millions

Cash flows from operating activities: Net income ..............................................

$ 3,050

Adjustments to reconcile net income to net cash provided by operating activities ............ 2,380 Net cash provided by operating activities.....................................................

5,430

Cash flows from investing activities: Purchases of property, plant, and equipment ..................................................

$(3,50 0)

Sales of property, plant, and equipment ...

Other investing cash payments................. (200) Net cash used for investing activities .... (3,640 ) Cash flows from financing activities: Issuance of common stock ........................

$ 200

Chapter 1

The Financial Statements 1-76

Net increase in cash .................................... $1,63 0 Cash, beginning .......................................... 270 Cash, ending ...............................................

$ 1,900

Req. 2 Operating activities provided the bulk of Tidal Wave Company's cash. This is a sign of strength because operations should be the main source of cash.

Chapter 1

The Financial Statements 1-77

(40-50 min.) P 1-75B (Thousands) INCOME STATEMENT 2022 Revenues................................................. 13,80 = $ 0 k Cost of goods sold.................................... (11,020 ) Other expenses........................................ (1,250) Income before income taxes ..................... 1,530 Income taxes (35% tax rate) ..................... Net income...........................................

Ending balance ........................................ 4,622 = BALANCE SHEET Assets: Cash ....................................................

1,840 644

994 = $

994 =

l m

= 1,196

$ 2,670 c

= 1,196

(98) (140) $ $ d = 3,726 p

$ q Property, plant and equipment.............. 1,487 Other assets......................................... 12,20 = r 5 Total assets ...................................... 14,67 =$ s 2

Long-term debt .................................... Other liabilities.....................................

$ n o

980 =

Liabilities: Current liabilities.................................. 3,955 =

$ t 4,450 995

e 1,316

12,060 $14,46 6

$ 5,610 3,360

Total liabilities ..................................

9,400

Stockholders’ Equity: Common stock ......................................

Chapter 1

= 1,090

1,140 f

= (13,11 5)

(1,220)

536 =

STATEMENT OF RETAINED EARNINGS Beginning balance.................................... 3,726 = Net income .............................................. Dividends declared...................................

2021 $16,17 5 a

= 10,11 0

The Financial Statements 1-78

450 u

Retained earnings ................................ 4,622 = Other stockholders’ equity ....................

450 g 180

= 3,726

200 Total stockholders’ equity ................. 5,272 =

4,356 v w

Total liabilities and stockholders’ 14,67 =$ equity ......................................... 2 STATEMENT OF CASH FLOWS Net cash provided by operating 700 = activities ................................................. Net cash used for investing activities .... Net cash used for financing activities .... Increase (decrease) in cash ............... Cash at beginning of year ..................... 1,090 =

$ x (300) (510) ( 110)

875 (575) (500) i = (200)

y Cash at end of year...............................

980 =$

= 14,46 6

1,290 $ j

= 1,090

Serial Case (15-20 min) C1-76 1. The

Cheesecake

corporation,

per

Factory the

name

organized of

the

business

(“Incorporated”). 2. Net income flows from the Income Statement to the Statement of Retained Earnings. 3. Ending retained earnings flows from the Statement of Retained Earnings to the Balance Sheet 4. Ending cash and cash equivalents flows from the Statement of Cash Flows to the Balance Sheet 5. The

Cheesecake

Factory

earned

net

income

$127,293 (in thousands) in fiscal 2019. This income

Chapter 1

The Financial Statements 1-79

was earned from January 1, 2019 to December 31, 2019. 6. The Cheesecake Factory’s accounting equation (in thousands): Assets

Liabilities

Shareholders’ Equity

$2,840,593 = $2,268,851* +

$571,742

7. Cheesecake Factory had $2,840,593 (Total Assets) to work with and owes $2,268,851* (Total Liabilities) to creditors. (Numbers in thousands) *($614,587 + $1,654,264 = $2,268,851)

Decision Cases (30-40 min.) C1-77

Req. 1 Based solely on these balance sheets, Insley Sales Co. appears to be the better credit risk because: 1. Queens Service has more assets ($150,000) than Insley Sales ($65,000), but Queens Service owes much more in liabilities ($130,000 versus $15,000 for Insley Sales). Insley Sales’ stockholders’ equity is far greater than Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-80

that of Queens Service ($50,000 compared to $20,000). Insley Sales is not heavily in debt, but Queens Service is. 2. You would be better off granting the loan to Insley Sales. You should consider what will happen if the borrower cannot pay you back as planned. Queens Service has far more liabilities to pay, and it may be hard for Queens Service to come up with the money to pay you. On the other hand, Insley Sales has little debt to pay to others before paying you.

Student responses may vary.

(20-30 min.) C1-78

Req. 1 Flowers Unlimited, Inc. Income Statement Year Ended Dec. 31, 2021 Revenue……… … $140,00 01 Expenses……… .. 140,0002

Flowers Unlimited, Inc. Balance Sheet Dec. 31, 2021 Cash………… …

$ 6,000

Liabilities…… $70,000 4 …

Other assets….

S/H 90,000 Equity……..

26,0005

Chapter 1

The Financial Statements 1-81

Net income………

$ 0-

Total assets…...

$96,00 and S/H 0 equity

$96,000

_____ 1$100,000 + $40,000 = $140,000 2$80,000 + $50,000 + $10,000 = $140,000 3$100,000 − $50,000 + $40,000 = $90,000 4$60,000 + $10,000 = $70,000 5$96,000 − $70,000 = $26,000

Req. 2 The company’s financial position is much weaker than originally reported. Assets and stockholders’ equity are lower and liabilities are higher. Results of operations are

worse than reported. The company did not earn any profit.

Req. 3 Based on the actual figures, I would not invest in Flowers Unlimited for reasons given in Req. 2.

Chapter 1

The Financial Statements 1-82

Ethical Issue (40-50 min) C1-79 Note to instructor:

student responses will vary on this

problem. Keep the discussion pointed toward use of the multiple-criteria model for making good ethical decisions, pointing out elements of students’ reasoning that may be faulty or incomplete. It might be useful to have a debate or role play, assigning students to different sides of the issue (for or against accepting a copy of the exam).

Req. 1 The fundamental ethical issue in this situation is whether you should accept a copy of the old exam from your friend.

Req. 2 The stakeholders are: a. You b. Your friend c. The remainder of the students in the class d. The professor e. The University f. Your family (This may not be a complete list; you may think of more.) Consequences are discussed in requirement 3.

Chapter 1

The Financial Statements 1-83

Chapter 1

The Financial Statements 1-84

(continued) C1-79

Req. 3 Analysis of the problem: Economic perspective: If use of the old exam turns out to help you (it may not) you might improve your grade and allow you to retain your scholarship. This might help you and your family financially. If you use the exam to your unfair advantage, and you are reported, you and possibly your friend might receive grades of F in the class although you might otherwise have passed.

This could cause

adverse economic consequences to you, your friend and your families. Legal perspective:

Although it may not violate local or

federal law, giving or accepting copies of old exams may violate the university’s honor code, which serves the same purpose as a legal code in this case.

If you use the old

exam and it turns out that you violated the University’s honor code, both you and your friend could be in trouble. Your

family

and

your

friend’s

family

could

also

impacted by any adverse consequences to you or her. Academic institutions establish policies against academic dishonesty because cheating hurts everyone—the student who commits the act, the other students in the class whose rights to fair treatment are violated by cheating, and the professor who must endure hours of investigating, reporting, and perhaps testifying.

Chapter 1

The Financial Statements 1-85

Ethical perspective:

Receiving questionable help from

others in the face of policies that prohibit it is, at best, risky, and at worst, downright wrong. Cheating is similar to stealing, since it is stealing (continued) C1-79 the work of another without their permission. It is usually accompanied by lying to cover it up, or at least, not revealing the truth.

Cheating violates other students’

rights to fair and equal treatment.

It violates the

instructor’s rights to run a course as a “fair game” for all participants.

Because the students and faculty are hurt

by cheating, the university is hurt too.

If cheating goes

unpunished, grades are inflated, ultimately damaging the academic reputation of the institution and eroding the value of its degrees. Parents of students who are caught cheating have to endure the agony of working through the problem with their son or daughter, and perhaps the social stigma that comes from adverse publicity. These are just some of the arguments against cheating. Of course, there is a question in this case as to whether taking the test actually violates the professor’s or the university’s policies.

Chapter 1

The Financial Statements 1-86

Req. 4 It would be helpful to find out what the professor’s policies are with respect to the use of fraternity and sorority test files. policy on this.

The university might have a blanket

(Some students might spend a little time

researching this by reading the university’s honor code on their web site; just reading the honor code will be an eyeopening experience for most students).

Advise your

students to research the use of fraternity and sorority test files on the university web site, or to (continued) C1-79 discuss the issue with the head of the department or the chair of the university honor council. Unfortunately, in this case, there is not much time. Researching the issue in the university’s honor code takes valuable time away from studying for the exam, which, if you do, could help you raise your grade and solve the whole problem! Probably the best solution to this problem is “when in doubt, don’t.” least

you

You may not do well on the test, but at

won’t

have

live

with

the

consequences of being accused as a cheater.

terrible It should

Chapter 1

The Financial Statements 1-87

may not make the highest grades in the class, at least you are not a cheater.

Req. 5 Cheating is very closely related to stealing, which is a form

fraud.

When

employees

steal

from

their

companies, they steal property that belongs to others. There are economic, legal, and ethical consequences to the

company,

the

employee

and

their

families,

and

customers (who ultimately have to pay for fraud through higher prices). We will study fraud in depth in Chapter 4.

Chapter 1

The Financial Statements 1-88

Focus on Financials: Apple Inc. (20-30 min.) C1-80 1. Students can emphasize a variety of points regarding Apple Inc., and its industry. For example, a discussion on the product innovation and competitive changes in technology

would

appropriate.

Additionally,

discussing recent news articles related to Apple or its competitors would also be appropriate. Student answers will vary. 2. Some important information in this portion of the financials

the

description

their

distribution

channels (third-party resellers), competitors (product innovation, market opportunities, etc.), and supply chain (shortages, component availability, outsourcing, etc). Additionally, the seasonality of Apple’s business is important to note given that it has higher sales in its first quarter relative to the last three.

Lastly, it may

come as a surprise that Apple employs approximately 137,000 full-time employees. (Student answers will vary.) 3. Samsung, Google, Sony, or HP are some of Apple Inc.’s competitors. It is important to identify competitors because competitors tend to have similar business

Chapter 1

The Financial Statements 1-89

dynamics to one another, meaning that their financial statements can be compared to and benchmarked against each other. Student answers will vary.

(continued) C1-80 4. Net income, because it shows the overall result of all the revenues minus all the expenses for a period. In effect, net income gives the results of operations in a single figure and shows whether the company has been profitable.

Apple’s net income after taxes decreased

from $59.5 billion in 2018 to $55.3 billion in 2019, which is unfavorable. 5. Apple Inc.’s largest expense is cost of sales. The company has cost of sales for products and cost of sales for services. The former is the cost of the products that the company sells, such as iPhones, iPads, Apple TVs, software, and Mac desktops. The cost of sales for services pertains to the cost of services that Apple provides such as iCloud, Siri, and Maps. Another title of this account is cost of goods sold. In this chapter, The Walt

Disney

Company

called

this

account

cost

products and cost of services.

Chapter 1

The Financial Statements 1-90

Total resources (total assets)at September 28, 2019.….$338,516 million

Amount owed (total liabilities) at September 28, 2019….$248,028 million

Portion of the company’s assets owned by the stockholders (stockholders’ equity) at September 28, 2019...………….$90,488 million

Apple Inc.’s accounting equation (in millions): Assets

= Liabilities + Stockholders’ Equity

$338,516 = $248,028 +

$90,488

p l

I n c . h a d $ 4 8 , 8 4

(continued) C1-80

4 m

7. At September 29, 2018, Apple Inc. had $25,913 million

of cash and cash equivalents. At September 28, 2019,

Chapter 1

The Financial Statements 1-91

lion of cash and cash equivalents.

Chapter 1

The Financial Statements 1-92

Focus on Analysis: Under Armour, Inc. (30 min.) C1-81 1. Under Armour, Inc. is an athletic apparel company. Students can emphasize a variety of points regarding Under Armour, Inc. and its industry.

For example, a

discussion on the brand, new product development, etc. would be appropriate.

Additionally, discussing recent

news articles related to Under Armour or its competitors would also be appropriate. (Student answers will vary.) 2. Note 1 states Under Armour is a developer, marketer and distributor of branded performance apparel, footwear, and accessories. These products are sold worldwide and worn by athletes of all levels and consumers with active lifestyles. 3.

Nike, Adidas, and Columbia Sportswear are some of Under Armour, Inc.’s competitors. It is important to identify competitors because competitors tend to have similar business dynamics to one another, meaning that their

financial

statements

can

compared

and

benchmarked against each other. (Student answers will vary.)

Chapter 2

Transaction 2-1

(continued) C1-81 4. Under Armour, Inc.’s Accounting Equation (in thousands): Assets

= Liabilities +

Shareholders’ Equity

$4,843,531 = $2,693,444 +

$2,150,087

If we express the numbers in millions: Assets

= Liabilities +

$4,843

$2,693

Shareholders’ Equity

$2,150

Under Armour, Inc. appears to be in strong financial condition. Total assets are significantly higher than the amount of total liabilities. This suggests that the company will have no difficulty paying its debts and will have money to expand. 5. The result of operations for 2019 was a net income of $92,139 thousand, following two years of net losses. This is good news for Under Armour, Inc.

Revenue exceeded

expenses for fiscal 2019, and there appears to be a reversal of the company’s fortunes from previous years. It is too early to tell, however, whether profitability is a trend. 6. According

Under

Armour,

Inc.’s

Consolidated

Statements of Stockholders’ Equity, the cause of the company’s increase in retained earnings during 2019 was comprehensive

income

$92,139

thousand.

Chapter 2

Transaction 2-2

7. The Consolidated Balance Sheets report cash and cash equivalents as part of the company’s financial position. The Consolidated (continued) C1-81 Statements

Cash

Flows

tell

why

equivalents increased or decreased.

cash

and

cash

Operating activities

provided $509,031 thousand, investing activities used $147,113

thousand,

and

financing

activities

used

$137,070 thousand.

Chapter 2

Transaction 2-3

Group Projects Student responses will vary.

Chapter 2 Transaction Analysis Ethics Check (5-10 min.) EC 2-1 a. Due care b. Due care c. Objectivity and independence d. Integrity

Chapter 2

Transaction 2-4

Short Exercises (5 min.) S 2-1 a.

Yes

No (no dollars involved yet)

Yes

No (no dollars involved)

Yes

No (no dollars involved yet)

Yes

(5 min.) S 2-2 a.

Chapter 2

Transaction 2-5

(5 min.) S 2-3 Crater’s payment was not an expense. Crater acquired an asset, Equipment, because the computer is an economic resource of the business.

(5 min.) S 2-4 a.

Purchase of asset for cash Sale of asset for cash Collection of an account receivable

Issuance of stock Revenue transaction (ex: provided services on account or for cash)

Purchase of asset on account Borrow money

Declaration and payment of dividends to owners

Chapter 2

Transaction 2-6

Expense transaction (ex: received and paid utility bill) e.

Pay a liability Return an asset purchased on account

(Answers may vary.)

(5-10 min.) S 2-5 Assets Incr Decr

Liabilities Incr Decr

Stk. Equity Incr

Decr Jan 2 Jan 4 Jan 10 Jan 1 Jan 18 Jan 21 Jan 31

X X

X X X

X X

(5 min.) S 2-6 a.

$10,500 ($8,000 + $2,500 + $7,200 − $7,200)

$ 2,500

Chapter 2

Transaction 2-7

(5-10 min.) S 2-7

Reqs. 1, 2 Cash 200,00 0

Computer Equipment 56,000

Accounts Payable 56,000

Common Stock 200,00 0

Req. 3 Total debits

$256,000 ($200,000 + $56,000)

Total credits

$256,000 ($56,000 + $200,000) (5-10 min.) S 2-8

Jul 1

Cash Jul 3 26,000

5,500

Jul 6 8,500 Bal. 29,000

(10 min.) S 2-9

DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Chapter 2

CREDI T

Transaction 2-8

July

1 5

Cash .........................................

64,000

Note Payable ...................... Borrowed money from the bank. 2 2

Accounts Receivable ..................

64,000 17,300

Service Revenue ................. Performed service on account. 2 8

Cash .........................................

17,300 16,000

Accounts Receivable ........... Received cash on account. 2 9

Utilities Expense .......................

16,000 1,800

Cash................................... Paid utility bill. 3 1

Salary Expense..........................

1,800 10,000

Cash................................... Paid salary expense.

10,000

(10-15 min.) S 2-10

Req. 1

DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

4,300 4,300 Chapter 2

Transaction 2-9

Purchased supplies on account. Accounts Payable ...................... Cash................................... Paid cash on account.

3,450 3,450

Req. 2 Accounts Payable 3,450 4,300 Bal. 850

Req. 3 The business owes $850, as shown in the Accounts Payable account.

Chapter 2

Transaction 2-10

(10-15 min.) S 2-11

Req. 1 Journal ACCOUNT TITLES AND EXPLANATION

DATE

DEBIT

CREDIT

Accounts Receivable................... Service Revenue ................... Performed service on account.

4,600

Cash ..........................................

2,100

4,600

Accounts Receivable ............. Received cash on account.

2,100

Req. 2 Cash

Accounts Receivable

2,100

4,600

Bal. 2,100

Bal. 2,500

Service Revenue

2,100

4,600 Bal. 4,600

Chapter 2

Transaction 2-11

(15-20 min.) S 2-12

DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Chapter 2

CREDIT

Transaction 2-12

July

Cash ...............................................

13,00 0

Common Stock .......................... Issued stock to owner. 5

13,000

Accounts Receivable………………………….. Service Revenue ....................... Provided (sold) services on account.

8,000

Office Supplies ................................ Accounts Payable ...................... Purchased supplies on account.

600

Cash ............................................... Service Revenue ....................... Provided (sold) services for cash.

3,100

Cash ............................................... Accounts Receivable.................. Collected cash on account.

8,000

Accounts Payable ............................ Cash ......................................... Paid on account.

600

Utilities Expense ............................. Cash ......................................... Paid expenses.

450

Office Furniture............................... Note Payable ............................ Purchased furniture with note payable.

2,500

Salary Expense................................ Cash ......................................... Paid payroll.

3,100

8,000

600

3,100

8,000

600

450

2,500

3,100

Chapter 2

Transaction 2-13

Harbor Marine Company Trial Balance December 31, 2021 DEBI CREDI ACCOUNT T T

Millions Cash ..................................

$ 4

Other assets.......................

Accounts payable ...............

$ 6

Other liabilities...................

Stockholders’ equity ...........

Revenues ...........................

Expenses............................

___

Total ..................................

$50

Harbor Marine Company’s net income: $11 million ($37 − $26)

(10 min.) S 2-14 1.

Total assets

= $101,500

($4,500 + $28,000 +

$5,000 + $45,000 + $19,000) 2.

Total liabilities

= $61,000

Net income (loss) = $17,500

($39,000 + $22,000) ($56,000 − $27,000 − $10,000 − $1,500)

Chapter 2

Transaction 2-14

(10 min.) S 2-15 1.

Total debits =

$ 99,500 ($140,000 + $4,500 −

$45,000) Total credits =

$140,000

Difference = $ 40,500 ($140,000 − $99,500); $40,500 / 9 = $4,500 (an integer), which suggests either a transposition or a slide. 2.

Total debits =

$194,000 ($140,000 + $82,000 −

$28,000) Total credits =

$140,000

Difference = $ 54,000 ($194,000 − $140,000); $54,000 / 9 = $6,000 (an integer), which suggests either a transposition or a slide. 3.

Total debits =

$112,000 ($140,000 − $28,000)

Total credits =

$168,000 ($140,000 + $28,000)

Difference = $ 56,000 ($168,000 − $112,000) $56,000 / 2 = $28,000 (original amount of accounts receivable).

(10 min.) S 2-16 E

1. Posting

7. Receivable

2. Expense

8. Chart of accounts

3. Debit

9. Payable

4. Trial balance

J 10. Journal

5. Equity

C 11. Normal balance

Chapter 2

Transaction 2-15

6. Net income

L 12. Ledger

(5-10 min.) S 2-17 1. Unsupervised learning 2. Supervised learning 3. Supervised learning 4. Unsupervised learning

(10 min.) S 2-18 1.

Python

Training set

7. Open-source

Unsupervised

8. Python, R, Julia, Java

Validation set

9. Machine learning

Artificial intelligence

6. Test set

10. Supervised

Chapter 2

Transaction 2-16

Exercises (15-20 min.) E 2-19A

Req. 1 In order to qualify as a financial transaction, there must be an event that has a financial impact on a business and can be measured reliably. Thus, the May events that do not meet these criteria include May 8 and May 18.

Req. 2

DATE

May 1

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash .........................................

CREDI T

100,00 0

Ticket Revenue ...................

100,00 0

Sold admission tickets. 3

Inventory .................................. Accounts Payable................ Purchased merchandise inventory on account.

5,000 5,000

Cash ......................................... 500 Rental Revenue ..................

Chapter 2

500 Transaction 2-17

Rented lockers to guests. 1 5

Salary Expense..........................

75,000

Cash................................... Paid employees. 2 0

75,000

Cash .........................................

200,00 0

Note Payable ......................

200,00 0

Borrowed money from bank.

(continued) E 2-19A

Req. 3

May 1 May 3 May 6 May 15 May 20

Assets Incr Decr X X X

Liabilities Incr Decr

Stk. Equity Incr Decr X

X X X

X X

Chapter 2

Transaction 2-18

(10-15 min) E2-20A

Cash (a)

Bal.

Accounts Receivable

25,50 (b) 0

1,500

(f)

11,0 00

(d)

2,900

Bal.

11,0 00

(e)

250

(g)

2,000

18,85 0 Office Supplies

Office Furniture

(c)

700

(a)

9,400

Bal.

700

Bal.

9,400

Accounts Payable (e)

Common Stock

250 (c)

700

(a)

Bal.

450

Bal.

34,900 34,900

Dividends

Service Revenue

(g)

2,000

(f)

11,00 0

Bal.

2,000

Bal.

11,00 0

Salary Expense

Rent Expense

(d)

2,90 0

(b)

1,500

Bal.

2,90

Bal.

1,500

Chapter 2

Transaction 2-19

Chapter 2

Transaction 2-20

(10-15 min.) E 2-21A a.

Decreased assets. (Cash)

No effect on total assets. Increase in land offsets the decrease in cash.

No effect on total assets. Increase in cash offsets the decrease in land.

No effect on total assets. Increase in cash offsets the decrease in accounts receivable.

Increased assets. (Equipment)

No effect. (A personal transaction)

Decreased assets. (Cash)

Increased assets. (Office supplies)

Increased assets. (Cash)

Chapter 2

Transaction 2-21

(15-20 min.) E 2-22A

Req. 1 Analysis of Transactions ASSETS

Date

Cash +

Accounts Medical Receivable Supplies + +

LIABILITIES

Accounts Payable Land = +

STOCKHOLDERS’ EQUITY

Note Common Payable Stock + +

Dec. 150,0 6 00 9

Type of Retained Stockholders’ Earnings Equity Transaction

150,00 0

(64,0 00)

Issued stock

64,0 00

2,400

15 Not a transaction of the business. 1531

4,900

4,900 9,800

15- (3,600) 31

Service revenue

(3,600 Salary ) expense

(900)

(900) Rent expense

(400)

(400) Utilities expense

1,000

(1,000 )

34,00 Chapter 2

Transaction Analysis 2-22

0 31 Bal.

(1,300) 119,700

(1,300 ) 4,900

1,400

$190,000

64,0 00

1,100

34,00 150,00 0 0

$190,000

Chapter 2

Transaction Analysis 2-23

4,900

(continued) E 2-22A

Req. 2 a.

$190,000

$4,900

$35,100 ($1,100 + $34,000)

$154,900 ($190,000 − $35,100, or $150,000 + $4,900)

$4,900 (Revenue, $9,800 minus expenses, $4,900 equals net income, $4,900.)

Chapter 2

Transaction

2-24

(10-15 min.) E 2-23A Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Chapter 2

CREDIT

Transaction

2-25

Dec.

Cash ...............................................

150,0 00

Common Stock .......................... Issued stock to owner. 9

Land……………………………………………

150,000 64,00 0

Cash ......................................... Purchased land. 12

Medical Supplies ............................. Accounts Payable ...................... Purchased supplies on account.

64,000 2,400 2,400

Not a transaction of the business.

1531

Cash ...............................................

4,900

Accounts Receivable........................ Service Revenue ....................... Performed services for cash and on account.

4,900

Salary Expense................................

3,600

Rent Expense .................................. Utilities Expense ............................. Cash ......................................... Paid expenses.

900 400

Cash ............................................... Medical Supplies ....................... Sold supplies.

1,000

Cash ...............................................

34,00 0

1531

9,800

4,900

1,000

Note Payable ............................ Borrowed money. 31

Accounts Payable ............................ Cash ......................................... Paid on account.

Chapter 2

34,000 1,300 1,300

Transaction

2-26

(20-30 min.) E 2-24A

Req. 1 Dec. 6 15-31 31 31 Bal.

Cash 150,0 Dec. 00 9 4,900 15-31 1,000 31 34,00 0 119,7 00

Medical Supplies Dec. Dec. 12 2,400 31 Bal.

64,00 0 4,900 1,300

1,000

1,400 Accounts Payable Dec. Dec. 31 1,300 12 Bal. Common Stock Dec. 6 Bal.

Accounts Receivable Dec. 1531 4,900 Bal. 4,900

Land Dec. 64,00 9 0 64,00 Bal. 0 Note Payable Dec. 34,00 31 0 34,00 Bal. 0

2,400 1,100

Service Revenue Dec. 1531

150,0 00 150,0 00

Bal.

Salary Expense Dec. 1531 Bal.

3,600 3,600

9,800 9,800

Rent Expense Dec. 1531 Bal.

900 900

Utilities Expense Dec. 1531 400 Bal. 400

Chapter 2

Transaction

2-27

(continued) E 2-24A

Req. 2 Dr. Helen Samoa, P.C. Trial Balance December 31, 2021 ACCOUNT DEBIT Cash ................................

$119,70 0

Accounts receivable .........

4,900

Medical supplies ..............

1,400

Land ................................

64,000

CREDIT

Accounts payable .............

$ 1,100

Note payable ...................

34,000

Common stock .................

150,000

Service revenue ...............

9,800

Salary expense ................

3,600

Rent expense ...................

900

Utilities expense .............. 400 Total................................

$194,90 $194,90 0 0

Req. 3 Total assets ($119,700 + $4,900 + $1,400 + $64,000) .....................................................................$190,000 Total liabilities ($1,100 + $34,000) .................

(35,100)

Chapter 2

Transaction

2-28

*Net income = $4,900 ($9,800 – $3,600 – $900 – $400)

Chapter 2

Transaction

2-29

(10-15 min.) E 2-25A

Req. 1 Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

1 Cash ................................................. . Common Stock .............................. Issued common stock. 2 Cash ................................................. . Note Payable ................................ Borrowed money; signed note payable.

8,500 8,500

9,000 9,000

3 Supplies ........................................... . Accounts Payable.......................... Purchased supplies on account. 4 Land ................................................. . Cash ............................................. Note Payable ................................ Purchased land by paying cash and signing a note payable.

800 800

38,000 13,000 25,000

5 Cash ................................................. . Supplies ....................................... Sold supplies for cash.

45 45

6 Accounts Payable .............................. . Cash ............................................. Paid cash on account. 7 Equipment ........................................ Copyright © 2022 Pearson Education Inc. Analysis

CREDIT

310 310 3,900

Chapter 2

Transaction

2-30

. Cash ............................................. Paid cash for equipment.

3,900

Cash balance = $335 ($8,500 + $9,000 − $13,000 + $45 − $310 − $3,900) Company owes $34,490 ($9,000 + $800 + $25,000 − $310)

Chapter 2

Transaction

2-31

(continued) E 225A Cash

Supplies

(1)

8,500 (4)

13,00 0

(3)

800 (5)

(2)

9,000 (6)

310

Bal.

755

(5)

45 (7)

3,900

Bal.

335 Land

Equipment

(4)

38,00 0

(7)

3,900

Bal.

38,00 0

Bal.

3,900

Accounts Payable (6)

310 (3) Bal.

Note Payable 800 490

(2)

9,000

(4)

25,000

Bal.

34,000

Common Stock (1) Bal.

8,50 0 8,50 0

Account

Ending Balance

Cash

$335

Chapter 2

Transaction

2-32

Supplies Land Equipment Accounts Payable Notes Payable Common Stock

755 38,000 3,900 490 34,000 8,500

Chapter 2

Transaction

2-33

(10-20 min.) E 2-26A

Req. 1 Deluxe Patio Service, Inc. Trial Balance April 30, 2021 ACCOUNT

DEBIT

Cash .................................

$19,300

Accounts receivable ..........

5,900

Equipment ........................

30,600

CREDIT

Accounts payable ..............

$ 4,600

Note payable.....................

21,500

Common stock ..................

16,700

Retained earnings .............

6,300

Dividends..........................

3,300

Service revenue ................

20,700

Salary expense..................

8,300

Utilities expense ...............

2,100

Delivery expense............... 300 Total.................................

$69,800

Req. 2 Deluxe Patio Service, Inc. Income Statement For the Month Ended April 30, 2021 Service revenue ......................

$20,700

Salary expense .......................

$8,300

Utilities expense .....................

2,100

10,700 Chapter 2

Transaction

2-34

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

$10,000

Chapter 2

Transaction

2-35

(15-25 min.) E 2-27A

Req. 1

Addison, Inc. Trial Balance September 30, 2021 ACCOUNT DEBIT

CREDIT

$14,800 Cash ................................. * Accounts receivable ..........

12,000*

Inventory..........................

16,900

Supplies ...........................

800

Land.................................

59,000

Accounts payable..............

$13,600*

Common stock ..................

47,300*

Sales revenue ...................

49,700

Insurance expense ............

3,400*

Salary expense .................

2,000

Rent expense....................

1,000

Utilities expense ...............

700* _______ $110,6 00 $110,600

Total ................................ _____

*Computations: Cash: $14,100 + $700 = $14,800 Accounts Receivable: $12,700 − $700 = $12,000 Accounts Payable: $12,300 + $1,000 − $100 + $400 = $13,600 Common Stock: $47,100 + $200 = $47,300 Insurance Expense: $0 + $3,400 = $3,400 Utilities Expense: $300 + $400 = $700

Chapter 2

Transaction

2-36

(15-20 min.) E 2-28A

Req. 1 (amounts in millions)

Cash (X) + Other assets (23) = Accounts payable (8) + Other liabilities (2) + S/E (6) + Revenues (33) – Expenses (21) Cash (X) = 5

Req. 2 (amounts in millions)

Old Center Company Trial Balance September 30, 2021 ACCOUNT DEBIT Cash ................................

$ 5

Other assets ....................

CREDIT

Accounts payable .............

$ 8

Other liabilities ................

Stockholders’ equity ........

Revenues.........................

Expenses .........................

Total................................

$49

Chapter 2

Transaction

2-37

(15-20 min.) E 2-29B

Req. 2

DATE

May 1

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash .........................................

CREDI T

150,00 0

Ticket Revenue ................... 150,00 0 Sold admission tickets. 3

Inventory .................................. Accounts Payable................ Purchased merchandise inventory on account.

9,000 9,000

Cash ......................................... 700 Rental Revenue .................. Rented lockers to guests.

1 5

Salary Expense..........................

700 92,000

Chapter 2

92,000

Transaction

2-38

2 0

Cash .........................................

400,00 0

Note Payable ......................

400,00 0

Borrowed money from bank.

(continued) E 2-29B

Req. 3

May 1 May 3 May 6 May 15 May 20

Assets Incr Decr X X X

Liabilities Incr Decr

Stk. Equity Incr Decr X

X X X

X X

Chapter 2

Transaction

2-39

(10-15 min.) E 2-30B Cash (a)

Bal.

Accounts Receivable

23,50 (b) 0

1,100

(f)

10,7 00

(d)

2,800

Bal.

10,7 00

(e)

200

(g)

2,900

16,50 0 Office Supplies

Office Furniture

(c)

800

(a)

8,600

Bal.

800

Bal.

8,600

Accounts Payable (e)

Common Stock

200 (c)

800

(a)

32,100

Bal.

600

Bal.

32,100

Dividends

Service Revenue

(g)

2,900

(f)

10,70 0

Bal.

2,900

Bal.

10,70 0

Salary Expense

Rent Expense

(d)

2,80 0

(b)

1,100

Bal.

2,80 0

Bal.

1,100

Chapter 2

Transaction

2-40

(10-15 min.) E 2-31B a.

No effect on total assets. Increase in notes receivable offsets the decrease in land.

No effect on total assets. Increase in equipment offsets the decrease in cash.

No effect. (A personal transaction)

Increased assets. (Land)

Increased assets. (Cash)

Increased assets. (Accounts receivable)

Decreased assets. (Cash)

Increased assets. (Cash)

Increased assets. (Supplies)

Chapter 2

Transaction

2-41

(10-20 min.) E 2-32B Req. 1

Cash +

Date

July 6

ASSETS

Analysis of Transactions = LIABILITIES

Accounts Medical Receivable Supplies + +

Land =

Accounts Payable +

+ STOCKHOLDERS’ EQUITY

Note Common Payable Stock + +

Type of Retained Stockholders’ Earnings Equity Transaction

Issued stock 155,00 0 9

155,00 0

(62,00 0)

62,00 0

1,500

15 Not a transaction of the business. 15-31

4,550

4,550 9,100

15-31 (3,300)

Service revenue Salary expense

(3,300) (1,400)

Rent expense (1,400)

(400) 31

500

(400) Utilities expense (500)

Chapter 2

Transaction Analysis 2-42

31 33,000 33,000 31 Bal.

(600) 125,35 0

(600) 4,550

1,000 62,00 0

900 33,000 155,00 0

$192,900

4,000

$192,900

Chapter 2

Transaction Analysis 2-43

(continued) E2-32B

Req. 2 a.

$192,900

$4,550

$33,900 ($900 + $33,000)

$159,000 ($192,900 − $33,900, or $155,000 + $4,000)

$4,000 (Revenue, $9,100 minus expenses, $5,100, equals net income, $4,000)

Chapter 2

Transaction

2-44

(10-15 min.) E 2-33B

Req. 1

Journal

DATE

July

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Cash........................................ 155,000 Common Stock .................. 155,000 Issued stock to owner.

Land........................................ 62,000 Cash ................................. Purchased land.

62,000

Medical Supplies...................... Accounts Payable .............. Purchased supplies on account.

1,500

Not a transaction of the business.

1531

Cash........................................

1,500

4,550

Accounts Receivable ................ 4,550 Service Revenue ............... Performed services for cash and on account. 1531

Salary Expense ........................

3,300

Rent Expense .......................... Utilities Expense ...................... Cash ................................. Paid expenses.

1,400 400

Cash........................................ Medical Supplies ............... Sold supplies.

500

5,100

500

Cash........................................ 33,000 Note Payable ....................

Chapter 2

9,100

33,000

Transaction

2-45

Borrowed money. 31

Accounts Payable .................... Cash ................................. Paid on account.

Chapter 2

600 600

Transaction

2-46

(20-30 min.) E 2-34B

Req. 1 Cash July 155,00 July 62,00 6 0 9 0 15-31 4,550 15-31 5,100 31 500 31 600 31 33,000 125,35 Bal. 0 Medical Supplies July July 12 1,500 31 Bal.

500

1,000

Accounts Receivable July 1531 4,550 Bal. 4,550

Land July 62,00 9 0 62,00 Bal. 0

Accounts Payable July July 31 600 12 1,500 Bal. Common Stock July 6 Bal.

Note Payable

900

33,00 July 31 0 33,00 Bal. 0

155,0 00 155,0 00

Service Revenue July 15- 9,10 31 0 9,10 Bal. 0

Salary Expense July 1531 3,300

July 1531 1,400

Bal.

3,300

Rent Expense

1,400

Utilities Expense July 1531 400 Bal. 400

Chapter 2

Transaction

2-47

(continued) E 2-34B

Req. 2 Dr. Char Morin, P.C. Trial Balance July 31, 2021 ACCOUNT DEBIT Cash ................................

$125,35 0

Accounts receivable .........

4,550

Medical supplies ..............

1,000

Land ................................

62,000

Accounts payable .............

CREDIT

$ 900

Note payable ...................

33,000

Common stock .................

155,000

Service revenue ...............

9,100

Salary expense ................

3,300

Rent expense ...................

1,400

Utilities expense ..............

400

Total................................

$198,00 $198,00 0 0

Req. 3 Total assets ($125,350 + $4,550 + $1,000 + $62,000) ............................................................$192,900 Total liabilities ($900 + $33,000) ......................... (33,900) Total stockholders’ equity ($155,000 + $4,000*) ..$159,000 *Net income = $4,000 ($9,100 − $3,300 − $1,400 − $400) Copyright © 2022 Pearson Education Inc. Analysis

Chapter 2

Transaction

2-48

(10-15 min.) E 2-35B

Req. 1 Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

1. Cash ...............................................

8,800

Common Stock .......................... Issued common stock. 2. Cash ...............................................

8,800 8,500

Note Payable ............................ Borrowed money; signed note payable.

8,500

3. Supplies .......................................... Accounts Payable...................... Purchased supplies on account.

900

4. Land ...............................................

34,000

900

Cash......................................... Note Payable ............................ Purchased land by paying cash and signing a note payable.

11,000 23,000

5. Cash. .............................................. Supplies ................................... Sold supplies for cash.

6. Accounts Payable ............................ Cash......................................... Paid cash on account.

290

7. Equipment ...................................... Cash......................................... Paid cash for equipment.

4,000

CREDIT

290

Chapter 2

4,000

Transaction

2-49

Cash balance = $2,100 ($8,800 + $8,500 − $11,000 + $90 − $290 − $4,000) Company owes $32,110 ($8,500 + $900 + $23,000 − $290)

Chapter 2

Transaction

2-50

(continued) E 235B Cash

Supplies

(1)

8,800 (4)

11,00 0

(3)

900 (5)

(2)

8,500 (6)

290

Bal.

810

(5)

90 (7)

4,000

Bal.

2,100 Land

Equipment

(4)

34,00 0

(7)

4,000

Bal.

34,00 0

Bal.

4,000

Accounts Payable (6)

290 (3) Bal.

Note Payable 900 610

(2)

8,500

(4)

23,000

Bal.

31,500

Common Stock (1) Bal.

8,80 0 8,80 0

Ending Balance $2,100 Chapter 2

Transaction

2-51

Supplies Land Equipment Accounts Payable Notes Payable Common Stock

810 34,000 4,000 610 31,500 8,800

Chapter 2

Transaction

2-52

(10-20 min.) E 2-36B Req. 1 Specialty Deck Service, Inc. Trial Balance April 30, 2021 ACCOUNT

DEBIT

CREDIT

Cash ..................................

$19,200

Accounts receivable ...........

5,300

Equipment .........................

30,800

Accounts payable ...............

$ 4,300

Note payable......................

21,000

Common stock ...................

16,200

Retained earnings ..............

7,800

Dividends...........................

3,100

Service revenue .................

20,500

Salary expense...................

8,400

Utilities expense ................

2,300

Delivery expense................

700

Total..................................

$69,800

Req. 2 Specialty Deck Service, Inc. Income Statement For the Month Ended April 30, 2021 Service revenue........................

$20,500

Salary expense .................

$8,400

Utilities expense ...............

2,300

Delivery expense............... 700 Total expenses .........................

11,400

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

$ 9,100

Chapter 2

Transaction

2-53

(15-25 min.) E 2-37B

Req. 1

St. James, Inc. Trial Balance September 30, 2021 ACCOUNT DEBIT Cash ..............................

$ 14,800*

Accounts receivable........

12,900*

Inventory .......................

17,500

Supplies .........................

300

Land ..............................

55,600

CREDIT

Accounts payable ...........

$ 15,700*

Common stock................

48,300*

Sales revenue.................

46,400

Insurance expense..........

5,400*

Salary expense ...............

1,900

Utilities expense.............

1,700*

Rent expense .................

_______ 300

Total ..............................

$110,40 $110,40 0 0

_____ *Computations: Cash: $14,400 + $400 = $14,800 Accounts Receivable: $13,300 − $400 = $12,900 Accounts Payable: $11,500 + $4,000 − $400 + $600 = $15,700 Common Stock: $47,900 + $400 = $48,300 Insurance Expense: $0 + $5,400 = $5,400 Utilities Expense: $1,100 + $600 = $1,700

Chapter 2

Transaction

2-54

(15-20 min.) E 2-38B

Req. 1 (amounts in millions)

Cash (X) + Other assets (21) = Accounts payable (5) + Other liabilities (1) + S/E (4) + Revenues (33) – Expenses (16) Cash (X) = 6

Req. 2 (amounts in millions)

All Towne Company Trial Balance September 30, 2021 ACCOUNT DEBIT Cash ................................

$ 6

Other assets ....................

CREDIT

Accounts payable .............

$ 5

Other liabilities ................

Stockholders’ equity ........

Revenues.........................

Expenses .........................

Total................................

$43

Chapter 2

Transaction

2-55

Serial Exercise (20-30 min.) E 2-39

Req. 1

DATE May

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

2 Cash ..........................................

CREDIT

12,000

Common Stock.....................

12,000

2 Rent Expense ............................. Cash....................................

500

3 Equipment ................................. Cash....................................

1,800

4 Furniture ................................... Accounts Payable ................

6,000

5 Supplies..................................... Accounts Payable ................

900

9 Cash ..........................................

600

500 1,800 6,000 900

Service Revenue ..................

600

12 Utilities Expense ........................ Cash....................................

750

18 Accounts Receivable................... Service Revenue ..................

3,100

750

Chapter 2

3,100

Transaction

2-56

(continued) E 2-39

Req. 2 Cash May 2 9 Bal.

Accounts Receivable

12,00 May 2 0

500

May 18

3,10 0

1,800

Bal.

3,10 0

750

600 9,550 Supplies

Equipment

May ...........................................................5 900 May ............................................ 1,80 0 Bal.

900

Bal.

Furniture

1,80 0 Accounts Payable

May ...........................................................4 6,000 May 4 Bal.

6,000

900 5 Bal.

Common Stock

6,900

Service Revenue

May ...........................................................2 12,00 May ...................... 600 0 Bal.

12,00 0

3,100 18 Bal.

Chapter 2

3,700

Transaction

2-57

Rent Expense

Utilities Expense

May ...........................................................2 500 May 750 12 Bal.

500

Bal.

750

Chapter 2

Transaction

2-58

(continued) E 2-39

Req. 3 Olivia Matthews, Certified Public Accountant, P.C. Trial Balance May 18, 2021 ACCOUNT

DEBIT

Cash ................................

$ 9,550

Accounts receivable .........

3,100

Supplies ..........................

900

Equipment .......................

1,800

Furniture .........................

6,000

CREDIT

Accounts payable .............

$ 6,900

Common stock .................

12,000

Dividends ........................

—

Service revenue ...............

3,700

Utilities expense ..............

750

Rent expense ...................

500

Salary expense ................

—

Total................................

$22,600

Chapter 2

$22,600

Transaction

2-59

Quiz Q2-40

Q2-41

Q2-42

Q2-43

Q2-44

Q2-45

Q2-46

Q2-47

Q2-48

Q2-49

($55,000 + $30,000 + $25,000) = $110,000

Q2-50

Q2-51

Q2-52

Q2-53

Q2-54

Q2-55

Q2-56

Q2-57

Q2-58

Q2-59

Chapter 2

Transaction

2-60

Problems (15-30 min.) P 2-60A

Req. 1 Dear Veronica, This trial balance lists the accounts of the company, along with their balances at December 31, 2021. The trial balance provides

the

data

for

computing

total

assets,

total

liabilities, and net income or net loss. Baker Specialties reports: a.

Total assets = $395,000 ($13,000 + $49,000 + $5,000

+ $103,000 + $225,000) b.

Total liabilities

Net income

= $144,400 ($50,400 + $94,000)

= $31,000 ($160,000 − $55,000 − $3,000

− $64,000 − $7,000)

Student responses may vary but should include these amounts.

Chapter 2

Transaction

2-61

(45-60 min.) P 2-61A

Req. 1 Analysis of Transactions = LIABILITIES + STOCKHOLDERS’ EQUITY

ASSETS

Cash

Bal. 2,500 a)

3,700

6,700

(4,700 )

Accounts + Receivable

+ Supplies

3,250

Accounts +Equipme = Payable nt

12,200

8,300

3,350 Issued stock 6,700

Service revenue

4,700

Service revenue

800

(1,300) 4,700

Type of Stockholders’ Equity Transaction

(4,700) 800

1,300

6,300 3,700

d) e)

Retained Common + + Stock Earnings

(1,900 )

(1,900) Rent expense

(500)

(500) Advertising expense

(3,400 )

Bal. 3,700

(3,400) Dividends 6,650

800

12,200

4,400

Chapter 2

10,000

8,950

Transaction Analysis 2-62

$23,350

Chapter 2

Transaction Analysis 2-63

(continued) P 2-61A

Req. 2

Grueser Computing, Inc. Income Statement Month Ended October 31, 2021

Revenues: Service revenue ($6,700 + $4,700) Expenses: Rent expense ................................

$11,40 0 $1,9 00

Advertising expense...................... 500 Total expenses.............................. Net income ..........................................

2,400 $9,000

Req. 3

Grueser Computing, Inc. Statement of Retained Earnings Month Ended October 31, 2021 Retained earnings, October 1, 2021 .............. Add: Net income .......................................... Subtotal Less: Dividends declared.............................. Retained earnings, October 31, 2021 ............

$ 3,350 9,000 12,350 (3,400) $ 8,950

Req. 4

Grueser Computing, Inc. Balance Sheet October 31, 2021 ASSETS LIABILITIES Cash ........................ $ Accounts payable ........ $ 3,700 4,400 Accounts receivable . 6,650 STOCKHOLDERS’ Supplies .................. 800 EQUITY Equipment ............... 12,200 Common stock............. 10,000 Retained earnings ....... Copyright © 2022 Pearson Education Inc. Analysis

Chapter 2

Transaction

2-64

Total stockholders’ equity Total liabilities and Total assets .............

$23,35 0

stockholders' equity

Journal ACCOUNT TITLES

DEBIT

Cash .........................................

3,700

Common Stock.................... b.

Cash .........................................

d. e.

6,700 6,700

Accounts Payable ...................... Cash...................................

4,700

Supplies.................................... Accounts Payable................

800

Cash .........................................

1,300

4,700 800

Accounts Receivable ........... f. g.

1,300

Accounts Receivable .................. Service Revenue .................

4,700

Rent Expense ............................ Advertising Expense .................. Cash...................................

1,900 500

Dividends.................................. Cash...................................

3,400

CREDIT

3,700

Service Revenue ................. c.

$23,3 50

(30-40 min.) P 2-62A

Req. 1

8,950 18,950

4,700

2,400

Chapter 2

3,400 Transaction

2-65

Chapter 2

Transaction

2-66

(continued) P 2-62A

Reqs. 2 and 3 Cash

Accounts Receivable

Supplies

Equipment

2,500 4,700

3,250 1,300

800

12,200

3,700 2,400

4,700

6,700 3,400

6,650

800

12,200

1,300 3,700 Accounts Payable

Common Stock

4,700 8,300

6,300

800

3,700

4,400

10,000

Service Revenue 6,700

Rent Expense

Retained Earnings

Dividends

3,350

3,400

3,350

3,400

Advertising Expense

1,900

500

1,900

500

4,700 11,400

The balances of all the accounts Cash through Common Stock agree with the ending balances obtained in Problem 2-61A.

Chapter 2

Transaction

2-67

(50-60 min.) P 2-63A

Req. 1 DATE Aug .

Journal ACCOUNT TITLES

DEBIT

2 Cash.......................................

69,000

Common Stock .................

69,000

3 Supplies ................................. Equipment ............................. Accounts Payable.............

500 11,800

4 Cash....................................... Service Revenue ..............

5,600

7 Land....................................... Cash ................................

33,000

11 Accounts Receivable ............... Service Revenue ..............

3,300

16 Accounts Payable.................... Cash ................................

11,800

17 Advertising Expense ............... Cash ................................

560

18 Cash....................................... Accounts Receivable ........

1,200

22 Utilities Expenses .................. Cash ................................

390

29 Cash....................................... Service Revenue ..............

3,000

31 Salary Expense ....................... Cash ................................

2,500

CREDIT

12,300 5,600 33,000 3,300 11,800 560 1,200 390 3,000

Chapter 2

2,500 Transaction

2-68

31 Dividends ............................... Cash ................................

2,000

Chapter 2

2,000

Transaction

2-69

(continued) P 2-63A

Req. 2 Aug. 2

Cash 69,00 Aug. 0 7

5,600

18 29

1,200 3,000

17 22 31

33,00 0 11,80 0 560 390 2,500

2,000

Bal.

Aug. 7 Bal.

28,55 0 Land 33,00 0 33,00 0

Aug. 31 Bal.

Supplies Aug. 3

500

Bal.

500

Aug. 3 Bal.

Accounts Payable Aug. 11,8 12,3 Aug. 3 16 00 00 Bal.

Accounts Receivable Aug. 3,30 Aug. 1,20 11 0 18 0 2,10 Bal. 0

500

Dividends 2,00 0 2,00 0

Equipment 11,80 0 11,80 0 Common Stock Aug. 69,00 2 0 69,00 Bal. 0 Service Revenue Aug. 5,600 4 11 3,300 29 3,000 11,90 Bal. 0

Salary Expense Aug. 31 Bal.

2,50 0 2,50 0

Advertising Expense Chapter 2

Transaction

2-70

Utilities Expense Aug. 22 Bal.

Aug. 17 Bal.

560 560

390 390

Chapter 2

Transaction

2-71

(continued) P 2-63A

Req. 3 Cloutier Services, Inc. Trial Balance August 31, 20XX ACCOUNT DEBIT Cash ................................

$28,550

Accounts receivable .........

2,100

Supplies ..........................

500

Land ................................

33,000

Equipment .......................

11,800

CREDIT

Accounts payable .............

Common stock .................

69,000

Dividends ........................

500

2,000

Service revenue ...............

11,900

Salary expense ................

2,500

Advertising expense.........

560

Utilities expense ..............

390

Total................................

$81,400

Req. 4 Total resources (assets)

= $75,950 $500 +

($28,550 + $2,100 + $33,000 + $11,800)

Amount owed (total liabilities) = $500 Profit (net income) $560 –

= $8,450

($11,900 − $2,500 − $390)

Chapter 2

Transaction

2-72

Chapter 2

Transaction

2-73

(40-50 min.) P 2-64A

Req. 1 Cash (a)

(c)

46,000

(b)

61,000 (e)

6,300

(f) (j) Bal.

3,700 (h) 1,500 (k) 52,900

200 1,800

41,000

Accounts Receivable 12,80 (g) (j) 1,500 0 Bal 11,30 . 0

Supplies (d)

340

(a)

Bal.

340

Bal .

Music Equipment (c) 46,000 Bal. 46,000

Accounts Payable (h) 200 (d) 340 (i) 800 Bal 940 .

Note Payable (b) 61,000 Bal.

Bal.

(k)

Rent Expense 1,000

Bal.

1,000

Common Stock 151,00 (a) 0 Bal 151,00 . 0

61,000

Service Revenue (f) 3,700 (g) 12,800 16,500

Building 110,0 00 110,0 00

(e) Bal .

Salary Expense 6,300 6,300

Advertising Expense (k) 800 Bal 800 . Chapter 2

Transaction

2-74

Utilities Expense (i) 800 Bal. 800

Chapter 2

Transaction

2-75

(continued) P 2-64A

Req. 2 Samuels Music Services Corporation Trial Balance January 31, 2021 ACCOUNT DEBIT CREDIT Cash ...............................

$ 52,900

Accounts receivable ........

11,300

Supplies..........................

340

Building ..........................

110,000

Music equipment .............

46,000

Accounts payable ............

940

Note payable… ................

61,000

Common stock ................

151,000

Service revenue ..............

16,500

Salary expense................

6,300

Rent expense… ...............

1,000

Utilities expense .............

800

Advertising expense ........

800

Total...............................

$229,440

Chapter 2

$229,440

Transaction

2-76

(15-30 min.) P 2-65B

Req. 1 Dear Clara, This trial balance lists the accounts of the company, along with their balances at December 31, 2021. The trial balance provides

the

data

for

computing

total

assets,

total

liabilities, and net income or net loss. Colby Design reports: a.

Total assets = $413,500 ($13,000 + $55,000 + $6,500 + $104,000 + $235,000)

Total liabilities

Net income

= $144,300 ($50,300 + $94,000)

= $76,000 ($200,000 − $28,000 − $6,000

− $85,000 − $5,000)

Student responses may vary but should include these calculations.

Chapter 2

Transaction

2-77

(45-60 min.) P 2-66B

Req. 1 Analysis of Transactions = LIABILITIES EQUITY

ASSETS

Cash

2,400

3,500

6,500

(4,400)

3,450

11,700

5,500

Type of Stockholders’ Equity Transaction

4,150 Issued stock 6,500

Service revenue

4,700

Service revenue

(4,400) 1,200

1,700

7,900

3,500

1,200

(1,700) 4,700

STOCKHOLDERS’

Accounts Accounts Common Receivable Supplies Equipmen Payable Stock Retained + Earnings + + + + t=

Bal.

(1,800)

(1,800) Rent expense

(550)

(550) Advertising expense

(2,700)

Bal.

4,650

___ 6,450

1,200

(2,700) Dividends 11,700

4,700

Chapter 2

9,000

10,300

Transaction Analysis 2-78

$24,000

Chapter 2

Transaction Analysis 2-79

(continued) P 2-66B

Req. 2 Davis Computing, Inc. Income Statement Month Ended October 31, 2021 Revenues: Service revenue ($6,500 + $4,700) ......

$11,20 0

Expenses: Rent expense .......................

$1,800

Advertising expense .............

550

Total expenses .....................

2,350

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

$ 8,850

Req. 3 Davis Computing, Inc. Statement of Retained Earnings For the Month Ended October 31, 2021 Retained earnings, October 1, 2021 .........

$ 4,150

Add: ......................................Net income 8,850 Subtotal

13,000

Less: Dividends declared ......................... (2,700) Retained earnings, October 31, 2021 .......

Chapter 2

$10,30 0

Transaction

2-80

(continued) P 2-66B

Req. 4 Davis Computing, Inc. Balance Sheet October 31, 2021 ASSETS

LIABILITIES

Cash ......................

$ Accounts payable ......... $ 4,650 4,700

Accounts receivable..............

6,450

STOCKHOLDERS’

Supplies ................

1,200

EQUITY

Equipment .............

11,70 Common stock .............. 9,000 0 Retained earnings ........ 10,30 0 Total stockholders’ 19,30 equity .......................... 0 Total liabilities and

Total assets ...........

$24,0 stockholders' $24,0 00 equity .......................... 00

Chapter 2

Transaction

2-81

(30-40 min.) P 2-67B

Req. 1 Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

a. Cash ........................................

3,500

Common Stock ................... b. Cash ........................................

3,500 6,500

Service Revenue ................

6,500

c. Accounts Payable .................... Cash ..................................

4,400

d. Supplies .................................. Accounts Payable...............

1,200

e. Cash ........................................

1,700

4,400 1,200

Accounts Receivable…........ f.

1,700

Accounts Receivable ................. Service Revenue ................

4,700

g. Rent Expense ........................... Advertising Expense ................. Cash ..................................

1,800 550

h. Dividends ................................. Cash ..................................

2,700

CREDIT

4,700

2,350

Chapter 2

2,700

Transaction

2-82

(continued) P 2-67B

Reqs. 2 and 3 Cash 2,400 4,400

Accounts Receivable 3,450

Supplies

Equipment

1,200

11,700

1,200

11,700

1,700 3,500 2,350

4,700

6,500 2,700

6,450

1,700 4,650

Accounts Payable

Common Stock

4,400 7,900

5,500

1,200

3,500

4,700

Service Revenue 6,500

Retained Earnings

Dividends

4,150

2,700

9,000

4,150

2,700

Rent Expense

Advertising Expense

1,800

550

1,800

550

4,700 11,200

The balances of all the accounts Cash through Common Stock agree with the ending balances obtained in Problem 2-66B.

Accrual Accounting & Income

(50-60 min.) P 2-68B

Req. 1 DATE Mar.

Journal ACCOUNT TITLES

DEBIT

CREDIT

2 Cash .......................................... 68,000 Common Stock .....................

68,000

3 Supplies..................................... 900 Equipment ................................. 12,000 Accounts Payable .................

12,900

4 Cash .......................................... Service Revenue ...................

5,600

7 Land .......................................... 32,000 Cash ....................................

32,000

11 Accounts Receivable................... Service Revenue ...................

4,700

16 Accounts Payable ....................... 12,000 Cash .................................... 17 Advertising Expense ................... Cash ....................................

540

18 Cash .......................................... Accounts Receivable .............

2,600

22 Utilities Expense ........................ Cash ....................................

370

29 Cash .......................................... Service Revenue ...................

3,000

31 Salary Expense........................... Cash ....................................

2,500

31 Dividends...................................

2,200

12,000 540 2,600 370 3,000 2,500

Accrual Accounting & Income

Cash ....................................

2,200

Accrual Accounting & Income

(continued) P 2-68B

Req. 2 Cash Mar. 2 4 18 29

Bal.

68,00 0 5,600 2,600 3,000

Accounts Receivable Mar. 7

32,0 00

Mar. Mar.1 11 4,700 8

12,0 00

Bal.

540

370

2,50 0

2,20 0

29,59 0

Bal.

Mar. 3

900

Bal.

900 Equipment

32,00 0 32,00 0

Mar. 3

12,00 0

Bal.

12,00 0

Accounts Payable Mar. 12,00 Mar. 12,9 16 0 3 00 Bal.

Mar.

2,100

Supplies

Land Mar. 7

2,600

900

Dividends 2,200

Common Stock Mar. 2 68,000 Bal.

68,000

Service Revenue Mar. 5,600 Accrual Accounting & Income

31 Bal.

4 2,200

11 29 Bal.

Salary Expense Mar. 31 Bal.

2,500 2,500

4,700 3,000 13,300

Advertising Expense Mar. 540 17 Bal.

540

Utilities Expense Mar. 22 Bal.

370 370

Accrual Accounting & Income

(continued) P 2-68B

Req. 3 Augusta Services, Inc. Trial Balance March 31, 20XX ACCOUNT

DEBIT

Cash ...............................

$29,590

Accounts receivable ........

2,100

Supplies..........................

900

Land ...............................

32,000

Equipment ......................

12,000

CREDIT

Accounts payable ............

Common stock ................

68,000

Dividends........................

2,200

Service revenue ..............

13,300

Salary expense................

2,500

Advertising expense ........

540

Utilities expense .............

370

Total...............................

900

$82,200 $82,200

Req. 4 Total resources (assets) $2,100 + $900 +

= $76,590

($29,590 +

$32,000 + $12,000) Amount owed (total liabilities) = $900 Profit (net income) $2,500 − $540 –

= $9,890

($13,300 − $370)

Accrual Accounting & Income

(40-50 min.) P 2-69B

Req. 1 Cash (a)

46,000 (c)

47,000

(b)

60,000 (e)

5,700

(f) (j) Bal.

3,710 (h) 1,200 (k) 56,010

300 1,900

(a) Bal.

Accounts Receivable 12,90 (g) (j) 1,200 0 11,70 Bal. 0 (d) Bal.

Building 106,00 0 106,00 0

Music Equipment (c) Bal.

Note Payable (b) 60,000 Bal. 60,000

(h)

Common Stock (a) Bal.

Supplies 530 530

47,00 0 47,00 0 Accounts Payable 300 (d) 530 (i) 700 Bal. 930

152,00 0 152,00 0

Service Revenue (f) 3,710 (g) 12,900 Bal. 16,610 Advertising Expense (k) 800 Bal. 800

(e) Bal.

Salary Expense 5,700 5,700

(k) Bal.

Rent Expense 1,100 1,100 Utilities Expense

Accrual Accounting & Income

(i) Bal.

700 700

Accrual Accounting & Income

(continued) P 2-69B

Req. 2 Shreve Music Corporation Trial Balance May 31, 2021 ACCOUNT

DEBIT

CREDIT

Cash.................................. $ 56,010 Accounts receivable ...........

11,700

Supplies ............................

530

Building ............................

106,000

Music equipment ...............

47,000

Accounts payable...............

930

Note payable .....................

60,000

Common stock ...................

152,000

Service revenue.................

16,610

Salary expense ..................

5,700

Rent expense ....................

1,100

Advertising expense ..........

800

Utilities expense ................

700

Total ................................. $229,540

$229,540

Accrual Accounting & Income

Challenge Exercises and Problem (20-40 min.) E 2-70

Req. 1 a.

Total cash paid during December: Cash Nov. 30 Bal.

14,500

Dec. receipts

99,000 Dec. payments

Dec. 31 Bal.

7,250

X = $106,250

$14,500 + $99,000 − X

=$ 7,250 X = $106,250

Cash collections from customers during December: Accounts Receivable Nov 30 Bal.

29,00 0

Dec. sales on account

49,00 Dec. collections 0

Dec. 31 Bal.

27,00 0

X = $51,000

$29,000 + $49,000 − X = $27,000 X = $51,000 c.

Cash paid on notes payable during December:

Accrual Accounting & Income

Notes Payable Nov. 30 Bal. X= $20,000

Dec. note payments X Dec. new borrowing Dec. 31 Bal.

15,50 0 28,00 0 23,50 0

$15,500 + $28,000 = $23,500 −X = $20,000 X

Accrual Accounting & Income

(20-30 min.) E 2-71

Req. 1

Jubilee, Inc. Trial Balance October 31, 2021 Cash…………………………...

$ 4,100

Accounts receivable………..

7,300

Land…………………………...

31,700

Accounts payable…………..

$ 6,700

Note payable…………………

5,400

Common stock………………

23,900

Retained earnings…………..

1,200

Service revenue……………..

9,800

Salary expense………………

2,500

Advertising expense……….

_______ 1,200

Totals………………………….

$46,800 $47,000

Out of balance by $200 The correct balance of Accounts Receivable is $7,500* ($7,300 + $200). After this correction, total debits will be $47,000 ($46,800 + $200), the same as total credits.

Req. 2 a. Total assets

$43,300

($4,100 + $7,500* +

$31,700) b. Total liabilities =

$12,100

($6,700 + $5,400)

Accrual Accounting & Income

c. Net income

$ 6,100

($9,800 − $2,500 −

$1,200)

(10-15 min.) E 2-72

Req. 1 Marion Co.: Income statement Employee medical exp.

November $48,000

December $ -0-

Nov. 30 $51,000 48,000

Dec. 31 $18,000* 15,000**

November $48,000

December $ -0-

Nov. 30 $ -048,000

Dec. 31 $33,000 15,000**

Balance sheet Cash ....................... Accounts payable .... Ashland Hospital: Income statement Service revenue ...... Balance sheet Cash ....................... Accounts receivable

Req. 2 Explanation: Marion’s $48,000 expense is Ashland’s revenue of $48,000. Marion’s $33,000 cash payment is Ashland’s cash receipt of $33,000. Marion’s $15,000 account payable is Ashland’s account receivable of $15,000. Marion’s $48,000 account payable is Ashland’s account receivable of $48,000. __________ *$51,000 − $33,000 = $18,000 **$48,000 − $33,000 = $15,000 Copyright © 2022 Pearson Education Inc. Chapter 3 3-14

Accrual Accounting & Income

(20 min.) E 2-73

Req. 1 Effect Date May

on Cash

Effect on Total Assets

Effect on Net Income

Understated

Overstated

$1,700

Understated

$3,600

Correct

Understated

$3,400

Correct

Overstated $5,500

Correct

Overstated

Correct

$3,900

Req. 2 Correct cash balance, $11,600 ($6,300 + $1,700 + $3,600)

Req. 3 Correct total assets, $21,400 ($20,000 – $1,700 + $3,600 + $3,400 – $3,900)

Accrual Accounting & Income

Cases (20-30 min) C2-74

Req. 1 Feb. 1

Cash

15,000

Sales Revenue

15,000

2 Inventory Accounts Payable

11,000

8 Advertising Expense Cash

2,000

11 Salary Expense Cash

75,000

12 Cash Note Payable

80,000

15 Utilities Expense Cash

1,500

19 Accounts Payable Cash

11,000

20 Cash Unearned Gift Card Revenue

1,000

27 Rent Expense Cash

3,500

11,000 2,000 75,000 80,000 1,500 11,000 1,000 3,500

Accrual Accounting & Income

(continued) C2-74

Req. 2 Feb. 1

Assets increase $15,000 Equity increases $15,000

2 Assets increase $11,000 Liabilities increase $11,000 8 Equity decreases $2,000 Assets decrease $2,000 11 Equity decreases $75,000 Assets decrease $75,000 12 Assets increase $80,000 Liabilities increase $80,000 15 Equity decreases $1,500 Assets decrease $1,500 19 Liabilities decrease $11,000 Assets decrease $11,000 20 Assets increase $1,000 Liabilities increase $1,000 27 Equity decreases $3,500 Assets decrease $3,500

Accrual Accounting & Income

Decision Cases (40-50 min.) C2-75

Reqs. 1 and 2 Cash

Accounts Receivable

(a)

7,000 (c)

1,300

(g)

8,000 (i)

(b)

6,000 (d)

1,800

Bal.

6,800

(h)

2,500 (f)

2,000

(i)

1,200 (f)

1,200

(j)

1,000

Bal.

9,400 Supplies

(c)

Furniture

1,300

(e)

Accounts Payable (j)

1,200

1,000 (e) Bal.

5,400 Notes Payable

5,400

(b)

4,400

Common Stock (a)

7,000

Service Revenue

Salary Expense

(g)

8,000

(h)

2,500

(f)

2,000 Accrual Accounting & Income

6,000

Bal.

10,50 0

Advertising Expense (d)

1,800

Rent Expense (f)

1,200

Accrual Accounting & Income

(continued) C2-75

Req. 3

Blast Networks, Inc. Trial Balance Current Date ACCOUNT

DEBIT

Cash .................................... $ 9,400 Accounts receivable ............. 6,800 Supplies .............................. 1,300 Furniture ............................. 5,400 Accounts payable ................. Notes payable ...................... Common stock ..................... Service revenue ................... Salary expense .................... 2,000 Advertising expense............. 1,800 Rent expense ....................... 1,200 Total.................................... $27,900

CREDIT

$ 4,400 6,000 7,000 10,500

$27,900

Req. 4 (net income or loss for first month of operations) Revenues: Service revenue ............ Expenses: Salary expense ............. Advertising expense...... Rent expense................ Total expenses..................... Net income for month...........

$10,500 $2,000 1,800 1,200 5,000 $5,500

Recommendation: Barton’s criteria for remaining in operation was to earn net income of $5,000. His actual result was just over this goal. Yes, I would recommend that he stay in business.

Accrual Accounting & Income

(20-30 min.) C2-76

Req. 1

Romano Castle, Inc. Income Statement Month Ended December 31, 2021

Sales revenue......................................

$42,00 0

Expenses: Cost of sales (expense) ........................

22,000

Rent expense ......................................

6,000

Advertising expense ............................ 5,000 Total expenses ................................ 33,000 Net income..........................................

$ 9,000

Romano Castle, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Cash ......................

$ Accounts payable ........ $ 8,000 12,000

Food inventory.......

5,000

Furniture ...............

STOCKHOLDERS’ EQUITY

Common stock.............

10,000

10,000 Retained earnings ....... 9,000* Total stockholders’ equity Total liabilities Total assets ........ $27,00

and stockholders’

Accrual Accounting & Income

19,000

0 equity ......................... $27,000 _____ *Must solve for this amount. It is also the amount of net income, which is the only change in retained earnings for the month.

Recommendation: Do not expand this month. The business falls

short of the goals for both net income and total assets. However, Romano Castle, Inc. appears to be profitable, and assets are building toward Ferritto’s goals. Maybe next month.

Accrual Accounting & Income

Ethical Issue 1 C2-77 1. The ethical issue is whether these alternatives of financing the business are proper from an economic, legal, and ethical standpoint. 2. The stakeholders are Shabby Fitch, the bank, potential new and existing creditors, and the friend who may become a stockholder. Consequences to the creditors are the inability of the company to pay interest and the loan.

Consequences

to the investors are the inability of the company to pay dividends and the possibility of loss of investment if the company goes bankrupt. 3. Option 1: Option 2:

Cash................................. Common Stock ............

200,000

Land ................................ Common Stock ............

200,000

Common Stock.................. Land ...........................

200,000

200,000 200,000 200,000

Option 1 is economically sound, perfectly legal, and also ethical because the sale of the stock is a valid transaction between the business and a stockholder.

The consequences of this decision

are that Fitch obtains additional financing at a cost (he now shares ownership of the business with his friend).

The friend

gives up cash in exchange for an ownership interest in the business.

The bank and future creditors obtain complete and

truthful disclosure of the manner in which the business has been financed.

Accrual Accounting & Income

Option 2 represents “window dressing” (making the company look like an entity that it is not). Although it might be legal in the strictest sense of the word (and it might not), this option does not faithfully represent economic reality. Thus, it is not in accordance with GAAP, which is a substitute for the legal criterion. This option is also unethical because the receipt of the land by the business is not a real transaction. The transfer of the land back to (continued) C2-77 Fitch means that the business never actually has the land for its use. It violates the rights of the bank and future creditors to give them information that is inaccurate and that does not faithfully represent economic reality. 4.

The best option to take is definitely Option 1.

The decision

maker can walk away from this transaction confident that he or

she

told

the

Accrual Accounting & Income

truth.

Ethical Issue 2

C2-78

Part a. 1.

The ethical issue is whether you should question your grade,

which is higher than you expected. Your choices are (a) discuss the grade with the professor; and (b) do not discuss the grade with the professor. 2, 3. Stakeholders are you, the professor, the other students in the class, and the university. The possible consequences to you of discussing the grade with the professor is that it may lead to the discovery that the professor made a mistake in calculating the grade, which may lead to a downward adjustment. While this could

possibly

have

adverse

economic

consequences

(i.e.,

perhaps loss of scholarship if the grade is substantially lowered), it is unlikely that a letter-grade drop in one course would have such an impact on grade point average as to cause loss of a scholarship. There is no legal consequence to reporting a grade that is too high. The ethical consequence is generally positive on all concerned, as it leads to clarification of the true grade. 4. Student opinions will vary on this part. Part b. 1. The ethical issue in this case is whether you should question your grade, which is now lower than you expected. Your choices are (a) discuss the grade with the professor; and (b) do not discuss the grade with the professor.

Accrual Accounting & Income

2, 3. Like part a, the stakeholders are you, the professor, the other students in the class, and the university.

The possible

consequences to you of discussing the grade with the professor is that it may lead to the discovery that the professor made a mistake

calculating

the

grade,

which

may

Accrual Accounting & Income

lead

(continued) C2-78 to an upward adjustment.

This could have positive economic

consequences (i.e., perhaps keeping a scholarship). Like part a, the ethical consequence of this action is generally positive on all concerned, as it leads to clarification of the true grade. 4.

Most students would probably respond “take it to the

professor.”

But shouldn’t we be just as concerned about

knowing the true grade either way?

The author recommends

discussing the grade with the professor one way or the other. Part c. Both course grades and financial statements report results that people use in order to make decisions that can carry both positive and negative consequences.

In both situations, it is

important that the user receive relevant information, and that the

information

faithfully

represent

facts

they

actually

occurred.

Accrual Accounting & Income

Focus on Financials: Apple Inc. (20-30 min.)

Reqs. 1 and 3

(All amounts in millions)

Cash 0 b. g.

Accounts Receivable, net 23,186 b. 260,434

260,434

171,584

e. 1,807 f. h. i.

34,462 10,481 10,695

22,926

Other Non-Current Assets

3,926 38,945

Inventories 3,956 d. 161,782 161,932 4,106 e. Property, Plant and Equipment, net 41,304

22,283 10,695 32,978

Accounts Payable 171,584 55,888 c. 161,932 46,236

3,926

37,378

260,174

Net Sales a. 260,174 260,174

Cost of Sales 161,782 161,782 f.

Other Income/(Expense), net g. 1,807 1,807

Operating Expenses 34,462 34,462

Provision for Income Taxes h. 10,481 10,481

Accrual Accounting & Income

(continued) Apple Inc.

Req. 2 a.

(Millions)

Accounts Receivable, net

260,17 4

Net Sales (Revenue) b.

260,17 4

Cash

260,43 4

Accounts Receivable, net c.

260,43 4

Inventories

161,93 2

Accounts Payable d.

161,93 2

Cost of Sales

161,78 2

Inventories e.

161,78 2

Accounts Payable

171,58 4

Cash f. g. h. i.

171,58 4

Operating Expenses Cash

34,462

Cash Other Income/(Expense), net

1,807

Provision for Income Taxes Cash

10,481

Other Non-Current Assets Cash

10,695

34,462 1,807 10,481 10,695 Accrual Accounting & Income

Cash Property, plant and equipment, net

3,926 3,926

Req. 4 All the selected account balances agree with Apple Inc.’s actual figures on the income statement or the balance sheet. (continued) Apple Inc.

Req. 5 (Millions)

Revenue: Net sales .......................................

$260,1 74

Other Income/(Expense), net .......... 1,807 Total revenue ....................................

261,98 1

Expenses: Cost of sales ...................................

$161,7 82

Operating expenses ........................

34,462

Provision for income taxes .............. Total expenses................................... Net Income .....................................

10,481

206,72 5 $ 55,256

The net income of $55,256 million equals the net income reported on Apple’s income statement.

Accrual Accounting & Income

Focus on Analysis: Under Armour, Inc. (20-30 min.)

Req. 1 During fiscal 2019, Under Armour, Inc. had more net revenues than cash collections. This is determined by analyzing net accounts receivable, as follows: Net accounts receivable:

(Thousand s)

Balance at the end of fiscal 2018 .................... + Net revenues during fiscal 2019 (from consolidated

$ 652,546 5,267,13 2

statements of income) .................................. − Collections from customers during fiscal 2019 .....................................................................

(X)

= Balance at the end of fiscal 2019 ....................

$ 708,714

Solving for X, collections were $5,210,964 ($652,546 + $5,267,132 – $708,714).

Another way to express this

relationship is that when accounts receivable increase during the year, revenues must exceed cash collections. If accounts

receivable

decrease

during

the

year,

collections must exceed revenues.

Accrual Accounting & Income

cash

(continued) Under Armour, Inc.

Req. 2

Net revenues increased overall, however the percentage change is less (1.4%) in 2019, compared to the 2018 percentage change (4.1%). The company experienced losses in both 2017 and 2018.

Due to implementation of the

company’s turnaround plan, which began in 2018, they were able to convert a $46.3 million loss in 2018 to a positive net income of $92.1 million in 2019, largely by cutting expenses rather

than

increasing

revenues.

Over

2017-2019,

net

income grew by a faster rate than net revenues.

2019 Net revenues (thousands)

2018

2017

$5,267,132 $5,193,185 $4,989,244

$ change

73,947

203,941

Percentage change

1.4%

4.1%

($73,947 ÷ ($203,941 $5,193,185) ÷ $4,989,244) Net income (loss)

$92,139

$(46,302)

$ change

138,441

1,958

Percentage change

299.0%

4.1%

($138,441÷

($1,958 ÷ $48,260)

$(48,260)

(thousands)

Accrual Accounting & Income

Group Projects Student responses will vary.

Chapter 3 Accrual Accounting & Income Ethics Check (5-10 min.) EC 3-1 a. Integrity b. Integrity c. Objectivity and independence d. Due Care

Accrual Accounting & Income

Short Exercises (10 min.) S 3-1

Sales revenue ................................................. Cost of goods sold .......................................... All other expenses .......................................... Net income ..................................................... Beginning cash ............................................... Collections ..................................................... Payments for: inventory ................................. everything else.......................... Ending cash ....................................................

Millions

$ 950 (260) (275) $ 415 $ 75 876 (410) (250) $ 291

(10 min.) S 3-2 Statement 1. Income statement

Reports (Amounts in millions) Interest expense ......................... $ 1.1

2. Balance sheet

Notes payable ($4.0 + $1.9 − $1.7) ..........................................

$4.2

Interest payable..........................

0.2

Accrual Accounting & Income

(10 min.) S 3-3 At the end of each accounting period, the business reports its performance through the preparation of financial statements.

In order to be useful to the various users of

financial statements they must be up-to-date.

Accounts

such as Cash, Equipment, Accounts Payable, Common Stock and Dividends are up-to date and require no adjustment at the end of the accounting period.

Accounts such as

Accounts Receivable, Supplies, Salary Expense and Salary Payable may not be up to date as of the last day of the accounting period. Why? Because certain transactions that took place during the month may not have been recorded. The accrued salaries, which are owed to the employees but have not been paid, are an expense related to the current period but also represent a liability or debt that is owed by the business. The business must make an adjusting entry to record the accrued salary owed as both an increase in Salary Expense and an increase in Salary Payable. If the business does not make this adjustment, the expenses will be understated, net income will be overstated, and liabilities will be understated. In addition, stockholders’ equity will be overstated. Student responses may vary.

Accrual Accounting & Income

(10 min.) S 3-4 The large auto manufacturer should record sales revenue when the revenue is earned by delivering automobiles to Budget or Hertz. The large auto manufacturer should not record any revenue prior to delivery of the vehicles, because the large auto manufacturer hasn’t earned the revenue yet. The revenue principle governs this decision. When the large auto manufacturer records the revenue from the sale, at that time — not before or after — the large auto manufacturer should also record cost of goods sold, the expense. The expense recognition principle tells when to record expenses. (10 min.) S 3-5 a.

The Expense Recognition Principle

b. The Revenue Principle c. The Time-Period Concept d. The Expense Recognition Principle e. The Revenue Principle (10 min.) S 3-6 (Amounts in millions) Income statement: Salary expense ($40.8 + $2.3)

2021 $43.1

Balance sheet:

2021

Accrual Accounting & Income

Salary payable

$ 2.3 (10 min.) S 3-7

a. March 31

Rent Expense ($7,200 × 1/6) ...

1,200

Prepaid Rent ..................... To record rent expense. Prepaid Rent March 1

7,200 March 31

Bal.

6,000

1,200

Rent Expense 1,200

March 31

1,20 0

Bal.

1,20 0

b. March 31

Supplies Expense (1050 − $400)

650

Supplies ............................. To record supplies expense. Supplies March 1

1,05 March 0 31

Bal.

400

650

Supplies Expense 650

March 31

650

Bal.

650

Accrual Accounting & Income

(10 min.) S 3-8

Req. 1 (a) Jan.

1 Equipment .................................

50,00 0

Cash ....................................

50,00 0

Purchased equipment. (b Dec. ) 31

Depreciation Expense − Equipment ..............................

12,50 0

Accumulated Depreciation − Equipment .......................... Record depreciation expense.

12,50 0

Req. 2

Equipment

Accumulated Depreciation − Equipment

Depreciation Expense − Equipment

Jan. 1

50,00 0

Dec. 31

12,50 0

Dec. 31

12,50 0

Bal.

50,00 0

Bal.

12,50 0

Bal.

12,50 0

Req. 3 Equipment ................................................... Less: Accumulated depreciation.................... Book value ...................................................

$50,000 (12,500) $37,500

Accrual Accounting & Income

(10 min.) S 3-9

Req. 1 Oct. 31 Interest Expense .................................. Interest Payable ............................... To accrue interest expense for October.

825

Nov. 30 Interest Expense .................................. Interest Payable ............................... To accrue interest expense for November.

825

Dec. 31

825

Interest Expense ..................................

825

Interest Payable ............................... To accrue interest expense for December.

Req. 2

Interest Payable Oct. 31 Nov. 30 Dec. Bal.

825

825 825 825 2,475

Req. 3 Jan. 2

Interest Payable ................................... 2,475 Cash ................................................ 2,475 To pay interest.

Accrual Accounting & Income

(10 min.) S 3-10

Req. 1 Oct. 31 Interest Receivable.............................. Interest Revenue .............................. To accrue interest revenue for October.

825

Nov. 30 Interest Receivable.............................. Interest Revenue .............................. To accrue interest revenue for November.

825

Dec. 31 Interest Receivable.............................. Interest Revenue .............................. To accrue interest revenue for December.

825

Req. 2 Interest Receivable Oct. 31

825

Nov. 30

825

Dec. 31

825

Bal.

2,475

Req. 3 Jan. 2

Cash ..............................................

2,47 5

Accrual Accounting & Income

2,47 5

(5-10 min.) S 3-11 Unearned revenues are liabilities because The New York

Times has received cash from subscribers in advance of providing

them

with

newspapers

and

online

access.

Receiving the cash in advance creates an obligation (a liability) for The New York Times. As The New York Times delivers newspapers and online content to subscribers, The

New York Times earns the revenue, and the dollar amount of the unearned revenue then goes into the revenue account. a. Cash ............................................. 85,000 Unearned Subscription Revenue . Received cash for revenue in advance. b. Unearned Subscription Revenue ...... Subscription Revenue ................. To record the earning of subscription revenue that was collected in advance.

85,000

40,000 40,000

(5-10 min.) S 3-12 a. Prepaid Rent ................................... Cash .......................................... To record annual payment for rent.

26,800

b. Rent Expense .................................. Prepaid Rent .............................. To record rent expense for the 5 months August 1 through December 31 ($26,800 ×

11,167

26,800

11,167

Accrual Accounting & Income

5 / 12). Prepaid Rent balance at December 31: $15,633 ($26,800 − $11,167) (10 min.) S 3-13 a.

Accounts Receivable ...................... Service Revenue ........................

22,000

Cash ............................................. Accounts Receivable ..................

9,000

Cash ............................................. Unearned Service Revenue .........

4,500

Unearned Service Revenue............. Service Revenue.........................

3,000

22,000 9,000

4,500

Accrual Accounting & Income

3,000

(15-30 min.) S 3-14 Robin Sporting Goods Company Income Statement For the Year Ended July 31, 2021

Thousands

Net revenues ...............................

$191,000

Cost of goods sold........................

136,800

All other expenses .......................

29,000

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

$ 25,200

Robin Sporting Goods Company Statement of Retained Earnings For the Year Ended July 31, 2021

Thousands Retained earnings, July 31, 2020 ....

$31,500

Add: Net income ............................

25,200

Retained earnings, July 31, 2021 ....

$56,700

Accrual Accounting & Income

(continued) S 3-14 Robin Sporting Goods Company Balance Sheet July 31, 2021

Thousands

ASSETS Current: Cash ............................................

$ 50,000

Accounts receivable .....................

34,000

Inventories ..................................

36,000

Other current assets ....................

5,000

Total current assets .................. 125,000 Property and equipment, net .........

19,400

Other assets ................................. 30,000 Total assets ......................................

$174,40 0

LIABILITIES Total current liabilities ..................

$ 80,000

Long-term liabilities ...................... 11,700 Total liabilities ..................................

91,700

STOCKHOLDERS’ EQUITY Common stock ..............................

26,000

$174,40

Accrual Accounting & Income

equity...............................................

Accrual Accounting & Income

(5-10 min.) S 3-15 CLOSING ENTRIES

Thousands July 31 Net Revenues ...........................

191,00 0

Retained Earnings .............. 31 Retained Earnings.....................

191,00 0 165,80 0

Cost of Goods Sold ............. All Other Expenses .............

136,80 0 29,000

Retained Earnings July 31, 2021 Expenses

165,80 July 31, 2020 Bal. 0

31,500

July 31, 2021 Revenues

191,00 0

July 31, 2021 Bal.

56,700

Retained Earnings’ ending balance agrees with the amount reported on the statement of retained earnings and the balance sheet (in S 3-14).

Accrual Accounting & Income

(5 min.) S 3-16 (Dollars in thousands)

Req. 1 Net working capital

=Total current assets

−

Total current liabilities $45,000

$125,000

−

$80,000

Req. 2 Current ratio

Total current assets Total current liabilities

Total liabilities Total assets

$125,000 = $80,000

1.56

0.53

Req. 3 Debt ratio

$91,700 $174,400

Net working capital of $45,000 means current assets exceed current liabilities—a positive sign.

The current ratio and

debt ratio values are strong.

Accrual Accounting & Income

(10 min.) S 3-17

Req. 1 Journal DATE

CREDI DEBIT T

ACCOUNT TITLES

Closing Entries Dec. 31 Sales Revenue ............................ Other Revenue ............................

513,0 00 37,00 0

Retained Earnings ................... 31 Retained Earnings .......................

550,0 00 441,0 00

Cost of Goods Sold ..................

256,0 00 185,0 00

Other Expenses....................... 31 Retained Earnings .......................

12,00 0

Dividends ...............................

12,00 0

Req. 2 Net income was $109,000 ($550,000 − $441,000).

Req. 3 Beginning retained earnings

$457,000

– 12,000 Accrual Accounting & Income

= Ending retained earnings

$554,000

(5 min.) S 3-18 1. Company D 2. Companies D and E 3. Companies A, B, and C

(15-25 min.) S 3-19 1. Bar Chart 2.50 2.00 1.50 1.00 0.50 0.00

2020 Azel Co.

Bakerton Co.

Crow Co.

Daisy Inc.

Elle Corp.

2. Line Chart

Accrual Accounting & Income

2.20 2.10 2.00 1.90 1.80 1.70 1.60

2016

2017

2018

2019

2020

Crow Co.

(continued) S 3-19 3. Line Chart Azel Co., Elle Corp., and Crow Co. have generally been trending down over the past five years. Bakerton Co. and Daisy Inc. have generally been trending up over the past five years. 2.50 2.00 1.50 1.00 0.50 0.00

2016

2017

2018

2019

2020

Azel Co.

Bakerton Co.

Crow Co.

Daisy Inc.

Elle Corp.

Accrual Accounting & Income

Exercises (5-10 min.) E 3-20A

Million s a.

Revenue .....................................................

$820

The revenue principle says to record revenue when it has been earned, regardless of when cash is collected. Therefore, report the amount of revenue earned, regardless of when the company collects cash. b.

Total expense ............................................. The expense recognition accounting for expenses.

principle

$520 governs

Revenue ($820 − $20) .................................

$800

Total expense .............................................

$610

The accrual basis measures revenues as earned and expenses as incurred, while the cash basis measures revenues collected in cash and expenses paid in Copyright © 2022 Pearson Education Inc. Chapter 3 3-53

Accrual Accounting & Income

cash. d.

The income statement reports revenues and expenses. The statement of cash flows reports cash receipts and cash payments.

Accrual Accounting & Income

(15-20 min.) E 3-21A

Req. 1 Adjusting Entries DAT E

CREDI DEBIT T

ACCOUNT TITLES

a. Insurance Expense.................................. Prepaid Insurance ($500 + $2,000 − $400) .....................................................

2,100

b. Interest Receivable................................. Interest Revenue ................................

2,500

c. Unearned Service Revenue ($1,700 − $300) ..................................................... Service Revenue .................................

1,400

d. Depreciation Expense—Building .............. Accumulated Depreciation—Building ....

5,600

e. Salary Expense ($19,000 × 2/5) ............... Salary Payable ....................................

7,600

f. Income Tax Expense ($21,000 × .35) ....... Income Tax Payable…..........................

7,350

2,100

2,500

1,400 5,600 7,600 7,350

Req. 2 Net income understated by omission of: Interest revenue ............................... $ 2,500 Service revenue ................................ 1,400 Total understatement........................

$ (3,900)

Net income overstated by omission of: Insurance expense ............................ $ 2,100 Depreciation expense ........................ 5,600 Salary expense.................................. 7,600 Income tax expense .......................... 7,350 Copyright © 2022 Pearson Education Inc. Chapter 3 3-55

Accrual Accounting & Income

Total overstatement .......................... Overall effect — net income overstated by

22,650 $18,750

Accrual Accounting & Income

(10-15 min.) E 3-22A Missing amounts in italics. 1 Beginning Supplies

$2,100 $ 1,100 $

700 $

500

Add: Purchases of supplies during the year

1,400

400

1,400

Total amount to account for

3,500

1,500

2,100

1,000

Less: Ending Supplies

(1,100)

(800)

(600)

(200)

Supplies Expense

$2,400

$ 700

$1,500

$800

500

Journal entries: Situation 1:

Supplies ............................... 1,400 Cash or Accounts Payable ................................

Situation 2:

Supplies Expense ..................

1,400 700

Supplies..........................

Accrual Accounting & Income

700

(10-20 min.) E 3-23A Adjusting Entries DATE

ACCOUNT TITLES

DEBIT CREDIT

a. Interest Expense ..................................... 3,100 Interest Payable ...............................

3,100

b. Interest Receivable ................................. 4,400 Interest Revenue…............................

4,400

c. Unearned Rent Revenue ($14,200 / 2 × 6 / 3,550 12) Rent Revenue ...................................

3,550

d. Salary Expense ($5,700 × 4) .................... 22,800 Salary Payable.................................. 22,800 e. Supplies Expense .................................... 1,900 Supplies ($3,100 − $1,200) ...............

1,900

f. Depreciation Expense−Equipment 28,000 ($140,000 / 5) ......................................... Accumulated 28,000 Depreciation−Equipment ......................... Book value = $112,000 ($140,000 − $28,000)

(10-15 min.) E 3-24A Prepaid Rent at December 31: a. Unadjusted amount.................................

$36,00 0

b. Adjusted amount ($36,000 − $12,000) .....

24,000

Accrual Accounting & Income

Rent Expense at December 31: c.

Unadjusted amount.................................

d. Adjusted amount ($36,000 / 3).................

-0-

12,000

(20-30 min.) E 3-25A

Req. 1

Pearl Industries, Inc. Income Statement Year Ended December 31, 2021

Thousands Revenues: Sales revenue .................

$43,20 0

Expenses: Cost of goods sold ...........

$25,10 0

Selling, administrative, and general expenses....... 10,500 Total expenses............. 35,600 Income before tax ...............

7,600

Income tax expense ............. 2,900 Net income..........................

$ 4,700

Pearl Industries, Inc. Statement of Retained Earnings Year Ended December 31, 2021

Accrual Accounting & Income

Thousands Retained earnings, December 31, 2020

$ 5,700

Add: Net income ..................................

4,700

Subtotal

10,400

Less: Dividends declared ..................... (1,600) Retained earnings, December 31, 2021

$ 8,800

Accrual Accounting & Income

(continued) E 3-25A

Pearl Industries, Inc. Balance Sheet December 31, 2021

Thousands ASSETS

LIABILITIES

Cash ............................

$ Accounts payable ..... $ 4,400 7,900

Accounts receivable .....

1,600 Income tax payable ..

Inventories ..................

2,700 Other liabilities ........

400 2,700

Prepaid expenses......... Prop., plant, equip.

1,800 Total liabilities ......... 11,00 0

$16,5 00

STOCKHOLDERS’

Less: Accum. Deprec..

EQUITY 14,10 Common stock.......... (2,400 0 14,50 ) 0

Other assets ................

9,700 Retained earnings .... 8,800 Total stockholders’ equity

23,30 0

Total liabilities and Total assets .................

$34,3 00

stockholders’ equity $34,3 00

Accrual Accounting & Income

(10-20 min.) E 3-26A One mechanism for solving this exercise is to prepare the relevant T-accounts, insert the given information, and solve for the unknown amounts, shown in italics.

Amounts in millions Receivables Beg. bal.

210

Sales revenue End. bal.

20,620 Collections

20,400

430

Prepaid Insurance Beg. bal.

400

Payment

470

End. bal.

330

Insurance expense

54 0

Accrued Liabilities Payable

Payments

Beg. bal.

640

Other operating expenses 4,000

4,070

End. bal.

710

Accrual Accounting & Income

(10-20 min.) E 3-27A Journal DATE

CREDI DEBIT T

ACCOUNT TITLES

Closing Entries Dec. 31 Service Revenue ......................... Other Revenue ............................ Retained Earnings ................... 31 Retained Earnings .......................

32,20 0 1,000 33,20 0 26,00 0

Cost of Services Sold ...............

14,80 0

Selling, General, and Administrative Expenses ........................... Depreciation Expense.............. Income Tax Expense ................ 31 Retained Earnings ....................... Dividends ...............................

6,200 4,100 900 500 500

Net income for 2021 was $7,200 ($33,200 − $26,000).

Retained Earnings Expenses Dividends

Dec. 31, 26,000 2020 500 Revenues Dec. 31,

2,00 0 33,2 00 8,70

Accrual Accounting & Income

2021

Accrual Accounting & Income

(15-25 min.) E 3-28A

Req. 1 DATE

Journal ACCOUNT TITLES

DEBI T CREDIT

Adjusting Entries Dec. 31 Unearned Service Revenue ...............

5,00 0

Service Revenue ($18,300 − $13,300) ..........................................

5,000

31 Salary Expense ($4,800 − $4,200) ..... Salary Payable .............................

600

31 Rent Expense ($2,100 − $1,700) ....... Prepaid Rent ................................

400

31 Depreciation Expense−Equipment ($900 − $0)...................................... Accumulated Depreciation−Equipment ..................

900

31 Income Tax Expense ($1,800 − $0)....

1,80 0

600 400

900

Income Tax Payable .....................

1,800

Closing Entries 31 Service Revenue ..............................

18,3 00

Retained Earnings ........................ 31 Retained Earnings ............................

18,300 9,60 0

Salary Expense ............................ Rent Expense ............................... Depreciation Expense−Equipment. Income Tax Expense ..................... Copyright © 2022 Pearson Education Inc. Chapter 3 3-65

Accrual Accounting & Income

4,800 2,100 900 1,800

31 Retained Earnings ............................

1,00 0

Dividends ....................................

Accrual Accounting & Income

1,000

(20-30 min.) E 3-29A

Req. 1 Crawford Production Company Balance Sheet December 31, Current Year ASSETS Current assets: Cash............................................................... $15,000 Prepaid rent ($1,000 − $400) ..........................

600

Total current assets.....................................

15,600

Plant assets: Equipment ....................................... $42,000 Less accumulated depreciation ($6,700 + $900) ............................

34,400 (7,600)

Total assets ........................................................ $50,000 LIABILITIES Current liabilities: Accounts payable............................................ $ 4,000 Salary payable ($4,800 − $4,200) ....................

600

Unearned service revenue ($8,600 − $5,000) ...

3,600

Income tax payable.........................................

1,800

Total current liabilities ................................

10,000

Note payable, long-term......................................

11,000

Total liabilities....................................................

21,000

STOCKHOLDERS’ EQUITY Common stock… .................................................

8,300

Retained earnings ($13,000 + $18,300 − $4,800 − $2,100 − $900 − $1,800 − $1,000)....

20,700

Total stockholders’ equity ...................................

29,000

Accrual Accounting & Income

Total liabilities and stockholders’ equity .............. $50,000

Accrual Accounting & Income

(continued) E 3-29A

Req. 2 Curren t Year Net working capital Current ratio

Prior Year

= Total current assets $15,600 − current liabilities = − = $5,600 $5,00 0 $10,000 Total current assets = $15,600 = 1.54 Total current $10,000 = 1.56 liabilities

Both net working capital and the current ratio have increased slightly, indicating that the ability to pay current liabilities with current assets has improved a little.

Total liabilities Debt ratio

Total assets

$21,00 0 = = $50,00 0

0.42

0.59

A decrease in the debt ratio indicates an improvement in the ratio. In summary, the overall ability to pay total liabilities improved.

Accrual Accounting & Income

(30 min.) E 3-30A (amounts in millions)

Current a. ratio

$20 = $10 + $5

1.3 = 3

$40 + $5 = $70 + $5 = 0.60

Debt ratio

The purchase of equipment on account hurts both ratios. $20 − $5 b.

Current ratio

$10

= 1.50

Debt ratio

$40 − $5 $70 − $5

= 0.54

The payment of long-term debt hurts the current ratio and improves the debt ratio. $20 + $4 c.

Current ratio

$10 + $4

= 1.71

Debt ratio

$40 + $4 = 0.59 $70 + $4

Collecting cash in advance hurts both ratios.

Current d. ratio

$20 = $10 + $3

$40 + $3 = = 0.61 $70

Debt = 1.54 ratio

Accruing an expense hurts both ratios.

Current e. ratio

$20 + $7 Debt = = 2.70 $10 ratio

$40 = $70 + = .52 $7

Accrual Accounting & Income

(5-10 min.) E 3-31B

Million s a.

Revenue ....................................................

$740

Total expense ............................................ The expense recognition accounting for expenses.

principle

$560 governs

Revenue ($740 − $26) ...............................

$714

Total expense ............................................

$610

The accrual basis measures revenues as earned and expenses as incurred, while the cash basis measures revenues collected in cash and expenses paid in cash. d.

The income statement reports revenues and expenses. The statement of cash flows reports cash receipts and cash payments.

Accrual Accounting & Income

(15-20 min.) E 3-32B

Req. 1 Adjusting Entries DAT E

CREDI DEBIT T

ACCOUNT TITLES

a. Insurance Expense.................................. Prepaid Insurance ($400 + $2,100 − $600) .....................................................

1,900

b. Interest Receivable................................. Interest Revenue ................................

2,400

c. Unearned Service Revenue ($1,700 − $400) ..................................................... Service Revenue .................................

1,300

d. Depreciation Expense—Building .............. Accumulated Depreciation—Building ....

5,300

e. Salary Expense ($21,000 × 2/5) ............... Salary Payable ....................................

8,400

1,900

2,400

1,300 5,300 8,400

f. Income Tax Expense ($30,000 × .35) ....... 10,500 Income Tax Payable ............................ 10,500

Req. 2 Net income understated by omission of: Interest revenue................................... $ 2,400 Service revenue.................................... 1,300 Total understatement ...........................

$ (3,700)

Net income overstated by omission of: Insurance expense................................ $ 1,900 Depreciation expense ........................... 5,300 Salary expense ..................................... 8,400 Income tax expense .............................. 10,500 Copyright © 2022 Pearson Education Inc. Chapter 3 3-73

Accrual Accounting & Income

Total overstatement .............................

26,100

Overall effect — net income overstated by...........................................................

$22,400

Accrual Accounting & Income

(10-15 min.) E 3-33B Missing amounts in italics. 1

$1,500

$ 700

$ 1,000

during the year

1,400

400

1,300

800

Total amount to account for

2,900

1,100

2,000

1,800

Less: Ending Supplies

(990)

(700)

(200)

Beginning Supplies Add: Purchases of supplies

Supplies Expense

$1,910

(900) $ 200

$1,300 $ 1,600

Journal entries: Situation 1:

Supplies ...............................

1,400

Cash or Accounts Payable.. Situation 2:

Supplies Expense ..................

1,400 200

Supplies ...........................

Accrual Accounting & Income

200

(10-20 min.) E 3-34B Adjusting Entries DATE

ACCOUNT TITLES

DEBIT

CREDIT

a. Interest Expense .................................... 3,800 Interest Payable .................................

3,800

b. Interest Receivable................................. 4,300 Interest Revenue ................................

4,300

c. Unearned Rent Revenue ($12,600 /2 × 3,150 6/12) ...................................................... Rent Revenue .....................................

3,150

d. Salary Expense ($6,500 × 4).................... 26,000 Salary Payable .................................... 26,000 e. Supplies Expense.................................... 2,100 Supplies ($3,300 − $1,200)..................

2,100

f. Depreciation Expense−Equipment 12,000 ($60,000 / 5)........................................... Accumulated Depreciation−Equipment 12,000

Book value = $48,000 ($60,000 − $12,000)

(10-15 min.) E 3-35B Prepaid Rent at December 31: a. Unadjusted amount.................................

$31,50 0

b. Adjusted amount ($31,500 − $10,500) .....

21,000

Accrual Accounting & Income

Unadjusted amount.................................

d. Adjusted amount ($31,500 / 3).................

-0-

10,500

Accrual Accounting & Income

(20-30 min.) E 3-36B

Req. 1

Sabrina, Inc. Income Statement Year Ended December 31, 2021

Thousands Revenues: Sales revenue .....................

$42,50 0

Expenses: Cost of goods sold ..............

$25,60 0

Selling, administrative, and general expenses ............ 10,600 Total expenses ............. 36,200 Income before tax ..................

6,300

Income tax expense ............... 2,500 Net income ............................

$ 3,800

Sabrina, Inc. Statement of Retained Earnings Year Ended December 31, 2021

Thousands

Retained earnings, December 31, 2020

$ 5,900

Add: Net income ................................

3,800

Subtotal

9,700

Accrual Accounting & Income

(1,200) Retained earnings, December 31, 2021

$ 8,500

Accrual Accounting & Income

(continued) E 3-36B Sabrina, Inc. Balance Sheet December 31, 2021

Thousands

ASSETS

LIABILITIES

Cash ............................

$ Accounts payable ..... $ 4,300 7,700

Accounts receivable .....

1,300 Income tax payable ..

Inventories ..................

2,400 Other liabilities ........

600 2,200

Prepaid expenses......... Prop., plant, equip.

1,800 Total liabilities ......... 10,50 0

$16,7 00

STOCKHOLDERS’

Less: Accum.

EQUITY

deprec (2,30 0) Other assets ................

14,40 Common stock.......... 0 14,60 0 9,400 Retained earnings .... 8,500 Total stockholders’ equity

23,10 0

Total liabilities and Total assets .................

$33,6 00

stockholders’ equity $33,6 00

Accrual Accounting & Income

(10-20 min.) E 3-37B One mechanism for solving this exercise is to prepare the relevant T-accounts, insert the given information, and solve for the unknown amounts, shown in italics.

Amounts in millions Receivables Beg. bal.

260

Sales revenue End. bal.

21,03 Collections 0

20,800

490

Prepaid Insurance Beg. bal.

450

Payment

480

End. bal.

330

Insurance expense

60 0

Accrued Liabilities Payable

Payments

Beg. bal.

640

Other operating expenses 4,800

4,890

End. bal.

730

Accrual Accounting & Income

(10-20 min.) E 3-38B Journal DATE

CREDI DEBIT T

ACCOUNT TITLES

Closing Entries Dec. 31 Service Revenue ............................ Other Revenue .............................. Retained Earnings ...................... 31 Retained Earnings .........................

31,70 0 100 31,80 0 26,20 0

Cost of Services Sold..................

14,40 0

Selling, General, and Administrative Expenses .............................. Depreciation Expense................. Income Tax Expense................... 31 Retained Earnings ......................... Dividends ..................................

6,400 4,600 800 500 500

Net income for 2021 was $5,600 ($31,800 − $26,200).

Retained Earnings Expenses Dividends

Dec. 31, 26,200 2020 500 Revenues Dec. 31, 2021

2,50 0 31,8 00 7,60 0

Accrual Accounting & Income

(15-25 min.) E 3-39B

Req. 1 DATE

Journal ACCOUNT TITLES

Adjusting Entries Dec. 31 Unearned Service Revenue ................. Service Revenue ($20,900 − $13,500)............................................

CREDI DEBIT T 7,400 7,400

31 Salary Expense ($5,000 − $4,700)....... Salary Payable ...............................

300

31 Rent Expense ($1,800 − $1,100) ......... Prepaid Rent ..................................

700

31 Depreciation Expense−Equipment ($950 − $0) ....................................... Accumulated Depreciation−Equipment....................

950

31 Income Tax Expense ($1,400 − $0) ..... Income Tax Payable........................

1,400

Closing Entries 31 Service Revenue ................................

300 700

950

1,400 20,90 0

Retained Earnings ..........................

20,90 0

31 Retained Earnings.............................. Salary Expense............................... Rent Expense ................................. Depreciation Expense−Equipment... Income Tax Expense .......................

9,150

31 Retained Earnings.............................. Dividends ......................................

1,500

5,000 1,800 950 1,400

Accrual Accounting & Income

1,500

Accrual Accounting & Income

(20-30 min.) E 3-40B

Req. 1

Lauer Production Company Balance Sheet December 31, Current Year ASSETS Current assets: Cash............................................................... Prepaid rent ($1,000 − $700) .......................... Total current assets..................................... Plant assets: Equipment ......................................... $45,000 Less accumulated depreciation ($6,100 + $950).............................. (7,050) Total assets .......................................................

$18,000 300 18,300

37,950 $56,250

LIABILITIES Current liabilities: Accounts payable........................................... Salary payable ($5,000 − $4,700) ................... Unearned service revenue ($8,900 − $7,400) .. Income tax payable ........................................ Total current liabilities ............................... Note payable, long-term..................................... Total liabilities ................................................... STOCKHOLDERS’ EQUITY Common stock ................................................... Retained earnings ($15,400 + $11,750* − $1,500).............................................................. Total stockholders’ equity .................................. Total liabilities and stockholders’ equity ............. Copyright © 2022 Pearson Education Inc. Chapter 3 3-86

$ 4,300 300 1,500 1,400 7,500 15,000 22,500 8,100 25,650 33,750 $56,250

Accrual Accounting & Income

* Net income = $11,750 ($20,900 − $5,000 − $1,800 − $950 − $1,400)

Accrual Accounting & Income

(continued) E 3-40B

Req. 2

Net working capital Current ratio

Curren t Year = Total current assets $18,300 − current liabilities = − = $10,80 0 $7,500 Total current assets $18,300 = = $7,500 = 2.44 Total current liabilities

Prior Year $10,6 00 2.40

Both net working capital and the current ratio have increased slightly, indicating that the ability to pay current liabilities with current assets has improved a little.

Total liabilities Debt ratio

Total assets

$22,50 0 = = $56,25 0

0.40

0.50

A decrease in the debt ratio indicates an improvement in the ratio. In summary, the overall ability to pay total liabilities has improved slightly.

Accrual Accounting & Income

(30 min.) E 3-41B $20 a.

Current ratio

$10 + $4

= 1.43

Debt ratio

$30 + $4 = = 0.53 $60 + $4

The purchase of equipment on account hurts both ratios.

Current ratio

$20 − $7 = = 1.30 $10

Debt ratio

$30 − $7 = = 0.43 $60 − $7

The payment of long-term debt hurts the current ratio and improves the debt ratio.

Current ratio

$20 + $5 = = 1.67 $10 + $5

Debt ratio

$30 + $5 = = 0.54 $60 + $5

Collecting cash in advance hurts both ratios. $20 d.

Current ratio

$10 + $6

= 1.25

Debt ratio

$30 + $6 = = 0.60 $60

Accruing an expense hurts both ratios.

Current ratio

$20 + $8 = = 2.8 $10

$30 Debt ratio

$60 + $8

Accrual Accounting & Income

= 0.44

Accrual Accounting & Income

Serial Exercise (3 hours) E 3-42

Reqs. 2, 5, and 7 Cash May 2

Bal.

Accounts Receivable

12,00 0

May 2

500

May 18

3,100 May 28

600

1,800

Bal.

2,400

750

Adj. (a)

2,000

3,100

900

Bal.

2,000

1,200

3,100

12,95 0 Supplies

May 5

900 Adj. (c)

Bal.

300

Equipment 600

May 3

1,800

Bal.

1,800

Accumulated Depreciation – Equipment Adj.(d

May 4

6,000

Bal.

6,000

Bal.

Furniture

Accumulated Depreciation – Furniture Adj.(d2

100

)

Bal.

Accounts Payable May 26

900 May 4

100

6,000 900

Accrual Accounting & Income

5 Bal.

Accrual Accounting & Income

6,000

(continued) E 3-42

Reqs. 2, 5, and 7 Salary Payable

Unearned Service Revenue

Adj. (e)

900

Bal.

900

Adj. (b)

Common Stock

800 May 21

2,400

Bal.

1,600

Retained Earnings

May 2

12,00 0

Clo.

2,880 Clo.

Bal.

12,00 0

Clo.

1,200 Bal.

Dividends May 31

1,200 Clo.

6,50 0

2,42 0

Service Revenue 1,200

May 9

600 3,100

Clo. Rent Expense May 2

500 Clo.

Bal.

3,700

Adj. (a)

2,000

Adj. (b)

800

6,500 Bal.

6,500

Utilities Expense 500

May 12

750 Clo.

750

Depreciation Expense – Equipment Accrual Accounting & Income

Adj. (e)

900 Clo.

900

Adj.(d

Depreciation Expense – Furniture Adj.(d

30 Clo.

100 Clo.

100

Supplies Expense Adj. (c)

600 Clo.

Accrual Accounting & Income

600

(continued) E 3-42

Req. 1

May 2 through 18 entries are repeated from Solution to E 239. Journal ACCOUNT TITLES

DATE

May

DEBIT

Cash ........................................... Common Stock .........................

12,000

Rent Expense .............................. Cash ........................................

500

Equipment .................................. Cash ........................................

1,800

Furniture .................................... Accounts Payable .....................

6,000

Supplies ..................................... Accounts Payable .....................

900

Cash ........................................... Service Revenue.......................

600

12 Utilities Expense ......................... Cash ........................................

750

18 Accounts Receivable.................... Service Revenue.......................

3,100

21 Cash ........................................... Unearned Service Revenue .......

2,400

2 3 4 5 9

CREDIT

12,000 500 1,800 6,000 900 600 750 3,100 2,400

22 No entry; no transaction yet 26 Accounts Payable ........................ Cash ........................................

900

28 Cash ........................................... Accounts Receivable .................

3,100

31 Dividends ...................................

1,200

900 3,100

Accrual Accounting & Income

Cash ........................................

Accrual Accounting & Income

1,200

Reqs. 3 and 4

(continued) E 3-42 Olivia Matthews, Certified Public Accountant, P.C. Trial Balance Worksheet May 31, 2021 TRIAL BALANCE

ACCOUNT TITLE

DEBIT

Cash 12,950 Accounts receivable 0 Supplies 900 Equipment 1,800 Accumulated depr. – equip. Furniture 6,000 Accumulated depr. – furn. Accounts payable Salary payable Unearned service revenue Common stock Retained earnings Dividends 1,200 Service revenue Rent expense Utilities expense Salary expense Depreciation expense – equip. Depreciation expense – furn. Supplies expense

CREDIT

ADJUSTMENTS DEBIT

CREDIT

(a) 2,000 (c) 600 —

(d1)

12,950 2,000 300 1,800

30 6,000

— 6,000 — 2,400 12,000 —

(d2) 100

100 6,000 900 1,600 12,000 —

(e) 900 (b)

800 1,200

3,700

(a)2,000 (b) 800

500 750

ADJUSTED TRIAL BALANCE DEBIT CREDIT

500 750 900 30

(e) 900 (d1) 30 (d2) 100 (c) 600 Accrual Accounting & Income

6,500

100 600 3-97

24,100

4,430

Accrual Accounting & Income

4,430

3-98

27,130

(continued) E 3-42

Req. 5 DATE

Journal ACCOUNT TITLES

DEBIT CREDIT

Adjusting Entries (a) May 31 Accounts Receivable ..................... 2,000 Service Revenue ........................ 2,000 (b) (c) (d1)

(d2)

(e)

31 Unearned Service Revenue ........... Service Revenue ........................

800

31 Supplies Expense ($900 − $300).... Supplies ....................................

600

31 Depreciation Expense – Equipment Accumulated Depreciation – Equip. ..........................................

31 Depreciation Expense – Furniture .. Accumulated Depreciation – Furn.............................................

100

31 Salary Expense ............................. Salary Payable ...........................

900

800 600 30

100

Accrual Accounting & Income

900

(continued) E 3-42

Req. 6 Olivia Matthews, Certified Public Accountant, P.C. Income Statement Month Ended May 31, 2021 Revenues: Service revenue.........................

$6,500

Expenses: Salary expense ..........................

$900

Utilities expense........................

750

Supplies expense.......................

600

Rent expense ............................

500

Depreciation expense – furniture

100

Depreciation expense – equipment.....................................

Total expenses........................

2,880

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

$3,620

Olivia Matthews, Certified Public Accountant, P.C. Statement of Retained Earnings Month Ended May 31, 2021 Retained earnings, May 1, 2021...........

Add: Net income ................................

3,620

Subtotal

3,620

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

(1,200)

Retained earnings, May 31, 2021.........

2,420

Accrual Accounting & Income

(continued) E 3-42

Req. 6 Olivia Matthews, Certified Public Accountant, P.C. Balance Sheet May 31, 2021 ASSETS LIABILITIES Current assets:

Current liabilities:

Cash

$12,9 50

Accounts payable

Accounts receivable

2,000

Salary payable

Supplies

$ 6,000 900

Unearned service 300

Total current assets

revenue

1,600

Total current liabilities

8,500

15,25 0

Plant assets: Equipment $1,800 Less: accum. depr.

STOCKHOLDERS’ EQUITY 1,770 Common stock

(30)

12,00 0

Retained earnings 2,420 Furniture $6,000

Total stockholders’ equity

Less: accum. depr.

Total liabilities and

(100)

5,900

Total assets

$22,9 stockholders' 20 equity

14,42 0 ______ $22,9 20

Accrual Accounting & Income

(continued) E 3-42

Req. 7 Journal DATE

ACCOUNT TITLES

Closing Entries May 31 Service Revenue.............................. Retained Earnings ........................

CREDI DEBIT T 6,500 6,500

31 Retained Earnings ........................... Salary Expense ............................ Utilities Expense .......................... Supplies Expense ......................... Rent Expense ............................... Depreciation Expense – Furniture.. Depreciation Expense – Equipment

2,880

31 Retained Earnings ........................... Dividends ....................................

1,200

900 750 600 500 100 30

Accrual Accounting & Income

1,200

(continued) E 3-42

Req. 8 Net working capital

Total current assets – current liabilities

$15,25 0– = = $6,750 $8,500

Total current assets

Current ratio

Debt ratio

Total current liabilities Total liabilities Total assets

$15,2 50 = = 1.79 $8,500

$8,500 = 0.37 $22,920

The company has an excess of current assets over its current liabilities.

The current and debt ratios indicate an

excellent financial position. The business has $1.79 in current assets for every $1.00 of current liabilities. The debt ratio of 37% is not too high, which suggests that, overall, the business should be able to pay its debts.

Accrual Accounting & Income

Quiz Q3-43

Q3-44

Q3-45

Q3-46

Q3-47

Q3-48

Q3-49

Q3-50

Q3-51

($2,700 × 9/12 = $2,025)

Q3-52

($5,500 + $19,000 − $16,000 = revenue of $8,500)

Q3-53

Q3-54

Q3-55

Q3-56

Q3-57

Current ratio

$31,200 / =

= 1.200

$26,000

$26,000 + $110,000 Debt ratio = $31,200 + $185,000 = .629 Q3-58 $5,55

($5,500 − $510 − $90 + $850 − $200)

0 Q3-59

Salary Payable Beg. bal.

Payment

141,00 Salary exp.

26,000 125,00

Accrual Accounting & Income

0 End. bal.

10,000

Accrual Accounting & Income

Problems (20-30 min.) P 3-60A

Req. 1 Berkley Consulting Amount of Revenue (Expense) for July Date Cash Basis Accrual Basis July 1 Expense $(3,900) $ 0 4 Expense (3,000) 0 5 Revenue

1,800

8 Expense

(300)

11 Revenue

3,100

24 Revenue

3,100

26 Expense

(1,600)

29 Expense

(1,100)

(1,10 0)

31 Expense

31 Revenue

$3,900 ÷ 3 = (1,30 0) 400

31 Expense

0 (408)

Req. 2

Income (loss) before$ (5,000) tax

$2,19 2

Accrual Accounting & Income

(continued) P 3-60A

Req. 3 The accrual-basis measure of net income is preferable because it accounts for revenues and expenses when they occur, not when they are received or paid in cash. For example, on July 11, the company earned $3,100 of revenue and increased its wealth as a result. The accrual basis records this revenue, but the cash basis ignores it. On July 24, the business collected the receivable that was created by the revenue earned on account at July 11. The accrual basis records no revenue on July 24 because the company’s increase in wealth occurred back on July 11. The cash basis waits until cash is received, on July 24, to record the revenue. This is too late.

Accrual Accounting & Income

(10-20 min.) P 3-61A DATE

Journal ACCOUNT TITLES

DEBIT

Dec. 31 a. Insurance Expense .................. Prepaid Insurance ................. To record insurance expense.

5,200*

31 b. Salary Expense ($6,100 × 3/5) . Salary Payable ...................... To accrue salary expense.

3,660

31 c. Interest Receivable.................. Interest Revenue ................... To accrue interest revenue.

700

31 d. Supplies Expense ....................

7,000*

CREDIT 5,200

3,660

700

* Supplies................................ To record supplies expense. 31 e. Unearned Service Revenue ($10,500 × 60%)...................... Service Revenue.................... To record revenue collected in advance that is now earned. 31 f. Depreciation Expense – Office Furniture .............................. Depreciation Expense – Equipment ................................... Accumulated Depreciation – Office Furniture ................ Accumulated Depreciation – Equipment ........................ To record depreciation expense.

7,000

6,300 6,300

3,800 5,400 3,800 5,400

Accrual Accounting & Income

** $3,000 + $6,200 – $2,200 = $7,000

Accrual Accounting & Income

(45-60 min.) P 3-62A

Req. 1

Princess, Inc. Trial Balance Worksheet December 31, 2023 TRIAL BALANCE

ACCOUNT TITLE

DEBIT

Cash Accounts receivable

9,400 2,200

Prepaid rent Supplies Furniture Accumulated depreciation Accounts payable Salary payable

1,200 2,600 48,000

Common stock Retained earnings Dividends Service revenue Salary expense

CREDIT

DEBIT

CREDIT

(b) 400* (c) 2,160 3,900

ADJUSTED TRIAL BALANCE DEBIT CREDIT

9,400 5,180

(a) 2,980

800 440 48,000

(d) 800**

4,700

3,800

3,800 9,000

(e) 9,000*** 6,000 32,210

6,000 32,210

3,800

3,800 25,100

3,300

Rent expense Utilities expense Depreciation expense

ADJUSTMENTS

(a) 2,980 (e) 9,000*** (b) 400*

12,300 400

510

510 800

(d) Accrual Accounting & Income

28,080

3-110

800** (c) 2,160

Supplies expense 71,010 71,010

15,340 15,340

_____

* ** ***

______

$1,200 ÷ 3 = $400 $48,000 ÷ 5 = $9,600 ÷ 12 = $800 $15,000 × 3/5 = $9,000

Accrual Accounting & Income

3-111

2,160 83,790

83,790

(continued) P 3-62A

Req. 2

Princess, Inc. Income Statement Month Ended December 31, 2023 Revenues: Service revenue

$28,080

Expenses: Salary expense

$12,300

Supplies expense

2,160

Depreciation expense – Furniture

800

Utilities expense

510

Rent expense

400

Total expenses 16,170 Net income

$11,910

Princess, Inc. Statement of Retained Earnings Month Ended December 31, 2023 Retained earnings, December 1, 2023

$32,210

Add:

11,910

Net income

Subtotal

44,120

Less: Dividends declared

(3,800)

Retained earnings, December 31, 2023

$40,320

Accrual Accounting & Income

(continued) P 3-62A

Req. 2 (continued) Princess, Inc. Balance Sheet December 31, 2023 ASSETS Current assets:

LIABILITIES Current liabilities:

Cash

$ 9,400

Accounts payable

Accounts receivable

5,180

Salary payable

$ 3,800 9,000

Prepaid rent

800

Total current liabilities

12,80 0

Supplies 440 Total current assets Furniture

15,82 0

$48,000

STOCKHOLDERS’ EQUITY

Less: Accum. deprec. (4,700)

Common stock 43,30 Retained earnings 0 Total stockholders’ equity

6,000 40,320 46,320

Total liabilities and Total assets

$59,12 0

stockholders’ equity

$59,12 0

Accrual Accounting & Income

(10-20 min.) P 3-63A

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBI CREDI T T

June 30 Accounts Receivable ($6,880 − $6,100) .. Rental Revenue.................................. To accrue rental revenue.

780

30 Interest Receivable ($600 − $0) ............. Interest Revenue ($1,650 − $1,050) .... To accrue interest revenue.

600

780

30 Supplies Expense ($1,300 − $0) ............. 1,30 0 Supplies ($1,500 − $200) ................... To record supplies expense. 30 Insurance Expense ($1,300 − $0) ........... 1,30 0 Prepaid Insurance ($3,100 − $1,800) .. To record insurance expense. 30 Depreciation Expense−Building ($1,400 1,40 − $0) .................................................... 0 Accumulated Depreciation−Building Copyright © 2022 Pearson Education Inc. Chapter 3 3-114

Accrual Accounting & Income

600

1,300

($9,200 − $7,800) ........................... To record depreciation expense. 30 Wage Expense ($2,570 − $1,700) ........... Wages Payable ($870 − $0) ................ To accrue wage expense.

1,400 870 870

30 Unearned Rental Revenue ($1,900 − 500 $1,400) ................................................. Rental Revenue ($20,630 − $19,350 − 500 $780).................................................... To record revenue that was collected in advance that is now earned.

Accrual Accounting & Income

(continued) P 3-63A

Req. 2 Total assets

= $81,080 ($8,400 + $6,880 + $600 + $4,400 + $200 + $1,800 + $68,000 − $9,200)

Total liabilities = $9,270

($7,000 + $870 + $1,400)

Net income

= $14,610 ($20,630 + $1,650 − $1,400 − $1,300 − $700 − $2,570 − $400 − $1,300)

Total equity

= $71,810 ($81,080 − $9,270) or ($16,000 + $44,500 + $14,610 − $3,300)

Accrual Accounting & Income

(20-30 min.) P 3-64A

Req. 1

Sunray Corporation Income Statement Year Ended March 31, 2021 Revenues: Service revenue

$105,000

Expenses: Salary expense

$40,400

Rent expense

10,100

Insurance expense

4,300

Interest expense

2,700

Supplies expense

2,400

Depreciation expense, equipment

1,500

61,400

Income before tax

43,600

Income tax expense

7,100

Net income

$ 36,500

Sunray Corporation Statement of Retained Earnings Year Ended March 31, 2021 Retained earnings, March 31, 2020

$ 2,000

Add:

36,500

Net income

Subtotal

38,500

Less: Dividends declared (12,000) Retained earnings, March 31, 2021

$26,500

Accrual Accounting & Income

(continued) P 3-64A

Req. 1 (continued)

ASSETS

Sunray Corporation Balance Sheet March 31, 2021 LIABILITIES

Cash

$ Accounts payable 13,000

$ 9,000

Accounts receivable

19,300 Interest payable

500

Supplies

2,900 Unearned service revenue

1,100

Prepaid rent

1,600 Income tax payable

2,100

Note payable

18,600

Total liabilities

31,300

Equipment

$37,20 0

Less: Accum. 33,000 deprec.

STOCKHOLDERS’ EQUITY

(4,200) Common stock

12,000

Retained earnings

26,500

Total stockholders’ equity

38,500

Total liabilities and Total assets

$69,80 stockholders’ 0 equity

$69,800

Req. 2 Debt ratio:

$31,300

0.45

Accrual Accounting & Income

$69,800 Sunray is in compliance with its debt agreement, which requires the company to maintain a debt ratio no higher than 0.50.

Accrual Accounting & Income

(20 min.) P 3-65A

Req. 1 DATE Jan.

Journal ACCOUNT TITLES

DEBIT

Closing Entries

31 Service Revenue........................ Retained Earnings ..................

96,000

31 Retained Earnings ..................... Advertising Expense ............... Depreciation Expense−Equipment .................. Interest Expense .................... Salary Expense....................... Supplies Expense ...................

44,100

31 Retained Earnings ..................... Dividends ..............................

15,000

CREDIT

96,000 10,800 2,100 400 26,300 4,500 15,000

Req. 2 Retained Earnings Jan. 31, 2021 Expenses 44,10 Jan. 31, 2020 Bal. 0

13,60 0

Jan. 31, 2021 Dividends 15,00 Jan. 31, 2021 Revenues 96,00 0 0 Jan. 31, 2021 Bal.

50,50 0

Net income = $51,900 ($96,000 − $44,100)

Accrual Accounting & Income

(25-40 min.) P 3-66A

Req. 1

Valley Services, Inc. Balance Sheet January 31, 2021 ASSETS

Current assets: Cash

$ 26,000

Accounts receivable

5,000

Prepaid expenses

6,600

Supplies

2,400

Total current assets

40,000

Plant assets: Equipment

$43,000

Less: Accumulated depreciation

(7,000)

36,000

Other assets, long-term

14,400

Total assets

$90,400 LIABILITIES

Current liabilities: Current portion of note payable

1,000

Accounts payable

14,000

Salary payable

2,300

Unearned service revenue

2,700

Total current liabilities

20,000

Note payable, long-term

15,400

Total liabilities

35,400 STOCKHOLDERS’ EQUITY

Common stock

4,500

Retained earnings

50,500*

Total stockholders’ equity

55,000

Total liabilities and stockholders’ equity *See next page

$90,400

Accrual Accounting & Income

(continued) P 3-66A

Req. 1 (continued) *Retained earnings = $90,400 − $35,400 − $4,500 = $50,500 OR *Retained earnings, January 31, 2020 .............. $13,600 Add: Net income ($96,000 − $10,800 − $2,100 − $400 − $26,300 − $4,500)...................... Subtotal

51,900 65,500

Less: Dividends declared ............................... (15,000 ) Retained earnings, January 31, 2021.............. $50,500

Req. 2 2021 2020 Net working capital

Current ratio

Total current assets $40,00 0− =– = $20,000 $19,500 current liabilities $20,00 0 Total current assets $40,000 = = $20,000 = 2.00 Total current 1.80 liabilities

The increase in both working capital and the current ratio indicate that the ability to pay current liabilities with current assets improved during 2021. 2021 2020 Copyright © 2022 Pearson Education Inc. Chapter 3 3-122

Accrual Accounting & Income

Debt ratio The

overall

Total liabilities Total assets debt

position

$35,400 = 0.39 $90,400

deteriorated

during

0.15 2021.

However, Valley Service’s overall debt position is strong because a debt ratio of .39 is not troublesome.

Accrual Accounting & Income

(45-60 min.) P 3-67A

Req. 1

(All amounts in millions)

Current ratio

Total current assets Total current liabilities

$15.2 = $9.4 = 1.62

$15.3 Debt ratio =

Total liabilities Total assets

$9.4 + $5.9 =

= 0.49 $31.1

Req. 2 Current Ratio

Debt Ratio

$15.2 + $2.6 $9.4

1.8 9

$15.3 $31.1 + $2.6

0.4 5

$15.2 + $5.0 $9.4

2.1 5

$15.3 + $5.0 $31.1 + $5.0

0.5 6

$15.2 − ($9.4 × 1/2) ($9.4 × 1/2)

0.4 0

2.2 = 3

$15.3 − ($9.4 × 1/2) $31.1 − ($9.4 × 1/2)

$15.2 − $1 $9.4

1.5 1

$15.3 $31.1 − $1

0.5 1

$15.2 $9.4 + $0.7

1.5 0

$15.3 + $0.7 $31.1

0.5 1

0.5 3

$15.2 − $1.7 f. $9.4

1.4 = 4

$15.3 + $2.7 $31.1 + $4.4 − $1.7

Accrual Accounting & Income

$15.2 $9.4

1.6 2

$15.3 $31.1− $0.9

Accrual Accounting & Income

0.5 1

(continued) P 367A

Req. 3 a. Revenues usually increase the current ratio. b. Revenues usually decrease the debt ratio. c. Expenses usually decrease the current ratio.

Note: Depreciation is an exception to this rule. d. Expenses usually increase the debt ratio. e. If a company’s current ratio is greater than 1.0, as it is for Bellwood, paying off a current liability will always increase the current ratio. f. Borrowing money on long-term debt will always increase both the current ratio and the debt ratio.

Accrual Accounting & Income

Req. 1 Date May

(20-30 min.) P 3-68B Westchester Consulting Amount of Revenue (Expense) for May Cash Basis Accrual Basis 1 Expense

$ (2,250)

Expense

4 Expense

(4,000)

Expense

5 Revenue

1,000

Revenue

1,000

8 Expense

(300)

Expense

(300)

11 Revenue

Revenue

3,500

19 Expense

Expense

24 Revenue

3,500

Revenue

26 Expense

(2,000)

Expense

29 Expense

(1,000)

Expense

(1,000)

31 Expense

Expense ($2,250

(750)

/ 3)

Req. 2

31 Revenue

Revenue

1,000

31 Expense

Expense

(108)

Income (loss) before tax

$(5,050) Income before tax

$3,342

Req. 3 The accrual-basis measure of net income is preferable because it accounts for revenues and expenses when they occur, not when they are received or paid in cash. For example, on May 11, the company earned $3,500 of revenue and increased its wealth as a result. The accrual basis records this revenue, but the cash basis ignores it. On May 24, the business collected the receivable that was created by the revenue earned on account at May 11. The accrual basis records no revenue on May 24 because the company’s increase in wealth Copyright © 2022 Pearson Education Inc. Chapter 3 3-127

Accrual Accounting & Income

occurred back on May 11. The cash basis waits until cash is received, on May 24, to record the revenue. This is too late.

(10-20 min.) P 3-69B Journal ACCOUNT TITLES AND EXPLANATION

DATE Dec. 31 a.

31 b.

31 c.

31 d.

DEBIT

Insurance Expense ................ Prepaid Insurance .............. To record insurance expense

5,200*

Salary Expense ($5,900 × 1/5) Salary Payable… ................ To accrue salary expense.

1,180

Interest Receivable ................ Interest Revenue ............... To accrue interest revenue.

400

Supplies Expense ................... Supplies ............................ To record supplies expense.

7,000**

CREDI T 5,200

1,180

400

7,000

31 e.

Unearned Service Revenue ($10,600 × 70%) .................... 7,420 Service Revenue ................ 7,420 To record unearned service revenue that has been earned.

31 f.

Depreciation Expense – Office Furniture ........................... Depreciation Expense – Equipment Accumulated Depreciation –

3,400 6,100

Accrual Accounting & Income

Office Furniture.............. Accumulated Depreciation – Equipment ..................... To record depreciation expense. _____ * $2,100 + $3,300 – $200 = $5,200 ** $2,700 + $6,400 – $2,100 = $7,000

Accrual Accounting & Income

3,400 6,100

(45-60 min.) P 3-70B

Req. 1

ACCOUNT TITLE

Royal, Inc. Trial Balance Worksheet December 31, 2023 TRIAL BALANCE DEBIT CREDIT

Cash Accounts receivable Prepaid rent

9,400 1,900 3,300

Supplies Furniture Accumulated depreciation Accounts payable Salary payable

2,600 72,000

Common stock Retained earnings Dividends Service revenue Salary expense

(a) 3,850 (b) 1,100* (c) 2,120 3,100

9,400 5,750 2,200 480 72,000

(d) 1,200**

4,300

3,400

3,400 8,400

(e) 8,400*** 12,000 58,620

12,000 58,620

4,200

4,200 19,300

2,500

Rent expense Utilities expense Depreciation expense

ADJUSTMENTS DEBIT CREDIT

ADJUSTED TRIAL BALANCE DEBIT CREDIT

(a)

3,850

(e) 8,400*** (b) 1,100*

10,900 1,100

520

520 1,200

(d)

Accrual Accounting & Income

23,150

3-130

Supplies expense 96,420 * ** ***

96,420

1,200** (c) 2,120 16,670

_____ 16,670

$3,300 ÷ 3 = $1,100 $72,000 ÷ 5 = $14,400 ÷ 12 = $1,200 $14,000 × 3/5 = $8,400

Accrual Accounting & Income

3-131

2,120 109,870

109,870

(continued) P 3-70B

Req. 2 (continued) Royal, Inc. Income Statement Month Ended December 31, 2023 Revenues: Service revenue

$23,150

Expenses: Salary expense

$10,900

Supplies expense 2,120 Depreciation expense-furniture Rent expense

1,200 1,100

Utilities expense

520

Total expenses

15,840

Net income

$ 7,310

Royal, Inc. Statement of Retained Earnings Month Ended December 31, 2023 Retained earnings, December 1, 2023 Add:

Net income

$58,620 7,310

Subtotal

65,930

Less: Dividends declared

(4,200)

Retained earnings, December 31, 2023

Chapter 3

$61,730

Accrual Accounting and

3-132

(continued) P 3-70B

Req. 2 (continued)

ASSETS

Royal, Inc. Balance Sheet December 31, 2023 LIABILITIES

Current assets:

Current liabilities:

Cash

$ 9,400

Accounts payable

Accounts receivable

5,750

Salary payable

Prepaid rent

$ 3,400 8,400

2,200 Total current liabilities

11,800

Supplies 480 Total current assets

17,83 0

Furniture $72,000

STOCKHOLDERS’ EQUITY

Less: Accum. deprec. (4,300)

Total assets

Common stock

12,000

67,70 Retained earnings 0

61,730

Total stockholders’ equity

73,730

______ Total liabilities and

______

$85,5 stockholders’ 30 equity

Chapter 3

$85,53 0

Accrual Accounting and

3-133

(10-20 min.) P 3-71B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

June 30 Accounts Receivable ($6,850 – $6,100) . Rental Revenue ............................... To accrue rental revenue.

CREDI DEBIT T 750 750

30 Interest Receivable ($1,000 − $0)......... 1,000 Interest Revenue ($2,100 − $1,100) . 1,000 To accrue interest revenue. 30 Supplies Expense ($1,600 − $0) ........... 1,600 Supplies ($1,800 − $200) ................. 1,600 To record supplies expense. 30 Insurance Expense ($1,000 − $0) ......... 1,000 Prepaid Insurance ($3,000 − $2,000) 1,000 To record insurance expense. 30 Depreciation Expense−Building ($1,400 1,400 − $0)................................................... Accumulated Depreciation−Building ($8,700 − $7,300)............................ 1,400 To record depreciation expense. 30 Wage Expense ($1,980 − $1,200) ......... Wages Payable ($780 − $0).............. To accrue salary expense.

780

30 Unearned Rental Revenue ($1,600 − $1,300) ............................................... Rental Revenue*.............................. To record unearned rental revenue that has been earned.

300

780

300

Chapter 3

Accrual Accounting and

3-134

Chapter 3

Accrual Accounting and

3-135

(continued) P 3-71B

Req. 2 Total assets

$81,150 ($8,400 + $6,850 + $1,000 + $4,800 + $200 + $2,000 + $66,600 – $8,700)

Total liabilities =

$9,080

Net income

$17,470 ($21,650 + $2,100 − $1,400 − $1,600 – $100 – $1,980 − $200 − $1,000)

Total equity

$72,070 ($81,150 − $9,080) or ($16,000 + $41,600 + $17,470 − $3,000)

($7,000 + $780 + $1,300)

Chapter 3

Accrual Accounting and

3-136

(20-30 min.) P 3-72B

Req. 1 Nelson Corporation Income Statement Year Ended July 31, 2021 Revenues: Service revenue

$106,600

Expenses: Salary expense

$40,200

Rent expense

11,100

Insurance expense

3,500

Interest expense

3,000

Supplies expense

2,000

Depreciation expense, equipment

1,200

61,000

Income before tax

45,600

Income tax expense

7,200

Net income

$38,400

Nelson Corporation Statement of Retained Earnings Year Ended July 31, 2021 Retained earnings, July 31, 2020 Add:

$ 4,000

Net income 38,400

Subtotal

42,400

Less: Dividends declared (12,000) Retained earnings, July 31, 2021

Chapter 3

$30,400

Accrual Accounting and

3-137

(continued) P 3-72B

Req. 1 (continued) Nelson Corporation Balance Sheet July 31, 2021 ASSETS

LIABILITIES

Cash

$17,00 Accounts payable 0

Accounts receivable

19,200 Unearned service

Supplies

2,100

$ 9,000

revenue 700

Prepaid rent

1,600 Interest payable 800

Equipment

$36,80 0

Less: Accum.

Income tax payable

2,200

Note payable

18,600

Total liabilities

31,300

(5,000) 31,800 deprec. STOCKHOLDERS’ EQUITY Common stock 10,000 Retained earnings 30,400 Total stockholders’ equity

40,400

stockholders’ equity Chapter 3

$71,700

Accrual Accounting and

3-138

Req. 2 Debt ratio:

$31,300 $71,700

0.44

Nelson Corporation’s debt ratio of 0.44 is in compliance with the lenders’ debt restriction.

Chapter 3

Accrual Accounting and

3-139

(20 min.) P 3-73B

Req. 1 Journal DATE

ACCOUNT TITLES

DEBIT

Closing Entries Jan. 31 Service Revenue......................... Retained Earnings ...................

CREDIT

95,500 95,500

31 Retained Earnings ...................... Salary Expense ........................ Supplies Expense..................... Advertising Expense ................ Depreciation Expense – Equipment ................................. Interest Expense .....................

46,300

31 Retained Earnings ...................... Dividends ................................

13,000

27,800 5,000 11,200 2,100 200 13,000

Req. 2 Retained Earnings Jan. 31, 2021 Expenses

46,30 Jan. 31, 2020 Bal. 0

Jan. 31, 2021 Dividends

13,00 Jan. 31, 2021 Revenues 95,50 0 0 Jan. 31, 2021 Bal.

13,70 0

49,90 0

Net income = $49,200 ($95,500 – $46,300)

Chapter 3

Accrual Accounting and

3-140

(30-40 min.) P 3-74B

Req. 1

Meadowbrook Service, Inc. Balance Sheet January 31, 2021 ASSETS Current assets: Cash.................................................... Accounts receivable ............................. Prepaid expenses ................................ Supplies .............................................. Total current assets.......................... Plant assets: Equipment........................................... $43,000 Less: accumulated depreciation............ (7,100) Other assets, long-term ........................... Total assets .............................................

$22,000 1,000 5,000 6,400 34,400

35,900 13,900 $84,200

LIABILITIES Current liabilities: Accounts payable................................. $10,000 Current portion of note payable............ Salary payable..................................... Unearned service revenue.................... Total current liabilities ..................... Note payable, long-term........................... Total liabilities......................................... STOCKHOLDERS’ EQUITY Common stock ......................................... Retained earnings … ................................ Copyright © 2022 Pearson Education Inc. Income

Chapter 3

2,200 2,000 3,000 17,200 15,600 32,800 1,500 49,900*

Accrual Accounting and

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Total stockholders’ equity… ..................... Total liabilities and stockholders’ equity ...

51,400 $84,200

*See next page (continued) P 3-74B

Req. 1 (continued) *Retained earnings = $84,200 − $32,800 − $1,500 = $49,900 OR *Retained earnings, January 31, 2020 ........ $ 13,700 Add: Net income ($95,500 − $27,800 − $5,000 − $11,200 − $2,100 − 49,200 $200) ....................................................... Subtotal 62,900 Less: Dividends declared ........................ (13,000) Retained earnings, January 31, 2021 ........ $49,900

Req. 2 Net working capital

2021 = Total current assets − current liabilities Total current assets

Current ratio

Total current liabilities

$34,400 – = $17,200 $34,40 0 = = $17,20 0

2020

$17,200 $16,700

2.00

1.75

The increase in both working capital and the current ratio indicate that the ability to pay current liabilities with current assets improved during 2021.

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Debt ratio

Total liabilities Total assets

$32,80 0 = = 0.39 $84,20 0

0.25

Meadowbrook Service’s overall debt position deteriorated from 2020 to 2021; however, the company’s overall debt position is strong because a debt ratio of .39 is not troublesome.

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(45-60 min.) P 3-75B

Req. 1

(All amounts in millions)

Current ratio

Total current assets $15.9 = = 1.66 Total current liabilities $9.6 $15.1

Debt ratio

Total liabilities Total assets

$9.6 + $5.5 = 0.47 $32.1

Req. 2 Current Ratio

Debt Ratio

$15.9 + $2.8

$15.1

= 1.95 $9.6

$15.9 + $7.0 $9.6

$15.9 − ($9.6 × 1/2) c. ($9.6 × 1/2)

= $32.1 + $2.8

= 2.39

$15.1 + $7.0 $32.1 + $7.0

= 0.57

= 2.31

$15.1 − ($9.6 × 1/2) $32.1 − ($9.6 × 1/2)

= 0.38

$15.9 − $.6 d.

$15.1 = 1.59

= 0.48

$9.6

$32.1 − $.6

$15.9

$15.1 + $0.8

= 1.53

= 0.50

$9.6 + $0.8

$32.1

$15.9 − $1.9

$15.1 + $2.7

$9.6

0.43

= 1.46

$32.1 + $4.6 − $1.9 Chapter 3

= 0.51

Accrual Accounting and

3-144

$15.9 g.

$15.1 = 1.66

$9.6

= 0.48 $32.1 − $0.4

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Accrual Accounting and

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(continued) P 3-75B

Req. 3 a. Revenues usually increase the current ratio. b. Revenues usually decrease the debt ratio. c. Expenses usually decrease the current ratio.

Note: Depreciation is an exception to this rule. d. Expenses usually increase the debt ratio. e. If a company’s current ratio is greater than 1.0, as for McClain, paying off a current liability will always increase the current ratio. f. Borrowing money on long-term debt will always increase both the current ratio and the debt ratio.

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Challenge Exercises and Problem (20-25 min.) E 3-76

(Dollar amounts in thousands) December 31, 2021 Current assets = $10,400 ($1,400 + $5,200 + $2,400 + $1,400) Current liabilities = $5,700 ($2,400 + $1,300 + $2,000) Net working capital = $4,700 ($10,400 – $5,700) Current = Ratio

$10,40 0 = 1.82 $5,700

January 31, 2022 Current assets = $10,300 ($7001 + $6,8002 +

$2,4003 +

$4004) Current liabilities = $4,900 ($1,3005 + $1,3006 + $2,3007) Net working capital = $5,400 ($10,300 – $4,900) Current = Ratio _____

$10,30 0 = 2.10 $4,900

Computations of January 31, 2022 balances: 1Cash = $1,400 − $7,400 + $7,800 − $1,100 = $700 2Receivables = $5,200 + $9,400 − $7,800 = $6,800 3No change in the Inventory balance. 4Prepaid expenses = $1,400 − $1,000 = $400 5Accounts payable = $2,400 − $1,100 = $1,300 6No change in the Unearned Revenue balance.

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7Accrued expenses payable = $2,000 + $300 = $2,300

Conclusion:

Saginaw’s net working capital and current ratio improved during January 2022. The company’s current ratio is very strong. (60 min.) E 3-77

a. Net income: Service revenue: ($158,000 + $1,620 + $31,600) ...... $191,22 0 Expenses: Salary ($36,000 + $3,000) ..............

$ 39,000

Depreciation expense– building ......

2,700

Supplies expense ...........................

3,500

Insurance expense .........................

1,500

Advertising expense ......................

7,100

Utilities expense ............................

2,200 56,000

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

$135,22 0

b. Total assets: Cash ..................................................

$ 7,200

Accounts receivable ($7,700 + $31,600)

39,300

Supplies ($4,600 − $3,500).................

1,100

Prepaid insurance ($3,400 − $1,500) ..

1,900

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Less: Accum. Depr. ($16,200 + $2,700)

86,100 (18,900)

Land.................................................. 57,000 Total assets ...................................

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$192,60 0

Accrual Accounting and

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(continued) E 3-77 c. Total liabilities: Accounts payable...........................

$ 6,600 3,000

Salary payable............................... Unearned service revenue ($5,400 − $1,620).......................

3,780 $ 13,380

Total liabilities............................... d. Total stockholders’ equity: Common stock ............................... Retained earnings, beginning ......... Add: Net income ........................... Subtotal Less: Dividends declared. .............. Total stockholders’ equity .............. e. Total = Total liabilities assets equity $192,600 = $13,380

$ 10,000 $ 46,000 135,220 181,220 (12,000)

169,220 $179,220

Total stockholders’

$179,220

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Accrual Accounting and

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(20 min.) P 3-78 Crystal Detailing Co. Balance Sheet January 31, 2022 ASSETS

LIABILITIES Cash (a) $ 25,900 Accounts payable $ (g) 1,000 Accounts receivable 600 Advertising 200 (c) payable (h) Supplies (d) 700 Salary payable (i) 400 Total current 27,200 Unearned gift assets certificate 1,400 revenue* (b) 3,000 Total liabilities Equipment (e) $38,500 24,500 Less: Accum. deprec.(f) (14,000) STOCKHOLDERS’ EQUITY

Total assets

Common stock (j) 22,000 Retained earnings 26,700 (k) Total stockholders’ 48,700 equity ______ ______ $51,70 Total liabilities and $51,700 0 stockholders’ equity

*Unearned Service Revenue and Unearned Gift Certificate Revenue are both Unearned Revenue accounts

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(continued) P 3-78

Supporting computations (a)

Bal. 12/31/2021

Cash 800

Cash collections from customers

8,000 Salaries paid

Issuance of common stock

37,70 0

800 Dividends paid 3,500 Purchase of equipment

8,000 6,100 Payments of accounts payable 2,200 Advertising paid 1,500

Bal. 1/31/2022

(b)

25,90 0 Unearned Gift Certificate Revenue 1,100 Bal. 12/31/2021

Gift certificate revenue earned

1,200

1,500 Sale of gift certificates 1,400 Bal. 1/31/2022 (given)

(c)

Accounts Receivable

Bal. 12/31/2021

1,800

Revenue on account

35,000 36,200 Collections from customers*

Bal. 1/31/2022

600

* Excludes the $1,500 for gift certificates which was received in advance, not on account (d)

Supplies

Bal. 12/31/2021

1,300

Purchase of supplies

3,100

Bal. 1/31/2022

3,700 Supplies expense

700

(e)

Equipment = $38,500 ($35,000 + $3,500)

(f)

Accumulated depreciation = $14,000 ($7,000 + $7,000)

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(continued) P 3-78 (g)

Accounts Payable 4,000 Bal. 12/31/2021

Payments on account

6,100

3,100 Purchase of supplies 1,000 Bal. 1/31/2022

(h) $2,400 Advertising expense – $2,200 advertising paid (i)

Salary Payable 1,400 Bal. 12/31/2021

Salaries paid

8,000

7,000 Salary expense 400 Bal. 1/31/2022

(j)

Common Stock = $22,000 ($14,000 + $8,000)

(k)

Retained Earnings 11,400 Bal. 12/31/2021

Dividends

800 16,100 Net income 26,700 Bal. 1/31/2022

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Serial Case (25 min.) C3-79

Req. 1

Dec. 31 a. Supplies Expense 64,298 Prepaid Expenses 64,298 ($13,378 + $63,500 – $12,580) b. Rent Expense 36,864 Prepaid Rent 36,864 ($5,236 + $47,700 – $16,072) c.

Gift Cards (Liability)

409,010 Gift Card Revenue 409,010 ($153,629 + $379,000 – $123,619) d.

Salaries and Wages Expense

39,401 Salaries and Wages Payable 39,401 ($31,570 – $31,570 + $39,401)

Req. 2 If these adjusting journal entries had not been made for 2019, Cheesecake Factory’s operating income would be impacted. Supplies Expense would be lower, Rent Expense would be lower, and Salaries Expense would be lower all resulting in ($64,298 + $36,864 + $39,401) $140,563 higher operating income than the reported amount. Gift Card Copyright © 2022 Pearson Education Inc. Income

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Revenue would be lower if the adjusting entry was not made, causing operating income to be understated by $409,010. Net impact on Operating Income = Expenses understated $140,563 Revenues understated 409,010 Operating income understated by

$268,447

Decision Cases (25 min.) C3-80 Req. 1 Unadjusted trial balance:

Debit

Cash……………………………………..

$ 8,000

Accounts receivable………………….

4,200

Supplies………………………………...

800

Prepaid rent……………………………

1,200

Land……………………………………..

43,000

Credit

Accounts payable……………………..

$12,000

Salary payable…………………………

–0–

Unearned service revenue…………..

700

Note payable, due in 3 years………..

23,400

Common stock………………………..

5,000

Retained earnings…………………….

9,300

Service revenue……………………….

9,100

Salary expense………………………...

3,400

Rent expense…………………………..

–0–

Advertising expense………………….

900

Supplies expense……………………..

–0–

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Totals……………………………………

$61,500

$59,500

Out of balance $2,000

(continued) C3-80

Req. 2 Adjusted trial balance:

Debit

Cash……………………………………………...

$ 8,000

Accounts receivable…………………………..

4,200

Supplies ($800 – $400)..……………………….

400

Prepaid rent ($1,200 × 11/12)…………………

1,100

Land ……………………………………………..

43,000

Credit

Accounts payable……………………………...

$12,00 0

Salary payable………………………………….

1,000

Unearned service revenue ($700 – $500)…..

200

Note payable, due in 3 years………………...

25,400

Common stock…………………………………

5,000

Retained earnings……………………………..

9,300

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Accrual Accounting and

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Service revenue ($9,100 + $500)…………….

9,600

Salary expense ($3,400 + $1,000)……………

4,400

Rent expense ($1,200 × 1/12)………………..

100

Advertising expense…………………………..

900

Supplies expense……………………………... 400 Total………………………………………………

$62,50 0

Req. 3 Current ratio

$8,000 + $4,200 + $400 + $1,100 $12,000 + $1,000 + $200 $13,700 $13,200

1.04

We might have trouble sleeping at night with a current ratio of 1.04. To be safe, the current ratio should be around 1.50 or higher.

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(20-30 min.) C3-81

Req. 1

Tree City Cafe, Inc. Income Statement Month Ended October 31, 2021 Sales revenue ............................

$32,000

Cost of goods sold......................

$12,000

Wages expense ..........................

5,000

Rent expense .............................

4,000

Insurance expense .....................

1,000

Depreciation expense, fixtures ...

1,000

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

23,000 $ 9,000

Tree City Cafe, Inc. Statement of Retained Earnings Month Ended October 31, 2021 Retained earnings, October 1, 2021 .....

Add: Net income ................................

9,000

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

(3,000)

Retained earnings, October 31, 2021 ...

$6,000

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(continued) C3-81 Tree City Cafe, Inc. Balance Sheet October 31, 2021 ASSETS

LIABILITIES

Cash

$ Accounts payable 8,000

$ 7,000

Food inventory

5,000 Unearned revenue 3,000

Prepaid insurance

1,000

Dishes, silver

4,000

Fixtures $24,000

10,000 OWNERS’ EQUITY

Less: Accum. deprec. (1,000) Total assets

Common stock Retained 23,00 earnings 0

$25,0 00 6,000 31,000

$41,0 Total liabilities and 00 equity

$41,00 0

Recommendation:Do not expand the business.

It is not meeting Pulito’s goals for net income or for total assets.

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(30-40 min.) C3-82

Req. 1 (your highest price) Advertising revenue ($22,000 + $4,000) Expenses: Salary Utilities Other (unrecorded) Salary of your manager Your expected monthly net income Multiplier to compute price Your highest price

$26,000 $4,000 900 1,100 5,000

11,000 $15,000 X 16 $240,000

Req. 2 (Gardner’s asking price) Gardner Advertising, Inc. Calculation of Asking Price Based on Stockholders’ Equity On June 30, 2021 Beginning retained earnings $ 93,000 Add:

Net income

Revenue ($22,000 + $4,000)

$26,000

Less: Expenses ($4,000 + $900 + $1,100)

20,000 (6,000)

Subtotal

113,000

Less: Dividends declared (9,000) Ending retained earnings

$104,000

Calculation of asking price: Ending retained earnings, above

$104,000

Add: Common stock

50,000

Chapter 3

$154,000

Accrual Accounting and

3-160

Multiplier to compute price

X 2

Gardner’s asking price

$308,000

Chapter 3

Accrual Accounting and

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(continued) C3-82

Req. 3 You may start by offering Gardner approximately $225,000 for the business. Her asking price is $308,000 so you are starting out quite far apart.

If Gardner appears especially

eager to sell out, you may be able to buy the firm for closer to your highest price of $240,000. However, if she is not so eager to sell and if you want the business badly enough, you may

have

pay

somewhere

between

$240,000

and

$308,000. It might pay to hire an expert to value the business’s assets.

You may find that Gardner’s price is

inflated based on the value of its assets.

You can always

raise your offer, but you cannot decrease it, so start the negotiating process with an offer around $225,000.

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Ethical Issues C3-83 1.

The journal entry to record the revenue is: Dec.

Accounts Receivable………... XXX Sales Revenue……………..

XXX

The debit to Accounts Receivable will increase total current assets and, as a result, increase (improve) the current ratio. The debit to Accounts Receivable will increase total assets and, as a result, decrease (improve) the debt ratio. 2. a. – c.

The issue is whether it is ethical to record the

revenue in the current year.

The contract has been

signed, but the implication is that the company will not have done everything it needs to do in order to earn the revenue in the current year.

The stakeholders are the

company, the bank, the stockholders, an\d the company’s other creditors. From an economic standpoint, the entry would

obviously

financial

improve

position.

the

However,

probably be short-lived.

company’s the

short

advantage

term would

When the bank finds out about

this entry, they will likely protest, and demand immediate payment, so the longer-term economic impact will likely be negative.

From a “legal” standpoint, to record this

transaction in December violates GAAP by violating the

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Accrual Accounting and

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made the sale (has not delivered the gas) to the customer and, therefore, has not earned the revenue prior to December

the

current

year.

From

ethical

standpoint, recording this revenue violates the bank’s rights for proper disclosure (continued) C3-83 of the company’s income and assets. Revenue should be recorded no earlier than when it is earned. Blue Vista expects to earn the revenue in January of next year. Blue Vista clearly cannot record this revenue until it is earned. To do so is not in their best economic, legal (GAAP) or ethical best interests.

3. The authors would suggest either of two actions. Blue Vista can either: a. Report the current ratio of 1.47 and the debt ratio of .51 because these are the true values. Then tell the bank of the signed contract for additional work and the hope for a better set of ratio values next year. In some cases, banks will agree to sign a waiver of the terms of loan covenants, meaning that, although the company is in violation,

the

bank

will

not

move

enforce

the

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Accrual Accounting and

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b. Pay off some current liabilities before year end. This will improve both the current ratio and the debt ratio. This may enable Blue Vista to bring its ratio values into compliance with the bank’s requirements.

Chapter 3

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C3-84 1. These transactions overstate the reported income of the company by $31,000 ($15,000 + $14,000 + $2,000). 2. It appears that Summit wants to improve the company’s reported income in order to borrow on favorable terms. Her action is unethical and probably illegal as well because she is deliberately overstating the company’s reported income. Summit appears to be letting the potential short term economic advantage of these deliberate misstatements take precedence.

She needs to remember that these

misstatements violate GAAP, and that, depending on what use is made of the financial statements, could subject the company to civil or criminal legal proceedings.

If this

happens, the short term economic gains ($31,000) would not even come close to the long-term economic costs associated with the legal actions, not to mention the negative publicity.

The business will need a bank loan,

and perhaps the money would be used to pay bills, expand the business, and so on. However, based on Summit’s lack of integrity, the money may be destined for her own use. Regardless of its use, the money is obtained under false pretenses and cannot be headed for a good outcome. The bank is harmed by Summit’s and Loftus’ actions. Lending money to Summit under false pretenses may lead the bank to charge an unrealistically low interest rate that robs the bank’s owners of interest revenue. In the Copyright © 2022 Pearson Education Inc. Income

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extreme, the public is robbed if taxpayers wind up financing the bailout of a failed institution.

(continued) C3-84 3. Personal advice will vary from student to student. The purpose of asking this question is to challenge students to take the high road of ethical conduct by having nothing to do with Summit’s scheme. The authors would advise Loftus, the accountant, to take these actions, in order: a. Refuse

take

any

part

Summit’s

explaining

that

the

result

overstatement

reported income.

scheme, of

This is both illegal and unethical,

and will ultimately have a negative economic impact on the company, as well. Accountants are bound to standards

ethical

conduct

that

these

actions

violate. They can go to prison when caught falsifying financial statements. b. To remain ethical, the accountant must be willing to lose his/her job. It is better to protect one’s reputation even if that causes a short-term hardship. Student

answers

may

Chapter 3

Accrual Accounting and

vary.

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Focus on Financials: Apple Inc. (15-20 min.)

Req. 1 Accrued expenses are expenses that have been incurred but that have not yet been paid as of the balance sheet date. The accrual basis of accounting and the expense recognition principle require that all expenses be recognized (recorded) during the period in which they are incurred in order to earn revenue, regardless of when they are paid.

Req. 2 (amounts in millions) This problem assumes that the account titled “other current liabilities” is totally accounted for by “accrued expenses.” These liabilities were $33,327 and $37,720 for 2018 and 2019 respectively. Since Apple has not paid these expenses that the company has incurred, it owes that amount to an external party or parties as of the balance sheet date, thus creating a liability. This account is classified as a current liability on the balance sheet.

Req. 3 (amounts in millions) Net working capital: 2019 Current assets $162,819 – Current − = = $57,101 liabilities $105,718

2018 $131,33 9− = $15,410 $115,92 9

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2019 Total current assets Total current liabilities

2018

$162,819 =

$131,339 = 1.54

$105,718

= 1.13 $115,929

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Accrual Accounting and

3-169

(continued) Apple Inc. Debt ratio: 2019 Total liabilities Total assets

$248,028 $338,516

2018

= 0.73

$258,578 $365,725

= 0.71

The current ratio and net working capital increased or improved, and the debt ratio slightly worsened during 2019. This reveals more liquidity and slightly higher debt. The trend in the liquidity measures examined is improving. The current ratio of 1.54 indicates financial strength. Many successful companies operate with this type of current ratio. The debt ratio did not change much, although it is increasing which is unfavorable. The debt ratio also indicates financial strength although a little higher than normal, because the norm for the debt ratio for most companies is 0.60 to 0.70.

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Focus on Analysis: Under Armour, Inc. (15-20 min.)

Req. 1

The Company recognizes revenue when it satisfies its performance obligations by transferring control of promised products or services to its customers, which occurs either at a point in time or over time, depending on when the customer obtains the ability to direct the use of and obtain substantially all of the remaining benefits from the products or

services.

Revenue

from

the

Company's

licensing

arrangements is recognized over time during the period that licensees are provided access to the Company's trademarks and benefit from such access through their sales of licensed products.

Revenue

from

Connected

Fitness

subscriptions

recognized on a gross basis and is recognized over the term of the subscription.

Under

Armour

imposes

sales

tax

the

company’s revenue on a net basis and do not affect net revenue. Additionally, Under Armour reduces gross revenue by returns, allowances, markdowns, and deductions. These are estimated based on historical rates and contractual obligations.

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licensees are generally due within 30 days of the sale. Thus, the receivables are included in revenues when the sales occur and become an account receivable.

The beginning

balance of Accounts Receivable, $653 million, represents revenue earned in fiscal 2018 but not received (collected in cash) until fiscal 2019. The ending balance of Accounts Receivable, $709 million, represents revenue earned in fiscal 2019 but not received (collected) until fiscal 2020. (continued) Under Armour, Inc. The balance will most likely not be 100% collectible because events

may

occur

that

might

cause

some

not

collected. Under Armour has allowed for $15.1 million and $22.2 million possible uncollectible accounts in 2019 and 2018 respectively.

Req. 3 (in millions) “Prepaid

expenses

and

other

current

assets”

include

expenses that Under Armour has paid for, but has not yet used.

Some examples of this could include supplies,

insurance, advertising, or rent: Journal DATE ACCOUNT TITLES AND EXPLANATION Supplies expense ........................... Supplies..................................... Or: Insurance expense ........................ Praid insurance ..........................

DEBIT 51

CREDIT 51

51 51

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Rent expense ................................. Prepaid rent ...............................

51 51

Req. 4 Since

depreciation

expense

increased

Accumulated

Depreciation by $177 million, a decrease of $23 million ($656 million + $177 million − $810 million) must have occurred as well. This decrease is most likely from the sale of

property,

plant,

and

equipment

when

accumulated

depreciation on the property disposed of was removed from the books.

(continued) Under Armour, Inc. Accumulated Depreciation 656 million Depreciation on 177 23 million assets sold million 810 million

Dec. 31, 2018 Depreciation Expense Dec. 31, 2019

Req. 5 The primary categories of items in Accrued Expenses are Accrued Compensation and Benefits, and Accrued Marketing Expenses.

When the company incurs compensation and

benefits expense, the Accrued Compensation and Benefits Payable account is credited. When the company pays the compensation and benefits, this amount is debited to Copyright © 2022 Pearson Education Inc. Income

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Accrued Compensation and Benefits Payable. A similar thing happens with accrued marketing expenses. The expense relating to the accrued compensation and benefits

was

recorded

incurred—when Accordingly,

the

employees

accrued

year

the

expense

performed

compensation

the

and

was work.

benefits

represents work performed during fiscal 2019 but not paid until fiscal 2020 or later.

The expense relating to the

accrued marketing expense was recorded in the year the expense was incurred—when the sponsors wore Under Armour’s brand.

As a result, some marketing expenses

incurred during fiscal 2019 will not be paid until fiscal 2020 or later.

(continued) Under Armour, Inc.

From 2018 to 2019, Under Armour’s Accrued Expenses increased

from

$340

million

$375

million.

(This

information is from the balance sheets.) This change would decrease the company’s overall net income because a higher amount of expenses relating to accrued expenses were recorded. This means Under Armour will have to spend more in 2020 or later to satisfy a larger amount of debt. Copyright © 2022 Pearson Education Inc. Income

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Group Project (45 min.)

Req. 1 (after Req. 6) Req. 2

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3-175

Whitmer Electronics, Inc. Income Statement Three Months Ended December 31, 2021 Service revenue ($33,000 + $3,000)

$36,000

Expenses: Payroll tax expense

$ 575

Rent expense ($3,000 × 1/2)

1,500

Utilities expense

825

Supplies expense

8,500

Salary expense ($3,500 + $5,000 + $500)

9,000

Fuel and maintenance expense

1,200

Insurance expense

700

Advertising expense

700

Depreciation expense – truck

300

($6,000/5 × 3/12) Depreciation expense – tools

100

($1,200/3 × 3/12) Income tax expense

1,680

Total expenses

25,080

Net income

$10,920

(continued) Group Project

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Accrual Accounting and

3-176

Three Months Ended December 31, 2021 Retained earnings, October 1, 2021 .....

Add: Net income ................................

10,920

Retained earnings, December 31, 2021

$10,920

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Accrual Accounting and

3-177

(continued) Group Project

Req. 4 Whitmer Electronics, Inc. Balance Sheet December 31, 2021 ASSETS LIABILITIES Current assets:

Current liabilities:

Cash

$10,800

Salary payable

Accounts receivable

3,000

Advertising payable

1,500

Prepaid rent

500 100

1,680

Income tax payable

Phone deposit

100

Supplies

1,000

Total current assets

Total current liabilities 2,280

16,400 STOCKHOLDERS’ EQUITY

Long-term assets:

Common stock

10,000

Tools

Retained earnings

10,920

Total stockholders’ equity

20,920

$1,200

Less: accum. deprec.

(100)

Truck

$6,000

1,100

Less: accum. deprec.

(300) 5,700

Total long-term assets

6,800

Total liabilities and

Total assets

$23,200

stockholders’ equity

Chapter 3

$23,200

Accrual Accounting and

3-178

Chapter 3

Accrual Accounting and

3-179

(continued) Group Project

Req. 5 Whitmer Electronics, Inc. Statement of Cash Flows Three Months Ended December 31, 2021 Cash flows from operating activities: Collections from $ 33,000 customers………………… Payments: For suppliers* .............................. $16,400 To employees............................... 8,500 24,900 Net cash provided by operating activities 8,100 Cash flows from investing activities: Purchase of truck ......................... Purchase of tools ......................... Prepaid for phone ........................ Net cash used for investing activities ... Cash flows from financing activities: Issuance of common stock ............ Net cash provided by financing activities ............................................. Net increase in cash…………………………... Cash balance, beginning ……………………….. Cash balance, ending ……………………………

$(6,000) (1,200) (100) (7,300)

10,000 10,000 $10,800 -0$10,800

* Payments to suppliers include supplies ($9,500), rent ($3,000), fuel

Chapter 3

Accrual Accounting and

3-180

and maintenance ($1,200), insurance ($700), utilities ($825), advertising ($600), and payroll taxes ($575).

(continued) Group Project

Req. 6 Current ratio $16,400/2,280 = 7.19 Net working capital = $16,400 – $2,280 = $14,120 Debt ratio = $2,280/$23,200 = 0.098 With a current ratio of 7.19, the company has a high amount of liquidity. With a debt ratio of 0.098, the company has very low debt ratio. They can easily take on more debt. If the 5 year loan for $15,000 is granted, the ratios would change as follows: Current ratio ($16,400 + $15,000)/$2,280 = 13.77 Net working capital = $16,400 + $15,000 – $2,280 = $29,120 Debt ratio = ($2,280 + $15,000)/($23,200 + $15,000) = 0.452 The current ratio and the debt ratio increase with the new loan. The current ratio improves with the inflow of cash from the loan. The debt ratio increases with the new loan, but it is not terribly high. As loan officer of the bank, I think the loan should be granted. The company has excellent liquidity and very little debt, so they should be able to handle interest and principal payments on the new loan. Copyright © 2022 Pearson Education Inc. Income

Chapter 3

Accrual Accounting and

3-181

Even with the loan, the company’s debt ratio is 0.452 which is not considered very high or risky.

Chapter 3

Accrual Accounting and

3-182

Req. 1 ASSETS

LIABILITIES

+ STOCKHOLDERS’ EQUITY

Incom e Cash

Phone Acct. Deposi Supplie Rec. t s

Truc Prepaidk Rent

Commo Tools Salar Adver y t. Taxes n Pay. Pay. Stock Pay.

Retaine d Stockho Earning Equity Tra s

10,000

Issued sto

10,000 (6,000 )

6,00 0

(1,200 )

1,20 0 3,000

(3,000 ) (100)

100

33,000 Service Re 33,000 3,00 0

3,000 Service Re

(5,000) Salary Exp (5,000 )

(3,500) Salary Exp (3,500 ) 500

(500) Salary Exp

(575) (9,500 )

(575) Payroll Ta 9,500 (8,500)

(8,500) Supplies E

(1,200) Fuel & Ma (1,200 ) (700)

(700) Insurance

(825)

(825) Utilities E

(600)

100

(700) Advert. Ex

(1,500 )

(1,500) Rent Exp. 1,680 (300

(1,680) Income Ta

(300) Depr. Exp

Chapter 6

Inventory & 6-

183

) (100) 10,800

3,00 0

100

1,000

1,500

5,70 1,100 0

(100) Depr. Exp 500

100 1,680

10,000

10,920 Totals

Chapter 4 Internal Control & Cash Ethics Check (5-10 min.) EC 4-1 a. Integrity b. Objectivity and independence c. Due care d. Integrity

Chapter 6

Inventory &

Short Exercises (5 min.) S 4-1

Fraud is an intentional misrepresentation of facts, made for the purpose of persuading another party to act in such a way that causes injury or damage to that party. The Three Components of the Fraud Triangle 1. Motive — Fraud generally results from either critical need or greed on the part of the perpetrator.

Regardless of whether

the driving force is need or greed most perpetrators are driven to attempt to acquire something that belongs to others. 2.

Opportunity — The opportunity to commit fraud usually

arises through weak internal controls. 3.

Rationalization — The perpetrator(s) is (are) convinced, in

their own minds, that they deserve the object of the fraudulent behavior. They may believe no one else will ever know or even that everybody else is engaging in fraudulent behavior

Chapter 6

Inventory & 6-

185

(5 min.) S 4-2 Franks should report the errors to Elise because Elise is Franks’ supervisor, and Elise is responsible for the errors. If Elise fails to take action, then Franks should report the errors to Elise’s supervisor in the organization. Franks should keep going up the chain of command until the errors are corrected. In any event, outsiders

who

are

relying

Southern

Technologies

Corporation’s financial statements must be made aware of the need to correct the reported net income figure.

Chapter 6

Inventory &

(5-10 min.) S 4-3 COMPONENTS OF INTERNAL CONTROL 1. Control environment — Top managers must set the “tone at the top” to establish a control environment. 2. Risk assessment — Each company must identify its own risks, based upon its particular line of business, and establish procedures to minimize the risks. 3. Control procedures — Specific procedures are needed for a good system of internal control. 4. Monitoring of controls — Auditors can monitor a company’s actions and its financial statements. Controls can also be programmed into the information system. 5. Information system — Accurate information is essential for success in business. Accounting information enters and exits through the information system. Student responses may vary for the descriptions.

(5-10 min.) S 4-4 Separation of duties is essential for safeguarding assets. The person who has custody of an asset should not also account for the asset. A person who performs both duties can steal the asset and hide the theft by making a false entry in the accounting records. Student responses may vary. Copyright © 2022 Pearson Education Inc. Cost of Goods Sold

Chapter 6

Inventory & 6-

187

(5-10 min.) S 4-5 There

are

several

major

internal

control

procedures

discussed in the chapter besides separation of duties: 1.

Smart hiring practices.

The company should be careful to

hire both competent and honest personnel. practices

involve

conducting

background

Smart hiring

checks

job

applicants, as well as training and supervision on the job. 2.

Comparisons and compliance monitoring.

department

should

allowed

No person or

completely

process

transaction from beginning to end without being checked by another

person

comparisons

and

computer

compliance

operating and cash budgets.

program.

monitoring

are

Examples

the

use

Also, in key functions, one

employee (or a computer program) double checks the work of another for accuracy. 3.

Adequate records help to assure that sufficient hard copy

documents or electronic information is kept by the entity to support the validity of transactions that were processed. Examples include sales invoices, purchase orders, shipping records, and customer remittance advices. Among the benefits of adequate records is the ability to provide an audit trail later for internal or external auditors to follow in auditing the entity’s financial statements.

Chapter 6

Inventory &

4. Limited access goes hand in hand with separation of duties to assure that only authorized individuals are allowed access to (a) the assets of

Chapter 6

Inventory & 6-

189

(continued) S 4-5 the company, such as cash or inventory; and (b) the records. Generally, only people with custodial responsibilities (such as the cashier or the warehouse personnel) should be allowed access to assets (such as cash or inventory). Only people with recordkeeping responsibilities (such as accountants) should have access to the company’s journals and ledgers. 5.

Proper approvals.

No transaction should be processed

without management’s general or specific approval. Generally, the larger the transaction, the higher the organizational level of approval necessary. Notice that the first letters of these attributes spell the acronym SCALP.

That’s an easy and comprehensive way to

remember the control procedures involved in internal controls. (20-30 min.) S 4-6 Cash is important not because of its amount as reported on the balance sheet, but because of its effect on a business. All transactions ultimately affect cash. Businesses purchase assets and must pay cash. They make sales and collect cash. All expenses ultimately require cash. Also, cash is susceptible to theft because it is a medium of exchange. These factors combine to give cash more importance than its account balance would suggest. 6-Copyright © 2022 Pearson Education Inc. 190 Cost of Goods Sold

Chapter 6

Inventory &

Student responses may vary.

Chapter 6

Inventory & 6-

191

(20-30 min.) S 4-7 Punching a hole through supporting documents reduces the opportunity

for

fraud.

Without

this

control

procedure,

dishonest employee could resubmit documents for payment a second time. The employee could change the payee’s address and have the check sent to an address the employee controls. Or the employee could arrange to have the second payee split the payment with the employee. Canceling the documents makes it difficult to get approval for a duplicate payment. Student responses may vary.

(5 min.) S 4-8 Reynolds will notice a gap in the sequence of sales receipts for the receipt that Cooper destroyed. This knowledge will lead Reynolds to investigate what happened to the missing receipt and what happened to the related cash.

Chapter 6

Inventory &

(10 min.) S 4-9 1. Paying by check carries three controls over cash:  The check provides a record of the payment.  The check must be signed by an authorized official.  Before signing the check, the official should study the evidence supporting the payment.

2. A dishonest purchasing agent could:  Purchase goods and have them delivered to his home or other location that he controls.  Approve payment by the company for goods that he spent too much on, and then split the excess with the supplier.

Companies avoid this internal control weakness by separating the following duties related to the purchase of, and payment for, goods:  purchasing goods  receiving goods  preparing check or EFT for payment  approval of payment

Chapter 6

Inventory & 6-

193

(10 min.) S 4-10 Reese Corp. Bank Reconciliation October 31, 2021 BANK

BOOKS

Balance, October 31

Balance, October 31 $5,570

Add: Deposit in transit Subtotal

300

$3,540 Add: Bank collection

600

Interest 5,870 revenue

Subtotal 4,150 Less:

Less:

Outstanding checks Adjusted bank balance

Service charge

(30)

NSF check

(50)

(1,800) Adjusted book $4,070 balance

$4,070

Reese has cash of $4,070. (5-10 min.) S 4-11 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Oct. 31 Cash……………………………………….. Accounts Receivable………………... Collection on account.

600

31 Cash……………………………………….. Interest Revenue……………………... Interest earned on bank balance.

31 Miscellaneous Expense………………...

Chapter 6

CREDIT

600

Inventory &

Cash……………………………………. Bank service charge.

31 Accounts Receivable…………………… Cash…………………………………….. NSF check.

50 50 (5 min.) S 4-12

It appears that the employee has stolen $1,250 (adjusted book balance, $5,290 − adjusted bank balance, $4,040). The adjusted

bank balance is the company’s true cash balance, and the company books show more cash on hand. Therefore, the books must be incorrect.

(5 min.) S 4-13 “Cash and cash equivalents” includes liquid assets such as time deposits, certificates of deposit, and high-grade U.S. or foreign government securities that are very close to maturity (three months or less at the time of purchase). Besides cash, all of these listed are considered to be “cash equivalents”—items quickly and easily converted to cash.

(5-10 min.) S 4-14 a.

deposit in transit

imprest

system b.

fraudulent financial reporting

fidelity bond

Chapter 6

Inventory & 6-

195

remittance advice

m. fraud

triangle d.

internal controls

outstanding check

phishing

misappropriation of assets f.

controller

firewall

treasurer

bank reconciliation

cash equivalents (5-10 min.) S 4-15 a. multiple reimbursements b. overstated expense c. fictitious expense d. mischaracterized expense e. fictitious expense f. overstated expense

Chapter 6

Inventory &

3. Mischaracterized expenses 4. Multiple reimbursements 5. Overstated expenses 6. Structured data 7. Unstructured data

Exercises (10-15 min.) E 4-17A a. Chen prepares the purchase order and also receives the goods. She can add some items to the purchase order and have these extra items shipped to a location she controls. When the goods come in, she checks the incoming shipment, so there’s no outside party to learn of her dishonesty. b. Frabotta has access to the cash collected, and she also prepares the cash report. With access to both items, Frabotta can steal cash and falsify her cash report to conceal her theft. Student responses may vary.

(10 min.) E 4-18A Cash receipts:

Chapter 6

Inventory & 6-

197

a. Weak internal control. There is not a good separation of duties. The bookkeeper both handles cash and accounts for cash. b. Strong internal control. There is a good separation of duties. Different people handle cash and account for cash. Cash payments: a. Strong internal control. There is a good separation of duties. Supervisors

request

equipment,

and

the

home

office

purchases the equipment. b. Weak internal control. Supervisors request, purchase, and pay for equipment with little oversight by the home office. (10-15 min.) E 4-19A The

main

internal

control

weakness

that

the

payroll

department both prepares and distributes the paychecks. With both duties, a dishonest person in the payroll department can create a time sheet for a fictitious employee and then keep the related paycheck after the treasurer returns the signed checks to the payroll department. To

correct

this

weakness,

Lander

company

should

have

someone other than the payroll department or the shop foreman distribute paychecks to employees. For example, the human resources department, which has no control over the time sheets or the paychecks, could distribute paychecks to the workers. 6-Copyright © 2022 Pearson Education Inc. 198 Cost of Goods Sold

Chapter 6

Inventory &

(10 min.) E 4-20A To prevent Bixby’s embezzlement, Uptown Allentown’s board of directors could have: a. Not permitted Bixby to write checks for Uptown Allentown. Instead, appoint a board member to write the checks. b. Not permitted Bixby to receive cash that came to Uptown Allentown. Have subscriber checks sent to a post office box belonging to a bank and have the bank collect the checks. c. Supervised Bixby’s work by examining Uptown Allentown’s documents such as paid checks. d. Had an audit of Uptown Allentown’s transactions and financial statements. Student responses may vary.

(10-20 min.) E 4-21A Sangreen Company Bank Reconciliation May 31, 2022 BANK: Balance, May 31

333

Add:

Deposit in transit

1,235

Less:

Outstanding checks: Check No. 626

$ 40

627

125

(165) $1,403

Chapter 6

Inventory & 6-

199

BOOKS: Balance, May 31

$1,522

Less: Correction of book error — Recorded $82 check as $28

$ 54

NSF check

Service charge

20 (119)

Adjusted book balance

$1,403

Chapter 6

Inventory &

(10-20 min.) E 4-22A Skatetown USA Bank Reconciliation March 31, 2021 BANK: Balance, March 31

710

Add: Deposit in transit

1,775

Subtotal

2,485

Less: Outstanding checks

(615)

Adjusted bank balance

$1,870

BOOKS: Balance, March 31

$1,865

Add: EFT collection — rent

315

Subtotal

2,180

Less: Service charge

$ 10

NSF checks

100

Charge for printed checks

Correction of book error — recorded $210 check as

189

(310)

$21 Adjusted book balance

$1,870

Patrick’s actual cash balance is $1,870.

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Inventory & 6-

201

(10-15 min.) E 4-23A Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Mar 31 Cash ............................................. . Rent Revenue ............................ EFT collection of rent.

315

31 Miscellaneous Expense ($11 + $10) Cash ......................................... Bank service charge and charge for printed checks.

31 Accounts Receivable ...................... Cash ......................................... NSF checks returned by bank.

100

31 Salary Expense ($210 − $21) .......... Cash ......................................... Correction of book error.

189

CREDIT

315

100

Chapter 6

189

Inventory &

(10-15 min.) E 4-24B a. Parker prepares the purchase order and also receives the goods. She can add some items to the purchase order and have these extra items shipped to a location she controls. When the goods come in, she checks the incoming shipment, so there’s no outside party to learn of her dishonesty. b. Makers has access to the cash collected, and she also prepares the cash report. With access to both items, Makers can steal cash and falsify her cash report to conceal her theft. Student responses may vary.

(10 min.) E 4-25B Cash receipts: a. Weak internal control. There is not good separation of duties. The bookkeeper both handles cash and accounts for cash. b. Strong internal control. There is a good separation of duties. Different people handle cash and account for cash. Cash payments: a. Strong internal control. There is a good separation of duties. Supervisors

request

equipment,

and

the

home

office

purchases the equipment.

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Inventory & 6-

203

b. Weak internal control. Supervisors both request, purchase, and pay for equipment with little oversight by the home office. (10-15 min.) E 4-26B The

main

internal

control

weakness

that

the

payroll

correct

this

weakness,

Harper

Company

should

have

Chapter 6

Inventory &

(10 min.) E 4-27B To prevent Jenson’s embezzlement, Downtown Bridgeport’s board of directors could have: a. Not

permitted

Jenson

write

checks

for

Downtown

Bridgeport. Instead, appoint a board member to write the checks. b. Not permitted Jenson to receive cash that came to Downtown Bridgeport.

Have

customer

checks

sent

lock

box

belonging to the bank and allow the bank to get the checks from the lock box. c. Supervised

Jenson’s

work

examining

Downtown

Bridgeport’s documents such as paid checks. d. Had an audit of Downtown Bridgeport’s transactions and financial

statements.

Student responses may vary.

Chapter 6

Inventory & 6-

205

(10-20 min.) E 4-28B Lexitech Bank Reconciliation January 31, 2021 BANK: Balance, January 31

268

Add:

Deposit in transit

1,240

Less:

Outstanding checks: Check No. 626

$ 70

627

140

Adjusted bank balance

(210) $1,298

BOOKS: Balance, January 31

$1,352

Less: Correction of book error — Recorded $87 check as $78

NSF check

Service charge

Adjusted book balance

(54) $1,298

Chapter 6

Inventory &

(10-20 min.) E 4-29B McCall Rinks Bank Reconciliation February 28, 2021 BANK: Balance, February 28

Add: Deposit in transit

1,775

Subtotal

2,530

Less: Outstanding checks

(612)

Adjusted bank balance

755

$1,918

BOOKS: Balance, February 28

$1,992

Add: EFT collection — rent

305

Subtotal

2,297

Less: Service charge

$ 7

NSF checks

120

Charge for printed checks

Correction of book error — recorded $270 check as

243

(379)

$27 Adjusted book balance

$1,918

McCall’s actual cash balance is $1,918.

Chapter 6

Inventory & 6-

207

(10-15 min.) E 4-30B Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Feb 28 Cash .......................................... Rent Revenue ........................ EFT collection of rent.

305

28 Miscellaneous Expense ($7 + $9) Cash ...................................... Bank service charge and charge for printed checks.

28 Accounts Receivable................... Cash ......................................

120

CREDIT

305

120

NSF checks returned by bank. 28 Salary Expense ($270 − $27) ...... Cash ......................................

243 243

Correction of book error.

Chapter 6

Inventory &

Quiz Q4-31

Q4-32

Q4-33

Q4-34

Q4-35

Q4-36

Q4-37

Q4-38

Q4-39

Q4-40

Q4-41

Q4-42

Chapter 6

Inventory & 6-

209

Problems (15-20 min.) P 4-43A The internal control weaknesses in Italian Imports’ system are: 1. Moretti controls the content of the invoices. With no supervision of her work, Moretti could have the suppliers overstate their prices and then arrange to have them split the excess with her after Italian Imports pays the invoices. 2. DeLuca has both cash handling and accounting duties. With both responsibilities, DeLuca could steal incoming cash and cover her theft by manipulating the accounting records. 3. DeLuca prepares the bank reconciliation.

DeLuca has cash

handling duties, recordkeeping duties and prepares the bank reconciliation. This is not a proper separation of duties. As with all small businesses, the key to effective internal control is more owner involvement. Rossi could: 1. Make the purchase and pay arrangements with the Irish artisans who supply Italian Imports’ products. Let Moretti keep locating new products, but don’t let her arrange for the purchases and payment. 2. Rossi could assign either cash handling or accounting duties to DeLuca and then hire someone else to do the other (accounting or cash-handling) duties. Also Rossi needs to

Chapter 6

Inventory &

perform the bank reconciliation to keep her eye on cash receipts and cash payments.

(10-20 min.) P 4-44A

Requirement 1 Missing Internal Control Characteristic

Requirement 2 Possible Problem

Requirement 3

Separation of duties

Theft of cash.

Separate accounting and cash-handling duties. Separate bank reconciliation from other duties.

Separation of duties

Theft of diamonds — the purchasing agent could have diamonds sent to a location he controls.

Separate purchasing, approval, and check-signing duties.

Assignment of responsibility

Lost revenue, because too many employees are managing the office and neglecting their duties.

Assign a single employee to manage the office when the owner is absent. Hire a worker from a temporary agency.

Solution

Chapter 6

Inventory & 6-

211

(25-30 min.) P 4-45A

Req. 1 There should have been separation of duties.

Kershey should

not have been allowed to approve the invoices.

An annual

independent audit by the company’s CPA might possibly select some of these invoices for inspection and verification. The internal audit department at Smucker should audit off-site employees.

Req. 2 It is a good policy for the company to rotate employees among jobs, or have another employee perform Kershey’s duties when he is on vacation. It is not a good policy to allow a trusted, longtime employee perform duties that are never verified or checked by another employee or Kershey’s supervisor.

Chapter 6

Inventory &

(20-30 min.) P 4-46A

Req. 1 Duffy Automotive Bank Reconciliation May 31, 2021 BANK: Balance, May 31, 2021

$ 8,923

Add: Deposits in transit ($982 + $2,577)

3,559

Subtotal

12,482

Less: Outstanding checks — Check No. 3119

476

3120

1,049

3121

257

3122

2,360

Adjusted bank balance, May 31, 2021

(4,142) $ 8,340

BOOKS: Balance, May 31, 2021 Add:

EFT collection of rent Bank collection of note

$ 6,593 $

700

1,325

receivable Book error — $1,390 check (#3115) recorded as $1,930

540

2,565

316 492

Chapter 6

Inventory & 6-

213

Service charge

Adjusted book balance, May 31, 2021

(818) $ 8,340

Chapter 6

Inventory &

(continued) P 4-46A

Req. 2 (entries based on the reconciliation) Journal DATE

ACCOUNT TITLES AND EXPLANATION

May 31 Cash ................................................. Rent Revenue ............................... EFT deposit for rent revenue earned.

DEBIT

700 700

31 Cash ................................................. 1,325 Note Receivable ............................ Note receivable collected by bank. 31 Cash ................................................. Accounts Payable.......................... Correction for check #3115 recorded incorrectly.

540

31 Insurance Expense ............................ Cash ............................................. EFT for payment of insurance.

316

31 Accounts Receivable.......................... Cash ............................................. Unauthorized signature customer check returned by bank.

492

31 Miscellaneous Expense ...................... Cash ............................................. Bank service charge.

CREDIT

1,325

540

316

Chapter 6

492

Inventory & 6-

215

(continued) P 4-46A

Req. 3 A bank account helps control cash by providing a place for safekeeping. The bank also provides a detailed list of the company’s cash transactions that managers can compare to the company’s own cash records and thereby correct any book errors quickly. The bank reconciliation helps control cash by ensuring that the company accounts for its cash transactions correctly and that the bank and book records of cash are correct. Also, the bank reconciliation establishes the balance of cash to report on the balance sheet.

Chapter 6

Inventory &

(15-20 min.) P 4-47B The internal control weaknesses in Parisian Imports’ system are: 1. Mast controls the content of the invoices. With no supervision of her work, Mast could have the suppliers overstate their prices and then arrange to have them split the excess with her after Parisian Imports pays the invoices. 2. Richter has both cash handling and accounting duties. With both responsibilities, Richter could steal incoming cash and cover her theft by manipulating the accounting records. 3. Richter prepares the bank reconciliation. Richter has cash handling duties, accounting duties and prepares the bank reconciliation. This is not a proper separation of duties. As with all small businesses, the key to effective internal controls is more owner involvement. Moreland could: 1. Make the purchase and pay arrangements with the artisans who

supply

Parisian

Imports’

products.

Let

Mast

keep

locating new products, but don’t let her arrange for the purchases and payment. 2. Moreland could assign either cash handling or accounting duties to Richter and then hire someone else to do the other (accounting or cash-handling) duties. Also Moreland needs to Copyright © 2022 Pearson Education Inc. Cost of Goods Sold

Chapter 6

Inventory & 6-

217

perform the bank reconciliation to keep her eye on cash receipts and cash payments.

Chapter 6

Inventory &

(10-20 min.) P 4-48B

Requirement 1 Missing Internal Control Characteristic

Requirement 2

Requirement 3

Possible Problem

Solution

a. Separation of duties

Theft of cash.

Keep accounting and cash handling duties separate. Bank reconciliation should be separated from cash handling and recordkeeping.

b. Separation of duties

Theft of cash or diamonds by the purchasing agent.

Have a manager, not the purchasing agent, approve invoices for payment and sign the checks.

c. Assignment of responsibilities

Lost revenue due to delay of architectural drawings.

Assign one senior architect to fulfill management duties while Silk is absent. Other senior architect should focus on producing architectural drawings. A temporary agency can provide temporary

Chapter 6

Inventory & 6-

219

employees.

(25-30 min.) P 4-49B

Req. 1 Booster Club funds:

There was no separation of duties.

Lambert had access to both the funds and the records. There were no approvals required from another individual. There was no independent audit by a CPA. Student activity fees:

There was no separation of duties.

Lambert had access to both the funds and the records. There were no approvals required from another individual. Booster

Club

reimbursement

for

travel:

There

was

separation of duties. Lambert had access to both the funds and the records.

There were no approvals required from another

individual. There was no independent audit by a CPA. Cash fund:

There was no separation of duties.

access to both the funds and the records.

Lambert had

There were no

approvals required from another individual.

Req. 2 Booster

Club

payments,

funds:

sign

Have

checks,

another

and

individual

perform

approve

monthly

Chapter 6

bank

Inventory &

reconciliations

order

separate

record-keeping

from

handling the cash. Be sure to have an annual audit of the funds by an independent CPA. Student

activity

payments,

fees:

sign

reconciliations

handling the cash.

Have

another

checks,

and

order

separate

individual

perform

approve

monthly

bank

record-keeping

from

The fees should be included in the annual

audit of the school. (continued) P 4-49B Booster Club reimbursement for travel: Have another individual approve payments, sign checks, and perform monthly bank reconciliations

order

separate

record-keeping

from

handling the cash. Be sure to have an annual audit of the funds by an independent CPA. Cash fund: Have another individual approve payments, sign checks, and perform monthly bank reconciliations in order to separate record-keeping from handling the cash. The fees should

included

the

annual

audit

Chapter 6

the

school.

Inventory & 6-

221

(20-30 min.) P 450B

Req. 1

Eddy Automotive Bank Reconciliation October 31, 2021

BANK: Balance, October 31, 2021

$ 9,805

Add: Deposits in transit ($904 + $2,152)

3,056

Subtotal

12,861

Less: Outstanding checks Check No. 3119

$ 478

3120

1,023

3121

234

3122

(4,023) 2,288

Adjusted bank balance, October 31, 2021

$ 8,838

BOOKS: Balance, October 31, 2021 Add:

EFT collection of rent

$ 7,158 $ 600

Bank collection of note receivable

1,500

Chapter 6

Inventory &

450

$1,830 (#3115)

2,550 9,708

Subtotal Less: check

Unauthorized signature

$ 419

EFT payment of

441

Service charge

insurance Adjusted book balance, October 31, 2021

(870) $ 8,838

Chapter 6

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223

(continued) P 4-50B

Req. 2 (entries based on the reconciliation) Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Oct. 31 Cash ................................................. Rent Revenue ............................... EFT deposit for rent revenue.

600

31 Cash ................................................. Note Receivable ............................ Note receivable collected by bank.

1,500

31 Cash ................................................. Accounts Payable .......................... Correction for check #3115 recorded incorrectly.

450

31 Accounts Receivable.......................... Cash ............................................. Unauthorized signature customer check returned by bank.

419

31 Insurance Expense ............................ Cash ............................................. EFT for payment of insurance.

441

31 Miscellaneous Expense ...................... Cash ............................................. Bank service charge.

CREDIT

600

Chapter 6

1,500

450

419

441

Inventory &

(continued) P 4-50B

Req. 3 A bank account helps control cash by providing a place for safekeeping. The bank also provides a detailed list of the company’s cash transactions that Eddy Automotive managers can compare to the company’s own cash records and thus correct any book errors quickly. The bank reconciliation helps control cash by ensuring that the company accounts for its cash transactions correctly and that the bank and book records of cash are correct. Also, the bank reconciliation establishes the balance of cash to report on the balance sheet.

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225

Challenge Exercises and Problem (15-25 min.) E 4-51 Vale could be:

Black could investigate by:

1. Writing business checks to 1. Performing the bank herself. reconciliation and examining all checks written by the business. 2. Submitting purchase 2. Examining purchase invoices a second time for invoices for authenticity duplicate payment, and comparing invoices to perhaps altering the receiving reports to mailing address on the determine that the duplicate invoice and business received all goods sending the check to a it paid for. post office box that Vale controls. Any invoice with a hole indicates it was paid earlier. Calling the suppliers directly to inquire about any questionable invoices. 3. Paying suppliers excess 3. Comparing the business’s amounts and arranging for ratio of cost of goods sold suppliers to kick back part to retail selling price to the of the excess to Vale. cost-to-retail ratio in the past. A kickback scheme would show up in higher cost figures and a lower profit percentage. 4. Making small cash payments to herself.

4. Examining all cash records and comparing the records to actual quantities of

Chapter 6

Inventory &

supplies and other items needed by the business. Student responses may vary.

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227

(20-30 min.) P 4-52 The Peterson Company Bank Reconciliation (Corrected) December 31 BANK: Balance, December 31

$ 4,065

Add: Deposit in transit Actual amount of December 30

610

deposit Subtotal

4,675

Less: Outstanding checks Check No. 1560

$187

1901

847

1902

162

Adjusted bank balance, December 31

(1,196) $ 3,479

BOOKS: Balance, December 31 Add: EFT receipt from customer Interest revenue

$11,755 53 6 59

Subtotal Less:

11,814 NSF check EFT payment of utilities Book error (overstatement

$ 100 735 5,000

of Dec. 24 deposit) Theft by bookkeeper*

$2,500

Adjusted book balance, December 31

(8,335) $3,479

Chapter 6

Inventory &

(continued) P 4-52 The amount of the theft by the bookkeeper is $2,500. The true cash balance is $3,479, which is obtained from the bank side of the bank reconciliation.

The difference between the adjusted

book balance and the true cash balance is $2,500. The theft of $2,500 was concealed by overstating deposits in transit at December 31 on the company’s bank reconciliation. Falsified

deposits

transit

December

(from

bookkeeper)….$3,110 Actual

deposit

transit

December

31……………………..……..…..$610 Difference $2,500

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229

Serial Case

Req. 1

(25 min.) C4-53 Start each day/shift

 with same amount $250

Blind cash count at the

 beginning of each shift

Cash discrepancies



must be explained to continue using the register Require use of written

 order tickets

Order entry must be



entered into the register to produce food or beverage No food or drink may



leave the kitchen without being entered into the system Management approval

 required for price overrides

Manager must visit



table to ensure that the customer actually requested or was due a price adjustment Cash reconciliation at

 the end of the night

More than one party

 present for the reconciliation

Daily cash deposited

Chapter 6

Inventory &

Reconciliation of total



sales and cash deposits performed by accounting department Investigation of any

 discrepancies

Req. 2 Cash is the asset primarily protected.

Inventory is also

protected because food and beverage use must be tied directly to orders entered into the computer system.

No food or

beverages can be given until the order is entered into the computer

system.

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231

Decision Cases (20-30 min.) C4-54 Nashville Motels, Inc. Bank Reconciliation September 30 BANK: Balance, September 30

$ 8,224

Add: Deposit of September 30 in transit

3,794

Subtotal

12,018

Less: Outstanding checks ($116 + $150 + $853 + $990 + $206 + $145)

(2,460)

Adjusted bank balance,

September 30

9,558

BOOKS: Balance, September 30

$10,402

Add: Bank collection 200 Subtotal Less:

10,602 Service charge

$ 8

NSF check

Adjust ed balance s do not agree.

Chapter 6

Inventory &

Adjusted book balance, September 30

$10,558

Based on the above reconciliation, it appears the bookkeeper has stolen $1,000, the difference between the adjusted bank and book amounts ($9,558 − $10,558). He understated the total of outstanding checks by $1,000 to cover his theft.

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233

(continued) C4-54 Colby should assign an employee with no cash-handling duties to prepare the bank reconciliation. The bookkeeper should not perform this duty, because a person who handles cash and also prepares the reconciliation can steal cash and manipulate the reconciliation to cover the theft. Perhaps Colby should prepare the reconciliation himself. Other internal control deficiencies: 1. The bookkeeper should not handle incoming mail. The mailroom employee should open the mail.

The mailroom

employee

treasurer

remittance

should

distribute

advices

checks the

the

accounting

and

department.

Recordkeeping should be separate from asset handling. 2. The bookkeeper should not make bank deposits.

The

treasurer should have the cashier deposit the checks in the bank.

Chapter 6

Inventory &

(15-30 min.) C4-55 The internal control weakness in this case is a lack of separation of duties. The foreman performs too many duties. 1. The foreman hires the workers. 2. The foreman controls workers’ employment documents. 3. The foreman fills out workers’ time sheets and transmits all documents to the home office. 4. The foreman passes out paychecks to workers. 5. The workers never go to the home office, so home-office personnel do not even know whether all workers exist. The foreman could steal from the company as follows: 1. The foreman could enter a fictitious worker into the payroll system and fill out bogus time sheets for the fictitious employee. Then the foreman could pocket the pay check written to the employee. 2. The foreman could enter more time than actually worked by an employee and arrange to split the extra pay received by the worker. 3. The foreman could pad his own hours to receive pay for time that he did not work. The following actions will correct the internal control weakness: 1. The home office could have the construction workers come to the office for processing their employee documents. Copyright © 2022 Pearson Education Inc. Cost of Goods Sold

Chapter 6

Inventory & 6-

235

Then the home office would at least know that all the workers exist. 2. Have employees sign their own time sheets. (continued) C4-55 3. Don’t allow Garcia to pass out paychecks.

Have employees

pick up paychecks at corporate office or have another corporate employee go and pass out paychecks.

The check

distributor should ask for a picture identification. 4. Have a home-office employee compare signatures on the workers’

time

sheets

their

signatures

file

and,

occasionally, to their endorsements on the backs of their paychecks. 5. Occasionally — or always — have a home-office employee go to the construction site to pass out paychecks. 6. Have a home-office employee go to the construction site occasionally to “take attendance” of workers on duty that day. Then match the names of workers on duty to the time sheets turned in at the end of the week. 7. Have employees deliver or mail time sheets to home office.

Chapter 6

Inventory &

Ethical Issues (30-45 min) C4-56 Issue 1 1. Identify the ethical issue. You must decide whether it is ethical for the auditor not to require the bank to record the loss. 2. What are the alternatives?

Require the client to record the

loss, or permit the client not to record the loss. 3. Identify the stakeholders.

The auditor, the bank, and the

public at large can be affected. The auditor’s reputation is on the line. The bank’s financial statements are in question. The public, including creditors and investors, can be affected if the bank issues financial statements that include erroneous amounts.

Assess the possible outcomes.

If the auditors require the

bank to record the loss, the auditor will keep his or her reputation intact. But the auditor will lose the client and also lose the revenue from this large audit. The accounting firm may then be unable to expand the firm as it had hoped to do. If the auditors okay the bank’s financial statements even after the bank did not record the loss, the auditor would keep the bank as a client, earn the audit revenue, and be able to expand

the

firm

planned.

But

the

bank’s

financial

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237

receivable. People relying on the bank’s financial statements may

suffer

losses

result.

The

accounting

firm’s

reputation would be hurt. (continued) C4-56 4. Make the decision.

The auditor should require the bank to

record the loss even if that means losing the bank as a client. By sticking to his or her belief that the bank should record the loss, the auditors’ reputation will not be harmed as it would by okaying financial statements that include errors. It’s far better to lose a client than to lose your reputation. Issue 2 1. Identify the ethical issue. Morris’s ethical issue is whether to use his knowledge of The Salvation Army’s plans and of West’s

situation

either

party’s

advantage

(or

disadvantage). Should Morris help The Salvation Army buy the land at the lowest price? Should he help West sell the land at the highest price? Morris’s position presents him with a conflict of interest. 2. What are the alternatives? There are several: (a)

Let other members of the Salvation Army board of directors know of West’s situation in order to help The Salvation Army buy the land at a bargain price.

Chapter 6

Inventory &

(b) Disclose West’s situation to fellow board members and insist that The Salvation Army pay market price ($3.6 million) for the land. (c)

Advise

West

The

Salvation

Army’s

plans

and

encourage him to hold out for a high price on the sale of the land.

Chapter 6

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239

(continued) C4-56 (d) Reveal nothing to The Salvation Army’s board or to West and take no part in the negotiation between the two parties. (e)

Take a temporary leave of absence from The Salvation Army board for unspecified “personal reasons.”

3. Identify the stakeholders involved.

Morris, The Salvation

Army, West, and University Banks.

Assess

the

possible

consequences.

Disclosing

West’s

weakened condition to The Salvation Army board may help The Salvation Army buy the land at a low price, depending on the ethical bearing of fellow board members. This would help The Salvation Army and hurt West, relative to his ability to sell the land at market value of $3.6 million. Insisting that The Salvation Army offer market price for the land would seem fair to both parties, but that would betray the trust of West. And it may or may not sway the board to go along with a $3.6 million offer for the land. Making West aware of The Salvation Army’s plans may help West get a higher price for the land than he would get otherwise. This would betray the trust of other members of The Salvation Army’s board. 6-Copyright © 2022 Pearson Education Inc. 240 Cost of Goods Sold

Chapter 6

Inventory &

Remaining silent would preserve Morris’s integrity. However, if either The Salvation Army or West ever learned of Morris’s relationship with the other party, they would wonder whether West used the information against them. (continued) C4-56 Taking a temporary leave of absence would preserve Morris’s integrity and remove him from the conflict of interest. It would also preserve West’s reputation for fairness and the reputation

University

Bank

for

keeping

depositor

information confidential. 4. Make the decision.

The authors would take the leave of

absence and hope other Salvation Army board members do not probe Morris’s “personal reasons.” This way neither The Salvation Army nor West can accuse Morris of using inside information to the advantage of the other party. Issue 3 1. Identify the ethical issue.

Gus’s ethical issue is whether to

tell Stevenson Chocolates’ personnel about Twix Foods’ possible bankruptcy. 2. What are the alternatives? (a)

Keep quiet and let nature take its course, or

Chapter 6

Inventory & 6-

241

(b) Tell Stevenson Chocolates’ top managers of Twix’s possible bankruptcy. 3. Identify the stakeholders involved.

Stevenson Chocolates,

Twix Foods, University Bank, and everyone connected to these

organizations

—

owners,

employees,

creditors,

depositors, and their communities.

(continued) C4-56

Assess

the

Chocolates

possible about

consequences.

Twix’s

possible

Telling

bankruptcy

Stevenson may

help

Stevenson Chocolates avoid wasted effort on Twix. This may enable

Stevenson

Chocolates

seek

profitable

ventures and aid IMS’s recovery. In turn, this may help Stevenson Chocolates pay its loan to University Bank. 4. Make the decision. Gus should not tell Stevenson Chocolates of Twix’s financial difficulties (after all, Twix isn’t bankrupt yet). Gus should let nature take its course. Then she will protect the bank’s (and her own) reputation for keeping client

information

confidential.

her

aiding

Stevenson

Chocolates through the loan-restructuring process, Gus may try to help Stevenson Chocolates find other customers that can take up the slack if the sale to Twix doesn’t go through.

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

243

Focus on Financials: Apple Inc. (20-30 min.)

Req. 1 Cash equivalents include assets that are slightly less liquid than cash, but similar enough to be reported together. Cash equivalents must be readily convertible to known amounts of cash and close to maturity (three months or less at the time of purchase).

Req. 2 Apple Inc. includes in its cash equivalents highly liquid instruments with maturities of three months or less at the time of purchase.

Req.3 Yes, Note 3 – Financial Instruments (Cash, Cash Equivalents, and Marketable Securities) contains more detail about cash equivalents. The categories are described in two levels. For 2019 fiscal year, level one cash equivalents include money market funds. Level two cash equivalents include U.S. Treasury securities, U.S. agency securities, Non-US government securities, certificates of deposit, time deposits, commercial paper, and corporate debt securities.

Chapter 6

Inventory &

Focus on Analysis: Under Armour, Inc. (20-30 min.)

Req. 1 Cash and cash equivalents changed for many reasons in 2019. The largest source of cash and cash equivalents was operating activities. Operating activities provided $509 million of cash and cash equivalents. Investing activities used $147 million of cash and cash equivalents. Financing activities used $137 million of cash and cash equivalents. The net change in cash and cash equivalents was an increase of $230 million. The seven largest line items on the statement of cash flows are: 1.

2. 3. 4. 5. 6. 7.

Depreciation and amortization, an expense which did not use cash, added back $186 million to net income, and was the largest single addition to cash provided by operations. Changes in inventories, which decreased by $150 million. When inventories decrease, the impact on cash flow is to add to cash provided by operations. Purchases of property and equipment, a decrease of $146 million, in its investing section. Payments on long-term debt and revolving credit facility, which used $163 million, in the financing section. Net income of $92 million, in the operating section. Payments on the customer refund liability, $81 million, decreasing cash in the operating section. Increase in accounts payable, signifying recognition of

Chapter 6

Inventory & 6-

245

expenses for which cash had not yet been paid as of yearend, which increased net income $59 million, in its operating section.

(continued) Focus on Analysis

Req. 2 The following items from the report are also mentioned in the chapter: 

Management has evaluated internal controls over financial

reporting as of the end of the fiscal year, and

has concluded

that internal controls and procedures over financial reporting were effective as of the end of the year. 

An accounting firm audited the internal controls and

reported on their effectiveness. 

Adequate internal controls over financial reporting will

ensure that the objectives of internal control are met. Student responses will vary.

Chapter 6

Inventory &

Group Project

(45 min.)

Student responses will vary.

Chapter 5 Receivables and Revenue

Ethics Check (5-10 min.) EC 5-1 a. Due care b. Objectivity and independence c. Integrity d. Integrity

Chapter 6

Inventory & 6-

247

Short Exercises (5 min.) S 5-1 No sales revenue should be reported because the goods were sold FOB destination, and revenue is not recorded until the goods are delivered on January 2, 2022.

(5 min.) S 5-2

Journal DATE

ACCOUNT TITLES AND EXPLANATION

Cash Credit Card Discount Expense Sales Revenue To record sales on credit cards.

DEBIT CREDIT

8,820 180* 9,000

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

249

(5-10 min.) S 5-3 Journal DATE

August

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

Cash ............................................... 510,0 00 Sales Revenue ............................. 510,00 0 To record sales. Cost of Sales................................... 400,0 00 Inventory ................................... 400,00 0 To record cost of sales. Sales Returns and Allowances ......... 15,30 0 Sales Refunds Payable ................. To record estimated returns of 3%. Inventory Returns Estimated ........... 12,00 0 Cost of Sales................................ To record estimated cost of returns of 3%.

15,30 0

12,00 0

(10 min.) S 5-4

Req. 1 DATE

April 4

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Ranger Corp.

50,000

Sales Revenue............................ April 4

Cost of Goods Sold .........................

50,000 34,000

CREDIT

Chapter 6

34,000 Inventory &

Cash ($50,000 − $2,500).................

47,500

Sales Discounts ($50,000 x .05)……………… Accounts Receivable—Ranger Corp. .............................................

2,500

11 50,000

Req. 2 a. Hamilton Company b. Ranger Company after leaves Hamilton Company c. Ranger Company (5 min.) S 5-5 3/10, n/30 means that Roswell Company will get a 3% discount if they pay the invoice within 10 days of the invoice date; otherwise, the full amount is due within 30 days. The potential savings resulting from taking advantage of the discount will be 3% of the original invoice price.

Roswell will need to pay the

invoice within 10 days of the original invoice date in order to take advantage of these savings.

(10 min.) S 5-6

Chapter 6

Inventory & 6-

251

Beg. bal. Service revenue End. bal.

Accounts Receivable 103,000 705,000Collections 713,000 95,000 Service Revenue Beg. bal. Service revenue End. bal.

0 705,000 705,000

(5-10 min.) S 5-7

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Uncollectible-Account Expense…………….. Allowance for Uncollectible Accounts ........................................

17,560 *

CREDIT

2021 Dec. 31

Req. 2

17,560

* ($439,000 × .04) = $17,560 ..........................................................

Balance sheet: Accounts receivable ............................$59,000 Less: Allowance for uncollectible accounts.................................................(17,560) 6-Copyright © 2022 Pearson Education Inc. 252 Cost of Goods Sold

Chapter 6

Inventory &

Accounts receivable, net .....................$41,440

(10 min.) S 5-8

Req. 1

$490,000 × 2% = $9,800 estimated uncollectible account expense Allowance for Uncollectible Accounts Beg. bal. 11,000 Uncollectible – account 9,800 expense End. bal. 20,800

Req. 2 Required ending balance in the Allowance account $21,000

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Inventory & 6-

253

Minus current balance in the Allowance account

–

11,000 Equals the amount of uncollectible-account expense $10,000

Allowance for Uncollectible Accounts Beg. bal. 11,000 Uncollectible – account 10,000 expense End. bal. 21,000

(5-10 min.) S 5-9

Req. 1 Interest for: 2021 ($240,000 × .08 × 7/12) ............ 2022 ($240,000 × .08)....................... 2023 ($240,000 × .08 × 5/12) ............

$11,200 19,200 8,000

Chapter 6

Inventory &

Wyoming State Bank has a note receivable and interest revenue. Lindsey Weston has a note payable and interest expense.

Req. 3 Payoff at November 30, 2021: Principal Interest ($240,000 × .08 × 6/12) Total

$240,000 9,600 $249,600 (10 min.) S 5-10

Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBI T

2021 a. Aug. Note Receivable — B. Totten............ 1,00 31 0 Cash ......................................... To loan money. 2022 b. June Interest Receivable ($1,000 × .06 × 30 10/12) ............................................ Interest Revenue....................... To accrue interest revenue.

CREDI T

1,000

50 50

2022 c. Aug. Cash ($1,000 + $60) ........................ 1,06 31 0 Interest Receivable ................... Interest Revenue ($1,000 × .06 × 2/12) ........................................... Note Receivable ........................ To collect on note receivable.

50 10 1,000

(10 min.) S 5-11

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Inventory & 6-

255

Loan Max holds a receivable from the borrower.

Req. 2 Cash decreases and Notes Receivable increases; there is no change in total assets, liabilities, or stockholders’ equity.

Req. 3 Student responses will vary for this opinion question.

Chapter 6

Inventory &

Req. 1

(Quick) Acidtest ratio

Cash + Short-term investments + Net current receivables Total current liabilities

$9,500 + $10,500 =

+ $79,000 $99,000

1.00

The company’s acid-test (quick) ratio compares favorably to the industry average of 0.92.

Req. 2 $1,077,000 365

One day’s sales

= $2,951

Days’ sales in receivables (DSO)

Average net accounts ($64,600 + $79,000) receivable /2 = = One day’s sales $2,951

= 24.33 days The company’s days’ sales in receivables (or days’ sales outstanding) (24.33) is better than (lower than) the 30-day period of the credit terms. An alternate way to compute days’ sales outstanding: Accounts receivable turnover

Net credit sales $1,077,000 Average net ($64,600 + $79,000) = = accounts /2 receivable = 15 times

Days’ sales = outstanding (DSO)

365 15

= 24.33 days Chapter 6

Inventory & 6-

257

(10-15 min.) S 5-13

1. $186,928 2. $2,397 3. $487 4. Uncollectible-Account Expense

487

Allowance for Uncollectible Accounts 487

(10-15 min.) S 5-14 Each student’s solution will differ, based on the data set given in MyAccountingLab.

Exercises

(10-15 min.) E 5-15A

Chapter 6

Inventory &

Req. 1 DATE

July 2

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Oceanside Jewels............................................. Sales Revenue.............................

50,00 0

Cash ...............................................

9,800

Credit Card Discount Expense .......... Sales Revenue.............................

200

Cash ...............................................

50,00 0

CREDIT

50,000

10,000

Accounts Receivable—Oceanside Jewels............................................. 17

50,000

Accounts Receivable—Precious Stones ............................................ Sales Revenue.............................

65,00 0

Sales Refunds Payable ....................

5,000

65,000

19 Accounts Receivable—Precious Stones ............................................ Cash ...............................................

5, 000 60,000

30 Accounts Receivable—Precious Stones ............................................

60,000

Req. 2 Gross sales revenue ($50,000 + $10,000 + $65,000) = .........................................................$125,000

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Inventory & 6-

259

(10-15 min.) E 5-16A

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable .......................

150,0 00

Sales Revenue............................. Cash ............................................... Credit Card Discount Expense .......... Sales Revenue............................. Cash ($150,000 × .50 × .98) ............ Sales Discounts............................... Accounts Receivable.................... Cash ...............................................

CREDIT

150,00 0 194,0 00 6,000 200,00 0 73,50 0 1,500 75,000 75,00 0

Accounts Receivable....................

75,000

Req. 2 Net sales revenue = $348,500

($150,000 + $200,000 – $1,500)

Chapter 6

Inventory &

(10-15 min.) E 5-17A

Req. 1 DATE

June 5

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable .......................

800

Service Revenue [($250 – $50) × 4] Sales Refunds Payable ....................

CREDIT

800 200

7 Accounts Receivable....................

200

Cash [($800 – $200) × .95]...............

570

Sales Discounts............................... Accounts Receivable....................

Chapter 6

600

Inventory & 6-

261

(15-20 min.) E 5-18A

Req. 1 DATE

Oct. 2

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Tim Hinkel .....

1,200

Sales Revenue............................. Accounts Receivable—Ben Hoffman .

CREDIT

1,200 2,600

10 Sales Revenue.............................

2,600

Cash ($1,200 x 99%) .......................

1,188

Sales Discounts............................... Accounts Receivable—Tim Hinkel .

Sales Refunds Payable ....................

2, 000

1,200

Accounts Receivable—Ben Hoffman

2,000

Cash ($600 x 98%) ..........................

588

Sales Discounts............................... Accounts Receivable—Ben

Chapter 6

600 Inventory &

Hoffman .........................................

Req. 2 Gross sales revenue ($1,200 + $2,600)$3,800 Less: ................................................Sales discounts (

24)

Sales revenue net of discounts ...........$3,776

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Inventory & 6-

263

(10-15 min.) E 5-19A

Req. 1 and 2 Beg. bal. Service revenue on account End. bal.

Accounts Receivable 100,000 Collections 697,000 Write-offs

714,00 0 8,000

75,000

Allowance for Uncollectible Accounts Beg. bal. 14,000 Uncollectible – Write-offs 8,000 account 11,000 expense End. bal. 17,000

Req. 3 BALANCE SHEET Accounts receivable ...................................

$75,000

Less Allowance for uncollectible accounts ... Accounts receivable, net ............................

Chapter 6

(17,000) $58,000

Inventory &

(10-15 min) E 5-20A Journal DATE

ACCOUNT TITLES AND EXPLANATION

2021 Dec 31 Uncollectible-Account Expense ($800,000 × .01). . Allowance for Uncollectible Accounts ............................................

CREDI T

DEBIT

8,000 8,00 0

BALANCE SHEET (Partial) Current assets: Accounts receivable, net of allowance for doubtful accounts of $8,870* ............

$84,130 **

_____ *$870 + $8,000 = $8,870 **$93,000 − $8,870 = $84,130

or BALANCE SHEET (Partial) Current assets: Accounts receivable

$93,000

Less: Allowance for doubtful accounts

(8,870)

Accounts receivable, net

$84,130

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Inventory & 6-

265

(15 min.) E 5-21A

Req. 1

Journal

DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

July

Accounts Receivable .........................

193,00 0

Sales Revenue .............................. July

Cash ................................................

193,00 0 164,00 0

Accounts Receivable ..................... July July

Allowance for Uncollectible Accounts. Accounts Receivable ..................... Uncollectible-Account Expense ($193,000 × .03)............................... Allowance for Uncollectible Accounts ..........................................

Req. 2 Accounts Receivable 35,000 164,000 193,000 2,870 Bal. 61,130

164,00 0 2,870 2,870 5,790 5,790

Allowance for Uncollectible Accounts 2,752 2,870 5,790 Bal. 5,672

Net accounts receivable = $55,458 ($61,130 − $5,672) Premier Party Planners expects to collect the net receivable amount.

Req. 3 BALANCE SHEET (Partial) Current assets: Accounts receivable

$61,130

(5,672) Chapter 6

Inventory &

accounts Accounts receivable, net

$55,458

IINCOME STATEMENT (Partial) Net sales revenue

$193,000

Chapter 6

Inventory & 6-

267

(15-30 min.) E 5-22A

Req. 1 The

credit

balance

December

Allowance

for

Uncollectible Accounts should be $19,360. The current balance is $15,500. Thus, the balance of the allowance account is too

low. 1-30 31-60 61-90 Over 90 days days days days $160,000 $120,000$80,000 $30,000 Est. % uncollectible x .006 Bal. in Allow. for Doubtful Accounts should be $960 Current balance Amount needed in adj. entry

Req. 2 DATE

Dec. 31

.02 x

.05 x

Total balance

.40

$2,400 $4,000 $12,000 $19,360 (15,500) $3,860

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Uncollectible-Account Expense .......

3,860

Allowance for Uncollectible Accounts .......................................

CREDIT

3,860

Allowance for Uncollectible Accounts 15,500 3,860 Bal. 19,360

Chapter 6

Inventory &

(continued) E 5-22A

Req. 3 BALANCE SHEET Current assets: Cash

Short-term investments

XX XX

Accounts receivable, net of allowance for uncollectible accounts of $19,360................................................

370,640*

Or *Another way to report accounts receivable is Accounts receivable

$390,000

Less: Allowance for doubtful accounts

370,640 (19,360)

(10-15 min.) E 5-23A

Req. 1 DATE

ACCOUNT TITLES AND EXPLANATION

April

Accounts Receivable ........................ Service Revenue .......................... Recorded revenue on account.

4,000

Bad-Debt Expense ($4,000 × .04) ..... Allowance for Bad Debts............... Recorded expense for the month.

160

Allowance for Bad Debts ($37 + $118) .............................................. Accounts Receivable.....................

155

April

DEBIT CREDIT

Chapter 6

4,000

160

155 Inventory & 6-

269

Wrote off uncollectible receivables.

Chapter 6

Inventory &

(10-15 min.) E 5-24A Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Oct.

1 Note Receivable — Brandy 21,000 Shields.......… Cash……………………………………… 21,000 ..

Dec.

6 Note Receivable — Lawn Pro. ……...…….. Service Revenue ………………………..

5,000

16 Note Receivable — Peabody Company…. Accounts Receivable – Peabody Co..…

4,000

31 Interest Receivable………………………….. Interest Revenue………………………….

5,000

4,000 573* 573*

_____ *($21,000 × .10 × 91/365) + ($5,000 × .09 × 25/365) + ($4,000 × .11 × 15/365) $524** + $31** + $18** = $573 **Rounded to nearest dollar.

Mediterranean Services earned interest revenue of $573 this year.

Chapter 6

Inventory & 6-

271

(10-15 min.) E 5-25A

Req. 1 (a )

Quick (acidtest) ratio

Cash

Marketable Net current + securities + receivables

= Total current liabilities =

$18,000 + $20,000 + $53,000 $19,000 + $108,000

$91,000 $127,000

0.72

A quick (acid-test) ratio of 0.72 is fairly weak. (b One day's ) sales

Sales revenue =

$900,000 =

365

Days’ sales in

= 365

$2,46 6

Average net accounts receivable

receivable s (DSO)

One day’s sales

($67,000 + $53,000) /2 = $2,466

= 24.33 days Or, an alternate way to calculate is: Days’ sales outstanding (DSO) = 365 Accounts receivable turnover =

365 Net credit sales/Avg. net Acc. Rec.

Chapter 6

Inventory &

365 $900,000/[($67,000 + $53,000)/2]

24.33 days (continued) E 5-25A

24.33 days’ sales in receivables is within an acceptable range relative to credit terms of net 30 days.

Req. 2 Moore could speed up cash flows from receivables by offering discounts for early payments or increasing penalties for late payments.

Chapter 6

Inventory & 6-

273

(10-15 min.) E 5-26A

Req. 1 Average collection period:

Millions of dollars

One day’s sales

Days’ sales in receivables (DSO) (average collection period)

$523,125 365

($4,510 + $3,860) / 2 $1,433

= $1,433

2.92 days

An alternate way to compute days’ sales outstanding: Accounts receivable turnover

Net credit sales $523,125 Average net ($4,510 + $3,860) / = = accounts 2 receivable = 125 times

Days’ sales = outstanding (DSO)

365 125

= 2.92 days

Req. 2 Geneva Co., Inc’s collection period is short because Geneva Co. sells mainly for cash and on credit cards and bank cards. The company’s receivables are very low.

Chapter 6

Inventory &

(10-15 min.) E 5-27B

Req. 1 DATE

July 2

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Lakeside Jewels............................................. Sales Revenue.............................

150,0 00

Cash ...............................................

11,76 0 240

3 Credit Card Discount Expense .......... Sales Revenue............................. Cash ............................................... 16

150,00 0

12,000 150,0 00

Accounts Receivable—Lakeside Jewels............................................. Accounts Receivable—Shining Stones 17

150,00 0 185,0 00

Sales Revenue............................. Sales Refunds Payable ....................

CREDIT

185,00 0 17,000

19 Accounts Receivable—Shining Stones ............................................ Cash ............................................... 30

17,000 168,00 0

Accounts Receivable—Shining Stones ............................................

168,00 0

Chapter 6

Inventory & 6-

275

Chapter 6

Inventory &

(10-15 min.) E 5-28B

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable .......................

350,0 00

Sales Revenue............................. Cash ............................................... Credit Card Discount Expense .......... Sales Revenue............................. Cash ($350,000 × .50 × .98) ............ Sales Discounts............................... Accounts Receivable.................... Cash ...............................................

CREDIT

350,00 0 245,0 00 5,000 250,00 0 171,5 00 3,500 175,00 0 175,0 00

Accounts Receivable....................

175,00 0

Req. 2 Net sales revenue = $596,500

($350,000 + $250,000 – $3,500)

Chapter 6

Inventory & 6-

277

(10-15 min.) E 5-29B

Req. 1 DATE

June 5

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable .......................

600

Service Revenue [($175 – $25) × 4] Sales Refunds Payable ....................

CREDIT

600 100

7 Accounts Receivable....................

100

Cash [($600 – $100) × .97]...............

485

Sales Discounts............................... Accounts Receivable....................

Chapter 6

500

Inventory &

Req. 1 DATE

June 2

(15-20 min.) E 5-30B Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Elisa Birch .....

700

Sales Revenue............................. 10

CREDIT

700

Accounts Receivable—Melissa Movens........................................... Sales Revenue ............................

2,400

Cash ($700 × .99) ...........................

693

Sales Discounts............................... Accounts Receivable—Elisa Birch..

Sales Refunds Payable .................... Accounts Receivable—Melissa Movens...........................................

1,400

Cash ($1,000 × .99).........................

990

Sales Discounts............................... Accounts Receivable—Melissa

2,400

700 1,400

Chapter 6

1,000 Inventory & 6-

279

Movens...........................................

Req. 2 Gross sales revenue ($700 + $2,400)..$3,100 Less: ................................................Sales discounts (

17)

Sales revenue net of discounts ..........$3,083

Chapter 6

Inventory &

(10-15 min.) E 5-31B

Req. 1 and 2 Beg. bal. Service revenue on account

Accounts Receivable 104,000 695,000

Collections Write-offs

720,00 0 8,000

End. bal. 71,000 Allowance for Uncollectible Accounts Beg. bal. 12,000 Uncollectible – Write-offs 8,000 account 15,000 expense End. bal. 19,000

Req. 3 BALANCE SHEET Accounts receivable ...................................

$71,000

Less Allowance for uncollectible accounts ... Accounts receivable, net ............................

Chapter 6

(19,000) $52,000

Inventory & 6-

281

(10-15 min.) E 5-32B Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

2021 Dec 31 Uncollectible-Account Expense 24,00 ($800,000×.03) .................................... . 0 Allowance for Uncollectible 24,00 Accounts ........................................... 0 BALANCE SHEET (Partial) Current assets: Accounts receivable, net of allowance for uncollectible accounts of $24,880*.....

$62,120 **

_____ *$880 + $24,000 = $24,880 **$87,000 − $24,880 = $62,120

or BALANCE SHEET (Partial) Current assets: Accounts receivable

$87,000

Less: Allowance for uncollectible accounts

(24,880)

Accounts receivable, net

$62,120

Chapter 6

Inventory &

(15 min.) E 5-33B

Req. 1

Journal

DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Dec .

Accounts Receivable ........................

200,00 0

Sales Revenue ............................. Dec .

Cash................................................

200,00 0 168,00 0

Accounts Receivable..................... Dec .

Allowance for Uncollectible Accounts

CREDIT

168,00 0 2,910

Accounts Receivable..................... Dec .

2,910

Uncollectible-Account Expense ($200,000 × .01) .............................. Allowance for Uncollectible Accounts .........................................

Req. 2 Accounts Receivable 41,000 168,000 200,000 2,910 Bal. 70,090

2,000 2,000

Allowance for Uncollectible Accounts 3,584 2,910 2,000 2,674

Net accounts receivable = $67,416 ($70,090 − $2,674) Palmer Party Planners expects to collect the net receivable amount.

Chapter 6

Inventory & 6-

283

Accounts receivable....................................

$70,090

Less: Allowance for uncollectible accounts.. (2,674) Accounts receivable, net ........................... $67,416 IINCOME STATEMENT (Partial) Sales revenue

$200,000

Chapter 6

Inventory &

(15-30 min.) E 5-34B

Req. 1 The

credit

balance

December

Allowance

for

Uncollectible Accounts should be $19,280. The current balance is $15,400. Thus, the balance of the allowance account is too

low. 1-30 31-60 61-90 Over 90 days days days days $130,000 $100,000 $70,000$30,000 Est. % uncollectible x .006 Bal. in Allow. for Uncoll. Accounts should be $780 Current balance Amount needed in adj. entry

Req. 2

.03 x

.05x

Total balance

.40

$3,000 $3,500$12,000 $19,280 (15,400) $3,880

Journal

DATE

ACCOUNT TITLES AND EXPLANATION

Dec. 31

Uncollectible-Account Expense..........

CREDI DEBIT T

3,88 0

Allowance for Uncollectible Accounts..........................................

3,880

Allowance for Uncollectible Accounts 15,400 3,880 Bal. 19,280

Chapter 6

Inventory & 6-

285

(continued) E 5-34B

Req. 3 BALANCE SHEET Current assets: Cash ..................................................

Short-term investments .....................

Accounts receivable, net of allowance for uncollectible accounts of $19,280 ................................................

310,720*

*Another way to report accounts receivable is Accounts receivable ........................... $330,000 Less: Allowance for uncollectible accounts ....................................

(19,280)310,720

(10-15 min.) E 5-35B

Req. 1 Journal DATE

Mar.

ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable ......................... 3,500 Service Revenue ........................... Recorded revenue on account. Bad-Debt Expense ($3,500 × .04)....... Allowance for Bad Debts ............... Recorded expense for the month.

Chapter 6

CREDI T

3,500

140 140 Inventory &

Mar.

Allowance for Bad Debts ($27 + $109) ............................................... Accounts Receivable ..................... Wrote off uncollectible receivables.

Chapter 6

136 136

Inventory & 6-

287

(10-15 min.) E 5-36B Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

Oct.

1 Note Receivable — Jill Waterman ....... 17,00 0 Cash ............................................. 17,000

Dec.

6 Note Receivable — Fairway Pro ......... 14,00 0 Service Revenue ........................... 14,000 16 Note Receivable — Paulson Co........... Accounts Receivable – Paulson Co. .

5,000

31 Interest Receivable ........................... Interest Revenue ..........................

445*

5,000 445

_____ *($17,000 × .08 × 91/365) × 15/365) = $445* $339** +

+ ($14,000 × .10 × 25/365) + ($5,000 × .05 $96**

$10**

** Rounded to nearest dollar.

Windham Golf earned interest revenue of $445 this year.

Chapter 6

Inventory &

(10-15 min.) E 5-37B

Req. 1 (a )

Marketable Net current Cash + securities + = receivables Total current liabilities

Acidtest ratio

$12,000 + $23,000 + $55,000 $18,000 + $105,000

$90,000 $123,000

0.73

An acid-test ratio of 0.73 is fairly weak. (b )

One day's

Sales revenue =

sales

365

Days’ sales in

Average net

receivable s

accounts receivable =

$868,000

One day’s sales

= 365

$2,37 8

($69,000 + $55,000) /2 = $2,378

= 26.07 days Or, an alternate way to calculate is: Days’ sales outstanding (DSO) = 365 Accounts receivable turnover =

365 Net credit sales/Avg. net Acc. Rec.

Chapter 6

Inventory & 6-

289

365 $868,000/[($69,000 + $55,000)/2]

= =

26.07 days

Chapter 6

Inventory &

(continued) E 5-37B

26.07 days’ sales in receivables is good relative to credit terms of net 30 days.

Req. 2 Swenson could speed up cash flows from receivables by offering discounts for early payments or increasing penalties for late payments.

Chapter 6

Inventory & 6-

291

(10-15 min.) E 5-38B

Req. 1 Average collection period:

Millions of dollars

One day’s sales

$398,500 365

Days’ sales in receivables (average collection period)

($4,110 + $3,860) / 2 $1,092

= $1,092

3.65 days

An alternate way to compute days’ sales outstanding: Accounts receivable turnover

Net credit sales $398,500 Average net ($4,110 + $3,860) / = = accounts 2 receivable = 100 times

Days’ sales = outstanding (DSO)

365 100

= 3.65 days

Req. 2 Norfolk Co., Inc.’s collection period is short because Norfolk Co. sells mainly for cash and on credit cards and bank cards. The company’s receivables are very low.

Chapter 6

Inventory &

Quiz

Q5-39

Q5-40

Q5-41

Q5-42

Q5-43

Q5-44

Q5-45

($5,000 – ($5,000 × .02)) = $4,900 [($150,000 × .02) + ($90,000 × .08) + ($10,000 × .18) − $4,000 = $8,000]

Q5-46

$238,00

($250,000 – $12,000)

0 Q5-47

($140,000 × .02 = $2,800)

Q5-48

($3,000 + $2,800 = $5,800)

Q5-49

$3,000

($5,800 − $2,800 = $3,000)

Q5-50

Q5-51

Q5-52

Q5-53

Q5-54

Q5-55

($50,000 × .09 × 5/12 = $1,875) ($50,000 × .09 × 6/12 = $2,250)

[($70,000 + $90,000) / 2] ÷ ($960,000 / 365 days) = 30.42 days]

Q5-56

Chapter 6

Inventory & 6-

293

Problems (20-30 min.) P 5-57A

Req. 1 DATE

Mar. 3

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Whittier Co. ...

15,00 0

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

6,000

Cash ...............................................

1,960

Credit Card Discount Expense ($2,000 × .02) .............................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

CREDIT

15,000 6,000

Sales Refunds Payable ....................

2,000 800 800 500

5 Accounts Receivable—Whittier Co. .................................................. Inventory........................................ Inventory Returns Estimated ....... Accounts Receivable—Madison, Inc. .

500 200 200 600

7 Sales Revenue............................. Cost of Goods Sold .......................... Inventory .................................... Cash ............................................... 15

600 240 240 14,50 0

14,500 22,00

Chapter 6

Inventory &

0 Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

22,000 8,800

Sales Refunds Payable ....................

1,000

8,800

21 Accounts Receivable—Zucca Co.... Inventory........................................ Inventory Returns Estimated .......

1,000 400 400 (continued) P 5-57A

Journal DATE

Mar. 23

ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Nichols Co. ....

32,00 0

Sales Revenue............................. Cost of Goods Sold ..........................

32,000 12,80 0

Inventory .................................... Cash ...............................................

CREDIT

12,800 21,000

25 Accounts Receivable—Zucca Co.... Sales Returns and Allowances .........

21,000 3,580

31 Sales Refunds Payable.................

3,580

[($15,000 + $2,000 + $600 + $22,000 + $32,000) × .05]

Inventory Returns Estimated ........... Cost of Goods Sold ......................

1,432 1,432

($3,580 × .40)

Req. 2

Chapter 6

Inventory & 6-

295

Gross sales revenue = $71,600 ($15,000 + $2,000 + $600 + $22,000 + $32,000)

Chapter 6

Inventory &

(20-30 min.) P 5-58A

Req. 1 Journal DATE

Oct. 1

ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Penzey Co. ....

6,000

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

1,500

Cash ...............................................

1,960

CREDIT

6,000 1,500

Accounts Receivable—Marigold Co. .. 7

2,000 500 500 23,00 0

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

23,000 5,750

Cash ...............................................

5,880

Sales Discounts ($6,000 × .02) ........ Accounts Receivable—Penzey Co. .

120

Accounts Receivable—Wolf Ent. .......

13,00 0

5,750

12 Sales Revenue............................. Cost of Goods Sold .......................... Inventory .................................... Cash ............................................... 16 Sales Discounts ($23,000 × .02) ...... Accounts Receivable—Marigold Co. ................................................. Copyright © 2022 Pearson Education Inc. Cost of Goods Sold

6,000

13,000 3,250 3,250 22,54 0 460

Chapter 6

23,000 Inventory & 6-

297

Cash ...............................................

13,00 0

31 Accounts Receivable—Wolf Ent. ...

13,000

Req. 2 Net sales revenue = $43,420 $120 + $13,000 – $460)

($6,000 + $2,000 + $23,000 – (15-20 min.) P 5-59A

Reqs. 1 and 3

(All amounts in millions)

Accounts Receivable

3,900 27,710

Allowance for Uncollectible Accts 210

26,364 851 135

851

831

40 4,300

190

Req. 2 Journal DATE

b. c.

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash ($32,600 × .15)............... Accounts Receivable ............... Service Revenue .................

4,890 27,710

Cash....................................... Accounts Receivable ...........

26,364

Uncollectible-Account Expense Allowance for Uncollectible

831

CREDIT

32,600 26,364

Chapter 6

Inventory &

Accounts ($27,710 × .03) . d.

831

Allowance for Uncollectible Accts ...................................... Accounts Receivable ...........

851

Notes Receivable .................... Accounts Receivable ...........

135

Interest Receivable ................. Interest Revenue ($135 × .09 ×

851 135 1

1/12).

Accounts Receivable .............. Cash ..................................

40 40 (continued) P 5-59A

Req. 4 These balances agree with the actual Lincoln Delivery amounts. Lincoln Delivery expects to collect $4,110 ($4,300 − $190) from its charge customers (plus the note receivable and interest).

Req. 5 INCOME STATEMENT Service revenue .................. + Interest revenue ............... – Uncollectible-account expense

$32,600 1 (831)

Net effect on net income .....

$31,770

Chapter 6

Inventory & 6-

299

(25-35 min.) P 5-60A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

Nov 30 Allowance for Uncollectible Accounts .......1,800 . Accounts Receivable — Clupper 1,300 Carpets................................................... Accounts Receivable — Medina 500 Antiques ................................................. Dec 31 Uncollectible-Account Expense ................7,418 . Allowance for Uncollectible Accounts .. 7,418 * _____ 1-30 31-60 61-90 Over 90 days days days days $144,000 $49,000 $17,000$28,000 Est. % uncollectible x .002 Bal. in Allow. for Uncollectible Accounts should be $288 Current balance Amount needed in adj. entry

.02 x

.15x

Total balance

.35

$980 $2,550 $9,800$13,618 (6,200) $7,418*

Req. 2 Allowance for Uncollectible Accounts Nov. 30 Write-offs 1,800 Sept. 30 Balance Dec. 31 Adjusting Dec. 31 Balance

Chapter 6

8,000 7,418 13,618

Inventory &

(continued) P 5-60A

Req. 3 New York Communications Comparative Balance Sheets (Partial) December 31, 2022 and December 31, 2021 2022 Accounts

$238,00

receivable…………………….............

$212,000

Less: Allowance for uncollectible

(4,300)

accounts…

(13,618)

Accounts receivable,

$224,38

net………………………..

2021

Chapter 6

$207,700

Inventory & 6-

301

(20-25 min.) P 5-61A

Req. 1 Cash ..................................................

$ 83,000

Accounts receivable ............................ $40,000 Less: Allowance for uncollectible

11,500

accts ..................................................

(28,500)

Inventory............................................

57,000

Prepaid expenses................................

18,000

Total current assets.........................

$169,500

Accounts payable................................

$ 62,000

Other current liabilities .......................

42,000

Total current liabilities ....................

$104,000

Req. 2 As reported

Corrected

Current $198,000 = = 1.90 ratio $104,000 Quick (acidtest) ratio

$83,000 + $40,000 $104,000

$169,500 = 1.63 $104,000 $83,000 + $11,500

= 1.18

= 0.91 $104,000

Chapter 6

Inventory &

(continued) P 5-61A

Req. 3 Net income, as reported

$93,000

Less: Correction for conversion to the allowance method — Correct uncollectible-account expense, per aging method

$28,500

Uncollectible-account expense as reported using the direct writeoff

method

(24,000) (4,500)

Net income, as corrected ...................

$69,000

Chapter 6

Inventory & 6-

303

(20-30 min.) P 5-62A

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

2021 Oct. 31 Note Receivable — Basic Foods ....... 30,000 Sales Revenue ............................. 30,000 Dec. 31 Interest Receivable ($30,000 × .0525 × 2/12) ............................................ Interest Revenue .........................

263 263

2022 Jan. 31 Cash............................................... 30,394 Note Receivable — Basic Foods ... 30,000 Interest Receivable...................... 263 Interest Revenue ($30,000 × .0525 131 × 1/12) ............................................ Nov. 11 Note Receivable — Strafford Shops.. 15,800 Cash ........................................... 15,800 Dec. 31 Interest Receivable ......................... Interest Revenue ($15,800 × .10 × 50/365) ...........................................

Chapter 6

216 216

Inventory &

(continued) P 5-62A

Req. 2 BALANCE SHEET

December 31, 2022 2021

Current assets: Note receivable Interest receivable .......................

$15,800

$30,000

216

263

Chapter 6

Inventory & 6-

305

(15-25 min.) P 5-63A

Req. 1 Dollar amounts in millions 2023 2022 a. Current ratio

Total current assets Total current liabilities

$935

= 1.51

$620

$875 $635

= 1.38

Cash + Short-term investments + Net current receivables

b. Quick $85+$160+$2 $60+$175+$2 (acid70 60 = = test) Total current liabilities $620 $635 ratio = c.

One day’s sales

Net sales 365

0.83 $7,685 365

= $21.05

Days’ ($270+$260 Average net receivables sales in )/2 = = receivable One day’s sales $21.05 s (DSO) =

0.78

$5,50 = 0 $15.07 365 ($260+$240)/ 2 $15.07 =

12.59 days

16.59 days

An alternate way to compute days’ sales outstanding: Accounts receivable = turnover

Net credit sales Average net accounts receivable

$7,685 $5,500 ($270 + $260) ($260 + $240) = /2 /2 29 times

22 times

Chapter 6

Inventory &

Days’ sales outstanding = (DSO)

365 / 29

12.59 days

365 / 22

= 16.59 days

Chapter 6

Inventory & 6-

307

(continued) P 5-63A

Req. 2 The current ratio improved from 1.38 to 1.51. The quick (acidtest) ratio increased slightly from 0.78 to 0.83. Days’ sales in receivables decreased from 16.59 days to 12.59 days. All three ratio values improved during the current year. This is a favorable trend because it shows that the company is finding it easier to pay bills and collect receivables. Student responses may vary.

Req. 3 Sunset Pools can improve cash flows from receivables by either offering a discount for early payment and/or emphasizing credit cards for sales.

Chapter 6

Inventory &

(40-50 min.) P 5-64A

Req. 1 Journal DATE

Nov. 3

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash ...............................................

300

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

120

Cash ...............................................

588

Credit Card Discount Expense ($600 × .02)................................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

CREDIT

300 120

Accounts Receivable—Willow Creek.

600 245 245 1,300

10 Sales Revenue............................ Cost of Goods Sold ......................... Inventory ................................... 11

1,300 500 500

Accounts Receivable—Amherst Shoppes.. Sales Revenue............................ Cost of Goods Sold ......................... Inventory ...................................

2,000

Accounts Receivable—Black River Inc

900

2,000 900 900

12 Sales Revenue............................ Cost of Goods Sold ......................... Inventory ...................................

900 387

Sales Refunds Payable ...................

150

387

Chapter 6

150 Inventory & 6-

309

Inventory ....................................... Inventory Returns Estimated.......

Cash ...............................................

1,960

Sales Discounts ($2,000 × .02) ........ Accounts Receivable—Amherst Shoppes

Chapter 6

2,000

Inventory &

(continued) P 5-64A Journal DATE

Nov. 22

ACCOUNT TITLES AND EXPLANATION

DEBIT

Sales Refunds Payable ....................

200

Accounts Receivable—Black River Inventory........................................ Inventory Returns Estimated .......

Cash ...............................................

686

Sales Discounts ($700 × .02) ........... Accounts Receivable—Black River

Accounts Receivable—Charleston Co.

5,000

CREDIT

200 86

22 700

23 Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

5,000 2,000

Cash ...............................................

1,150

2,000

25 Accounts Receivable—Willow Creek Allowance for Uncollectible Accounts

1,150 150

26 Accounts Receivable –Etna Ent. .... Accounts Receivable—Denis’s One27

150 700

Stop-Shop

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

700 245

Accounts Receivable .......................

7,200

245

7,200 3,000

Chapter 6

Inventory & 6-

311

Inventory .................................... 3,000 1-

Cash ...............................................

2,450

Credit Card Discount Expense ($2,500 × .02) .............................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

30 2,500 900 900

(continued) P 5-64A Journal DATE

Nov. 130

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash ............................................... Accounts Receivable....................

4,500

Sales Returns and Allowances .........

1,025

CREDIT

4,500

30 Sales Refunds Payable................. Inventory Returns Estimated ........... Cost of Goods Sold ......................

1,025* 410

Uncollectible Account Expense ........

171*

410*

30 Allowance for Uncollectible Accounts ........................................

171

*Calculations: Total sales = ($300 + $600 + $1,300 + $2,000 + $900 + $5,000 + $700 + $7,200 + $2,500) = $20,500 Total sales $20,500 × .05 = Estimated future returns $1,025 Cost of sales = .40 × $1,025 = $410

Chapter 6

Inventory &

Credit sales = ($1,300 + $2,000 + $900 + $5,000 + $700 + $7,200) = $17,100 Credit sales $17,100 × .01 = Uncollectible account expense $171

(continued) P 5-64A

Req. 2 Net realizable value of accounts receivable = $12,969 Accounts receivable, beginning $ 5,100 Plus: Credit sales (on account)

17,100

Less: Reductions to A/R

(8,850)*

Less: Allowance for uncollectible accounts

(381)**

Net realizable value of A/R, ending$12,969

Chapter 6

Inventory & 6-

313

**Allowance for Uncollectible Accounts = $381 Allowance, beginning

$360

Plus: Uncoll. account expense171 Less: Write-offs

(150)

Allowance, ending

$381

Chapter 6

Inventory &

(20-30 min.) P 5-65B

Req. 1 Journal DATE

Mar. 3

ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Greenleaf Co..

25,00 0

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

8,750

Cash ...............................................

3,920

Credit Card Discount Expense ($4,000 × .02) .............................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

CREDIT

25,000 8,750

Sales Refunds Payable ....................

4,000 1,400 1,400 5,000

5 Accounts Receivable—Greenleaf Co............................................... Inventory........................................ Inventory Returns Estimated ....... Accounts Receivable—Athens, Inc. ...

5,000 1,750 1,750 1,000

7 Sales Revenue............................. Cost of Goods Sold .......................... Inventory .................................... Cash ............................................... 15

1,000 350 350 20,00 0

Accounts Receivable—Greenleaf Co. ................................................. Accounts Receivable—Zurich Co....... 19 Sales Revenue............................. Cost of Goods Sold .......................... Copyright © 2022 Pearson Education Inc. Cost of Goods Sold

20,000 12,00 0 12,000 4,200

Chapter 6

Inventory & 6-

315

Inventory ....................................

4,200

Sales Refunds Payable ....................

500

21 Accounts Receivable—Zurich Co. .. Inventory........................................ Inventory Returns Estimated .......

500 175 175

(continued) P 5-65B Journal DATE

Mar. 23

ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Niles Co.........

38,00 0

Sales Revenue............................. Cost of Goods Sold ..........................

38,000 13,30 0

Inventory .................................... Cash ...............................................

CREDIT

13,300 11,500

25 Accounts Receivable—Zurich Co. .. Sales Returns and Allowances .........

11,500 3,200

31 Sales Returns Payable .................

3,200

[($25,000 + $4,000 + $1,000 + $12,000 + $38,000) × .04]

Inventory Returns Estimated ........... Cost of Goods Sold ......................

1,120 1,120

($3,200 × .35)

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

317

(20-30 min.) P 5-66B

Req. 1 Journal DATE

Oct. 1

ACCOUNT TITLES AND EXPLANATION

DEBIT

Accounts Receivable—Pez Co. ..........

8,000

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

2,400

Cash ...............................................

980

Credit Card Discount Expense ($1,000 × .02) .............................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

CREDIT

8,000 2,400

Accounts Receivable—Magnolia Co... 7

1,000 300 300 32,00 0

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

32,000 9,600

Cash ...............................................

7,840

Sales Discounts ($8,000 × .02) ........ Accounts Receivable—Pez Co. ......

160

Accounts Receivable—Wexler Ent.....

17,00 0

9,600

12 Sales Revenue............................. Cost of Goods Sold .......................... Inventory .................................... Cash ............................................... 16 Sales Discounts ($32,000 × .02) ...... Accounts Receivable—Magnolia Co. ................................................. 6-Copyright © 2022 Pearson Education Inc. 318 Cost of Goods Sold

8,000

17,000 5,100 5,100 31,36 0 640

Chapter 6

32,000 Inventory &

Cash ............................................... 31

17,00 0

Accounts Receivable—Wexler Ent.

17,000

Req. 2 Net sales revenue = $57,200 $160 + $17,000 – $640)

($8,000 + $1,000 + $32,000 – (15-20 min.) P 5-67B

Reqs. 1 and 3

(All amounts in millions)

Accounts Receivable 4,000 29,900 43 4,200

28,123 1,485 135

Allowance for Uncollectible Acct 160 1,485 1,495 170

Req. 2 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Cash ($32,500 × .08) ...................... 2,600 Accounts Receivable ...................... 29,900 Service Revenue ........................ 32,500

Cash ............................................. 28,123 Accounts Receivable ..................

28,123

Uncollectible-Account Expense .......1,495 Allowance for Uncollectible Accts ($29,900 × .05) .........................

1,495

Chapter 6

Inventory & 6-

319

Allowance for Uncollectible Accts ...1,485 Accounts Receivable ..................

Notes Receivable ........................ Accounts Receivable ...............

135

Interest Receivable ..................... Interest Revenue ($135 × .09 ×

1,485 135 1

1/12) ..............................................

Accounts Receivable ................... Cash ......................................

43 43 (continued) P 5-67B

Req. 4 These balances agree with the Hopewell Shipping Corp. amounts. Hopewell Shipping expects to collect $4,030 ($4,200 − $170) from its charge customers (plus the note receivable and interest).

Req. 5 INCOME STATEMENT Service revenue .................. + Interest revenue ............... −..................................................Uncol lectible-account expense .. Net effect on net income .....

$32,500 1 (1,495) $31,006

Chapter 6

Inventory &

(25-35 min.) P 5-68B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

Nov. 30 Allowance for Uncollectible Accounts . 2,000 Accounts Receivable — Looper 1,200 Carpets............................................. Accounts Receivable — Williams 800 Antiques ............................................ Dec. 31 Uncollectible-Account Expense........... 10,55 0 Allowance for Uncollectible 10,550 Accounts........................................... * _____ 1-30 31-60 61-90 Over 90 days days days days $132,000 $52,000 $15,000$36,000 Est. % uncollectible x .005 Bal. in Allow. for Uncollectible Accounts should be $660 Current balance Amount needed in adj. entry

.02 x

.15x

Total balance

.35

$1,040 $2,250$12,600$16,550 (6,000) $10,550*

Req. 2 Allowance for Uncollectible Accounts Nov. 30 Write-offs 2,000 Sept. 30 Balance Dec. 31 Adjusting Dec. 31 Balance

Chapter 6

8,000 10,550 16,550

Inventory & 6-

321

(continued) P 5-68B

Req. 3 West Point Communications Comparative Balance Sheets (Partial) December 31, 2022 and December 31, 2021 2022 2021 Accounts receivable ......................... $235,00 $212,00 0 0 Less: Allowance for uncollectible accounts .......................................... (16,550) (4,800) Accounts receivable, net .................. $218,45 $207,20 0 0

Chapter 6

Inventory &

(20-25 min.) P 5-69B

Req. 1 Cash

$ 77,000

Accounts receivable $39,000 Less: Allowance for uncollectibles

15,500 (23,500)

Inventory

59,000

Prepaid expenses

9,000

Total current assets

$160,500

Total current liabilities ......................

$104,000

Req. 2 As reported

Corrected

Current $184,000 = = 1.77 ratio $104,000 Quick (acidtest) ratio

$77,000 + $39,000 $104,000

= 1.12

$160,500 = 1.54 $104,000

$77,000 + $15,500

= 0.89

$104,000

Chapter 6

Inventory & 6-

323

(continued) P 5-69B

Req. 3 Net income, as reported $93,000 Less: Correction for conversion to the allowance method — Correct uncollectible-account expense, per aging method

$23,500

Uncollectible-account expense as reported using the direct writeoff

(8,500) (15,000)

method Net income, as corrected ...................

$78,000

Chapter 6

Inventory &

(20-30 min.) P 5-70B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

2021 Oct. 31 Note Receivable — Rose Foods............ 32,00 0 Sales Revenue ............................... 32,00 0 Dec.31 Interest Receivable ($32,000 × .055 × 2/12) ................................................. Interest Revenue ...........................

293 293

2022 Jan. 31 Cash .................................................. 32,44 0 Note Receivable — Rose Foods ....... 32,00 0 Interest Receivable ........................ 293 Interest Revenue ($32,000 × .055 × 147 1/12) ................................................. Nov.11 Note Receivable — Franklin Shops ...... 15,80 0 Cash .............................................. 15,80 0 Dec.31 Interest Receivable ............................ Interest Revenue ($15,800 × .0975 × 50/365)...............................................

211

Inventory & 6-

Chapter 6

211

325

(continued) P 5-70B

Req. 2 December 31 2022 2021

BALANCE SHEET Current assets: Note receivable ................................ Interest receivable ...........................

$15,80

$32,0

211

293

Chapter 6

Inventory &

(30-40 min.) P 5-71B

Req. 1

a. Current ratio

Dollar amounts in millions 2023 2022 =

Total current assets Total current liabilities

$900

$950

= 1.64

$550

$640

= 1.48

Cash + Short-term investments + Net current receivables

b. Quick $90 + $150 + $95 + $180 + (acid$270 $280 = = test) Total current liabilities $550 $640 ratio =

c. One day’s = sales

Net sales 365

0.93

$7,700 365

= $21.10

0.87

$5,35 = 5 $14.67 365

($270+$280 ($280+$230) Days’ Average net receivables )/2 /2 sales in = = receivable One day’s sales $21.10 $14.67 s (DSO) 13.03 = 17.38 = days days An alternate way to compute days’ sales outstanding: Accounts receivable = turnover

Net credit sales Average net accounts receivable

$7,700 $5,355 ($270 + $280) ($280 + $230) = /2 /2 28 times

21 times

Chapter 6

Inventory & 6-

327

Days’ sales outstanding = (DSO)

365 / 28

13.04 days

365 / 21

= 17.38 days

Chapter 6

Inventory &

(continued) P 5-71B

Req. 2 The current ratio improved from 1.48 to 1.64. The quick (acidtest)

ratio

increased

from

0.87

0.93.

Days’

sales

receivables improved from 17.38 days to 13.04 days. All three ratio values improved during the current year. This is a favorable trend because it indicates that the company is finding it easier to pay its bills and collect its receivables. Student responses may vary.

Req. 3 Diamond Pools can improve cash flow from receivables by offering a discount for early payment and/or emphasizing credit cards for sales.

Chapter 6

Inventory & 6-

329

(40-50 min.) P 5-72B

Req. 1 Journal DATE

Nov. 3

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash ...............................................

500

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

200

Cash ...............................................

1,568

Credit Card Discount Expense ($1,600 × .02) ............................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

CREDIT

500 200

Accounts Receivable—Rapid City.....

1,600 592 592 1,500

10 Sales Revenue............................ Cost of Goods Sold ......................... Inventory ................................... Accounts Receivable—Appalachian 11

1,500 500 500 20,00 0

Shoppes

Sales Revenue............................ Cost of Goods Sold ......................... Inventory ...................................

20,000 8,400

Accounts Receivable—Ontario Inc ...

800

8,400

12 Sales Revenue............................ Cost of Goods Sold ......................... Inventory ...................................

800 344

Sales Refunds Payable ...................

100

344

Chapter 6

100 Inventory &

Inventory ....................................... Inventory Returns Estimated.......

Cash ...............................................

19,60 0 400

20 Sales Discounts ($20,000 × .02) ...... Accounts Receivable—Appalachian Shoppes…………………………………….

Chapter 6

20,000

Inventory & 6-

331

(continued) P 5-72B Journal DATE

Nov. 22

ACCOUNT TITLES AND EXPLANATION

DEBIT

Sales Refunds Payable ....................

300

Accounts Receivable—Ontario Inc. Inventory........................................ Inventory Returns Estimated .......

129

Cash ...............................................

490

Sales Discounts ($500 × .02) ........... Accounts Receivable—Ontario Inc.

Accounts Receivable—Carlsbad Co. ..

7,000

CREDIT

300 129

22 500

23 Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

7,000 2,800

Cash ...............................................

1,400

2,800

25 Accounts Receivable—Rapid City .. Allowance for Uncollectible Accounts

1,400 125

26 Accounts Receivable –Eagle Ent. .. Accounts Receivable—Dave’s One27

125 1,300

Stop-Shop

Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

1,300 245

Accounts Receivable .......................

9,200

245

30 Sales Revenue............................. Cost of Goods Sold .......................... Inventory .................................... 6-Copyright © 2022 Pearson Education Inc. 332 Cost of Goods Sold

9,200 3,895

Chapter 6

Inventory &

3,895 1-

Cash ...............................................

4,900

Credit Card Discount Expense ($5,000 × .02) .............................................. Sales Revenue............................. Cost of Goods Sold .......................... Inventory ....................................

100

30 5,000 1,800 1,800

(continued) P 5-72B Journal DATE

Nov. 130

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash ............................................... Accounts Receivable....................

7,000

Sales Returns and Allowances .........

2,345

CREDIT

7,000

30 Sales Refunds Payable................. Inventory Returns Estimated ........... Cost of Goods Sold ......................

2,345* 938

Uncollectible Account Expense ........

398*

938*

30 Allowance for Uncollectible Accounts ........................................

398

*Calculations: Total sales = ($500 + $1,600 + $1,500 + $20,000 + $800 + $7,000 + $1,300 + $9,200 + $5,000) = $46,900 Total sales $46,900 × .05 = Estimated future returns $2,345 Cost of sales = .40 × $2,345 = $938 Credit sales = ($1,500 + $20,000 + $800 + $7,000 + $1,300 + $9,200) = $39,800 Copyright © 2022 Pearson Education Inc. Cost of Goods Sold

Chapter 6

Inventory & 6-

333

Credit sales $39,800 × .01 = Uncollectible account expense $398

(continued) P 5-72B

Req. 2 Net realizable value of accounts receivable = $19,442 Accounts receivable, beginning $ 10,100 Plus: Credit sales (on account) Less: Reductions to A/R

39,800 (29,425)*

Less: Allowance for uncollectible accounts

(1,033)**

Net realizable value of A/R, ending$19,442

Chapter 6

Inventory &

Allowance, beginning

760

Plus: Uncoll. account expense398 Less: Write-offs Allowance, ending

(125) $1,033

Chapter 6

Inventory & 6-

335

Challenge Exercises and Problem (15-20 min.) E 5-73

Req. 1

Sales revenue

Actual without Bank Expected with Cards Bank Cards $500,000 $550,000*

……………………....... Cost of goods

$250,000

$275,000**

18,000

—

sold…………………….. Uncollectible-account expense………. Bank-card discount

—

9,000***

165,000

156,000****

433,000

440,000

$ 67,000

$110,000

expense…………. Other expenses…………………………. Total expenses………………………….. Net income……………………………….

Decision:

Accept bank cards because of the expected increase in net income.

Chapter 6

Inventory &

**$250,000 × 1.10 = $275,000 ***$550,000 − $250,000 = $300,000 × .03 = $9,000 The switch to bank cards should produce bankcard discount expense on only the portion of sales that are made on bank cards. ****$165,000 − $9,000 = $156,000

Chapter 6

Inventory & 6-

337

(15-20 min.) E 5-74

Req. 1

T-accounts are helpful, as follows (in millions):

(a )

Allowance for Uncollectible Accounts Beg. bal. 67 WriteExpense 13

offs

End. bal.

Gross Accounts Receivable Beg. bal. ($2,260 + 2,327 $67) 43,33 Write-offs Total revenue 3

Collections End. bal. ($2,582 + $72)

42,998

(b )

2,654

Chapter 6

Inventory &

(15-20 min.) P 5-75

Req. 1 Beginning Allowance balance $

940

+ Uncollectible account expense b260 – Write-offs

120

= Ending Allowance balance $1,080

Req. 2 Beginning Acct. Rec. balance $ 9,500 + Credit sales

15,700

– Write-offs - Sales returns – Collections

120 700

15,000

= Ending Acct. Rec. balance $ 9,380

Req. 3 Accounts Receivable Beg. Bal 9,500 Cr. sales 15,700

Allowance for Uncollectible Accounts 940Beg. Bal

700 Returns 120 Write-offs

Write-offs 120

260Uncoll. Acct. exp.

15,000

Collections

End. Bal 9,380

1,080 End. Bal

Chapter 6

Inventory & 6-

339

(continued) P 5-75 Journal entries: Journal DATE

ACCOUNT TITLES AND EXPLANATION

2021 a. Accounts Receivable

DEBIT

15,70 0

Sales Revenue

15,70 0

b. Cost of Goods Sold Inventory

7,700 7,700

c. Sales Returns & Allowances ($15,700 x 4%) Sales Refunds Payable

628

d. Inventory Returns Estimated ($7,700 x 4%) Cost of Goods Sold

308

e. Sales Refunds Payable Accounts Receivable

700

f. Inventory Inventory Returns Estimated

400

628

308

700

400

g. Cash Sales Discounts ($15,000 x 90% x 2%) Accounts Receivable

14,73 0 270

CREDI T

Chapter 6

15,00 0 120

120 Inventory &

i. Uncollectible-Account Expense Allowance for Uncollectible Accounts

260 260

Chapter 6

Inventory & 6-

341

Serial Case (15 min.) C5-76

Req. 1 (in thousands) The Cheesecake Factory had a balance of $25,619 in accounts receivable in 2019.

Req. 2 a. No entry on order date b. Accounts Receivable Sales Revenue 7,500

7,500

c. Cash 7,500 Accounts Receivable

7,500

Req. 3 Transaction

a. b. c.

Order date Shipment date Payment date

Assets = Liabilities + Equity (increase + (increase + (increase + or or or decrease -) decrease -) decrease -) 0 = 0 + 0 +7,500 = 0 + +7,500 +7,500 -7,500

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

343

Decision Cases (20-25 min.) C5-77 Lyons Entertainment, Inc. Summary Income Statement Year Ended December 31, 2021 Service revenue .................................

$940,000

Total expenses, excluding bad debt ....

(670,000)

Bad-debt expense ($940,000 × .05) .... (47,000) Net income ........................................

$223,000

Conclusion: The business was profitable during 2021. Computation: Accounts Receivable Dec. 31, 2020 Balance

110,000

2021 Revenues

940,000 2021 Collections

840,000

2021 Write-offs

30,000

Dec. 31, 2021 Balance

180,000

Chapter 6

Inventory &

(15-20 min.) C5-78

Req. 1 The trend of sales is increasing.

(Dollars in thousands)

Days’ sales in receivables

2022

2021

($115* + $96*) / 2 $1,475 / 365 days

($96* + $85*) / 2 $1,001 / 365 days

= 26.11 days

= 33.03 days

_____ *Net accounts receivable

Days’ sales in receivables decreased nicely during 2022. Cash collections from customers for 2022 and 2021: 2022 2021 Beginning gross accounts receivable + Sales revenue − Ending gross accounts receivable = Estimated cash collections

107

1,475 (128) $1,454

1,001 (107) $ 988

Collections from customers increased dramatically during 2022. Based on the improving trends of sales and collections from customers, and the drop in days’ sales in receivables, we would lend $500,000 to Byron’s Beauty Solutions.

Chapter 6

Inventory & 6-

345

Ethical Issue (20-30 minutes) C5-79

Req. 1

The ethical issue in this case is whether it is acceptable to “smooth” earnings by way of judgmental positive or negative changes to uncollectible accounts expense that understate or overstate the amount, based on what management decides they want net income to be.

What should be the determining factors in making the

judgments for this computation?

Req. 2 and Req. 3 The stakeholders to this decision are Strasburg Loan Company, its officers and directors, its shareholders, its creditors, Strasburg’s banker, securities analysts, and the equity and credit markets. Economic analysis: surprises.

The stock and credit markets don’t like

The markets usually reward steadily performing and

upward-trending earnings with increasing share prices and good credit ratings, but only if these trends are real and not “engineered” by management. Lanser’s reasoning is faulty. The income overstatements may offset the income understatements in some periods, but there is no guarantee that this will always occur.

The

accounting

literature

full

instances

where

misstatements of income have dulled people’s perceptions of the truth and resulted in tragic losses of resources and reputations. An article in The Wall Street Journal concluded with this statement, “The danger with spin artistry in accounting is that the spinner may believe the spin.” While manipulations such as this might have a temporarily positive impact, in the long run, creditors and analysts 6-Copyright © 2022 Pearson Education Inc. 346 Cost of Goods Sold

Chapter 6

Inventory &

will catch on that the company is manipulating earnings, and the markets will react in a harshly negative way toward Strasburg, hurting all parties concerned.

Chapter 6

Inventory & 6-

347

(continued) C5-79 Legal analysis: As explained in chapter 4, material and intentional manipulations

earnings

reporting, and are illegal.

are

known

fraudulent

financial

Such dealings will eventually result in

adverse legal and regulatory consequences for the company, as well as its officers and directors. Ethical analysis:

Strasburg Loan Company’s practice of smoothing

income is unethical because the owner deliberately underestimates Uncollectible-Account Expense in some periods and overstates the expense in other periods. Lanser’s purpose is to manipulate income. This is lying, which violates the rights of all other stakeholders in favor of temporary enrichment for a few. Rather than manipulating the accounting information, Lanser should be using accounting information to represent the business truthfully to her bank lender. We can be sure the bank as well as securities analysts expect truthful financial statements from Strasburg Loan Company.

Req. 4 Uncollectible accounts expense and the allowance for uncollectible accounts should be based on a truthful and accurate projection of how much a company truly expects to collect over the next operating cycle, rather than figuring out what a company wants net income to be and adjusting the expense and allowance accordingly. While Student responses may vary to this question, this represents the main message.

Chapter 6

Inventory &

Focus on Financials: Apple Inc. (30-40 min.)

Req. 1 The Company recognizes revenue at the amount to which it expects to be entitled when control of the products or services is transferred to its customers. Control is generally transferred when the Company has a present right to payment and title and the significant risks and rewards of ownership of products or services are transferred to its customers. For most of the Company’s Products net sales, control transfers when products are shipped and, as a result, revenue is recognized when the products are shipped. For services, control transfers over time as

services

are

delivered,

and

revenue

accordingly

recognized over time. For sales with multiple performance obligations,

revenue

allocated

each

performance

obligation based on stand-alone selling prices. The nature of the

performance

obligation

determines

when

revenue

recognized. Apple earns revenue from

(1) sales of products, (2) sales of

services such as iCloud, Siri and Maps, and (3) sales of multiple performance

obligations

such

hardware

and

bundled

software, product-related bundled services such as iCloud, Siri, and Maps, and future software upgrades related to software bundled on each device.

Chapter 6

Inventory & 6-

349

“Net” means “net of allowance for doubtful accounts.”

Net

means a small amount or an allowance has been subtracted from the gross amount of Accounts Receivable. Allowances reflect factors that might affect the (continued) Apple Inc. customers’

ability

pay

their

accounts

receivable.

The

allowance reflects the amount of receivables that a company does not expect to collect.

Req. 3 According to Note 3, “Accounts Receivable” includes trade receivables and vendor non-trade receivables.

Req. 4 The amount of the allowance for doubtful accounts, although it exists, is not separately disclosed, probably because the company and its auditors view the allowance as immaterial.

Req. 5

2019

(Dollar amounts in millions)

Current ratio: Total current assets Total current liabilities

2018

$162,819 =

$105,718

$131,339 = 1.54

$115,929

Chapter 6

1.1 3

Inventory &

Quick ratio: Quick assets* Total current liabilities

$123,483 $105,718 = 1.17

$89,487 0.7 $115,929 = 7

*Quick assets include cash, short-term marketable securities and net accounts receivable. For 2019: $48,844 + $51,713 + $22,926; For 2018: $25,913 + $40,388 + $23,186

(continued) Apple Inc.

Net working capital: Current assets – Current liabilities

= =

$162,819 – $105,71 8 $57,101 =

$131,339 – $115,92 9 $15,410

As of the end of 2019, Apple, Inc.’s current ratio and quick ratio increased from 2018, indicating that liquidity has increased. Additionally, net working capital, the difference between its current assets and current liabilities, increased. The trends in the three statistics are favorable. Industry averages for these ratios would be helpful in evaluating these ratios.

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351

Focus on Analysis: Under Armour, Inc. (20 min.)

Req. 1 According to Note 2, Under Armour, Inc.’s revenue primarily comes from net sales and license and other revenues. Sales are recognized at the passage of title and when risk of loss is transferred. License revenues are recognized based on the shipment of the licensed product sold by the company’s licensees. The majority of that revenue is from large sporting goods retailers. Most of the company’s revenues are earned from the sale of apparel, footwear and accessories. Other sources of revenue are licenses and Connected Fitness subscriptions. According to the information in Note 2 (Concentration of Credit Risk), none of the company’s customers as of the end of either 2019 or 2018 accounted for more than 10% of the company’s business (revenues or accounts receivable).

This means that

the company’s customer base is wide and fairly deep, and

Chapter 6

Inventory &

therefore helping to assure that the company is not dependent on just a few customers to survive.

Req. 2 In Note 2 (Concentration of Credit Risk), the company indicates that the accounts receivable primarily result from business with its large retailers.

These receivables are necessary for more

sales, maintaining relationships, and ensuring cash payment happens.

(continued) Under Armour, Inc.

Req. 3 Selling receivables to another business (called a factor) is a means of speeding up collections. The factor earns revenue by paying

discounted

price

for

the

receivable,

and

hopefully, collecting the full amount from the customer.

then, The

difference between the amount paid for the receivable and the amount collected is the factor’s profit. The benefit to the selling company is the immediate receipt of cash, which is often needed by the company. The disadvantage of factoring is that it is often quite expensive when compared to the costs of

retaining

the

receivable

the

books

and

ultimately

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353

process.

For these reasons, factoring is not often used by

companies who have other less costly means to raise cash, such as short-term borrowing.

It is most often used by cash-

strapped companies that have limited other means of raising short-term liquidity.

(continued) Under Armour, Inc.

Req. 4 Current ratio: 2019

2018

(Dollar amounts in thousands) Total current assets Total current liabilities

$2,702,209 1.9 = $1,422,009 = 0

$2,593,628 1.9 = $1,315,977 7

= $1,496,786 = 1.0

$1,209,949 = 0.9

Quick ratio: Quick assets*

Chapter 6

Inventory &

Total current liabilities

$1,422,009

$1,315,977

*Quick assets include cash and accounts receivable.

Net working capital: Current assets – Current liabilities

$2,702,209 – $1,422,009 =

$2,593,628 – $1,315,9 77 = $1,277,6 51

$1,280,200

Accounts receivable turnover: Net sales $5,267,132

$5,193,185

Avg. accounts receivable

680,630

7.74 $631,108*= 8.23 *2017 accounts receivable = 609,670 (from 2018 annual report)

Days’ sales outstanding

365/7.74 = 47

365/8.23 = 44 The quick ratio and net working capital have increased slightly from 2018 to 2019. The current ratio has decreased slightly from 2018 to 2019. Thus, (continued) Under Armour, Inc. the company’s liquidity has increased from 2018 to 2019 with regard

the

quick

ratio.

The

company’s

liquidity

has

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355

company would have no trouble paying its current liabilities in liquidation.

The

accounts

receivable

turnover

decreased

slightly between 2018 and 2019, indicating that it took the company about 3 more days to collect an average receivable in 2019. This is unfavorable although it only involves 3 days. Some information that would be very helpful in evaluating these ratios would be industry averages for these ratios. This would allow for benchmarking Under Armour to the industry.

Chapter 6

Inventory &

Group Project Student responses will vary.

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Inventory & 6-

357

Chapter 6 Inventory & Cost of Goods Sold Ethics Check (5-10 min.) EC 6-1 a. Due care b. Objectivity and independence c. Integrity d. Integrity

Chapter 6

Inventory &

Short Exercises (10-15 min.) S 6-1 1.

(Journal entries) Inventory Accounts Payable

125,000

Accounts Receivable Sales Revenue

163,750

Cost of Goods Sold Inventory ($125,000 × .75)

93,750

Cash ($163,750 × .25) Accounts Receivable

40,938

125,000 163,750 93,750 40,938

(Financial statements) BALANCE SHEET Current assets: Inventory ($125,000 − $93,750) ............

$ 31,250

INCOME STATEMENT Sales revenue ...........................................

$163,75 0

Cost of goods sold ....................................

93,750

Gross profit ..............................................

$70,000

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Inventory & 6-

359

2. 14,000 × $10.50 = $147,000 cost of goods sold 3. $210,000 – $147,000 = $63,000 gross margin (gross profit)

Chapter 6

Inventory &

(5 min.) S 6-3 Purchases

$260,000

Freight-in

+ 3,500

Purchase returns & allowances – 25,500 Purchase discounts

– 2,800

Cost of inventory

$235,200

(10-15 min.) S 6-4 Carson Print Supplies, Inc Income Statement Year Ended December 31, Current Year Averag e Sales revenue (600 × $21.50)

FIFO

$12,90

LIFO $12,900

0 $12,900 Cost of goods sold (600 ×

5,820

$9.70*) (100 × $9.00) + (500 ×

5,800

$9.80) (600 × $9.80) Gross profit

5,880 7,080

7,100

7,020 4,000

4,000

$ Chapter 6

$ Inventory & 6-

361

3,080

3,100

3,020

_____ *Average cost per unit: Beginning inventory (100 @ $8.90) .................

Purchases (800 @ $9.80) ................................

7,840

Cost of goods available ..................................

$8,730

Average cost per unit $8,730 / 900 units .....

$ 9.70

Chapter 6

890

Inventory &

(10-15 min.) S 6-5 Carson Print Supplies, Inc. Income Statement Year Ended December 31, Current Year Average Sales revenue (600 × $21.50)

FIFO

$12,900 $12,900

LIFO $12,90 0

Cost of goods sold (600 ×

5,820

$9.70*) (100 × $9.00) + (500 ×

5,800

$9.80) (600 × $9.80)

______

5,880

7,100

7,020

Gross profit 7,080 Operating expenses

4,000

4,000 4,000

Income before income tax

$ 3,080 $ 3,100

$ 3,020

Income tax expense (25%)

Net income

$2,310

770

775

$2,325

755 $2,

265

Method to maximize reported income (before tax): FIFO (because COGS is lowest)

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Inventory & 6-

363

Method to minimize income tax expense: LIFO (because COGS is highest)

*From calculations in S 6-4

(5-10 min.) S 6-6 Average cost per unit: Beginning inventory (90 @ $4.00) ...................

360

Purchases (180 @ $7.00) ................................

1,260

Cost of goods available ..................................

$1,620

Average cost per unit $1,620 / 270 units .....

$ 6.00

Therefore, ending inventory = 80 × $6.00 = $480 And cost of goods sold = 190 × $6.00 = $1,140

(5 min.) S 6-7 Ending inventory = 80 × $7.00 = $560 And cost of goods sold = (90 × $4.00) + (100 × $7.00) = $1,060

Chapter 6

Inventory &

(5 min.) S 6-8 Ending inventory = 80 × $4.00 = $320 And cost of goods sold = (180 × $7.00) + (10 × $4.00) = $1,300

(10-15 min.) S 6-9 FIFO

1. Results in a cost of ending inventory that is close to the current cost of replacing the inventory.

SpecificIdentification 2. Used to account for automobiles, jewelry, and art objects. LIFO Average

3. Generally associated with saving income taxes. 4. Provides a middle-ground measure of ending inventory and cost of goods sold.

FIFO

5. Maximizes reported income.

LIFO

6. Enables a company to keep reported income from dropping lower by liquidating older layers of inventory.

All

7. Writes inventory down when net realizable value drops below historical cost.

LIFO

8. Results in an old measure of the cost of ending inventory.

Chapter 6

Inventory & 6-

365

LIFO

9. Matches the most current cost of goods sold against sales revenue.

LIFO

10. Enables a company to buy high-cost inventory at year end and thereby to decrease reported income and income tax.

(5-10 min.) S 6-10 BALANCE SHEET Current assets: Inventories, at market (which is lower than cost $66,000) .......................................................

$ 42,000

INCOME STATEMENT Cost of goods sold [$450,000 + ($66,000 − $42,000)] .............................................................

Chapter 6

$474,00 0

Inventory &

(5-10 min.) S 6-11

Dollars in Millions Gross profit percentage

Inventory turnover

$24,600 − $9,840 $24,600

= 60.0%

$9,840 ($1,000 + $1,400) /2

8.2 times

(5-10 min.) S 6-12 Beginning inventory ................................

$ 275,000

+ Purchases ............................................... 1,850,000 = Cost of goods available ............................ 2,125,000 − Cost of goods sold: Sales revenue ........................... $2,600,000 Less estimated gross profit (40%) ..........................................

(1,040,000)

Estimated cost of goods sold................. (1,560,000 ) = Estimated cost of ending inventory ..........

$ 565,000

Chapter 6

Inventory & 6-

367

(5 min.) S 6-13 1. Last year’s reported gross profit was understated. Correct gross profit last year was $5.0 million ($3.1 + $1.9). 2. This year’s gross profit is overstated. Correct gross profit for this year is $1.5 million ($3.4 − $1.9). 3. Last year’s reported cost of goods sold was overstated. Correct cost of goods sold last year was $3.3 million ($5.2 − $1.9). 4. This year’s cost of goods sold is understated. Correct cost of goods sold for this year is $7.2 million ($5.3 + $1.9).

Chapter 6

Inventory &

(10-15 min.) S 6-14 Talladega Company Schedule of Cost of Goods Sold (Corrected) Years 2021 and 2020 2021 2020 Beginning inventory Net purchases Cost of goods avail. Ending inventory Cost of goods sold

$ 1,000*

$ 650 1,250

1,150 2,150

1,900

(750)

(1,000)* $1,400

$900

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Inventory & 6-

369

1. $900 2. Overstated by the amount of the error ($400) 3. $1,400 4. Understated by the amount of the error ($400) 5. Both 2020 and 2021, because the 2020 ending inventory error carries over to the 2021 beginning inventory.

(10-15 min.) S 6-15 1. a. Popcorn Machine, Antique Style w/ Cart b. Popcorn Oil, 64 oz c. Finley d. Kent 2. Description 3. Warehouse location 4. =XLOOKUP(A2,InvList!$A$2:$A$12,InvList!$D$2:$D$12)

Chapter 6

Inventory &

(10-15 min.) S 6-16 Each student’s solution will differ, based on the data set given in MyAccountingLab.

Chapter 6

Inventory & 6-

371

Exercises (15-20 min.) E 6-17A

Req. 1 Perpetual System 1. Purchases: Inventory ....................................... Accounts Payable ........................

61,000 61,000

2. Sales: Cash ($100,000 × .23) ..................... 23,000 Accounts Receivable ($100,000 × .77) ................................................ Sales Revenue .............................

77,000 100,00 0

Cost of Goods Sold .......................... 49,000 Inventory .................................... 49,000

Req. 2

BALANCE SHEET Current assets: Inventory……………………………….

$19,000

INCOME STATEMENT

Chapter 6

Inventory &

Sales revenue…………………………….

$100,000

Cost of goods sold………………………

49,000

Gross profit……………………………….

$51,000

Chapter 6

Inventory & 6-

373

(15-25 min.) E 6-18A Journal DATE

Req. 1

Req. 2

Req. 3

ACCOUNT TITLES AND EXPLANATION

DEBIT

Inventory ($830 + $2,275) .............. Accounts Payable .......................

3,105

Accounts Receivable (16 @ $500).... Sales Revenue............................

8,000

Cost of Goods Sold ......................... Inventory ...................................

2,665*

Sales revenue ............................. Cost of goods sold ...................... Gross profit ................................

$8,000 2,665 $5,335

Ending inventory ($1,485 + $830 + $2,275 − $2,665) ......................................

$1,925 **

CREDIT

3,105

8,000

2,665

_____ *(9 @ $165) + (5 @ $166) + (2 @ $175) = $2,665 **Or, (11 @ $175) = $1,925

Chapter 6

Inventory &

(10-15 min.) E 6-19A

Req. 1 Inventory Beg. bal.

(9 units @ $165) 1,485

Purchases Dec 15 26 End. bal.

(5 units @ $166) 830 (13 units @ $175) 2,275 (11 units @ $?) ?

Cost of goods sold (16 units @ $?)

Ending Inventory

Cost of Goods Sold (a) Spec ific unit cost

= $2,735

(7 @ $165) = $1,85 + 5 (4 @ $175)

(b)Avera ge cost

(16 × $170*) = $2,720

(11 × $170*) = $1,87 0

(9 @ $165) = $2,665 + (5 @ $166) + (2 @ $175)

(11 @ $175)

(d) LIFO

(13 @ = $2,773 $175) + (3 @ $166)

(2 @ $166) = $1,81 + 7 (9 @ $165)

(2 @ $165) + (5 @ $166) + (9 @ $175)

= $1,92 5

_____ *Average cost per

= unit

($1485 + $830 + $2,275)

(9 + 5 + 13)

$170

Chapter 6

Inventory & 6-

375

Req. 2 LIFO produces the highest cost of goods sold, $2,773. FIFO produces the lowest cost of goods sold, $2,665. The increase in inventory cost from $165 to $175 per unit causes the difference in cost of goods sold.

Chapter 6

Inventory &

(5-10 min.) E 6-20A Cost of goods sold: LIFO ($2,773) − FIFO ($2,665) ......................

$ 108

× Income tax rate ........................................

× .30

Tax savings advantage of LIFO ........................

$ 32.40

(10-15 min.) E 6-21A

Reqs. 1, 2, and 3 Ending Inventory

Cost of Goods Sold (1)Avera ge cost

= $207,20 0

(1,500 × $11.20*)

= $16,80 0

(4,000 @ $8) = $206,00 + 0 (14,500 @ $12)

(1,500 @ $12)

= $18,00 0

(3) LIFO (16,000 @ = $212,00 $12) + 0 (2,500 @ $8)

(1,500 @ $8)

(2) FIFO

(18,500 × $11.20*)

$12,00 0

_____ *Average cost per

($32,000 + $192,000) =

unit

(4,000 + 16,000)

= $11.20 Chapter 6

Inventory & 6-

377

Chapter 6

Inventory &

(15 min.) E 6-22A

Req. 1 a

FIFO

. Cost of goods sold: (10 @ $46) .............................

$460

Ending inventory: (7 @ $68) + (1 @ $46)............. b

$522

LIFO

. Cost of goods sold: (7 @ $68) + (3 @ $46).............

$614

Ending inventory: (8 @ $46) ...............................

$368

Req. 2 Woody’s Income Statement Month Ended March 31, 2021 Sales revenue (10 @ $91) ............................

$910

Cost of goods sold .......................................

460

Gross profit.................................................

450

Operating expenses ....................................

330

Chapter 6

Inventory & 6-

379

Income before income tax............................

120

Income tax expense (35%) ...........................

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

$ 78

Chapter 6

Inventory &

(15 min.) E 6-23A

Req. 1

FIFO

LIFO

$510,00

$510,0

Gross profit: Sales revenue ................................... Cost of goods sold FIFO: 50,000 × $5 .......................... 250,000 LIFO: (25,000 × $2.20) + (10,000 × $3.10) 161,00

+ (15,000 × $5) ....................

0 Gross profit ......................................

$349,0

260,000

Req. 2 Gross profit under FIFO and LIFO differ because inventory costs

decreased during the period. (5-10 min.) E 6-24A

Req. 1 Oak Ridge Garden Supplies Income Statement (partial) Year Ended May 31, 2021

Chapter 6

Inventory & 6-

381

Sales revenue .................................................... Cost of goods sold [$71,000 + ($13,000 −

$120,000 72,000

$12,000)] .......................................................... Gross profit .......................................................

$ 48,000

Note: Cost is used for beginning inventory because cost is lower than market. Market (net realizable value) is used for ending inventory because market is lower than cost at year end.

Chapter 6

Inventory &

(15-20 min.) E 6-25A

$63,000

$20,000 + $59,000 − $16,000 = $63,000

$37,000

$100,000 − $63,000 = $37,000

Must first solve for d

$73,000

$125,000 − $52,000 = $73,000

$90,000

$28,000 + c − $45,000 = $73,000; c = $90,000

$96,000

$60,000 + $36,000 = $96,000

$28,000

f + $52,000 − $20,000 = $60,000; f = $28,000

$ 3,000

$7,000 + $29,000 − g = $33,000; g = $3,000

$55,000

$88,000 − $33,000 = $55,000

Req. 1 Sutherland Company Income Statement Year Ended December 31, 2021 Net sales.................................

$100,0 00

Cost of goods sold Beginning inventory ............

$ 20,000

Net purchases .....................

59,000

Cost of goods available ........

79,000

Chapter 6

Inventory & 6-

383

Gross profit .............................

37,000

Operating and other expenses . 36,000 Net income..............................

$ 1,000

Chapter 6

Inventory &

(20-30 min.) E 6-26A Company

Gross Profit Percentage

Inventory Turnover

$37

$63 = 37.0% ($20 + $16) / = 3.5 times $100 2

Sutherland

$52

$73 = 41.6% ($28 + $45) / = 2.0 times $125 2

Crossen

$36 Williams

$96 $55 $88

Scott

has

the

$60 = 37.5% ($28 + $20) / = 2.5 times 2 = 62.5%

highest

gross

$33 ($7+ $3) / 2

profit

= 6.6 times

percentage,

62.5%.

Sutherland has the lowest gross profit percentage, 37.0%. Scott has the highest rate of inventory turnover, 6.6 times. Crossen has the lowest rate of inventory turnover, 2.0 times. Based on these data, Scott looks the most profitable because its gross profit percentage is higher than the other companies’ gross profit percentages. And Scott’s inventory turnover is higher than the other companies’ turnovers.

Chapter 6

Inventory & 6-

385

(15 min.) E 6-27A

Gross profit percentage

Inventory turnover

1 FIFO $144,000 − $81,360 $144,000

2 LIFO $144,000 − $92,880 $144,000

= 43.5%

= 35.5%

$81,360 ($15,160 + $30,040) / 2

$92,880 ($12,440 + $18,520) / 2

= 3.6 times

= 6.0 times

1. FIFO produces a higher gross profit percentage. 2. LIFO produces a higher rate of inventory turnover.

Req. 1

(10-15 min.) E 6-28A

Year ended January 31, 2021

Millions

Budgeted cost of goods sold ($6,300 × 1.12) .......

$ 7,056

Budgeted ending inventory ................................

2,000

Budgeted cost of goods available........................

9,056

Actual beginning inventory .................................

(1,700)

Budgeted purchases...........................................

$ 7,356

Inventory &

Chapter 6

(10-15 min.) E 6-29A Beginning inventory ..............................

$ 49,300

Net purchases .......................................

50,200

Cost of goods available..........................

99,500

Estimated cost of goods sold: Net sales revenue .............................

$81,300

Less: estimated gross profit of 45% ... (36,585) Estimated cost of goods sold .............

44,715

Estimated cost of inventory destroyed ...

$ 54,785

Another reason that managers use the gross profit method to estimate ending inventory is to test the reasonableness of ending inventory.

Chapter 6

Inventory & 6-

387

(10-15 min.) E 6-30A

Banta Tile & Marble Corporation Income Statement (Corrected) Years Ended November 30, 2021 and 2020 2021 2020 Sales revenue Cost of goods sold: Beginning inventory Net purchases

$138,000

$125,00 0 $ 14,500

$23,500 66,000 78,000

Cost of goods avail. 101,500 Ending inventory (18,500 ) Cost of goods sold Gross profit Operating expenses Net income

80,500 (23,500)* 83,000 55,000 31,000 $ 24,000

57,000 68,000 29,000 $ 39,000

_____ *$15,000 + $8,500 = $23,500

Banta Tile & Marble Corporation actually performed poorly in 2021, compared to 2020, with net income down from $39,000 to $24,000.

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

389

(15-20 min.) E 6-31B

Req. 1 Perpetual System 1. Purchases: Inventory ....................................... 53,000 Accounts Payable ........................ 53,000 2. Sales: Cash ($73,000 × .18)....................... 13,140 Accounts Receivable ($73,000 × .82) ................................................ 59,860 Sales Revenue ............................. 73,000 Cost of Goods Sold .......................... 46,000 Inventory .................................... 46,000

Req. 2 BALANCE SHEET Current assets: Inventory ...................................

$ 20,000

INCOME STATEMENT Sales revenue ................................

$73,000

Cost of goods sold .........................

46,000

Gross profit ...................................

$27,000

Chapter 6

Inventory &

(15-25 min.) E 6-32B Journal DATE

Req. 1

Req. 2

ACCOUNT TITLES AND EXPLANATION

DEBIT

Inventory ($805 + $2,380)................ Accounts Payable .........................

3,185 3,185

Accounts Receivable (18 @ $560) ..... 10,080 Sales Revenue ............................. 10,08 0 Cost of Goods Sold ........................... Inventory .....................................

Req. 3

CREDI T

Sales revenue..............................

2,915* 2,915

Cost of goods sold ....................... Gross profit .................................

$10,08 0 2,915 $7,165

Ending inventory ($1,600 + $805 + $2,380 − $2,915*) ......................................

$1,870 **

_____ *(10 @ $160) + (5 @ $161) +(3 @ $170) = $2,915 **Or, (11 @ $170) = $1,870

Chapter 6

Inventory & 6-

391

(10-15 min.) E 6-33B

Req. 1 Inventory Beg. bal.

(10 units @ $160) 1,600

Purchases May. 15 (5 units @ $161) 805 26 (14 units @ $170) 2,380 Ending bal. (11 units @ $?) ?

Cost of goods sold

Cost of Goods Sold

(18 units @ $?)

Ending Inventory

(a) Specifi c unit cost

(3 @ $160) + (5 @ $161) + (10 @ $170)

= $2,98 5

(7 @ $160) + = $1,80 0 (4 @ $170)

(b)Avera ge cost

(18 × $165*)

= $2,97 0

(11 × $165*) = $1,81 5

(10 @ $160) + = $2,91 5 (5 @ $161) + (3 @ $170)

(11 @ $170)

(d) LIFO

(14 @ $170) + = $3,02 4 (4 @ $161)

(1 @ $161) + = $1,76 1 (10 @ $160)

= $1,87 0

_____ *Average cost per

= unit

($1,600 + $805 + $2,380) (10 + 5 + 14)

$165

Chapter 6

Inventory &

LIFO produces the highest cost of goods sold, $3,024. FIFO produces the lowest cost of goods sold, $2,915. The increase in inventory cost from $160 to $170 per unit causes the difference in cost of goods sold.

Chapter 6

Inventory & 6-

393

(10 min.) E 6-34B

Cost of goods sold: LIFO ($3,024) − FIFO ($2,915).............

$ 109

× Income tax rate ..............................

× .25

Tax savings advantage of LIFO ...............

$27. 25

(10-15 min.) E 6-35B

Reqs. 1, 2, and 3 Ending Inventory

Cost of Goods Sold (1)Avera ge cost

(19,800 × $5.80*)

= $114,84 0

(200 × $5.80*) = $1,160

(2) FIFO (2,000 @ $4) + = $114,80 0 (17,800 @ $6)

(200 @ $6)

= $1,200

(3) LIFO (18,000 @ $6) = $115,20 + 0 (1,800 @ $4)

(200 @ $4) = $800

_____ *Average cost per

($8,000 + $108,000) =

unit

(2,000 + 18,000)

$5.80

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

395

(15 min.) E 6-36B

Req. 1 a

FIFO

. Cost of goods sold: (13 @ $49) ..............................

$637

Ending inventory: (5 @ $49) + (3 @ $64).............. b

$437

LIFO

. Cost of goods sold: (3 @ $64) + (10 @ $49) ............

$682

Ending inventory: (8 @ $49) ................................

$392

Req. 2 Paulson’s Income Statement Month Ended June 30, 2021 Sales revenue (7 @ $115) + (6 @ $103) .......

$1,423

Cost of goods sold ......................................

637

Gross profit… .............................................

786

Operating expenses....................................

340

Income before income tax...........................

446

Income tax expense (35%) ..........................

156

Chapter 6

Inventory &

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

Chapter 6

$ 290

Inventory & 6-

397

(15 min.) E 6-37B

Req. 1 FIFO

LIFO

$960,0

Gross profit: Sales revenue ................................... Cost of goods sold FIFO: 110,000 × $8.00 ................... 880,00 0 LIFO: (50,000 × $5.20) + (35,000 × $6.10) + (25,000 × $8.00) ................

______ 673,50 0

Gross profit.......................................

$286,5

80,000

Req. 2 Gross profit under FIFO and LIFO differ because inventory costs

decreased during the period.

(5-10 min.) E 6-38B

Chapter 6

Inventory &

Year Ended October 31, 2021 Sales revenue ................................................... Cost of goods sold [$73,000 + ($15,500 −

$119,000 77,500

$11,000)].......................................................... Gross profit ......................................................

$ 41,500

Note: Cost is used for beginning inventory because cost is lower than market. Market (net realizable value) is used for ending inventory because market is lower than cost at year end.

Chapter 6

Inventory & 6-

399

(15-20 min.) E 6-39B

$ 69,000

$26,000 + $63,000 − $20,000 = $69,000

$ 46,000

$115,000 − $69,000 = $46,000

Must first solve for d

$ 93,000

$150,000 − $57,000 = $93,000

$ 91,000

$31,000 + c − $29,000 = $93,000; c = $91,000

$ 100,000

$69,000 + $31,000 = $100,000

$ 37,000

f + $55,000 − $23,000 = $69,000; f = $37,000

$ 5,000

$11,000 + $26,000 − g = $32,000; g = $5,000

$ 48,000

$80,000 − $32,000 = $48,000

Req. 1 Altieri Company Income Statement Year Ended December 31, 2021 $115,000

Net sales................................. Cost of goods sold ................... Beginning inventory ............

$26,000

Net purchases .....................

63,000

Cost of goods available ........

89,000

Ending inventory .................

(20,000)

Cost of goods sold ...............

69,000

Gross profit .............................

46,000

Operating and other expenses .

34,000

Chapter 6

Inventory &

$ 12,000

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

Chapter 6

Inventory & 6-

401

(20-30 min.) E 6-40B

Gross Profit Percentage

Company

Inventory Turnover

$46

Altieri

$69 = 40.0% ($26 + $20) / = 3.0 times $115 2 $57

Malbasa

$93 = 38.0% ($31 + $29) / = 3.1 times $150 2 $31

Hoffman

$69 = 31.0% ($37 + $23) / = 2.3 times $100 2

Hinkel

$48 $80

= 60.0%

$32 = 4.0 times ($11 + $5) / 2

Hinkel has the highest gross profit percentage, 60%. Hoffman has the lowest gross profit percentage, 31.0%.

Hinkel has the highest rate of inventory turnover, 4.0 times. Hoffman has the lowest rate of inventory turnover, 2.3 times. Based on these data, Hinkel looks the most profitable because its gross profit percentage is far greater than the other companies’

gross

profit

percentages.

Hinkel’s

inventory

turnover is also higher than the other companies.

Chapter 6

Inventory &

(15 min.) E 6-41B

Req. 1 and 2

Gross profit percentage

Inventory turnover

1 FIFO

2 LIFO

$138,000 − $87,630 $138,000

$138,000 − $97,980 $138,000

= 36.5%

= 29.0%

$87,630 ($27,920 + $30,500) / 2

$97,980 ($12,510 + $20,150) / 2

= 3.0 times

= 6.0 times

FIFO produces a higher gross profit percentage. LIFO produces a higher rate of inventory turnover.

Req. 1

(10-15 min.) E 6-42B

Year ended January 31, 2021:

Millions

Budgeted cost of goods sold ($6,400 × 1.12) .

$7,168

Budgeted ending inventory...........................

1,800

Budgeted cost of goods available..................

8,968

Chapter 6

Inventory & 6-

403

Budgeted purchases.....................................

$7,468

(10-15 min.) E 6-43B

Beginning inventory ..........................

$ 48,400

Net purchases...................................

51,300

Cost of goods available .....................

99,700

Estimated cost of goods sold: Net sales revenue .........................

$104,00 0

Less: estimated gross profit of 35% (36,400 ) Estimated cost of goods sold .........

67,600

Estimated cost of inventory destroyed

$ 32,100

Another reason managers use the gross profit method to estimate ending inventory is to test the reasonableness of ending inventory.

Chapter 6

Inventory &

(10-15 min.) E 6-44B Simon Granite & Stone Corporation Income Statement (Corrected) Years Ended September 30, 2021 and 2020 2021 2020 Sales revenue

$140,000

$121,00 0

Cost of goods sold: Beginning inventory

$ 12,000 $19,000

Net purchases

74,000 78,000

Cost of goods avail.

86,000 97,000

Ending inventory (16,000 )

(19,000)*

Cost of goods

81,000

sold

67,000

Gross profit

59,000

Operating expenses

29,000

54,000 19,000

Net income

$ 30,000

$ 35,000

Chapter 6

Inventory & 6-

405

Simon Granite & Stone Corporation actually performed poorly in 2021, compared to 2020, with net income down from $35,000 to $30,000.

Chapter 6

Inventory &

Quiz Q6-45

Q6-46

Q6-47

Q6-48

Q6-49

Q6-50

Q6-51

Q6-52

Q6-53

Q6-54

Q6-55

Q6-56

Q6-57

Q6-58

Q6-59

Q6-60

Q6-61

($143,000 + $219,000 = $362,000)

Chapter 6

Inventory & 6-

407

Problems (20-30 min.) P 6-62A

Req. 1 Inventory .......................................

8,321,00 0

Accounts Payable ....................... Accounts Payable ...........................

8,321,000 7,993,00 0

Cash .......................................... Cash .............................................. Accounts Receivable .......................

7,993,000 4,700,00 0 10,572,5 00

Sales Revenue............................

15,272,50 0

Cost of Goods Sold (149,000 × $59.58*)......................................... Inventory ...................................

8,877,42 0

Operating Expenses........................

4,250,00 0

8,877,420

Cash ($4,250,000 × .70).............. 2,975,000 1,275,000

Accrued Liabilities ($4,250,000 × .30)................................................ Income Tax Expense ....................... Income Tax Payable (see Req. 3) .

858,032 858,032

Chapter 6

Inventory &

Chapter 6

Inventory & 6-

409

(continued) P 6-62A

Req. 2 Beg. bal. Purchases End. bal.

Inventory 1,272,000 8,321,000 COGS 715,580

8,877,420

Req. 3 Eastern Trading Company, San Diego Store Income Statement Year Ended January 31, 2021 Sales revenue ............................ $15,272,50 0 Cost of goods sold...................... 8,877,420 Gross profit................................

6,395,080

Operating expenses…................. 4,250,000 Income before tax ......................

2,145,080

Income tax expense (40%) .......... 858,032 Net income ................................

$ 1,287,048

Chapter 6

Inventory &

(20-30 min.) P 6-63A

Req. 1 The store uses FIFO. This is apparent from the flow of costs out of inventory. For example, the August 13 sale shows unit cost of $31, which came from the beginning inventory. This is how FIFO, and only FIFO, works.

Req. 2 Cost of goods sold: 16

$31

496

806

429

= 1,188 $2,919

Sales [(42 units × $63) + (49 units x $64)] ........

$5,78 2

Cost of goods sold ........................................... (2,919 ) Gross profit .....................................................

$2,86 3

Chapter 6

Inventory & 6-

411

Req. 3 Cost of August 31 inventory (32 × $33) + (18 × $35)

Chapter 6

$1,686

Inventory &

(20-30 min.) P 6-64A

Req. 1 Inventory (80 units @ $10) 800

Beg. bal.

Purchases: Jul. 6 (90 units @ $20) 1,800 18 (100 units @ $25) 2,500 26 (30 units @ $30) End. bal. (50 units @ $?)

Cost of goods sold (250 900units @ $?) ?

Cost of Goods Sold Average cost ____

250 × $20* = $5,000

*Average cost per unit FIFO

Ending Inventory 50 × $20* = $1,000

($800 + $1,800 + $2,500 + $900) =

= $20 (80 + 90 + 100 + 30)

(80 @ $10) +

(90 @

(20 @ $25)

$20)

+ +

(80 @ $25)

= $4,600

LIFO (30 @ $30) + (100 @ $25) + (90 @ $20) + (30 @ = $5,500 $10)

(30 @ $30) = $1,400

50 @ $10

Chapter 6

= $500

Inventory & 6-

413

Chapter 6

Inventory &

(continued) P 6-64A

Req. 2 LIFO cost of goods sold is highest because (a) prices are rising and (b) LIFO assigns the cost of the latest inventory purchases to cost of goods sold. When costs are rising, these latest inventory costs are the highest, and that makes cost of goods sold the highest under LIFO.

Student responses may vary.

Req. 3 Navy Surplus Income Statement Month Ended July 31, 2021 Sales revenue (250 x $52) .........................

$13,000

Cost of goods sold ....................................

5,000

Gross profit ..............................................

8,000

Operating expenses ..................................

3,250

Income before income taxes......................

4,750

Income tax expense (40%) ........................

1,900

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

$ 2,850

Chapter 6

Inventory & 6-

415

(30-40 min.) P 6-65A

Req. 1 (partial income statements) Atlanta Aviation Partial Income Statement Year Ended July 31, 2021 Sales revenue Cost of goods sold Gross profit

AVERAGE $128,169 62,721 $ 65,448

FIFO $128,169 61,930 $ 66,239

LIFO $128,169 64,252 $ 63,917

Computations of cost of goods sold: Average cost per unit

($4,000 + $3,400 + $56,000 + $5,600) =

$6.90

(800 + 500 + 8,000 + 700) =

Average cost COGS = 9,090 × $6.90 FIFO COGS LIFO COGS

= =

$62,721

(800 @ $5.00) + (500 @ $6.80) + (7,790 @ $7.00) (700 @ $8.00) + (8,000 @ $7.00) + (390 @ $6.80)

= $61,930 =

Chapter 6

Inventory & Cost of Goods Sold

$64,252

Use the LIFO method to minimize income tax because cost of goods sold is highest (gross profit is lowest) under LIFO when inventory costs are rising.

Chapter 6

Inventory & Cost of Goods Sold

6417

(15-30 min.) P 6-66A a.

Anderson Trade Mart should apply the lower-of-cost-

or-market

rule

realizable

value

account

ending

for

inventories.

inventory

The less

net than

Anderson’s actual cost, so Anderson must write the inventory down to net realizable value, with the following journal entry: b. Cost of Goods Sold ................ 55,000 Inventory ......................... To write inventory down to market value.

55,000

Anderson Trade Mart should report the following amounts in its financial statements: c. BALANCE SHEET Inventory at market (which is lower than cost of $265,000) ................................... d. INCOME STATEMENT Cost of goods sold ($820,000 + $55,000) ... _____

$210,000*

$875,000

*$265,000 − $55,000 = $210,000

e. Relevance and Representational faithfulness are the reasons to account for inventory at the lower of cost or market value. Representational faithfulness directs accountants to report inventory at the most realistic and transparent amount. In this case the net realizable value (market value) of Anderson Trade Mart’s ending inventory is less than cost, 6-Copyright © 2022 Pearson Education Inc. 418 & Cost of Goods Sold

Chapter 6

Inventory

and the lower-of-cost-or-market rule requires a write-down of the inventory value to net realizable value. In addition, the market value is more relevant to financial statement users. Student responses may vary.

Chapter 6

6Inventory

419

(20-25 min.) P 6-67A

Req. 1 Crispy Donut, Inc. Calhoun Coffee Corp.

Dollars in Millions

Gross profit: Sales ...................... Cost of goods sold...

$600 540

$7,000 6,370

Gross profit ............

$ 60

Gross profit percentage:

$60 = 10.0% $600

630

$630 $7,000

Inventory turnover: Cost of goods sold $540 = Average inventory ($25 + $15) / 2

= 9.0%

$6,370 ($600 + $700) / 2

= 27 times

= 9.8 times

Req. 2 From these statistics, Crispy Donut is the more profitable company.

Crispy

Donut

has

much

faster

inventory

turnover, and also has a higher gross profit percentage.

Chapter 6

Inventory

(25-30 min.) P 6-68A

Req. 1 (estimate of ending inventory by the gross profit method) Beginning inventory .......................

$ 57,700

Purchases ......................................

$490,800

Less: Purchase discounts .............

(17,000)

Purchase returns .................. (70,900) Net purchases .............................

402,900

Cost of goods available...................

460,600

Cost of goods sold: Sales revenue .............................

$660,000

Less: Estimated gross profit of

(270,600)

41% Estimated cost of goods sold .......

389,400

Estimated cost of ending inventory .

$ 71,200

Chapter 6

6Inventory

421

(continued) P 6-68A

Req. 2 (income statement through gross profit) Cleveland Company Income Statement (partial) Two Week Period Ending October 15 (date of the fire) Net sales revenue .............................

$660,000

Cost of goods sold.............................

389,400*

Gross profit ......................................

$270,600

_____ *Cost of goods sold: Beginning inventory .............................. Purchases...........................

$490,800

Less: Purchases discounts ...

(17,000)

Purchase returns.........

(70,900)

57,700

Net purchases ......................................

402,900

Cost of goods available for sale .............

460,600

Less: Ending inventory..........................

(71,200)

Cost of goods sold ................................

$389,400

Chapter 6

Inventory

(20-25 min.) P 6-69A

Req. 1 Cost of sales, budgeted ($719,000 ×

$ 769,330

1.07) ........................................................ + Ending inventory, budgeted ...................

80,000

= Cost of goods available..........................

849,330

− Beginning inventory ..............................

(67,000)

= Purchases, budgeted .............................

$ 782,330

Req. 2 Ricky’s Convenience Stores Budgeted Income Statement Year Ended December 31, 2021 Sales ($955,000 × 1.07) ...........................

$1,021,85 0

Cost of sales ($719,000 × 1.07) ................

769,330

Gross profit .............................................

252,520

Operating expenses ($111,000 − $10,480)

100,520

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

$ 152,000

Chapter 6

6Inventory

423

(15-20 min.) P 6-70A

Req. 1 (corrected income statements)

Timberlake Home Store Income Statement (adapted; amounts in millions) Years Ended December 31, 2021, 2020, and 2019 2021 2020 Net sales revenue............... $40 $37 Cost of goods sold: Beginning inventory ....... $19 $15 Net purchases ................ 29 27 Cost of goods available ... 48 42 Ending inventory ............ (12) (19) Cost of goods sold .......... 36 23 Gross profit ........................ 4 14 Operating expenses ............ 3 3 Net income......................... $ 1 $ 11

Chapter 6

2019 $34 $ 9 25 34 (15)

Inventory & Cost of Goods Sold

19 15 3 $ 12

(continued) P 6-70A

Req. 2 The corrections did not change total net income over the three-year period. But the corrections drastically altered the trend of net income — from an increasing pattern to a decreasing pattern.

Req. 3 The shareholders will not be happy with a declining trend of net

income

because

the

company’s

profits

actually

decreased from 2019 to 2021.

Chapter 6

6Inventory

425

(20-30 min.) P 6-71B

Req. 1 Inventory..........................................

8,869,00 0

Accounts Payable..........................

Accounts Payable..............................

8,869,00 0 8,541,00 0

Cash .............................................

Cash ................................................. Accounts Receivable .........................

8,541,00 0 4,900,00 0 10,987,5 00

Sales Revenue ..............................

Cost of Goods Sold (155,000 × $63.24*) ...........................................

15,887,5 00

9,802,20 0*

Inventory......................................

Operating Expenses ..........................

9,802,20 0 2,250,00 0

Cash ($2,250,000 × 0.70) ..............

1,575,00 0 675,000

Accrued Liabilities ($2,250,000 × 0.30) ................................................ Income Tax Expense.......................... Income Tax Payable (see Req. 3)....

1,534,12 0 1,534,12 0

Chapter 6

Inventory

_____ *($1,060,000 + $8,869,000) ÷ (20,000 + 29,000 + 49,000 + 59,000) = $63.24

Chapter 6

6Inventory

427

(continued) P 6-71B

Req. 2 Inventory Beg. bal. Purchases End. bal.

1,060,000 8,869,000 COGS 126,800

9,802,200

Req. 3 Western Trading Company in Nashville Income Statement Year Ended January 31, 2021 Sales revenue............................... $15,887,50 0 Cost of goods sold ........................ 9,802,200 Gross profit ..................................

6,085,300

Operating expenses ...................... 2,250,000 Income before tax.........................

3,835,300

Income tax expense (40%) ............ 1,534,120 Net income ...................................

$ 2,301,180

Chapter 6

Inventory

(20-30 min.) P 6-72B

Req. 1 The store uses FIFO. This is apparent from the flow of costs out of inventory. For example, the December 13 sale shows a unit cost of $34, which came from the beginning inventory. This is how FIFO, and only FIFO, works.

Req. 2 Cost of goods sold: 20

$34

680

918

396

= 1,116 $3,110

Sales [(47 units × $63) + (42 x $64)] ..............

$5,649

Cost of goods sold .........................................

(3,110)

Gross profit ...................................................

$2,539

$ 2,466

Chapter 6

6Inventory

429

(20-30 min.) P 6-73B

Req. 1 Beg. bal.

Inventory (100 units @ $10) 1,000

Purchases: Mar 6 (110 units @ $20) 2,200 18 (120 units @ $25) 3,000 26 (40 units @ $30) 1,200 End. bal. (52 units @ $?) ? Cost of Goods Sold Average cost

318 × $20* $6,360

Cost of goods sold (318 units @ $?)

Ending Inventory 52 × $20* = $1,040

FIFO

(100 @ $10) + (110 @ $20) + (108 @ $25)

= $5,900

(12 @ $25) = $1,500 + (40 @ $30)

LIFO

(40 @ $30) + (120 @ $25) + (110 @ $20) + (48 @ $10)

= $6,880

(52 @ $10) = $520

____ *Average cost per unit

($1,000 + $2,200 + $3,000 + $1,200) =

$20.00

(100 + 110 + 120 + 40)

Chapter 6

Inventory

(continued) P 6-73B

Req. 2 LIFO results in the highest cost of goods sold because (a) the company’s prices are rising and (b) LIFO assigns the cost of the latest inventory purchases to cost of goods sold. When costs are rising, these latest inventory costs are the highest, and that makes cost of goods sold the highest under LIFO.

Student responses may vary.

Req. 3 SWAT Surplus Income Statement Month Ended March 31, 2021 Sales revenue (318 × $52)....................

$16,536

Cost of goods sold ...............................

6,360

Gross profit .........................................

10,176

Operating expenses .............................

3,250

Income before income taxes .................

6,926

Chapter 6

6Inventory

431

Income tax expense (36%) ...................

2,493

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

$ 4,433

Chapter 6

Inventory

(30-40 min.) P 6-74B

Req. 1 (partial income statements) Eaton Aviation Income Statement Year Ended July 31, 2021 Sales revenue Cost of goods sold Gross profit

AVERAGE $130,935 67,725 $ 63,210

FIFO $130,935 67,125 $ 63,810

LIFO $130,935 68,193 $ 62,742

Computations of cost of goods sold: Average cost per unit

($5,600 + $3,550 + $60,750 + $5,100) (800 + 500 + 8,100 + 600)

$7.50 =

Average cost COGS = 9,030 × $7.50 FIFO COGS LIFO COGS

= =

$67,725

(800 @ $7.00) + (500 @ $7.10) + (7,730 @ $7.50) (600 @ $8.50) + (8,100 @ $7.50) + (330 @ $7.10)

= $67,125 = $68,193

Chapter 6

Inventory & Cost of Goods Sold

6433

Use LIFO to minimize income taxes. LIFO reports the highest cost of goods sold and the lowest gross profit and net income.

Chapter 6

Inventory & Cost of Goods Sold

(15-20 min.) P 6-75B a. Freshwater Trade Mart should apply the lower-of-cost-or-

market rule to account for inventories. The net realizable value of ending inventory is less than Freshwater Trade Mart’s actual cost, so Freshwater Trade Mart must write the inventory down to net realizable value, with the following journal entry: b. Cost of Goods Sold ......... 60,000 Inventory ................... 60,000 To write inventory down to market value. Freshwater Trade Mart should report the following in its financial statements: c. BALANCE SHEET Inventory, at market (which is lower than cost of $210,000) ...........................................

$150,000*

d. INCOME STATEMENT Cost of goods sold ($820,000 + $60,000) ..... $880,000 *$210,000 − $60,000 = $150,000

e. Relevance and representational faithfulness are the reasons to account for inventory at the lower of cost or market

value.

Representational

faithfulness

directs

Chapter 6

6Inventory

435

value) of Freshwater Trade Mart’s ending inventory is less than cost, and the lower-of-cost-or-market rule requires a write-down of the inventory value to net realizable value. In addition, the market value is more relevant to financial statement users. Student responses may vary.

(20-30 min.) P 6-76B

Req. 1 Sprinkle Top, Inc.

Coffee Shop Corp.

$450

$8,000

360

6,500

$90

$1,500

Millions

Gross profit: Sales…………………… . Cost of sales…………... Gross profit……………. Gross profit percentage:

$90 = 20.0% $450

Millions

$1,500 = 18.75% $8,000

Inventory turnover: Cost of goods sold Average inventory

$360

$6,500

($10 + $30) / 2

($780+ $470) / 2

= 18 times

= 10.4 times

Chapter 6

6Inventory

436

From these statistics, Sprinkle Top is the more profitable company.

Sprinkle

Top

has

much

faster

inventory

turnover, and also has a higher gross profit percentage.

Chapter 6

6Inventory

437

(25-30 min.) P 6-77B

Req. 1 (estimate of ending inventory by the gross profit method) Beginning inventory .........................

$ 57,700

Purchases ........................................

$490,500

Less: Purchase discounts ..............

(15,000)

Purchase returns ................. (70,500) Net purchases...............................

405,000

Cost of goods available ....................

462,700

Cost of goods sold: Sales revenue ...............................

$664,000

Less: Estimated gross profit of 44%

(292,160)

Estimated cost of goods sold .........

371,840

Estimated cost of ending inventory ...

$ 90,860

Chapter 6

6Inventory

438

(continued) P 6-77B

Req. 2 (income statement through gross profit) Ross Company Income Statement (partial) Two Week Period ending December 15 (date of the fire) Net sales revenue ......................... $664,000 Cost of goods sold ........................

371,840*

Gross profit ..................................

$292,160

_____ *Cost of goods sold: Beginning inventory .........................

$ 57,700

Purchases ........................................

$490,500

Less: Purchase discounts ..............

(15,000)

Purchase returns ................. (70,500) Net purchases...............................

405,000

Cost of goods available ....................

462,700

Ending

90,860

inventory………………………………… Cost of goods

$371,840

sold………………………………

Chapter 6

6Inventory

439

(20-25 min.) P 6-78B

Req. 1 Cost of sales, budgeted ($717,000 ×

$ 781,530

1.09) ..................................................... + Ending inventory, budgeted ................ 84,000 = Cost of goods available ....................... 865,530 − Beginning inventory............................

(65,000)

= Purchases, budgeted ..........................

$ 800,530

Req. 2 Eddie’s Convenience Stores Budgeted Income Statement Year Ended December 31, 2021 Sales ($958,000 × 1.09) ....................... $1,044,220 Cost of sales ($717,000 × 1.09) ............

781,530

Gross profit .........................................

262,690

Operating expenses ($108,000 −

106,690

$1,310) ............................................... Net income..........................................

Chapter 6

156,000

6Inventory

440

(15-20 min.) P 6-79B

Req. 1 (corrected income statements) Boston Home Store Income Statement (adapted; amounts in millions) Years Ended December 31, 2021, 2020, and 2019 2021 2020 Net sales revenue............... $41 $38 Cost of goods sold: Beginning inventory ........ $ 16 $ 14 Net purchases ................. 31 29 Cost of goods available .... 47 43 Ending inventory ............. (10) (16) Cost of goods sold ........... 37 27 Gross profit ........................ 4 11 Operating expenses ............ 3 3 Net income......................... $ 1 $ 8

Chapter 6

2019 $35 $

7 27 34 (14)

Inventory &6-Cost of Goods Sold 441

20 15 3 $ 12

(continued) P 6-79B

Req. 3 The shareholders will not be as happy with the corrected trend of net income, since the company’s profit actually decreased from 2019 to 2021.

Plant Assets, Natural Resources, &

Challenge Exercises and Problem (5-10 min.) E 6-80 a.

Use FIFO.

Use any method. They all produce the same results because inventory costs are stable.

Use FIFO.

Use average cost.

Buy inventory late in the year. Use LIFO.

Company is using LIFO.

Plant Assets, Natural Resources, & 443

(20-30 min.) E 6-81

Req. 1 LIFO cost of goods sold = 1. From purchase in December (33 @ $1,200) .... $ 39,600 2. From purchase in June (47 @ $1,175) .............

55,225

3. From purchase in February (17 @ $1,050) ......

17,850

4. From beginning inventory (15 @ $1,025)........

15,375

LIFO cost of goods sold ............................. $128,050

Req. 2 Cost

goods

sold

with

the

additional

year-end

purchase (this would have avoided a LIFO liquidation—that is, kept year-end inventory at the same level it was at the beginning of the year): 1. From purchase in December (48* @ $1,200) ... $ 57,600 2. From purchase in June (47 @ $1,175) .............

55,225

3. From purchase in February (17 @ $1,050) ......

17,850

Cost of goods sold (with no LIFO

$130,675

liquidation)................................................... _____ *Must purchase a total of 48 units in December to keep ending inventory at 41 units, which was the level of beginning inventory. Copyright © 2022 Pearson Education Inc. Chapter 7 444 Intangibles

Plant Assets, Natural Resources, &

Plant Assets, Natural Resources, & 445

(20-30 min.) E 6-82

Req. 1

Sales increased, the gross profit increased then dropped, and net income slid into a net loss, as shown here:

Dollars in millions

2021

2020

2019

Sales Cost of sales Gross profit

$36.2 28.7 7.5

$35.2 27.5 7.7

$34.3 26.7 7.6

0.4

1.3

$7.5 = 20.7 $36.2 %

$7.7 = 21.9 $35.2 %

$7.6 = 22.2 $34.3 %

$28.7

$27.5

$26.7

Net income (net loss) Gross profit = percenta ge Inventor y = turnover

($8.0 + $7.6) / 2

(0.7)

3. 7

($7.6 + $7.0) / 2

3. 8

($7.0 + $6.4) / 2

= 4.0

Both the gross profit percentage and the rate of inventory turnover dropped during this period.

This suggests that

Westpark Video was having to discount its merchandise more and more just to sell the goods. The end result was a net loss in 2021. Selling expenses increased significantly, which suggests that Westpark Video was having to advertise heavily in order to sell its inventory. This dragged down profits. Copyright © 2022 Pearson Education Inc. Chapter 7 446 Intangibles

Plant Assets, Natural Resources, &

Plant Assets, Natural Resources, & 447

(20-30 min) P 6-83

Req. 1 Beginning inventory

299,000

+ Purchases

- Ending inventory

$3,909,000

(344,000)

= Cost of goods sold

$3,864,000

Req. 2 Inventory..................... 3,909,000 Accounts Payable .. 3,909,000 Accounts Receivable .... 7,360,000 Sales .................... 7,360,000 Cost of Goods Sold ....... 3,864,000 Inventory .............. 3,864,000 Inventory Beg. Bal 299,000

3,864,000

Purchases 3,909,000

Cost of goods

sold

End. Bal 344,000

Plant Assets, Natural Resources, &

(continued) P 6-83

Req. 3 Beginning inventory ($21,000 higher under FIFO)$ 320,000 + Purchases

3,909,000

- Ending inventory ($26,000 higher under FIFO) = Cost of goods sold (FIFO)

(370,000)

$3,859,000

Req. 4 BrightWorld $616,000 $1,760,000

= 35.0%

BioTech

= 47.6%

$3,501,000 $7,360,000

Req. 5 BrightWorld

$1,144,000 [($80,000 + $96,000)/2]

= 13.0

BioTech

$3,859,000 [($320,000 + $370,000)/2]

= 11.2

Req. 6 BioTech

has

higher

gross

profit

percentage

which

indicates that BioTech has a gross profit of $.476 of every sales dollar and BrightWorld has a gross profit of $.350 of

Plant Assets, Natural Resources, & 449

every sales dollar.

BioTech has a slightly lower inventory

turnover than BrightWorld, although both appear strong.

Serial Case (15-25 min.) C6-84

Req. 1 a. Answers may vary. Some examples of possible restaurant food and supplies inventory include pasta, tomatoes, cheese, steak, mushrooms, potatoes, burgers, chicken, bacon, buns, rolls, beverages, cheesecake, etc. b. Answers may vary. Some examples of possible bakery finished goods and work in progress inventory include cheesecake (different flavors), layered cakes, tortes, cakes that have been mixed but not yet baked, finished cheesecake that still need decorating, etc. c. Answers may vary. Some examples of possible bakery raw materials and supply inventory include eggs, sugar, milk, flour, vanilla, chocolate, caramel, nuts, fruit, cream, brown sugar, graham cracker crust, etc.

Req. 2 (in thousands) Inventory is found on the balance sheet. The Cheesecake Factory had a balance of $47,225 as of December 31, 2019 and $38,886 as of January 1, 2019.

Plant Assets, Natural Resources, &

December 31, 2019 is $561,783. The Cheesecake Factory’s cost of sales for the year ended January 1, 2019 is $532,880. The Cheesecake Factory’s cost of sales for fiscal 2017 is $519,388.

(continued) C6-84

Req. 4 (in thousands) The Cheesecake Factory’s gross improved slightly from 2018 to 2019. Sales

profit

percentage

- Cost of = Gross sales profit

/ Net sales = Gross revenue Profit % 2019 2,482,692 - 561,783 = 1,920,909 / 2,482,692 = 77.4% 2018 2,332,331 - 532,880 = 1,799,451 / 2,332,331 = 77.2%

Req. 5 (in thousands) The Cheesecake Factory’s inventory turnover decreased slightly from 2018 to 2019. Cheesecake Factory’s inventory turnover was 13.09 times in 2018, while in 2019 it turned over 13.05 times. Cost of / Inventory, + Inventory, / 2 = Inventory Sales Y1 Y2 Turnover 2019 561,783 / [(38,886 + 47,225) / 2] = 13.05 2018 532,880 / [(42,560

+ 38,886)

/ 2] = 13.09

Plant Assets, Natural Resources, & 451

Students’ answers may vary. The number of days’ inventory outstanding makes sense and seems reasonable. The Cheesecake Factory has a lot of fresh inventory that would go bad if it was not sold quickly. On the other hand, much of The Cheesecake Factory’s inventory is frozen and shipped to other retailers to be sold. Therefore, a days’ inventory outstanding ratio of about 28 seems to be a reasonable balance between the fresh and frozen products. 365

Inventory = Days Inventory Outstanding Turnover

2019

365

13.05

27.97

2018

365

13.09

27.88

Decision Cases (50-60 min.) C6-85

Req 1

Sales revenue Cost of goods sold: Gross profit Operating expenses Income before income tax expense Income tax expense ($415,000 × .40) ($355,000 × .40) Net income _____

Jasper Corporation Income Statement FIFO $1,200,000 585,000* 615,000 200,000

LIFO $1,200,000 645,000** 555,000 200,000

415,000

355,000

166,000 142,000 $

249,000

213,000

Plant Assets, Natural Resources, &

*$100,000 + $485,000 = $585,000 **$160,000 + $485,000 = $645,000

Req. 2 Net income…………

FIFO $249,000

LIFO $213,000

FIFO net income is higher because (1) prices are rising (from $100 to $121.25 to $160), and (2) FIFO and LIFO assign costs to expense (cost of goods sold) in opposite patterns. Student responses may vary.

Plant Assets, Natural Resources, & 453

(15-25 min.) C6-86

Req. 1

This question provides a rich setting for a class discussion. There’s no single correct answer to this question. Some students may favor Company B because it reports higher net income than Company A. B may be preferred because it appears more successful than A, and B’s stock price may therefore rise more than A’s stock price. Thus it may appear that Company B would be a better investment than A. Other students may prefer Company A because it discloses the inventory method it uses. Company B does not let outsiders know which method it uses to account for its inventory. These students may trust Company A more than B because A is more willing to “bare its soul to the public.” Professors can point out that A, the LIFO company, may be better off because of the lower income taxes that A pays by using the LIFO method. We don’t know whether Company B is making the most of this cash-flow advantage of LIFO. Student responses will vary.

Req. 2 Yes, the authors would prefer managers to be faithful in representing the disclosures for inventory — for all the reasons accountants are transparent and truthful. We would prefer

that

the

financial

statements

present

the

most

Plant Assets, Natural Resources, &

liabilities, revenue, and expenses are measured and reported. It is only then that financial markets can operate in the way intended.

Plant Assets, Natural Resources, & 455

Ethical Issue C6-87

Req. 1 Changing accounting methods year after year hurts a company’s credibility, which makes it hard for the company to borrow or raise money from outside investors. The question that arises about such a company is: What is the business trying to hide?

Req. 2 The consistency principle is violated.

Req. 3 Creditors

and

outside

investors

could

harmed

accounting changes year after year. It becomes difficult to tell which changes in the business are real and which changes result from the shift in the accounting method. Outsiders find it difficult to track the company’s operating results and financial position over time. Ultimately the company suffers because lenders will not want to lend it money, and outsiders will be reluctant to invest money in the business. This may deprive the entity of needed funds and hurt its chances for success or survival.

Plant Assets, Natural Resources, &

Focus on Financials: Apple Inc. (30 min.)

Req. 1 Millions

Inventory (from the balance sheet)

September 28, 2019

September 29, 2018

$4,106

$3,956

Apple Inc. reports all of its’ inventory on the balance sheet. Note 1 of the Consolidated Financial Statements (Summary of Significant Accounting Policies), under Inventories, does not allude to any consignment goods.

Req. 2 Note 1 of the Consolidated Financial Statements (Summary of

Significant

Accounting

Policies),

under

Inventories,

states: “Inventories are computed using the first-in, firstout method.” We also know that the company uses the lower of cost or net realizable value (from page 7 of Apple 2019 10-K).

Req. 3 Millions

Rearranging: Beginning Inventory

+ Purchases

Cost of sales, products (2019 income $144,99 statement) 6 + Ending inventory

Plant Assets, Natural Resources, & 457

= Cost of goods available − Ending Inventory

= Cost of sales

(at Sep. 28, 2019) 4,106 = Cost of goods available149,102 − Beginning inventory (at Sep. 29, 2018) (3,956) = Purchases, products $145,14 6

Plant Assets, Natural Resources, &

(continued) Focus on Financials: Apple Inc.

Req. 4 The gross profit percentage for products decreased substantially during 2019: Net product sales Cost of product sales Gross profit, products

2019 $213,883 100.0% 144,996 67.8% $ 68,887 32.2%

2018 $225,847 100.0% 148,164 65.6% $77,683 34.4%

Overall, the gross profit percentage for products and services decreased slightly during 2019: Net sales Cost of sales Gross profit

2019 $260,174 100.0% 161,782 62.2% $ 98,392 37.8%

2018 $265,595 100.0% 163,756 61.7% $101,839 38.3%

Req. 5 Apple Inc.’s rate of inventory turnover for 2019 is 35.97 times. Cost of sales Average inventory

$144,996 ($4,106 + $3,956) / 2

35.97 times

On a number-of-days basis, this works out to once about every 10 days (365/35.97). Compared to other companies in the tech business, Apple Inc.’s inventory turnover is relatively fast. On average, the technology industry has an inventory turnover of 12 times per year in 2019 (Source: https://www.stock-analysis-on.net/NASDAQ/Company/ Apple-Inc/Ratios/Short-term-Operating-Activity#InventoryTurnover). The inventory turnover increased slightly in 2019 when compared to 2018.

Plant Assets, Natural Resources, & 459

(continued) Focus on Financials: Apple Inc.

2018 inventory turnover is 33.63 times. Cost of sales Average inventory

$148,164 ($3,956 + $4,855) / 2

33.63 times

Req. 6 Using Apple’s 10-K for the year ending September 26, 2020 2020 inventory turnover is 37.05 times. The inventory turnover increased slightly from 35.97 in 2019 (Req. 5) to 37.05 in 2020. Cost of sales Average inventory

$151,286 ($4,106 + $4,061) / 2

37.05 times

The gross profit percentage for products decreased slightly (0.7%) in 2020, from 32.2% in 2019 to 31.5% in 2020. Net product sales Cost of product sales Gross profit, products

2020 $220,747 100.0% 151,286 68.5% $69,461 31.5%

2019 $213,883 100.0% 144,996 67.8% $68,887 32.2%

Plant Assets, Natural Resources, &

Over products and services, the gross profit percentage increased slightly in 2020 from 37.8% in 2019 to 38.2% in 2020. Net sales Cost of sales Gross profit

2020 $274,515 100.0% 169,559 61.8% $104,956 38.2%

2019 $260,174 100.0% 161,782 62.2% $98,392 37.8%

Information describing changes in various ratios can be found in the Management’s Discussion and Analysis. The gross profit percentage for products decreased in 2020 due to weakness in foreign currencies relative to the U.S. dollar and a different product mix (page 23, Apple 2020 10-K). The gross profit percentage for services increased in 2020 due to a different services mix and higher leverage (page 23, Apple 2020 10-K). Overall, the company’s gross profit percentage increased slightly in 2020 from 2019, which suggests the gross profit percentage increases for services outweighed the gross profit percentage decreases for products.

Plant Assets, Natural Resources, & 461

Focus on Analysis: Under Armour, Inc. (30-40 min.)

Req. 1 a. Inventory on hand at fiscal 2019 year end, $892 million. b. Cost of goods sold, $2,797 million. c.

Millions

Purchases Cost of goods sold ................ + Ending inventory……………………. = Cost of goods available − Beginning inventory .............

2,797 892 3,689 (1,019)

= Purchases ............................ $2,670

Req. 2 Purchases are most directly related to cash flow because Under Armour, Inc. must pay for the inventory it purchases.

Req. 3

+ − =

Accounts payable, beginning of 2019 (ending balance for fiscal 2018) ..................... Purchases 2019 (Req. 1) ................................ Cash payments on account 2019 .................... Accounts payable, end of 2019.......................

Millions $ 561 2,670 (X) $ 618

2019 Cash payments (X) = $2,613 million

Plant Assets, Natural Resources, &

(continued) Focus on Analysis: Under Armour, Inc.

Req. 4 Note 2 of the Consolidated Financial Statements (Summary of

Significant

Accounting

Policies),

under

Inventories,

states: “The company values its inventory…using the firstin, first-out method…”. The company also uses the lower of cost or net realizable value for inventory.

Req. 5 (Dollars in millions) Gross profit percentage

2019

2018

$5,267 - $2,797 $5,267

$5,193 − $2,853 $5,193

46.9%

45.1%

Gross profit percentage increased by 1.8% in 2019, a significant amount, largely due to the fact that sales were increasing and cost of sales were decreasing Inventory turnover

Inventory

$2,797 ($892 + $1,019) / 2

$2,853 ($1,019 + $1,159) /2

2.927

2.620

turnover

increased

2019.

Overall,

Under

Armour’s (a) gross profit percentage increased slightly during 2019 and (b) rate of inventory turnover increased during 2019.

Therefore, the company was able to turn a

profit for the first time in 3 years.

This was largely due to

Plant Assets, Natural Resources, & 463

the company’s turnaround plan which was instituted in 2018 (discussed in the next requirement). (continued) Focus on Analysis: Under Armour, Inc.

Req. 6

The company started executing a 5-year turnaround plan in 2018.

They began by appointing a new

management team, and followed up by changing the company’s marketing strategy to focus more on emerging markets in China and India, where they were already showing strength in marketing their products. They also slashed inventory levels and cut cost of goods sold. As a result, the company’s gross margins started to turn around, thus returning the company’s bottom line to profitability in 2019. Many events, both internal and external to the company, have happened since.

Only time will tell whether

the new strategy will work over the long term.

Plant Assets, Natural Resources, &

Group Project

Student responses will vary.

Plant Assets, Natural Resources, & 465

Chapter 6 Appendix Appendix Short Exercises (10-15 min.) S6A-1

(Journal entries)

General Journal 1. Purchases Accounts Payable

1,160

2. Accounts Receivable Sales Revenue

2,600

1,160

Purchased inventory on account.

2,600

Sold inventory on account.

3. End-of-period entries to update

inventory and record Cost of Goods sold:

a. Cost of Goods Sold Inventory (beginning balance)

560

b. Inventory (ending balance) Cost of Goods Sold

640

560

Transfer beginning inventory to COGS.

640

Set up ending inventory based on physical count.

c. Cost of Goods Sold Purchases

Transfer purchases to COGS.

1,160 1,160

Plant Assets, Natural Resources, &

Req. 1 Posting general journal entries 560*

(10-15 min.) S6A-2

Inventory 560

640 640 * Beginning inventory was $560 Cost of Goods Sold 560 640 1,160 1,080

Req. 2

Cost-of-Goods-Sold Model Beginning inventory $ 560 + Purchases

1,160

= Cost of goods available

1,720

– Ending inventory

640

= Cost of goods sold

$1,080

Req. 3 Wexton Technologies Income Statement (Partial) Sales revenue $2,600 Cost of goods sold: Beginning inventory

$ 560

Purchases

1,160

Cost of goods

1,720

Plant Assets, Natural Resources, & 467

available Ending inventory Cost of goods sold Gross profit

(640) 1,080 $1,520

Plant Assets, Natural Resources, &

Appendix Exercises (10-15 min.) E6A-3 Inventory Begin. Bal.

(4 units @ $60) 240

Purchases Oct. 8

(3 units @ $60) 180 15 (12 units @ $70) 840 26 (1 unit @ $80) 80 Ending Bal. (5 units @ $?)

Cost of goods sold

(15 units @ $?) ?

Cost of Goods Sold

Ending Inventory

(1) Specific unit (4 @ $60) + (10 @ $70) + (1 @ = $1,02 cost $80) 0 (2) Averag e cost

(15 × $67*)

= $1,00 5

(3 @ $60) + (2 @ $70)

= $320

(5 × $67*)

= $335

_____ ($240 + $180 + $840 *Average cost per = + $80) unit (4 + 3 + 12 + 1) (3) FIFO

(7 @ $60) + (8 @ $70)

$980

= $67.00

(1 @ $80) +

= $360

Plant Assets, Natural Resources, & 469

(4 @ $70) (4) LIFO

(1 @ $80) + (12 @ $70) + (2 @ $60)

= $1,04 0

(5 @ $60)

= $300

Plant Assets, Natural Resources, &

Reqs. 1, 2, & 3

(10-15 min.) E6A-4

(Journal entries) General Journal

1. Purchases Accounts Payable

1,100 1,100

Purchased inventory on account.

2. Accounts Receivable 4,125 Sales Revenue (15 × $275)

4,125

Sold inventory on account.

3. End-of-period entries to update

inventory and record Cost of Goods Sold:

a. Cost of Goods Sold Inventory (beginning balance)

240

b. Inventory (ending balance) Cost of Goods Sold

300

240

Transfer beginning inventory to COGS.

300

Set up ending inventory based on physical count.

c. Cost of Goods Sold Purchases

1,100 1,100

Transfer purchases to COGS.

Plant Assets, Natural Resources, & 471

Req. 4 Cost-of-Goods-Sold Model Beginning inventory + Purchases = Cost of goods available - Ending inventory = Cost of goods sold

$ 240 1,100 1,340 300 $1,040

Plant Assets, Natural Resources, &

Appendix Problems (20-25 min.) P6A-5

Req. 1 Inventory Begin. Bal.

(52 units @ $18) 936

Purchases July 8

(86 units @ $19) 1,634 30 (22 units @ $20) 440 Ending Bal. (70 units @ $?)

Cost of goods sold (90 units @ $?)

Cost of Goods Sold

Ending Inventory

FIFO (52 @ $18) + (38 @ = $1,65 $19) 8

(22 @ $20) + (48 @ $19)

= $1,3 52

Req. 2 Date July 3 July 11 July 19 July 24 July 31 Total

Units Sold 18 34 2 33 3 90

Selling Price $75 $75 $77 $77 $77

Total Revenue $1,350 2,550 154 2,541 231 $6,826

Plant Assets, Natural Resources, & 473

Purchases Cost of goods available Ending inventory Cost of goods sold Gross profit

2,074 3,010 (1,352)

1,658 $5,168

Plant Assets, Natural Resources, &

(20-30 min.) P6A-6

Req. 1

(Journal entries) General Journal

1. Purchases Accounts Payable

Purchased inventory on account

2. Accounts Receivable Cash Sales Revenue

(thousands) 1,180 1,180 2,720 680 3,400

Sold inventory for cash and on account

3. End-of-period entries to update inventory and record Cost of Goods Sold: a. Cost of Goods Sold Inventory (beginning balance)

510

b. Inventory (ending balance) Cost of Goods Sold

690

510

Transfer beginning inventory to COGS

690

Set up ending inventory based on physical count

c. Cost of Goods Sold Purchases

Transfer purchases to COGS

1,180 1,180

Plant Assets, Natural Resources, & 475

(continued) P6A-6 Req. 2 Just Desserts, Inc. Income Statement (Partial) Sales revenue Cost of goods sold: Beginning inventory Purchases Cost of goods available Ending inventory Cost of goods sold Gross profit

$3,400 $ 510 1,180 1,690 (690) 1,000 $2,400

Cost-of-Goods-Sold Model Beginning inventory + Purchases = Cost of goods available – Ending inventory = Cost of goods sold

$ 510 1,180 1,690 690 $1,000

Current asset section of the balance sheet reports: Inventory, $690

Plant Assets, Natural Resources, &

Chapter 7 Plant Assets, Natural Resources, & Intangibles Ethics Check (5-10 min.) EC 7-1 a. Objectivity and independence b. Due care c. Integrity d. Due care

Plant Assets, Natural Resources, & 477

Short Exercises (5 min.) S 7-1 1.

Albrecht’s

reported

Buildings

and

leasehold

improvements of $2,219,765 (thousand) and Fixtures and equipment of $1,580,325 (thousand) at September 30, 2021.

Included in these categories are costs such as

original cost of each asset; all costs incurred to bring the asset to its intended use; and any taxes, commissions, and other amounts paid to bring the asset ready for use. (Student responses may vary)

2. Cost Book value Book

value

= is

= $3,956,790 thousand $2,078,823 thousand

less

than

cost

because

accumulated

depreciation is subtracted from cost to compute book value.

Plant Assets, Natural Resources, &

(5-10 min.) S 7-2 Land ($280,000 × .40*) ..................... Building ($280,000 × .10*) ................ Equipment ($280,000 × .50*) ............ Note Payable............................... *Supporting computations: Current Market Value

112,000 28,000 140,000 280,000

Percent of Total

Land .......................

$ 124,000

$124,000 / $310,000

40.0%

Building ..................

31,000

$ 31,000 / $310,000

10.0%

$155,000 / $310,000

50.0%

Equipment .............. 155,000 Total.......................

$310,00 0

100.0%

(10 min.) S7-3 1. Capital expenditure 2. Expense 3. Neither 4. Capital expenditure 5. Capital expenditure 6. Capital expenditure 7. Expense 8. Capital expenditure 9. Capital expenditure 10. Expense Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

Plant Assets, Natural Resources, & 479

(5 min.) S 7-4 1. a.

Capitalized

Expensed

2. An expense reduces income in the current period.

capitalized cost means the long-term asset (except for land) will be expensed through depreciation in the future, and the expense will reduce income in the future rather than currently.

Plant Assets, Natural Resources, &

(10-15 min.) S 7-5 1.

First-year depreciation:

Straight-line ($58,900,000 − $4,900,000) / 5 $ years ............................................................. 10,800,00 0 Units-of-production $7.50/mile* × 750,000 $ miles.............................................................. 5,625,000 Double-declining-balance ($58,900,000 × 40%) $23,560,0 00 Second-year depreciation: Straight-line ($58,900,000 − $4,900,000) / 5 $10,800,0 years ............................................................. 00 Units-of-production $7.50/mile* × 1,375,000 $10,312,5 miles.............................................................. 00 Double-declining-balance [($58,900,000 − $23,560,000) × 40%].......... $14,136,0 00 *[($58,900,000 − $4,900,000) / 7,200,000 miles] = $7.50/mile 2.

Book value: Straight-

Units-of-

Double-

Plant Assets, Natural Resources, & 481

Line

Production

DecliningBalance

Cost ........................ $58,900,00 $58,900,00 $58,900,00 0 0 0 Less: Accumulated Depreciation ........ (10,800,000 (5,625,000) (23,560,000 ) ) Book value, Year 1... $48,100,00 $53,275,00 $35,340,00 0 0 0

Plant Assets, Natural Resources, &

(10 min.) S 7-6

1. Double-declining-balance (DDB) depreciation offers the tax advantage for the first year of an asset’s use. Because DDB’s first-year depreciation is greater than first-year depreciation under other methods, net income is lower.

The method also produces the fastest tax

deductions and conserves cash that the taxpayer can invest to earn more income. 2. DDB depreciation....................................

$23,560,000

Straight-line depreciation ....................... (10,800,000 ) Excess depreciation tax deduction........... Income tax rate ...................................... Income tax savings for first year .............

$12,760,000 ×

.34

$ 4,338,400

Plant Assets, Natural Resources, & 483

(5-10 min.) S7-7 $29,000 / 4 years = $7,250 / year, straight-line depreciation Depreciation

Accumulated

Expense

Depreciation

Book Value 2020: 2021: 2022: 2023:

$7,250 7,250 7,250 7,250

$ 7,250 14,500 21,750 29,000

$21,750 14,500 7,250 -0(5-10 min.) S 7-8

$29,000 / 290,000 miles = $.10 / mile, units-of-production depreciation Depreciation Accumulated Miles Depreciation 2020: 40,000 2021: 75,000 2022: 90,000 2023: 85,000

$4,000 7,500 9,000 8,500

Book Expense Value $ 4,000 11,500 20,500 29,000

$25,000 17,500 8,500 -0(5-10 min.) S 7-9

Plant Assets, Natural Resources, &

Depreciation Accumulated

Book Rate

Depreciation 2020: 2021: 2022: 2023:

.50 .50 .50 .50

Expense Value

$14,500 7,250 3,625 3,625*

$29,000 14,500 7,250 3,625 -0-

$14,500 21,750 25,375 29,000

* Remaining book value is the last year depreciation expense, to bring book value to -0-.

(5-10 min.) S 7-10 ($17,000 — $1,400) / 4 years = $3,900 / year, straight-line depreciation Depreciation

Accumulated

Expense

Depreciation

Book Value 2020: 2021: 2022: 2023:

$3,900 3,900 3,900 3,900

$ 3,900 7,800 11,700 15,600

$13,100 9,200 5,300 1,400 (5-10 min.) S 7-11

($17,000 — $1,400) / 100,000 miles = $.156 / mile, units-ofproduction depreciation Depreciation Accumulated Miles Depreciation 2020: 16,000

$2,496

Book Expense Value $ 2,496

$14,504

Plant Assets, Natural Resources, & 485

2021: 19,000 2022: 17,000 2023: 48,000

2,964 2,652 7,488

5,460 8,112 15,600

11,540 8,888 1,400

(5-10 min.) S 7-12 Rate for double-declining-balance depreciation for 4 years = 2/4 or 50% Depreciation Accumulated

Book Rate

Depreciation 2020: 2021: 2022: 2023:

.50 .50 .50 .50

Expense Value

$8,500 4,250 2,125 725*

$17,000 8,500 4,250 2,125 1,400

$ 8,500 12,750 14,875 15,600

* Last year depreciation expense, to bring book value to $1,400.

(5-10 min.) S 7-13 First-year depreciation (for a partial year): a. Straight-line (€45,000,000 − €6,000,000) / 4 years × 3/12 ................................................... €2,437,500 b. Units-of-production [(€45,000,000 − €6,000,000) / 4,000,000 miles × 350,000 miles] ........... €3,412,500 c. Double-declining-balance (€45,000,000 × 2/4 × 3/12) .................................................. €5,625,000

Plant Assets, Natural Resources, &

SL depreciation produces the highest net income (lowest depreciation). DDB depreciation produces the lowest net income (highest depreciation).

(10 min.) S 7-14 Depreciation Expense — Concession Stand....... 84,000 Accumulated Depreciation — Concession 84,000 Stand ............................................................. Depreciation for years 1-4: $500,000 / 25 years

$ 20,000 × 4 years Asset’s remaining depreciable ÷ book value

$500,000 − $80,000

$20,000 per year =

$80,000 for years 1-4

(New) Estimated useful life remaining

(New) Annual depreciation

5 years

$84,000 per year

$420,000 (5-10 min.) S 7-15 1.

($810,000 − $50,000) / 4 years × 2 = $380,000

Loss on sale of machinery: Sale price of machinery

$350,00 0

Plant Assets, Natural Resources, & 487

Cost Less: Accumulated depreciation

$810,00 0 (380,00 (430,00 0) 0)

Loss on sale .......................................... 2. 2022 Jan. 1 Cash .................................... Accumulated Depreciation – Machinery ........................... Loss on Sale of Machinery..... Machinery ........................

$ (80,000)

350,000 380,000 80,000 810,000 (5-10 min.) S 7-16

1. Units-of-production depreciation method is similar to the method used to calculate depletion.

2. Oil Inventory ($18* × 1 billion) ................. Oil Reserves ........................................ *$18 = $180 / 10 3. Cost of Oil Sold ($18 × .8) ........................ Oil Inventory .......................................

Billions

14.4

Plant Assets, Natural Resources, &

(5-10 min.) S 7-17

Req. 1 Cost of goodwill purchased:

Millions

Purchase price paid for Sweet Snacks Company Market value of Sweet Snacks’ net assets: Market value of Sweet Snacks’ assets Less: Sweet Snacks’ liabilities

$5.4

$ 10.0

(7.1) Market value of Sweet Snacks’ net assets Cost of goodwill

2.9 $2.5

Req. 2 In future years Munchies, Inc. will determine whether its goodwill has been impaired. If the goodwill’s value has not been impaired, there is nothing to record. But if the goodwill’s value has been impaired, Munchies, Inc. will record a loss and write down the book value of the goodwill. (5-10 min.) S 7-18

Asset

Book Value

Estimate d Future Cash Flows

$190,000 $157,000

Fair Value

Impair Amoun ed? t of (Y or Loss N) $135,00 Y $55,00 0

Plant Assets, Natural Resources, & 489

$420,000 $540,000

Trademark c. Land

$485,00

–

$28,00

0 $60,000

$38,000

$32,000

0 d. Factory building

$10

million

Plant Assets, Natural Resources, &

–

(5 min.) S7-19 (Dollar amounts in millions) Return on assets 9%

= =

Net income $18

÷ ÷

Average total assets $200

(5 min.) S 7-20 DuPont Analysis Net profit X margin ratio (Net income/Net X sales)

2021

$43,700 $500,000 X

ROA

(Net income/Average total assets)

$500,000 $230,000

2.1739

$34,650 $410,000 X

$410,000 $210,000

1.9524

.0874

2020

Total asset turnover (Net sales/Average total assets)

.0845

19%

16.5%

The net profit margin ratio improved slightly over 2020, and the asset turnover improved from 2020 to 2021; these improvements caused the ROA to increase in 2021.

Plant Assets, Natural Resources, & 491

(5 min.) S 7-21

Silverspring Systems, Inc. Statement of Cash Flows For the Year Ended December 31, 2021 Cash flows from investing activities:

Millions

Purchase of other companies ...........................

$(10.0)

Capital expenditures........................................

(8.6)

Proceeds from sale of North American operations ..........................................................

8.4

Net cash (used in) investing activities ...........

$(10.2)

Plant Assets, Natural Resources, &

(10-15 min.) S 7-22 Year 1: $39,142.86 Year 2: $46,244.90 Year 3: $51,317.78 Year 4: $54,941.27 Year 5: $57,529.48 Year 6: $59,378.20 Year 7: $61,445.51 (10-15 min.) S 7-23 1. Year 1: $4,000.00 Year 2: $4,000.00 Year 3: $4,000.00 Year 4: $4,000.00 Year 5: $4,000.00 Year 6: $4,000.00 Year 7: $4,000.00 Year 8: $4,000.00 2. Year 1: $9,250.00 Year 2: $6,937.50 Year 3: $5,203.13 Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

Plant Assets, Natural Resources, & 493

Year 4: $3,902.34 Year 5: $2,926.76 Year 6: $2,195.07 Year 7: $1,585.20 Year 8: $0.00 Exercises (5-10 min.) E 7-24A Land: $160,000 + $185,000 + $2,000 + $6,000 + $11,000 = $364,000 Land improvements: $66,000

$52,000 + $11,000 + $3,000 =

Building:$58,000 + $700,000 = $758,000

(10-15 min.) E 7-25A Allocation of cost to individual machines: Appraise Machin d e Value 1

$ 38,250

73,100

3 58,650 Totals $170,00 0

Percentage of Total Appraised (Market) Value

Cost of Each Machin e

Total Cost

$38,250 / = .225 $167,000 × $170,000 .225

73,100 / = .430 170,000

= 71,810

167,000 × .430

58,650 / = .345 167,000 × 170,000 .345 1.000

$ 37,575

= 57,615 $167,0 00

Plant Assets, Natural Resources, &

Sale price of machine no. 3 ............. Cost ............................................... Gain on sale of machine ..................

$58,650 57,615 $ 1,035

Plant Assets, Natural Resources, & 495

(5-10 min.) E 7-26A (a) Periodic lubrication

Immediate

(b) Reinforcement to platform

expense

Capital expenditure

(d) Training of personnel

Capital expenditure Capital expenditure (e) Purchase price

Capital

(f) Income tax

expenditure

(g) Ordinary recurring repairs

Immediate expense Immediate expense

(h) Transportation and insurance

Capital expenditure

(i) Sales tax

Capital expenditure (j) Lubrication before machine is placed in

service

(k) Installation

Capital expenditure Capital expenditure

Plant Assets, Natural Resources, &

(15 min.) E 7-27A

Req. 1 Journal ACCOUNT TITLES

DEBIT CREDIT

a. Land..................................................

481,00 0

Cash.............................................. b. Building ($1,200 + $15,200 + $679,900 + $28,180)............................................ Note Payable .................................

481,00 0 724,48 0 679,90 0 44,580

Cash ($1,200 + $15,200 + $28,180) c. Depreciation Expense – Building ......... Accumulated Depreciation – Building ($724,480 − $335,000) / 35 × 6/12 ..

5,564 5,564

Req. 2 BALANCE SHEET Plant assets: Land..............................................

$481,00 0

Building......................................... $724,480 Less Accumulated depreciation ...... Building, net..................................

(5,564) 718,916

Plant Assets, Natural Resources, & 497

Depreciation expense ....................

$ 5,564

Plant Assets, Natural Resources, &

(15-20 min.) E 7-28A

Req. 1 Year

Straight-Line

Units-ofProduction

Double-DecliningBalance

2021

$ 5,000

$ 8,000

$11,000

2022

5,000

7,000

5,500

2023

5,000

3,750

2,750

2024

5,000

1,250

750

$20,000

_____ Computations: Straight-line: ($22,000 − $2,000) ÷ 4 = $5,000 per year. Units-of-production: ($22,000 − $2,000) ÷ 80,000 miles = $.25 per mile: 202 1

32,000

$.25

= $8,00 0

202 2

28,000

.25

= 7,000

202 3

15,000

.25

= 3,750

202 5,000 4 .25

= 1,250*

*Or, ($20,000 − $8,000 − $7,000 − $3,750 = $1,250). Total depreciation cannot exceed $20,000, therefore the last year may be limited, if there are rounding differences. Double-declining-balance — Twice the straight-line rate: 1/4 × 2 = 50% 202 $22,000 × .50 1 Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

= $11,00 Plant Assets, Natural Resources, & 499

0 202 ($22,000 – $11,000) × .50 2

5,500

202 ($11,000 – $5,500) x .50 3

2,750

202 ($20,000 max. deprec. − $11,000 − $5,500 − = 4 $2,750)

750

(continued) E 7-28A

Req. 2 The units-of production method most closely tracks the wear and tear on the van.

Req. 3 For income tax purposes, the double-declining-balance method is best because it provides the most depreciation and, thus, the largest tax deductions in the early life of the asset. The company can invest the tax savings to earn a return on the investment.

Plant Assets, Natural Resources, &

(15 min.) E 7-29A INCOME STATEMENT Expenses: Depreciation expense — Building [($58,000 + $110,000 + $62,000) − $51,000] / 25

$ 7,160

Depreciation expense — Furniture and Fixtures ($55,000 × 2/5) ..........................................

22,000

Supplies expense ($9,400 − $1,300).......................................

8,100

BALANCE SHEET Current assets: Supplies .......................................................

$ 1,300

Plant assets: Building ($58,000 + $110,000 + $62,000)… Less: Accumulated depreciation………….

$230,000 (7,160) $222,84 0

Furniture and fixtures……………………..... Less: Accumulated depreciation………….

55,000 33,000 (22,000)

STATEMENT OF CASH FLOWS Cash flows from investing activities: $(120,000 Purchase of buildings ($58,000* + $62,000) ... ) Purchase of furniture and fixtures ................. _____ Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

(55,000)

Plant Assets, Natural Resources, & 501

*Does not include the $110,000 note payable because it is a noncash transaction.

Plant Assets, Natural Resources, &

(10-15 min.) E 7-30A Journal DATE

CREDI DEBIT T

ACCOUNT TITLES

Yea 20 Depreciation Expense – Building ($358,000 ÷ 40) r 8,950 Accumulated Depreciation — Building............................................. 8,950 Yea 21 Depreciation Expense – Building ......... 17,60 r 0* Accumulated Depreciation — Building

17,60 0

_____ *Computations: Depreciable cost: $440,000 − $82,000 = $358,000 Depreciation through year 20: = $358,000 / 40 = $8,950 x 20 = $179,000 Asset’s remaining depreciable book value: $440,000 − $179,000 − $14,600 (new residual value) = $246,400 New annual depreciation: $246,400 ÷ 14 (revised life remaining) = $17,600 (10 min.) E 7-31A 1. ($910,000 – $80,000) / 8 years = $103,750 per year $103,750 × 4 = $415,000 Book value = $910,000 – $415,000 = $495,000 2. The journal entry on January 1, 2024 to record the sale: Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

Plant Assets, Natural Resources, & 503

Cash

350,000

Accumulated Depreciation – Machine Loss on Sale of Machine

415,000 145,000

Machine 910,00 0

(15-20 min.) E 7-32A Journal DATE

ACCOUNT TITLES

2022

Depreciation for 8 months:

Aug.

31 Depreciation Expense – Fixtures..

CREDI DEBIT T 1,424 *

Accumulated Depreciation — 1,424

Fixtures ................................

Sale of fixtures: 31

Cash ..........................................

2,80 0

Accumulated Depreciation — Fixtures ($3,560 + $1,424)........ Loss on Sale of Fixtures ..............

4,98 4 1,116* *

Fixtures .................................

8,900

Plant Assets, Natural Resources, &

**Loss on sale of fixtures: Sale price of old fixtures........................

$ 2,800

Book value of old fixtures: Cost .................................................. Less: Accumulated depreciation ($3,560 + $1,424) ................................... Loss on sale ..........................................

$8,900 (4,984 (3,916 ) ) $(1,116 )

Plant Assets, Natural Resources, & 505

(10-15 min.) E 7-33A Cost of old truck .........................................

$420,000

Less: Accumulated depreciation: ($420,000 − $100,000) ×

77 + 175 + 190 + 45 1,000

(155,840)* _______ $264,160

Book value of old truck .............................. _____ *Alternate solution setup for accumulated depreciation: ($420,000 − $100,000) 1,000,000 miles

= $.32 per mile

77,000 + 175,000 + 190,000 + 45,000 = 487,000 miles driven Accumulated depreciation

= 487,000 miles × $.32 = $155,840

Calculation of gain or loss: Purchase price of Freightliner truck$270,000 Cash paid for Freightliner truck

(31,000)

Trade-in value of Mack truck

239,000

Book value of Mack truck

(264,160)

Net loss on exchange of Mack truck$ (25,160)

Journal DAT E 2024

ACCOUNT TITLES Truck – Freightliner......................... Accumulated Depreciation – Mack

DEBIT 270,00 0 155,84

CREDI T

Plant Assets, Natural Resources, &

Truck ............................................. Loss on Exchange of Mack Truck...... Truck – Mack ................................ Cash ............................................

0 25,160 420,0 00 31,00 0

Plant Assets, Natural Resources, & 507

(10-15 min.) E 7-34A Journal ACCOUNT TITLES

DATE

DEBIT

(a) Purchase of mineral assets: Mineral Asset........................... 425,00 0 Cash....................................

CREDIT

425,00 0

(b) Payment of fees and other

costs:

Mineral Asset ($110 + $2,000).. Cash....................................

2,110

Mineral Asset........................... Cash....................................

55,390

2,110

55,390

67,550*

(d) Sale of ore Cost of Mineral Asset Sold........ 55,970** Mineral Asset Inventory .......

67,550

55,970

_____ *$425,000 + $110 + $2,000 + $55,390 = $482,500 $482,500 ÷ 250,000 tons = $1.93 per ton 35,000 tons × $1.93 = $67,550 **29,000 tons x $1.93 = $55,970

Plant Assets, Natural Resources, &

(10-15 min.) E 7-35A Journal ACCOUNT TITLES

DATE

DEBIT

CREDIT

Req.1 (a) Purchase of patent: Patents .................................... 400,000 Cash .....................................

400,000

(b) Amortization for each year: Amortization Expense — Patents ($400,000 ÷ 10) .................... 40,000 Patents ...............................

40,000

Req.2

Impairment of patent in year 10: Impairment Loss on Patents ...... 200,000* * Patents ..............................

200,000

Yes, the asset is impaired because its net book value ($200,000*) is greater than the estimated future cash flows ($130,000). _____ *Asset remaining book value: $400,000 − ($40,000 × 5) = $200,000 **Impairment loss: $200,000 [$200,000 (book value) − $0 (fair value)]

Plant Assets, Natural Resources, & 509

(5-10 min.) E 7-36A

Req. 1 Cost of goodwill purchased:

Millions

Purchase price paid for Roeder Industries ..

$15

Market value of Roeder Industries’ net assets: Market value of Roeder Ind.s’ assets ($14 + 18). ...........................................................

$32

Less: Roeder Industries’ liabilities.......... (23) Market value of Roeder Industries’ net assets Cost of goodwill ........................................

9 $ 6

Req. 2 Journal DATE

ACCOUNT TITLES Current Assets ................................ Long-Term Assets............................ Goodwill ......................................... Liabilities ................................... Cash ..........................................

DEBI CREDI T T 18 14 6 23 15

Req. 3 Each year, Kaledan Co. will determine whether its goodwill has been impaired in value. If the goodwill’s value has not been impaired, there is nothing to record. But if goodwill’s Copyright © 2022 Pearson Education Inc. Chapter 7 510 Intangibles

Plant Assets, Natural Resources, &

value has been impaired, Kaledan Co. will record a loss and write down the book value of the goodwill.

Plant Assets, Natural Resources, & 511

(5-10 min.) E 7-37A

Req. 1 Net profit margin ratio for the years ended:

January 31, 2021

January 31, 2020

Net earnings Net sales

$ 2,200 = 4.40% $50,000

$ 2,100 = 4.34% $48,350

The net profit margin ratio improved slightly from 2020 to 2021.

Req. 2 Asset turnover for the years ended:

January 31, 2021

Net sales Average total assets

$50,000 = $40,000

1.25

January 31, 2020 $48,350 = $39,300

1.23

The asset turnover improved slightly from 2020 to 2021.

Req. 3 Return on assets for the years ended: Net earnings Average total assets

January 31, 2021 $ 2,200 = $40,00 0

or 4.40% x 1.25

5.50%

= 5.50%*

January 31, 2020 $ 2,100 = 5.34 % $39,300 4.34% x 1.23

= 5.34 %*

Plant Assets, Natural Resources, &

The return on assets slightly improved from 2020 to 2021; the increase in asset turnover was mostly responsible for this. *difference due to rounding

Plant Assets, Natural Resources, & 513

(10 min.) E 7-38A a. Proceeds from sale of building (or disposal of building)..

$670,000

b. Insurance proceeds from fire (or disposal of building)….

200,000

c. Renovation of store (or capital expenditures)……………..

(140,000)

d. Purchase of store fixtures (or capital expenditures)……..

(110,000)

(5-10 min.) E 7-39B Land: $170,000 + $180,000 + $2,000 + $2,500 + $3,000 = $357,500 Land improvements: $74,000

$55,000 + $14,000 + $5,000 =

Building:$57,000 + $600,000 = $657,000 (10-15 min.) E 7-40B Allocation of cost to individual machines: Appraise Machin d e Value

Percentage of Total Appraised (Market) Value

Cost of Each Machin e

Total Cost

$ $73,100 / 73,100 $215,000

= .34 $209,000 × .34

120,400 / 120,400 215,000

= .56

209,000 × .56

= 117,04 0

21,500 /

= .10

209,000 ×

$ 71,060

Plant Assets, Natural Resources, &

21,500 215,000 Totals $215,00 0

.10 1.00 0

Sale price of machine no. 3 .............

20,900 $209,0 00

$ 21,500

Cost ............................................... (20,900 ) Gain on sale of machine ..................

$ 600

Plant Assets, Natural Resources, & 515

(5-10 min.) E 7-41B (a) Purchase Price

Capital expenditure

(b) Installation (c) Reinforcement to platform

Capital

(d) Ordinary recurring repairs

expenditure Capital expenditure Immediate expense

(e) Lubrication before machine is placed

Capital

expenditure service

(f) Sales tax (g) Major overhaul

Capital expenditure Capital expenditure

(h) Training of personnel (i)

Income tax

Capital expenditure Immediate expense

(j) Periodic lubrication

Immediate expense

(k) Transportation and insurance

Capital expenditure

Plant Assets, Natural Resources, &

Plant Assets, Natural Resources, & 517

(15 min.) E 7-42B

Req. 1

Journal ACCOUNT TITLES

DEBIT CREDIT

a. Land..................................................

486,00 0

Cash.............................................. b. Building ($1,000 + $15,000 + $670,000 + $28,020)............................................ Note Payable .................................

486,00 0 714,02 0 670,00 0 44,020

Cash ($1,000 + $15,000 + $28,020) c. Depreciation Expense – Building ......... Accumulated Depreciation – Building ($714,020 − $330,000) / 35 × 6/12 ..

5,486 5,486

Req. 2 BALANCE SHEET Plant assets: $486,00 0

Land.............................................. Building.........................................

$714,020

Less: Accumulated depreciation .....

(5,486)

Building, net..................................

708,534

Req. 3 INCOME STATEMENT Expense: Depreciation expense – Building .....

$ 5,486

Plant Assets, Natural Resources, &

Plant Assets, Natural Resources, & 519

(15-20 min.) E 7-43B

Req. 1 Units-ofProduction

Double-DecliningBalance

Year

Straight-Line

2021

$ 4,275

$ 6,150

$ 9,300

2022

4,275

4,800

4,650

2023

4,275

4,620

2,325

2024

4,275

1,530

825

$17,100

_____ Computations: Straight-line: ($18,600 − $1,500) ÷ 4 = $4,275 per year. Units-of-production: ($18,600 − $1,500) ÷ 57,000 miles = $.30 per mile: 202 1

20,500

$.30

$6,15 0

202 2

16,000

.30

4,800

202 3

15,400

.30

4,620

202 4

5,100 .30

= 1,530*

*Or, ($17,100 − $6,150 − $4,800 − $4,620 = $1,530). Total depreciation cannot exceed $17,100, therefore the last year may be limited, if there are rounding differences. Double-declining-balance — Twice the straight-line rate: 1/4 × 2 = 50% 202 $18,600 × .50 1

202 ($18,600 − $9,300) × .50 2

$9,300 4,650

Plant Assets, Natural Resources, &

202 ($9,300 − $4,650) x .50 3

2,325

202 ($17,100 max. depreciation − $9,300 − $4,650 = 4 − $2,325)

825

(continued) E 7-43B

Req. 2 The units-of production method most closely tracks the wear and tear on the van.

Plant Assets, Natural Resources, & 521

(15 min.) E 7-44B INCOME STATEMENT Expenses: Depreciation expense — Building [($157,000 + $60,000) − $52,000] / 25 .........

$ 6,600

Depreciation expense — Furniture and Fixtures ($51,000 × 2/5) ...........................................

20,400

Supplies expense ($9,600 − $1,600)........................................

8,000

BALANCE SHEET Current assets: Supplies .........................................................

$ 1,600

Plant assets: Building ($157,000 + $60,000) .........

$217,000

Less: Accumulated depreciation ....... (6,600) Furniture and fixtures......................

$210,40 0

51,000

Less: Accumulated depreciation .......

30,600 (20,400)

STATEMENT OF CASH FLOWS Cash flows from investing activities: Purchase of buildings ($56,000* + $60,000) .. $(116,000) Purchase of furniture and fixtures................. (51,000) _____ *Does not include the $101,000 note payable because it is a noncash transaction.

Plant Assets, Natural Resources, &

(10-15 min.) E 7-45B Journal DATE

CREDI DEBIT T

ACCOUNT TITLES

Yea 20 Depreciation Expense – Building ($360,000 ÷ 40) ..................................... r Accumulated Depreciation — Building .............................................

9,000 9,000

Yea 21 Depreciation Expense – Building ......... 16,930 r * Accumulated Depreciation — Building 16,930 _____ *Computations: Depreciable cost: $430,000 − $70,000 = $360,000 Depreciation through year 20: $360,000 ÷ 40 = $9,000 × 20 = $180,000 Asset’s remaining depreciable book value: $430,000 − $180,000 − $12,980 = $237,020 New annual depreciation: $237,020 ÷ 14 (revised life remaining) = $16,930

(10

min.) E 7-46B

1. ($930,000 – $110,000) / 8 years = $102,500 per year $102,500 × 4 = $410,000 Book value = $930,000 – $410,000 = $520,000 2. The journal entry on January 1, 2024 to record the sale: Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

Plant Assets, Natural Resources, & 523

Cash

250,000

Accumulated Depreciation – Machine Loss on the Sale of Machine

410,000 270,000

Machine ......................................................... 930,00 0 (15-20 min.) E 7-47B Journal DATE

ACCOUNT TITLES

2022

Depreciation for 9 months:

Sept .

30 Depreciation Expense – Fixtures..

CREDI DEBIT T 1,458 *

Accumulated Depreciation — 1,458

Fixtures ..............................

Sale of fixtures: 30

Cash ..........................................

2,40 0

Accumulated Depreciation — Fixtures ($3,240 + $1,458)....... Loss on Sale of Fixtures ..............

4,69 8 1,002* *

Fixtures .................................

8,100

_____ *2021 depreciation: $8,100 × 2/5 = $3,240 2022 depreciation: ($8,100 − $3,240) × 2/5 × 9/12 = $1,458

Plant Assets, Natural Resources, &

Sale price of old fixtures........................

$ 2,400

Book value of old fixtures: Cost .................................................. Less: Accumulated depreciation ($3,240 + $1,458)........................... Loss on sale ..........................................

$8,100 (4,698 (3,402 ) ) $(1,002 )

Plant Assets, Natural Resources, & 525

(10-15 min.) E 7-48B Cost of old truck ........................................ Less: Accumulated depreciation: ($450,000 − $20,000) × 80+ 175 + 185 + 40 1,000

$450,000

(206,400)* _______ $243,600

Book value of old truck ............................. _____ *Alternate solution setup for accumulated depreciation: ($450,000 − $20,000) 1,000,000 miles

$.43 per mile

80,000 + 175,000 + 185,000 + 40,000 = 480,000 miles driven Accumulated depreciation

480,000 miles × $.43

$206,400

Calculation of gain or loss: Purchase price of Freightliner truck $250,000 Cash paid for Freightliner truck ...... (30,000) Trade-in value of Mack truck ..........

220,000

Book value of Mack truck ............... (243,600) Net loss on exchange of Mack truck $ (23,600) Journal DAT E ACCOUNT TITLES 2024 Truck – Freightliner ................. Accumulated Depreciation – Mack Copyright © 2022 Pearson Education Inc. Chapter 7 526 Intangibles

DEBIT 250,000

CREDIT

206,400

Plant Assets, Natural Resources, &

Truck.................................. Loss on Exchange of Mack Truck…… Truck – Mack ................... Cash ...............................

23,600 450,000 30,000

Plant Assets, Natural Resources, & 527

(10-15 min.) E 7-49B

DATE

Journal ACCOUNT TITLES AND EXPLANATION

(a) Purchase of mineral assets: Mineral Asset ......................... Cash ..................................

DEBIT

CREDIT

433,000 433,00 0

(b) Payment of fees and other

costs:

Mineral Asset ($155 + $2,800) Cash ..................................

2,955

Mineral Asset ......................... Cash ..................................

95,045

(c) Depletion for the year Mineral Asset Inventory.......... Mineral Asset..................... (d) Sales of ore Cost of Mineral Asset Sold ......

2,955

95,045

88,500* 88,500

84,960* *

Mineral Asset Inventory .....

84,960

_____ *$433,000 + $155 + $2,800 + $95,045 = $531,000 $531,000 ÷ 450,000 tons = $1.18 per ton 75,000 tons × $1.18 = $88,500 **72,000 tons x $1.18 = $84,960

Plant Assets, Natural Resources, &

(10-15 min.) E 7-50B Journal ACCOUNT TITLES

DATE

DEBIT

CREDIT

Req.1 (a) Purchase of patent: Patents ............................... Cash ................................

700,000 700,000

(b) Amortization for each year: Amortization Expense — Patents ($700,000 ÷ 8)..................... 87,500 Patents...........................

Req.2

Impairment loss in year 8: Impairment Loss on Patents . Patents ............................

The

87,500

asset

impaired

because

the

350,000 350,000 net

book

value

($350,000*) is greater than the estimated future cash flows ($270,000). The amount of the impairment loss is $350,000 (net book value minus fair value of $-0-). *Asset remaining book value: $700,000 – ($87,500 x 4) = $350,000

Plant Assets, Natural Resources, & 529

(5-10 min.) E 7-51B

Req. 1 Cost of goodwill purchased:

Millions Purchase price paid for Brighton Industries ......

$22

Market value of Brighton Industries’ net assets: Market value of Brighton Industries’ assets

$30

($11 + $19).

Less: Brighton Industries’ liabilities ............. (23) Market value of Brighton Industries’ net assets .............................................................

Cost of goodwill...............................................

$15

Req. 2 Journal DATE

ACCOUNT TITLES Current Assets ...................................... Long-Term Assets ................................. Goodwill ............................................... Liabilities ......................................... Cash ................................................

DEBI CREDI T T 11 19 15 23 22

Req. 3 Each year, Voltron Co. will determine whether its goodwill has been impaired in value. If the goodwill’s value has not been impaired, there is nothing to record. But if goodwill’s Copyright © 2022 Pearson Education Inc. Chapter 7 530 Intangibles

Plant Assets, Natural Resources, &

value has been impaired, Voltron Co. will record a loss and write down the book value of the goodwill.

Plant Assets, Natural Resources, & 531

(5-10 min.) E 7-52B

Req. 1 Net profit margin ratio for the years ended:

January 31, 2021

January 31, 2020

Net earnings Net sales

$ 4,200 = 5.00% $84,000

$ 4,050 = 4.90% $82,600

The net profit margin ratio improved slightly from 2020 to 2021.

Req. 2 Asset turnover for the years ended: Net sales Average total assets

January 31, 2021

January 31, 2020

$84,000 = $70,000

$82,600 = $69,450

1.20

1.19

The asset turnover improved slightly from 2020 to 2021.

Req. 3 Return on assets for the years ended: Net earnings Average total assets

January 31, 2021

January 31, 2020

$ 4,200 = 6.00% $70,000

$ 4,050 = 5.83 % $69,450

or 5.00% x 1.20

= 6.00% *

4.90% x 1.19

= 5.83 %

Plant Assets, Natural Resources, &

The return on assets improved from 2020 to 2021; the increase in the net profit margin ratio was mostly responsible for this. *difference due to rounding

Plant Assets, Natural Resources, & 533

(10 min.) E 7-53B a. Proceeds from sale of building (or disposal of $690,000 building).. b. Insurance proceeds from fire (or disposal of building)…. c. Renovation of store (or capital expenditures)……………..

(120,000)

d. Purchase of store fixtures (or capital expenditures)……..

240,000

(80,000)

Plant Assets, Natural Resources, &

Quiz Q754

Q755

Q756

[$510,000 / ($510,000 + $240,000) × ($2,800,000 + $1,100,000)] ÷ 15 = $176,800

Q757

Q758

DDB [($99,000 × 2/5) = $39,600; ($99,000 − $39,600) × 2/5] = $23,760 UOP ($99,000 − $9,000) /100,000 hrs. = $.90 × 27,000 hrs.) = $24,300

Q759

Q760

Q761

Q762

Q763

($27,000 − $8,000) / 5 × 2 = $7,600; ($27,000 − $7,600) / 8 = $2,425

SL depreciation = $1,680 [($9,800 – $1,400) / 5] Book value = $6,440 ($9,800 – $3,360)

Q764

$1,160 gain = $7,600 (sale price) − $6,440 (book value)

Q765

$960,000/$240,000 × (40,000) = $160,000

Q7-

$62 − ($80 − $24) = $6

66 Q767

$1,300,000 − $1,025,000

Plant Assets, Natural Resources, & 535

Q768

$54,000 / $360,000

Plant Assets, Natural Resources, &

Problems (20-30 min.) P 7-69A

Req. 1

ITEM

LAND

(a)

$263,500

(b)

8,800

(c)

LAND IMPROVEMENT SALES GARAGE S BUILDING BUILDING FURNITURE

$ 76,500 $ 31,400

(d)

1,100

(e)

5,800

(f)

1,900

(g)

700

(h)

87,800

(i)

518,000

(j)

37,100

(k)

9,900

(l)

6,100*

(m)

52,200

(n)

7,500

(o)

4,000

33,600

2,400

(p)

$79,000

(q)

1,000

Totals $279,200

$103,100

$650,000 $116,000

$80,000

Computations: (a) Land: $310,000 / $400,000 × $340,000 = $263,500 Garage building: $ 90,000 / $400,000 × $340,000 = $76,500 (o) Land improvements: $ 40,000 × .10 = $4,000 Copyright © 2022 Pearson Education Inc. Chapter 7 Intangibles

Plant Assets, Natural Resources, & 537

Sales building: Garage building:

$ 40,000 × .84 = $33,600 $ 40,000 × .06 = $2,400

_____ *Some accountants would debit this cost to the Land account.

Plant Assets, Natural Resources, &

(continued) P 7-69A

Req. 2 DATE

Journal ACCOUNT TITLES

Dec. 31 Depreciation Expense — Land Improvements ($103,100 / 15 × 9/12)

DEBIT

5,155 *

Accumulated Depreciation — Land Improvements

5,155

31 Depreciation Expense — Sales Building ($650,000 / 30 × 9/12) 16,25 0 Accumulated Depreciation — Sales Building

31 Depreciation Expense — Garage Building ($116,000 / 30 × 9/12) Accumulated Depreciation — Garage Building 31 Depreciation Expense — Furniture ($80,000 / 12 × 9/12) Accumulated Depreciation — Furniture

CREDI T

16,25 0

2,900 2,900

5,000 5,000

____ *$4,850 ($97,000 / 15 × 9/12) if $6,100 (l in Req. 1) is debited to Land.

Plant Assets, Natural Resources, & 539

(continued) P 7-69A

Req. 3 This problem shows how to determine the cost of a plant asset. It also demonstrates the computation of depreciation for

variety

businesses

use

plant

assets. assets,

Because a

virtually

manager

needs

all to

understand how those assets’ costs and depreciation amounts are determined. Depreciation affects net income. Managers need to understand the meaning, components, and

computation

net

income,

because

often

their

performance is measured by how much net income the business earns. This problem covers all these concepts with specific examples.

Student responses will vary.

Plant Assets, Natural Resources, &

(15 min.) P 7-70A

Req. 1 Journal ACCOUNT TITLES

DEBIT CREDIT

Equipment ................................................

109,00 0

Cash....................................................

109,00 0

Depreciation Expense — Buildings ............. Accumulated Depreciation — Buildings .

31,250

Depreciation Expense — Equipment ........... Accumulated Depreciation — Equipment

38,300

31,250 * 38,300 **

*($706,000 − $81,000) / 20 **[($406,000 − $269,000) × 2/10 + ($109,000 × 2/10 × 6/12)]

Req. 2 BALANCE SHEET Property, plant, and equipment: Land ................................................. Buildings ..........................................

$149,000 $ 706,000

Less: Accumulated depreciation ($342,000 + $31,250) ..............(373,250) 332,750 Equipment ($406,000 + $109,000) .....

$ 515,000

Plant Assets, Natural Resources, & 541

($269,000 + $38,300) ..............(307,300) Total property, plant, and equipment ....

207,700 $689,450

Plant Assets, Natural Resources, &

(25-35 min.) P 7-71A

Req. 1 DATE Jan.

Journal ACCOUNT TITLES

DEBIT CREDIT

3 Equipment (new) ......................... 171,000 Accumulated Depreciation — Equipment ................................. 63,000 Equipment (old) ....................... 130,00 0 Cash ........................................ 100,00 0 Gain on Exchange of Equipment [$71,000 – ($130,000 − 4,000 $63,000)] ....................................

June 30 Depreciation Expense — Building [($635,000 − $295,000) / 40 x 6/12]........................................... Accumulated Depreciation — Building ..................................

4,250

June 30 Cash ........................................... 135,000 Note Receivable .......................... 325,750 Accumulated Depreciation — Building ($170,000 + $4,250) ...... 174,250 Building................................... 635,00 0 Oct. 31 Land ($108,900 / $363,000 ×

102,000

$340,000) ....................................... Building ($254,100 / $363,000 × 238,000 $340,000) .......................................

Cash ........................................

340,00 0

Plant Assets, Natural Resources, & 543

Accumulated Depreciation — Equipment .............................. Dec. 31

Depreciation Expense — Building [($238,000 – $23,800) / 40 X 2/12]

68,400

893

Accumulated Depreciation — Building ................................. 893

Plant Assets, Natural Resources, &

(30-40 min.) P 7-72A

Req. 1 Straight-Line Depreciation Schedule Depreciation for the Year

DATE

ASSET COST

DEPRECIATION DEPRECIABLE RATE COST × =

DEPRECIATIO ACCUMULATED N DEPRECIATION EXPENSE

1-03-2021 $265,00 0

ASSET BOOK VALUE

$265,000

12-31-2021

1/5

$250,000

$50,000

$ 50,000

215,000

12-31-2022

1/5

250,000

50,000

100,000

165,000

12-31-2023

1/5

250,000

50,000

150,000

115,000

12-31-2024

1/5

250,000

50,000

200,000

65,000

12-31-2025

1/5

250,000

50,000

250,000

15,000

Asset cost: $230,000 + $1,000 + $6,000 + $28,000 = $265,000 Depreciation for each year: ($265,000 − $15,000) / 5 years = $50,000

Plant Assets, Natural Resources, & Intangibles

545

(continued) P 7-72A

Req. 1 Units-of-Production Depreciation Schedule Depreciation for the Year

DATE

1-03-2021

ASSET COST

DEPRECIATION NUMBER OF DEPRECIATION ACCUMULATE ASSET BOOK PER DOCUMENT EXPENSE D VALUE x DOCUMENTS DEPRECIATIO = N

$265,00 0

$265,000

12-31-2021

$2.00

30,000

$60,000

$ 60,000

205,000

12-31-2022

2.00

27,500

55,000

115,000

150,000

12-31-2023

2.00

25,000

50,000

165,000

100,000

12-31-2024

2.00

22,500

45,000

210,000

55,000

12-31-2025

2.00

20,000

40,000

250,000

15,000

Total documents

125,000

Depreciation per document: ($265,000 − $15,000) / 125,000 documents = $2.00

Plant Assets, Natural Resources, & Intangibles

(continued) P 7-72A

Req. 1 Double-Declining-Balance Depreciation Schedule Depreciation for the Year

DATE

ASSET COST

DDB RATE ×

ASSET BOOK VALUE =

DEPRECIATION ACCUMULATED EXPENSE DEPRECIATION

1-03-2021 $265,00 0

ASSET BOOK VALUE

$265,000

12-31-2021

.40*

$265,000

$106,000

159,000

12-31-2022

.40

159,000

63,600

169,600

95,400

12-31-2023

.40

95,400

38,160

207,760

57,240

12-31-2024

.40

57,240

22,896

230,656

34,344

19,344**

250,000

15,000

12-31-2025

*DDB rate = (1/5 years × 2) = 2/5 = .40 **Depreciation for 2025: $34,344 – $15,000 = $19,344

Plant Assets, Natural Resources, & Intangibles

547

(continued) P 7-72A

Req. 2

The depreciation method that maximizes reported income in the first year of the computer’s life is the straight-line method. Straight-line produces the lowest depreciation for that year ($50,000). The method that maximizes cash flow by minimizing income tax payments in the first year is the double-decliningbalance method (or MACRS depreciation when used for tax purposes),

which

produces

the

highest

depreciation

amount for that year ($106,000).

Req. 3

Net income for first year: Net cash provided by operations before income tax Depreciation expense

DEPRECIATION METHOD THAT IN THE EARLY YEARS MAXIMIZES MINIMIZES REPORTED INCOME TAX INCOME PAYMENTS SL DDB $157,000

$157,000

50,000

106,000

Income before income tax

107,000

51,000

Income tax expense (40%)

42,800

20,400

$ 64,200

$ 30,600

Chapter 7

Plant Assets &

income tax

$157,000 $157,000

Income tax paid

(42,800) (20,400)

Net cash provided by operations (called “cash flow”)

$114,200

Cash flow advantage of DDB over SL

Chapter 7

$136,600 $22,400

Plant Assets &

549

(20-25 min.) P 7-73A

Req. 1 Millions Cost of plant assets ......................

$4,833

Less: Accumulated depreciation .... (2,129) Book value, net.............................

$2,704

Req. 2 Evidences of the purchase of plant assets and goodwill: 1. Property, plant, and equipment increased on the balance sheet. 2. Goodwill increased on the balance sheet. 3. Statement of cash flows reports “Additions to property, plant, and equipment.”

Req. 3 Property, Plant, and Equipment 3/31/20 Bal.

Accumulated Depreciation

4,19 Cost of 6

Purchased

assets sold

during 2021

712

3/31/21 Bal.

4,83 3

in 2021

Accum. depr.

3/31/20 Bal. 1,723

of assets sold

Depr. during

in 2021

2021

3/31/21 Bal. 2,129

Goodwill 3/31/20 Bal.

512

Purchased during 2021

40*

473

Chapter 7

Plant Assets &

3/31/21 Bal.

552

_____ *Determined by deduction, since there was no loss on goodwill.

(continued) P 7-73A

Req. 4 2021

Cash......................................... Accumulated Depreciation— Property, Plant and Equipment................ Gain on Sale of Property, Plant and Equipment ......................... Property, Plant & Equipment.

Chapter 7

150 67 142 75

Plant Assets &

551

(20-30 min.) P 7-74A

Req. 1

Journal DATE ACCOUNT TITLES Iron Ore Rights............................... Cash ..........................................

DEBIT CREDIT 3,000,0 00 3,000,0 00

Iron Ore Rights............................... Cash ..........................................

70,000

Iron Ore Rights............................... Cash ..........................................

79,000

Iron Ore Rights...............................

38,200

70,000

79,000

Note Payable.............................. Iron Ore Inventory ..........................

38,200 471,440 *

Iron Ore Rights ........................... Accounts Receivable (28,500 × $39)

471,440 1,111,5 00

Sales Revenue............................

1,111,5 00

Cost of Iron Ore Sold (28,500 × $13.28) .......................................... Iron Ore Inventory ......................

378,480

Operating Expenses ....................... Cash ..........................................

258,000

Income Tax Expense (see Req. 2) ....

190,008

Chapter 7

378,480

258,000

Plant Assets &

Income Tax Payable ....................

190,008

*$3,000,000 + $70,000 +$79,000 + $38,200 = $3,187,200; $3,187,200 / 240,000 = $13.28 depletion per ton 35,500 tons × $13.28 = $471,440

Chapter 7

Plant Assets &

553

(continued) P 7-74A

Req. 2 Pacific Energy Company Income Statement — Iron Ore Operations Year 1 Sales revenue .............................. Cost of iron ore sold.....................

$1,111,50 0 $378,480

Other operating expenses ............

636,480 258,000

Income before tax ........................

475,020

Income tax expense (40%)............

190,008

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

$285,012

The iron ore operations were profitable. Net income of $285,012 on sales of $1,111,500 is quite high (26% of sales).

Req. 3

Iron ore inventory ($471,440 − $378,480) ......

Iron ore rights ($3,187,200 − $471,440).........

2,715,760

Accounts receivable ......................................

1,111,500

Income taxes payable ...................................

190,008

Note payable ................................................

38,200

Chapter 7

92,960

Plant Assets &

(30-40 min.) P 7-75A

Req. 1 To determine the gain or loss on the sale of a plant asset, compare the cash received to the asset’s book value, as follows:

Billions

Cash received from sale of asset ...............

$ 0.7

Book value of asset sold: Cost .....................................................

$ 1.2

Less: Accumulated depreciation ............

(.8) (0.4)

Gain (Loss) on sale ...................................

$ 0.3

Req. 2 Balance sheet at December 31, 2021: Property, plant, and equipment ($4.9 + $2.1 − $1.2) ............................................................................

$ 5.8

Less: Accumulated depreciation ($2.7 + $1.6 − $.8)

(3.5)

Property, plant, and equipment, net (book value) ...

$ 2.3

Req. 3 Statement of cash flows for 2021: Cash flows from operating activities: Net income ($26.0 − $21.6) ................................

$ 4.4

Adjustment to reconcile net income to net cash provided by operations: Depreciation expense ................................... Gain on sale of plant assets……………………………….

1.6 (0.3)

Cash flows from investing activities:

Chapter 7

Plant Assets &

555

Purchases of property, plant, and equipment ......... (2.1) Sales of property, plant, and equipment................. 0.7

Chapter 7

Plant Assets &

(20-30 min.) P 7-76A

Req. 1

Dec. 31, 2020

Dec. 31, 2019

Net income

$ 3,900

$ 3,600

÷ Net revenue

÷ $60,000

÷ $50,000

= Net profit margin ratio

Req. 2

$60,000

$50,000

÷ $55,675

÷ $45,150

1.08

1.11

Dec. 31, 2020

Dec. 31, 2019

$ 3,900

$ 3,600

÷ $55,675

÷ $45,150

Net income ÷ Average total assets = Return on assets

7.2%

Dec. 31, 2019

÷ Average total assets

Req. 3

Dec. 31, 2020

Sales

= Asset turnover

6.5%

7.00%

7.97%

Req. 4

The following contributed to the decrease in ROA during the most recent year.  Cost of goods sold (as a percent of sales) increased, causing gross profit (as a percent of sales) to decrease. Net profit margin ratio decreased.  Cost of goods sold grew faster than sales.  Total asset turnover decreased. Copyright © 2022 Pearson Education Inc. Intangibles

Chapter 7

Plant Assets &

557

(20-30 min.) P 7-77A

Req. 1 (amounts in millions) Property & Equipment 12/31/20 Bal.

25,6 X 70 =

Purchased during 2021 12/31/21 Bal.

Accumulated Depreciation

Cost of

Accum. depr. = X

12/31/20 Bal.

assets sold

of assets sold

Depr. during

in 2021

2021

1,690

12/31/21 Bal.

18,77 0

2,64 0 27,4 90

X = $820, cost of P & Eq. sold

X = $450, accumulated depreciation on P & Eq. sold

Req. 2 Cost –

$820

Acc. Depr.

– 450

Book value of assets $370

sold Sales

price Book

17,53 0

370

Chapter 7

Plant Assets &

value =

Loss on

$(320)

sale There is a loss because the sales price (proceeds) is less than the book value.

Chapter 7

Plant Assets &

559

(continued) P 7-77A

Req. 3 Cash Accumulated Depreciation – Prop. & Equipment Loss on Sale of Prop. & Equipment Property & Equipment

50 450 320 820

Assets decrease, liabilities unaffected, and stockholders’ equity decreases; revenues unaffected, expenses (losses) increase, and net income decreases. The total book value of $370 ($820 − $450) is $320 more than the sales price of $50. This is the same calculation as in Req. 2.

Req. 4 Property & Equipment, net 12/31/20 Book value, assets Bal. 8,140 370 sold 1,69 Depreciation Purchases 2,640 0 expense 12/31/21 Bal. 8,720

Chapter 7

Plant Assets &

(20-30 min.) P 7-78B

Req. 1 ITEM

LAND

(a)

$263,50 0

(b)

8,700

(c)

GARAGE

FURNITURE

$ 76,500 $ 31,500

(d)

1,000

(e)

5,100

(f)

LAND SALES IMPROVEMENTS BUILDING

1,700

(g)

500

(h)

31,480

(i)

510,000

(j)

40,140

(k)

9,000

(l)

6,200*

(m)

52,400

(n)

7,900

(o)

4,620

34,020

3,360

(p)

$79,800

(q)

2,600

$278,30 0 $104,320 Totals

$120,00 $585,000 0

$82,400

Computations: (a) Land: $310,000 / $400,000 × $340,000 = $263,500 Garage: $90,000 / $400,000 × $340,000 = $76,500 (o) Land improvements: $42,000 × .11 = $4,620 Sales building: $42,000 × .81 = $34,020 Garage: $42,000 × .08 = $3,360

Chapter 7

Plant Assets &

561

*Some accountants would debit this cost to the Land account.

Chapter 7

Plant Assets &

(continued) P 7-78B

Req. 2 Journal DATE

ACCOUNT TITLES

DEBIT

CREDI T

Dec. 31 Depreciation Expense — Land Improvements ($104,320 / 20 × 9/12) 3,912* Accumulated Depreciation — Land Improvements.....................

3,912

31 Depreciation Expense —Sales Building ($585,000 / 50 × 9/12) ....... 8,775 Accumulated Depreciation — Sales Building ............................. 31 Depreciation Expense — Garage ($120,000 / 50 × 9/12) .................... Accumulated Depreciation — Garage........................................ 31 Depreciation Expense — Furniture ($82,400 / 12 × 9/12) ...................... Accumulated Depreciation — Furniture ....................................

8,775

1,800 1,800

5,150 5,150

_____ *$3,680 ($98,120 / 20 × 9/12) if $6,200 (l in Req. 1) is debited to Land.

Chapter 7

Plant Assets &

563

(continued) P 7-78B

Req. 3 This problem shows how to determine the cost of a plant asset. It also demonstrates the computation of depreciation for

variety

businesses

use

plant

assets. assets,

Because a

virtually

manager

needs

all to

understand how those assets’ costs and depreciation are determined. Depreciation affects net income. Managers need

understand

computation

the

net

meaning,

income

components,

because

often

and their

performance is measured by how much net income the business earns. This problem covers all these concepts with specific examples.

Student responses will vary.

Chapter 7

Plant Assets &

(15 min.) P7-79B

Req. 1 Journal ACCOUNT TITLES

DEBIT CREDIT

Equipment ................................................ Cash .....................................................

109,000

Depreciation Expense — Buildings ............. Accumulated Depreciation — Buildings ...

30,950*

Depreciation Expense — Equipment ...........

37,700* *

109,00 0 30,950

Accumulated Depreciation — Equipment.

37,700

*($705,000 − $86,000) / 20 = $30,950] **[($403,000 − $269,000) × 2/10] + ($109,000 × 2/10 × 6/12) = $37,700]

Req. 2 BALANCE SHEET Property, plant, and equipment: Land ............................................... Buildings.........................................

$ 142,000 $705,0 00

Less: Accumulated Depreciation ($342,000 + $30,950)............... Equipment ($403,000 + $109,000) ...

(372,950 ) $512,0 00

332,050

Chapter 7

Plant Assets &

565

($269,000 + $37,700)...............

(306,700 )

Total property, plant, and equipment...

Chapter 7

205,300 $679,350

Plant Assets &

(25-35 min.) P 7-80B

Req. 1 DATE Jan.

Journal ACCOUNT TITLES

DEBIT

CREDI T

3 Equipment (new)................................ 180,00 0 Accumulated Depreciation — Equipment ........................................ 65,000 Equipment (old) .............................. 132,0 00 Cash............................................... 108,0 00 Gain on Exchange of Equipment\ ..... 5,000 [$72,000 − ($132,000 − $65,000)]

June 30 Depreciation Expense — Building [($660,000 − $220,000) / 40 × 6/12].... Accumulated Depreciation — Building.........................................

5,500 5,500

30 Cash .................................................. 105,00 0 Note Receivable ................................. 414,50 0 Accumulated Depreciation — Building ($135,000 + $5,500)............. 140,50 0 Building.......................................... 660,0 00 Oct. 31 Land [$147,000 / ($147,000 + $273,000) × 129,50 $370,000] ............................................ 0 Building [$273,000 / ($147,000 + $273,000) × 240,50 $370,000] .............................................. 0 Copyright © 2022 Pearson Education Inc. Intangibles

Chapter 7

Plant Assets &

567

Cash...............................................

370,0 00

Dec. 31 Depreciation Expense — Equipment ($180,000 × 2/10) ............. 36,000 Accumulated Depreciation — Equipment...................................... 36,000 31 Depreciation Expense — Buildings [($240,500 − (20% × $240,500)) / 40 × 2/12] ..............................................802 Accumulated Depreciation — Buildings ........................................

Chapter 7

Plant Assets &

802

(30-40 min.) P 7-81B

Req. 1 Straight-Line Depreciation Schedule Depreciation for the Year

DATE

1-022021 12-312021 12-312022 12-312023 12-312024 12-312025

ASSET COST

DEPRECIATIO DEPRECIABLE DEPRECIATIO ACCUMULATE ASSET BOOK N COST N D VALUE = RATE EXPENSE DEPRECIATIO  N

$310,000

$310,000 1/5

$275,000

$55,000

1/5

275,000

1/5

55,000

255,000

55,000

110,000

200,000

275,000

55,000

165,000

145,000

1/5

275,000

55,000

220,000

90,000

1/5

275,000

55,000

275,000

35,000

Asset cost: $270,000 + $1,800 + $6,900 + $31,300 = $310,000 Depreciation for each year: ($310,000 − $35,000) / 5 years = $55,000

Chapter 7

Plant Assets & Intangibles

569

(continued) P 7-81B

Req. 1 Units-of-Production Depreciation Schedule Depreciation for the Year

DATE

1-02-2021

ASSET COST

DEPRECIATION NUMBER OF PER DOCUMENT DOCUMENTS  =

DEPRECIATIO ACCUMULATE ASSET BOOK N D VALUE EXPENSE DEPRECIATIO N

$310,00 0

12-31-2021 12-31-2022 12-31-2023 12-31-2024 12-31-2025 Total documents

$310,000 $2.20 2.20 2.20 2.20 2.20

30,000 27,500 25,000 22,500 20,000 125,000

$66,000 60,500 55,000 49,500 44,000

$ 66,000 126,500 181,500 231,000 275,000

244,000 183,500 128,500 79,000 35,000

Depreciation per document: ($310,000 − $35,000) / 125,000 documents = $2.20 per document

Chapter 7

Plant Assets & Intangibles

(continued) P 7-81B

Req. 1 Double-Declining-Balance Depreciation Schedule Depreciation for the Year

DATE

1-02-2021 12-31-2021 12-31-2022 12-31-2023 12-31-2024 12-31-2025

ASSET COST

DDB RATE 

ASSET BOOK DEPRECIATIO ACCUMULATE ASSET BOOK VALUE N D VALUE = EXPENSE DEPRECIATIO N

$310,000 .40* .40 .40 .40

$310,000 186,000 111,600 66,960 40,176

$124,000 74,400 44,640 26,784 5,176

$ 124,000 198,400 243,040 269,824 275,000

$310,000 186,000 111,600 66,960 40,176 35,000

* DDB rate: (1/5 years × 2) = 2/5 = .40 ** Depreciation for 2025: $40,176 − $35,000 = $5,176

Chapter 7

Plant Assets & Intangibles

571

(continued) P 7-81B

Req. 2 The depreciation method that maximizes reported income in the first year of the computer’s life is the straight-line method, which produces the lowest depreciation for that year ($55,000). The method that maximizes cash flow by minimizing income tax payments in the first year is the double-declining-balance method (or MACRS depreciation when used for tax purposes) which produces the highest depreciation amount for that year ($124,000).

Req. 3 DEPRECIATION METHOD THAT IN THE EARLY YEARS MAXIMIZES MINIMIZES REPORTED INCOME TAX INCOME PAYMENTS

Net income for first year: SL Net cash provided by operations before income tax $154,000 Depreciation expense 55,000 Income before income tax 99,000 Income tax expense (35%) 34,650 Net income $ 64,350 Net income advantage of SL over DDB $44,850 Cash flow analysis for first year: Net cash provided by operations before income tax Copyright © 2022 Pearson Education Inc.

Chapter 1

$154,000

DDB $154,000 124,000 30,000 10,500 $ 19,500

$154,000

The Financial Statements 1-572

Income tax paid Net cash provided by operations (cash flow) Cash flow advantage of DDB over SL

Chapter 1

(34,650)

(10,500)

$119,350

$143,500

$24,150

The Financial Statements 1-573

(20-25 min.) P 7-82B

Req. 1

Millions Cost of plant assets ......................

$ 4,834

Less: Accumulated depreciation ....

(2,128)

Book value of plant assets.............

$ 2,706

Req. 3 Property, Plant, and Equipment 4/30/20 Bal.

Accumulated Depreciation

4,19 Cost of 3

Purchased

assets sold

during 2021

714

4/30/21 Bal.

4,83 4

in 2021

Accum. depr.

4/30/20 Bal. 1,730

of assets sold

Depr. during

in 2021

2021

4/30/21 Bal. 2,128

Goodwill 4/30/20 Bal.

519

Purchased during 2021

35*

463

Chapter 1

The Financial Statements 1-574

4/30/21 Bal.

554

_____ *Determined by deduction, since there was no loss on goodwill.

(continued) P 7-82B

Req. 4 2021

Cash......................................... Accumulated Depreciation— Property, Plant & Equipment ..... Gain on Sale of Property, Plant & Equipment ........................ Property, Plant & Equipment.

Chapter 1

142 65 134 73

The Financial Statements 1-575

(20-30 min.) P 7-83B

Req. 1

Journal ACCOUNT TITLES AND DATE EXPLANATION Iron Ore Rights ...........................

DEBIT 2,900,00 0

Cash .......................................

2,900,00 0

Iron Ore Rights ........................... Cash .......................................

68,000

Iron Ore Rights ........................... Cash .......................................

78,000

Iron Ore Rights ........................... Note Payable ..........................

38,750

Iron Ore Inventory ...................... Iron Ore Rights .......................

479,850*

Accounts Receivable (28,500 × $38) ........................................... Sales Revenue ........................

1,083,00 0

Cost of Iron Ore Sold (28,500 x $13.71)....................................... Iron Ore Inventory...................

390,735

Operating Expenses .................... Cash .......................................

256,000

Chapter 1

CREDIT

68,000

78,000

38,750

479,850

1,083,00 0

390,735

256,000

The Financial Statements 1-576

Income Tax Expense (see Req. 2) . Income Tax Payable ................

174,506 174,506

*$2,900,000 + $68,000 + $78,000 + $38,750 = $3,084,750; $3,084,750 / 225,000 = $13.71 depletion per ton 35,000 × $13.71 = $479,850

(continued) P 7-83B

Req. 2 Atlantic Energy Company Income Statement — Iron Ore Mine Project Year 1 Sales revenue .............................. $1,083,00 0 Cost of iron ore sold..................... $390,735 Operating expenses ..................... 256,000 646,735 Income before tax ........................ 436,265 Income tax expense (40%)............ 174,506 Net income .................................. $ 261,759 The Iron Ore Mine project was very profitable. Net income of $261,759 on sales of $1,083,000 (24%) is outstanding.

Req. 3

Iron ore inventory ($479,850 – $390,735) ....................................

Chapter 1

89,115

The Financial Statements 1-577

Iron ore rights ($3,084,750 – $479,850) ....................................

2,604,900

Accounts receivable .....................

1,083,000

Income tax payable ......................

174,506

Note payable ...............................

38,750

Chapter 1

The Financial Statements 1-578

(30-40 min.) P 7-84B

Req. 1

To determine the gain or loss on the sale of a plant asset, compare the cash received to the asset’s book value, as follows:

Billions $ 0.5

Cash received from sale of asset ................ Book value of asset sold: Cost ......................................................

$ .8

Less: Accumulated depreciation .............

(.7)

Gain (Loss) on sale ....................................

( 0.1) $ 0.4

Req. 2 Balance sheet at December 31, 2021: Property, plant, and equipment ($4.5 + $1.4 − $.8) Less: Accumulated depreciation ($3.4 + $1.0 − $.7) Property, plant, and equipment, net (book value)

$ 5.1 (3.7) $ 1.4

Req. 3 Statement of cash flows for 2021: Cash flows from operating activities: Net income ($27.1 − $22.1)..............................

$5.0

Adjustment to reconcile net income to net cash provided by operations: Depreciation ............................................ Gain on sale of plant assets…………………………… Copyright © 2022 Pearson Education Inc.

Chapter 1

1.0 (0.4)

The Financial Statements 1-579

Cash flows from investing activities: Purchases of property, plant, and equipment........ $(1.4) Sales of property, plant, and equipment ...............

Chapter 1

0.5

The Financial Statements 1-580

(20-30 min.) P 7-85B

Req. 1

Dec. 31, 2020

Net income

Dec. 31, 2019

$ 8,200

$ 6,370

÷ Net revenue

÷ $80,000

÷ $62,000

= Net profit margin ratio

Req. 2

10.25%

Dec. 31, 2020

Sales (net revenue)

$80,000

÷ Average total assets

÷ $39,500

Req. 3

Dec. 31, 2019 $62,000 ÷ $29,500

= 2.03

Asset turnover

Dec. 31, 2020

Net income

10.27%

2.1

Dec. 31, 2019

$8,200

$ 6,370

÷ Average total assets

÷ $39,500

÷ $29,500

= Return on assets

20.76%

21.59%

Req. 4

Chapter 1

The Financial Statements 1-581

 While net income increased slightly, the gross profit percentage decreased, thus decreasing the net profit margin ratio.  Assets increased, decreasing the asset turnover.

Chapter 1

The Financial Statements 1-582

(20-30 min.) P 7-86B

Req. 1 (Amounts in millions) Property & Equipment 12/31/20 Bal.

22,6 X 30 =

Purchased during 2021

2,36 0

12/31/21 Bal.

24,5 10

Accumulated Depreciation

Cost of

Accum. depr. = X

12/31/20 Bal.

assets sold

of assets sold

Depr. during

in 2021

2021

1,250

12/31/21 Bal.

16,77 0

X = $480, cost of P & Eq. sold

15,84 0

X = $320, accumulated depreciation on P & Eq. sold

Req. 2 Cost –

Acc. Depr.

= Book value of assets sold Sales price Book value = Loss on sale

$48 0 – 320 $16 0

$ 48 160 $(112)

Chapter 1

The Financial Statements 1-583

There is a loss because the sales price (proceeds) is less than the book value.

Chapter 1

The Financial Statements 1-584

(continued) P 7-86B

Req. 3 Cash………………………………………………………………… 48 Accumulated Depreciation – Property & 320 Equipment………. Loss on Sale of Property & 112 Equipment………………………. Property & Equipment ..................................... 480 Assets decrease, liabilities unaffected, and stockholders’ equity decreases; revenues unaffected, expenses (losses) increase, and net income decreases. The total book value of $160 ($480 − $320) is $112 more than the sales price of $48. This is the same calculation as in Req. 2.

Req. 4 Property & Equipment, net 12/31/20 6,79 Book value, assets Bal. 0 160 sold 2,36 1,25 Depreciation Purchases 0 0 expense 12/31/21 7,74 Bal. 0

Chapter 1

The Financial Statements 1-585

Challenge Exercises and Problem (15-20 min.) E 7-87

Net income under straight-line depreciation ..............................................

Millions

$52

Difference in depreciation for 2022 (year 2 of 8): Straight line depreciation, as reported ....

$18

DDB depreciation for year 2 (see below)..

Increase in depreciation expense ............

Decrease in net income ..............................

(9)

Net income Borzani can expect for 2022 if the company uses DDB depreciation ....

$43

DDB depreciation by year: Year 1 $144 × 2/8 ......................................... 2 ($144 − $36) × 2/8 ..............................

Chapter 1

Millions $36 27

The Financial Statements 1-586

(15-25 min.) E 7-88 Year 1

Millions of Euros (€) 1. Total current assets 2. Equipment, net 3. Net income

No effect €4.5 U* €4.5 U*

€3 U** €1.5 O

€1.5 U €1.5 O

Correct €1.5 O

_____ U = Understated O = Overstated *Cost (€6.0 million) − Depreciation expense (€1.5 million) = €4.5 million ** Cost (€6.0 million) − Two years’ depreciation (€3 million) = €3 million

Chapter 1

The Financial Statements 1-587

(20-30 min.) P 7-89

(All amounts in millions) Req.1

Property and Equipment

Bal 5/31/2020 (BS)

27,960

Capital expenditures (SCF) 3,440 Bal.5/31/2021 (BS)

250 Impairment loss 2,280 Original cost of plant and equipment sold (plug)

28,870

Accumulated Depreciation Acc. Depr. on assets sold 1,760

17,900

Bal. 5/31/2020 (BS)

2,000

Depr. exp. (note)

18,140

Bal 5/31/2021 (BS)

(plug)

Req. 2

Journal ACCOUNT TITLES AND DATE EXPLANATION Property and Equipment ............ Cash .................................... Depreciation Expense—Prop. & Equip.. ...................................... Accumulated Depreciation— Prop. & Equip………………………………….

Chapter 1

DEBIT

CREDIT

3,440 3,440 2,000 2,000

The Financial Statements 1-588

Serial Case (15-25 min.) C7-90

1. Assuming the Cheesecake Factory paid cash, total assets, total liabilities, and total equity would remain unchanged. The journal entry would be a debit to Leasehold Improvements, an asset, and the credit would be to Cash, also an asset. Another journal entry would debit Furnishings, Fixtures and Equipment and credit Cash. Therefore, total assets remain unchanged. No liability or equity accounts are impacted. 2. The costs of building and equipping the new restaurant would be found on the balance sheet. These costs are capital expenditures, therefore, they are capitalized. This means the costs are added to an asset account rather than being expensed immediately. The investing section of the statement of cash flows would also report the cost of building and equipping the new restaurant because it is a cash outflow. 3. The balance sheet and the income statement are both impacted by depreciation. When depreciation is recorded, Depreciation expense is debited and accumulated depreciation is credited. Depreciation Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-589

expense is found on the income statement while accumulated depreciation is on the balance sheet. The statement of cash flows also has an adjustment for depreciation expense in the operating activities section of the statement.

(continued) C7-90 4. a. $77,991 ($44,803 + $33,188) Cost of leasehold improvements ($7,965 x 75%) Less salvage value ($5,973,750 x 10%) Depreciable cost Divide by life in years Straight-line depreciation per year Partial depreciation for 1st year ($268,819 x 2/12) Cost of furniture, fixtures and equipment ($7,965 x 25%) Less salvage value ($1,991,250 x 10%) Depreciable cost Divide by life in years Straight-line depreciation per year Partial year deprecation for 1st year ($199,125 x 2/12)

$5,973,750 597,375 =5,376,375 20 $ 268,819 $ 44,803 $1,991,250 199,125 1,792,125 9 199,125 $ 33,188

Chapter 1

The Financial Statements 1-590

Leasehold improvements straight-line dep. per year FF&E straight-line depreciation per year Total depreciation per year

5. $7,419,065 ($5,660,128 + $1,758,937) Cost of leasehold improvements ($7,965,000 x 75%) Less 2019 depreciation Less 2020 depreciation Net book value Cost of furniture, fixtures, equipment ($7,965,000 x 25%) Less 2019 depreciation Less 2020 depreciation Net book value

Chapter 1

$268,819 $199,125 $467,944

$ 5,973,750 (44,803) (268,819) $ 5,660,128 $ 1,991,250 (33,188) (199,125) $ 1,758,937

The Financial Statements 1-591

Decision Cases (30-45 min.) C7-91

Req. 1 Bahama Bakery and Burgers Galore Income Statements For the Year Ended December 31 Bahama Bakery Burgers Galore ACCOUNT TITLE (FIFO and SL) (LIFO and DDB) Sales $350,00 $350,000 revenue…………………… 0 Cost of goods 149,000* sold…………….. 128,000* Gross 222,000 201,000 margin………………....... Operating $50,00 $50,00 expenses………....... 0 0 Depreciation expense Bahama (SL): [($150,000 − $20,000) / 10]. 13,000 Burgers (DDB): ($150,000 × 1/10 × 2)……... 30,000 Total 80,000 expenses………………….. 63,000 Income before 159,000 121,000 tax…………....... Income tax expense 48,400 (40%)……. 63,600 Net $ $ 72,600 income………………………. 95,400

Chapter 1

The Financial Statements 1-592

(Calculations follow)

Chapter 1

The Financial Statements 1-593

(continued) C7-91

Req. 1 *Cost of goods sold:

Units

Cost

Bahama (FIFO):

10,000

$ 40,000

5,000 7,000 3,000 25,000

× × ×

5 6 7

= = =

25,000 42,000 21,000 $128,000

Burgers (LIFO): 10,000 7,000 5,000 3,000 25,000

× × × ×

$7 6 5 4

= = = =

$ 70,000 42,000 25,000 12,000 $149,000

Req. 2 1. Bahama

Bakery’s

income

statement

reports

net

income of $95,400 compared to $72,600 for Burgers Galore. On the surface, Bahama Bakery appears to be more profitable. This difference is illusory, however, because Bahama uses the FIFO method to account for inventories and the straight-line method to account for depreciation of its plant assets. If prices continue to rise, use of these methods result in the highest possible reported income. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-594

Chapter 1

The Financial Statements 1-595

(continued) C7-91 2. Burgers Galore reports a lower net income than Bahama Bakery,

but

Burgers

has

cash

invest

promising projects because Burgers pays less in income taxes. Burgers uses the LIFO method for inventories and the double-declining-balance method for depreciation. These methods result in lower net incomes. More importantly, LIFO and DDB result in the lowest amount of income tax and thereby save money that Burgers can invest in new projects. 3. Over the long run we favor an investment in Burgers Galore because Burgers will have more cash to invest. That should result in higher real profits even if those profits

don’t

show

the

income

statement

immediately.

Student responses will vary.

Chapter 1

The Financial Statements 1-596

(20-30 min.) C7-92 1. A dishonest manager might debit an expense account for the cost of a plant asset for two reasons: (1) To obtain a quicker tax deduction for the expense than for depreciation expense over the life of the asset, and (2) To understate reported asset and income amounts. 2. A dishonest manager might debit the cost of an expense to a plant asset account in order to overstate reported asset and income amounts. Remember the WorldCom case discussed in the chapter. 3. We support the recording and reporting of intangible assets

cost,

less

accumulated

amortization,

accordance with GAAP because the business paid a price for intangibles like any other asset. The argument for recording intangibles at $1 or $0 is consistent with the perspective of a lender, who might reason that, in the liquidation of a business, most of its intangibles are worthless. However, accounting serves other users besides

lenders.

Also,

someone

who

evaluates

company and believes its intangibles are worthless can simply subtract the intangibles’ cost from total assets and from total owners’ equity to compute revised totals for analytical purposes. But the reverse is not true. If Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-597

intangibles were not reported on the balance sheet, a user of the statements who believes the intangibles have value could not add the unknown amount to compute revised total assets and total owners’ equity. Student responses will vary.

Chapter 1

The Financial Statements 1-598

Ethical Issue C7-93

Req. 1

The ethical issue in this case is “What is the proper amount of the purchase price to allocate to the land and the proper amount to allocate to the building?” The taxpayer wants to allocate as much of the purchase price as possible to the building because tax laws allow a deduction from taxable income for depreciation expense on plant assets other than land. The greater the allocation to the building, the greater the depreciation deduction, and therefore the lower the tax payments because there is no tax deduction on the land. The cost of the land is not depreciated.

Req. 2 and Req. 3 The stakeholders in this situation include Toledo National Bank, their management, their shareholders, the Internal Revenue Service, creditors, and taxpayers in general.

The

immediate economic consequences of the decision are positive

for

management.

Toledo

National

Bank

well

their

However, those consequences, as well as

legal consequences, could ultimately turn negative for them if an IRS audit finds them to be unlawfully evading taxes. Toledo

National

Bank’s

allocation

was

unethical.

The

Chapter 1

The Financial Statements 1-599

is fraud to knowingly misrepresent the value of your assets. This could lead to criminal charges or further criminal behavior.

Req. 4 Toledo National Bank should change the allocation of their purchase price to 60% building and 40% land.

In the long

run, for fair and equitable

(continued) C7-93 treatment for all taxpayers, as well as the best economic and legal outcome, there is nothing like the truth.

Chapter 1

The Financial Statements 1-600

Focus on Financials: Apple Inc. (30-40 min.)

Req. 1 Property, Plant and Equipment includes buildings, land, machinery,

equipment,

leasehold

improvements

and

internal-use software.

Req. 2 Note 1 states that the depreciation method used for the financial statements is the straight-line method.

Note 1

does not state the method used for income-tax purposes, but Apple most likely uses the Modified Accelerated Cost Recovery System (MACRS). This

method

preferable

for

income-tax

purposes

because it provides the most depreciation expense as quickly

possible.

This

decreases

immediate

tax

payments and saves cash for use in the business.

Req. 3 Millions

Depreciation (and amortization) expense $11,300 Accumulated depreciation and amortization

Chapter 1

$ 58,579

The Financial Statements 1-601

Depreciation (and amortization) expense on property and equipment of $11.3 billion includes the straight-line, annual

depreciation

software,

amount

equipment,

and

Accumulated

depreciation

and

expense

for

depreciation

and

leasehold and

amortization only

the

buildings,

machinery,

improvements.

amortization expense

current

amortization

exceeds

because

the

year.

Accumulated

the

sum

the

depreciation and amortization amounts for all years the company has used its property and equipment. Focus on Analysis: Under Armour, Inc. (20-30 min.)

Req. 1 Under Armour, Inc. paid about $146 million for capital expenditures during fiscal 2019. This information is found in the investing activities section of the cash flows statement.

Req. 2 Depreciation and amortization are calculated using the straight-line method over the following useful lives: 3-10 years for furniture, office equipment, software and plant equipment; 10-35 years for site improvements, buildings, and building equipment; 3 years for in-store fixtures and

Chapter 1

The Financial Statements 1-602

displays; and the shorter of useful life or lease term for leasehold and tenant improvements.

Req. 3 Under Armour includes the following categories in its property, plant and equipment: leasehold and tenant improvements; furniture, fixtures, and displays; buildings; software; office and plant equipment; land; construction in

progress;

and

other.

The

company

recorded

depreciation and amortization expense of property, plant and equipment of $177.3 million for 2019 and $173.4 million for 2018. To estimate the age of the property and equipment, we compute the ratio of accumulated depreciation to the cost of the property and equipment.

(continued) Under Armour, Inc. 2019

2018

$810,119

$655,595

Age: Accumulated Depreciation ÷

Cost

$1,602,267

$1,482,463

50.6%

Chapter 1

44.2%

The Financial Statements 1-603

Based on this ratio, the property and equipment is slightly newer in 2018 when compared to 2019. At December 31, 2018, 44.2% of the fixed assets are used up. At December 31, 2019, 50.6% of the fixed assets are used up.

Req. 4 As a part of the 2018 and 2017 restructuring plans, the Company abandoned the use of several assets included within Property and equipment, resulting in an impairment charge of $12.1 million and $30.7 million during the years ended December 31, 2018 and 2017, respectively, reducing the carrying value of these assets to their estimated fair values. Fair value was estimated using an incomeapproach based on management’s forecast of future cash flows expected to be derived from the asset's use. An impairment loss occurs when the expected future cash flows from a long-term asset fall below the asset’s book value. If an asset is impaired, the company is required to adjust the book value downward to its fair value. An impairment loss reduces net income. For the year ending December 31, 2018, income was reduced $12.1 million due to the impairment loss associated with property and equipment. For the year ending December 31, 2017, income was reduced $30.7 million for the same reason. (continued) Under Armour, Inc.

Req. 5 Under Armour records intangibles when it acquires user base,

technology,

customer

relationships,

Chapter 1

another

The Financial Statements 1-604

business.

The

company

lists

definite-lived

intangible

assets that include user base, technology,

customer

relationships, lease-related intangible assets, nutrition database and other. The company also has goodwill and other indefinite-life assets. Definite-life and indefinite-life intangible assets are recorded at fair value at the date of acquisition. Goodwill and other indefinite-life intangible assets are not amortized but are subject to annual (or sooner) tests for impairment.

Definite-life intangible

assets are amortized and also tested for impairment. During 2017 and 2018, the company made strategic decisions during the third quarter to abandon the use of certain intangible assets in the Company's Connected Fitness reporting unit. These intangible assets included technology and brand names, resulting in total intangible asset impairment charges of $12.1 million in 2017, reducing the carrying value of these assets to their estimated fair values. Fair value was estimated using an income-approach based on management’s forecast of future cash flows expected to be derived from the asset's use. In addition, the Company also made the strategic decision to not pursue certain other planned future revenue streams in connection with the 2017 restructuring plan. The Company determined sufficient evidence existed to trigger the examination of an interim goodwill impairment for the Company’s Connected Fitness reporting unit. Using updated cash flow projections, the Company calculated the fair value of the Connected Fitness reporting unit based on the discounted cash flows model. The Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-605

(continued) Under Armour, Inc. carrying value exceeded the fair value, resulting in an impairment of goodwill. As the excess of the carrying value over the fair value for the Connected Fitness reporting unit was greater than the goodwill for this reporting unit, the Company recorded a goodwill impairment of $28.6 million, which represented all of the goodwill for this reporting unit. In all, the company incurred $203.9 million in restructuring costs in 2018 and $129.1 million of these costs in 2017. These costs were treated as losses and charged against income in these years, and were the principal cause of the company’s net losses on the income statement during those years.

Req. 6 (in millions) The Dupont formula: Net profit margin ratio: Net income (loss) ÷

Sales

2018

$92

$(46)

$5,267

1.75%

Asset turnover ratio: Sales ÷ Average total assets

2019

5,193 =

(0.9)%

2019

2018

$5,267

$5,193

÷($4,844 + $4,245) / ÷ ($4,245 + $4,006) 2 /2

Chapter 1

The Financial Statements 1-606

= Return on assets

1.16

1.75% x 1.16 =

1.26

(0.9)% x 1.26=

2.03%

(1.13)%

(continued) Under Armour, Inc. From this analysis, we can see that the company’s net profit margin ratio was negative in 2018 due to the impairment losses.

This ratio improved slightly in 2019,

because the company turned a profit in that year.

Asset

turnover declined in 2019 from 2018, indicating the company became less efficient in the use of its assets, producing fewer sales per dollar invested.

From a

profitability standpoint, the company is still producing far less return on its assets than it once did, and the company is also regarded as a relatively weak performer in its industry. Using return on assets, the company performed better

2019

Chapter 1

than

2018.

The Financial Statements 1-607

Group Projects Student responses will vary.

Chapter 8 Current and Contingent Liabilities Ethics Check (5-10 min.) EC 8-1 a. Due care b. Integrity c. Objectivity and independence d. Integrity

Chapter 1

The Financial Statements 1-608

Short Exercises (5-10 min.) S 8-1 1. Accrued warranties payable 2. Accrued income tax payable 3. Accounts payable 4. Accrued payroll taxes payable, FICA tax payable, State unemployment tax payable, Federal unemployement tax payable, Employee income tax payable 5. Notes payable (short-term) 6. Unearned (deferred) revenue 7. Accounts payable 8. Accrued salaries payable

(5-10 min.) S 8-2 Cost of goods sold…………………………………………

$55,000

Add: Ending inventory……….……………………………

14,500

Less: Beginning balance of inventory…………………. $12,000 Purchases from suppliers ……………………………....

Chapter 1

$57,500

The Financial Statements 1-609

Alternatively, from the T-account for Inventory: Inventory Beg. bal. 12,000 Purchase X s

Cost of goods sold 55,000

End. bal. 14,500 Solving for X, Purchases from suppliers = $57,500

Chapter 1

The Financial Statements 1-610

(5-10 min.) S 8-3 Beginning accounts payable $50,000 Ending accounts payable 54,000 Average accounts payable [($50,000 + $54,000)/ 2] $52,000 Cost of goods sold ÷ Average accounts payable =

times $1,508,000 ÷ $52,000 Days’ payable outstanding (365 / 29)

12.59

days Landy Corporation took an average of 12.59 days to pay its suppliers.

Since the credit terms are n/30, Landy is

paying ahead of schedule, which is usualy characteristic of a company with great liquidity.

(5-10 min.) S 8-4 Journal DATE

ACCOUNT TITLES AND EXPLANATION

Chapter 1

CREDI DEBIT T

90,00

The Financial Statements 1-611

0 Note Payable, Short-Term............

90,00 0

Purchased inventory by issuing a note payable. Dec. 31 Interest Expense ($90,000 × .08 × 7/12) ............................................... Interest Payable .......................... Accrued interest for 7 months at year-end.

4,200 4,200

(5-10 min.) S 8-5 Journal DATE

ACCOUNT TITLES AND EXPLANATION

2021 Jan. 1 Inventory ........................................

DEBIT

CREDI T

25,00 0

Note Payable, Short-Term............

25,00 0

Purchased inventory by issuing a note payable. July

1 Note Payable, Short-Term ................ Interest Expense ($25,000 × .12 × 6/12) ............................................... Cash ...........................................

25,00 0 1,500 26,50 0

Chapter 1

The Financial Statements 1-612

Req. 1 DAT E

Journal ACCOUNT TITLES AND EXPLANATION Cash ($641,000 × .15).................... Notes Receivable ($641,000 − $96,150) ....................................... Sales Revenue ...........................

DEBIT CREDIT 96,150 544,85 0 641,00 0

To record sales and receipt of cash and notes receivable. Warranty Expense ($641,000 × .03) Accrued Warranty Payable ......... To accrue warranty expense.

19,230

Accrued Warranty Payable ............. Cash ......................................... To pay warranty claims.

18,500

19,230

18,500

Req. 2 Accrued Warranty Payable Bal. 14,000 18,500 19,230 Bal. 14,730

Chapter 1

The Financial Statements 1-613

(5-10 min.) S 8-7 Warranty expense = $19,230 The expense recognition (matching) principle addresses this situation. The warranty expense for the year does not necessarily equal the year’s cash payments for warranties. Cash payments for warranties do not determine the amount of warranty expense for that year. Instead, the warranty expense is estimated and matched against total sales during the period of the sale, regardless of when the company pays for warranty claims. Student responses may vary.

Chapter 1

The Financial Statements 1-614

Chapter 1

The Financial Statements 1-615

(10-15 min.) S 8-8

$$ Per day

$$ Portion in 2020

Total wages paid

112,00 0 8,000*

96,000

Employee taxes withheld

1,115* 15,610 *

13,380

Total $$

FICA Gross Wages Expense Number of days in pay period Number of days in pay period in 2020

12,600 900*** 10,800 140,21 10,01 0 5 120,180 14 12

*$112,000 /14 days = $8,000/day; $8,000 × 12 days = $96,000 **$15,610 /14 days = $1,115; $1,115 x 12 days = $13,380 ***12,600 / 14 days = $900; $900 x 12 days = $10,800 December 31, 2020 journal entry: Journal DATE

ACCOUNT TITLES AND EXPLANATION

2020 Dec. 31 Wages Expense ............................... Employee Income Tax Payable ..... FICA Tax Payable......................... Wages Payable............................ Copyright © 2022 Pearson Education Inc.

Chapter 1

CREDI DEBIT T

120,1 80 13,38 0 10,80 0 96,00 0

The Financial Statements 1-616

(5-10 min.) S 8-9 1. These are contingent liabilities, because, at the time of the note, Martinson Cycles, Inc., was not liable for any of these product losses. 2. In the United States, the contingency can become a real liability if a user of a Martinson Cycles, Inc., product suffers a loss for which the company is responsible. Martinson Cycles, Inc., must pay for all individual losses up to $3.8 million and all individual losses above $26.3 million. The company is insured against individual losses between $3.8 million and $26.3 million. 3. Outside the United States, the contingency becomes a real liability the same way — if a Martinson Cycles, Inc., user

suffers

loss

for

which

Chapter 1

the

company

The Financial Statements 1-617

responsible. Outside the United States, the company is insured for product liability up to $26.3 million per individual claim and in the aggregate. Outside the United States, Martinson Cycles, Inc., must pay only for losses above $26.3 million because the company is insured against losses up to $26.3 million per individual claim and in the aggregate.

Chapter 1

The Financial Statements 1-618

12. Bot-ready 13. Bot-ready 14. Manual 15. Bot-ready 16. Bot-ready (5-10 min.) S8-11 a. Check mark

f. Check mark

b. Check mark

g. Check mark

c. No check mark

h. No check mark

d. Check mark

I. No check mark

e. Check mark

j. Check mark

Exercises (20-30 min.) E 8-12A

Req. 1 Accounts payable are amounts owed to suppliers for products

services

that

have

been

purchased

account.

Chapter 1

The Financial Statements 1-619

Accrued expenses are expenses that the company has incurred but not yet paid. They are liabilities for expenses such as interest and income taxes. Accrued

employee

compensation

and

benefits

are

amounts owed to employees for salaries and other payrollrelated expenses. Current portion of long-term debt is next year’s payment on the company’s long-term debt. Long-term debt is the amount of long-term notes and bonds payable that the company expects to pay after the coming year. Post-retirement

benefits

payable

are

the

company’s

liabilities for providing benefits — mainly health care — to retirees. The other liabilities are a catch-all group of liabilities that do not fit one of the more specific categories. The other liabilities are long-term, as shown by the fact that they are not listed among the current liabilities.

Chapter 1

The Financial Statements 1-620

(continued) E 8-12A

Req. 2 Total assets =

$3,782 million, the sum of total liabilities and stockholders’ equity.

Req. 3 Accounts payable turnover

Days’ payable outstanding Current ratio

2021 Cost of goods sold Average Accounts payable 365 Accts. payable turnover Current assets Current liabilities

2020

$2,656 = $166* 16.0

$2,046 $186** = 11.0

*($148 + $184) / 2

**($184 + $188) /2

365 16

$656 $314

= 22.8 (23 days)

= 2.09

365 11.0

$591 $411

= 33.2

= 1.44

The company’s ability to cover accounts payable and current liabilities over the year improved in 2021.

Chapter 1

The Financial Statements 1-621

Chapter 1

The Financial Statements 1-622

(5-10 min.) E 8-13A

Req. 1 2021

2020

Accounts payable turnover: Purchases* Average accounts payable

$3,100,000 = 10.9 $285,000

$3,050,000 =12.7 $240,000

365 = 33.5 days 10.9

days

Days payable outstanding: 365 Accounts payable turnover

365

= 28.7

12.7

*Purchases = COGS + Ending inventory – Beginning inventory 2021 = $2,850,000 + $650,000 – $400,000 = $3,100,000 2020 = $2,900,000 + $400,000 – $250,000 = $3,050,000

Req. 2 The company’s liquidity position has deteriorated during 2021.

Chapter 1

The Financial Statements 1-623

(15-20 min.) E 8-14A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

2022 Aug. 1 Inventory ........................................

CREDI DEBIT T

40,00 0

Note Payable, Short-Term............

40,00 0

Purchased inventory by issuing a note payable.

Req. 2 Dec.

31 Interest Expense ($40,000 × .06 × 5/12) ............................................... Interest Payable .......................... Accrued interest expense.

1,000 1,000

Chapter 1

The Financial Statements 1-624

Interest payable 1,000

Req. 4 2023 Feb. 1 Note Payable, Short-Term ................ Interest Payable .............................. Interest Expense ($40,000 × .06 × 1/12) ............................................... Cash ...........................................

40,00 0 1,000 200 41,20 0

Paid note payable and interest at maturity.

Chapter 1

The Financial Statements 1-625

(5-10 min.) E 8-15A

Req. 1 Accrued interest, Dec. 31, 2021

$58,000 × .04 × 6/12

$1,160

$58,000 + ($58,000 × .04) =

$60,320

Req. 2 Final payment on July 1, 2022

Req. 3

Interest expense for: 2021 =

$58,000 × .04 × 6/12

$1,160

2022 =

$58,000 × .04 × 6/12

$1,160

Chapter 1

The Financial Statements 1-626

(10-15 min.) E 8-16A Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

31 Inventory ........................................

30,00 0

CREDI T

2021 a. July

Note Payable, Short-Term............

30,00 0

Purchased inventory by issuing a note payable. 2022 b. Apr. 30 Interest Expense ($30,000 × .06 × 9/12) ............................................... Interest Payable .......................... Accrued interest expense. c. July

31 Note Payable, Short-Term ................ Interest Payable .............................. Interest Expense ($30,000 × .06 × 3/12) ............................................... Cash ...........................................

1,350 1,350

30,00 0 1,350 450 31,80 0

Paid note payable and interest at maturity. d.

Chapter 1

The Financial Statements 1-627

Current liabilities: Note payable, short-term

$30,000

Interest payable

1,350

Income Statement, For the Year Ended April 30, 2022: Interest expense

$1,350

(5-15 min.) E 8-17A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

Warranty Expense ($110,000 × .08) ................................................... Accrued Warranty Payable .......

8,800

Accrued Warranty Payable ........... Cash .......................................

7,500

8,800 7,500

Req. 2 INCOME STATEMENT Sales revenue ........................................

$110,000

Warranty expense ..................................

8,800

BALANCE SHEET Current liabilities

Chapter 1

The Financial Statements 1-628

Accrued warranty payable ($3,500 + $8,800 − $7,500)..............

4,800

Req. 3 Accrued warranty payable, a current liability, will cause a company’s current ratio to decrease.

(10-15 min.) E 8-18A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

CREDI DEBIT T

2021 Oct. 1 Cash ................................................ 1,980 Unearned Subscription Revenue .... Sales Tax Payable ($1,800 × .10) ... Nov.

Dec.

1 Sales Tax Payable ............................. 5 Cash .............................................

180

3 Unearned Subscription Revenue ........ 1 Subscription Revenue ($1,800 × 3/12) ................................................

450

Chapter 1

1,800 180

180

The Financial Statements 1-629

450

BALANCE SHEET Current liabilities: Unearned subscription revenue ($1,800 − $450)

$1,350

(10 min.) E 8-19A INCOME STATEMENT Expenses: Salary & wage expense.................................

$150,000

Payroll tax expense ($150,000 × .10) ............

15,000

BALANCE SHEET Current liabilities: Salary payable .............................................

$8,000

Payroll tax payable.......................................

1,000

Chapter 1

The Financial Statements 1-630

Req. 1

(15-20 min.) E 8-20A Robson Electronics Balance Sheet (partial) March 31, 2021

Current liabilities: a.

Accrued warranty payable [$32,000 + ($2,050,000 × .09) − $53,000]

$163,50 0

Current portion of long-term note payable 11,000 Interest payable ($55,000 × .03 × 1/12) ....

138

c. Unearned sales revenue ($125,000 − $90,000) .......................................................

35,000

Employee income tax payable...................

30,500

FICA tax payable ($280,000 × .0765 × 2)...

42,840*

Total current liabilities ........................

$282,97 8

Long-term liabilities: Note payable ($55,000 − $11,000) ............

$ 44,000

*Federal income tax laws require that both the employer and the employee pay 7.65% FICA tax on the employees’ wages.

Chapter 1

The Financial Statements 1-631

(5-10 min.) E 8-21A

Req. 1 Pine Security Systems should report this situation in a note to the financial statements. It is the company’s policy to disclose legal situations where it is reasonably possible a liability has been incurred.

Our lawyers believe a

product liability case is reasonably possible to result in a significant legal judgment against the company.

Req. 2 Pine would report an accrued expense on the income statement and the related liability on the balance sheet.

Chapter 1

The Financial Statements 1-632

(10-20 min.) E 8-22B

Req. 1

Accounts payable are amounts owed to suppliers for products

services

that

have

been

purchased

account. Accrued expenses are expenses that the company has incurred but not yet paid. They are liabilities for expenses such as interest and income taxes. Accrued

employee

compensation

and

benefits

are

Chapter 1

The Financial Statements 1-633

Post-retirement

benefits

payable

are

the

company’s

(continued) E 8-22B

Req. 2

Total assets = $4,453 million, the sum of total liabilities and stockholders’ equity.

Req. 3 Accounts payable turnover

2021 Cost of goods sold Average accounts payable

$1,704 $142*

= 12.0

*($174 + $110) / 2 Days payable outstanding

365 Accts. payable

2020 $1,239 $177**

= 7.0

**($180 + $174) / 2

365 12.0

= 30.4 (30

365 7.0

Chapter 1

The Financial Statements 1-634

= 52.1 (52 days)

turnover Current ratio

Current assets Current liabilities

days) $663 $308

= 2.15

$613 $361

= 1.7

The company’s ability to cover accounts payable and current liabilities over the year improved.

Chapter 1

The Financial Statements 1-635

(5-10 min.) E 8-23B

Req. 1 Accounts payable turnover: Purchases* Average accounts payable

2021

2020

$3,050,000 = 10.0 $305,000

$2,900,000 = 11.4 $255,000

Days payable outstanding: 365 Accounts payable turnover

365 = 36.5 10.0

365 32.0 11.4

*Purchases = COGS + Ending inventory – Beginning inventory 2021 = $2,850,000 + $800,000 – $600,000 = $3,050,000 2020 = $2,700,000 + $600,000 – $400,000 = $2,900,000

Req. 2 The company’s liquidity position has deteriorated during 2021.

Chapter 1

The Financial Statements 1-636

(15-20 min.) E 8-24B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

2022 Sept. 1 Inventory ........................................

CREDI DEBIT T

63,00 0

Note Payable, Short-Term............

63,00 0

Purchased inventory by issuing a note payable.

Req. 2 Dec.

31 Interest Expense ($63,000 × .08 × 4/12) ............................................... Interest Payable .......................... Accrued interest expense.

1,680 1,680

Chapter 1

The Financial Statements 1-637

Req. 4 2023 Mar. 1 Note Payable, Short-Term ................

63,00 0 1,680 840

Interest Payable .............................. Interest Expense ($63,000 × .08 × 2/12) ............................................... Cash ...........................................

65,52 0

Paid note payable and interest at maturity.

(5-10 min.) E 8-25B

Req. 1 Interest to accrue at

$56,000 × .07 × 9/12

= $2,940

Dec. 31, 2021

Req. 2 Final payment = on April 1, 2022

$56,000 + ($56,000 × .07)

= $59,920

Chapter 1

The Financial Statements 1-638

Interest expense for: 2021 = $56,000 × .07 ×

$2,940

9/12 2022 =

$56,000 × .07 ×

980

3/12

(10-15 min.) E 8-26B Journal DATE

ACCOUNT TITLES AND EXPLANATION

a. 2021 July 31 Inventory ........................................ Note Payable, Short-Term............

CREDI DEBIT T

30,00 0 30,00 0

Chapter 1

The Financial Statements 1-639

note payable. b. 2022 Apr. 30 Interest Expense ($30,000 × .04 × 9/12) ............................................... Interest Payable .......................... Accrued interest expense. c. July 31 Note Payable, Short-Term ................ Interest Payable .............................. Interest Expense ($30,000 × .04 × 3/12) ............................................... Cash ...........................................

900 900 30,00 0 900 300 31,20 0

Paid note payable and interest at maturity. d.

Balance Sheet on April 30, 2022: Current liabilities: Note payable, short-term

$30,000

Interest payable

900

Income Statement, For the Year Ended April 30, 2022: Interest expense

$900

Chapter 1

The Financial Statements 1-640

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

Warranty Expense ($104,000 × .08) 8,320 Accrued Warranty Payable.........

8,320

Accrued Warranty Payable ............. 7,500 Cash .........................................

7,500

Req. 2 INCOME STATEMENT Sales revenue .........................................

$104,000

Warranty expense ...................................

8,320

BALANCE SHEET Current liabilities Accrued warranty payable ($5,500 + $8,320 − $7,500) ................

$ 6,320

Req. 3 Accrued warranty payable, a current liability, will cause a company’s current ratio to decrease.

Chapter 1

The Financial Statements 1-641

(10-15 min.) E 8-28B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

2021 Oct. 1 Cash................................................ Unearned Subscription Revenue ...

2,226 2,10 0 126

Sales Tax Payable ($2,100 × .06) .. Nov.

Dec.

CREDI T

1 Sales Tax Payable ............................ 5 Cash ............................................

126

3 Unearned Subscription Revenue ....... 1 Subscription Revenue ($2,100 × 3/12) ...............................................

525

126

525

BALANCE SHEET Current liabilities: Unearned subscription revenue ($2,100 − $525).

$1,575

(10 min.) E 8-29B INCOME STATEMENT Expenses: Salary & wage expense.................................

$170,000

Payroll tax expense ($170,000 × .09) ............

15,300

Chapter 1

The Financial Statements 1-642

BALANCE SHEET Current liabilities: Salary payable .............................................

$ 7,800

Payroll tax payable.......................................

850

Chapter 1

The Financial Statements 1-643

Req. 1

(15-20 min.) E 8-30B Western Electronics Balance Sheet (partial) March 31, 2021

Current liabilities: a.

Accrued warranty payable [$37,000 + ($2,400,000 × .09) − $59,000]

$194,00 0

Current portion of long-term note payable ...

4,000

Interest payable ($20,000 × .06 × 1/12) .......

100

c. Unearned sales revenue ($140,000 − $55,000)...........................................................

85,000

30,500

Employee income tax payable ...................... FICA tax payable ($260,000 × .0765 x 2).......

39,780* Total current liabilities ............................

$353,38 0

Long-term liabilities: Note payable ($20,000 − $4,000) .................

$ 16,000

*Federal income tax laws require that both the employer and the employee pay 7.65% FICA tax on the employees’ wages.

Chapter 1

The Financial Statements 1-644

(5-10 min.) E 8-31B

Req. 1 Diamond Security Systems should report this situation in a note to the financial statements. It is the company’s policy to disclose legal situations where it is reasonably possible a liability has been incurred.

Our lawyers believe a

product liability case is reasonably possible to result in a significant legal judgment against the company.

Req. 2 Diamond would report an accrued expense on the income statement and the related liability on the balance sheet.

Chapter 1

The Financial Statements 1-645

Quiz

Q8-32

Q8-33

Q8-34

Q8-35

Q8-36

Q8-37

Q8-38

Q8-39

Q8-40

Q8-41

Q8-42

Q8-43

Q8-44

Q8-45

Chapter 1

The Financial Statements 1-646

Problems (15-20 min.) P8-46A

Req. 1 a. Sales tax payable ($120,000 × .05) ...................

$6,000

b. Note payable, short-term.................................. $86,000 Interest payable ($86,000 × .06 × 4/12) ............

$1,720

c. Unearned service revenue ($2,400 × 2/6) ..........

$800

d. Accrued warranty payable ($11,800 + $34,000 − $34,500) .................... $11,300 e. Portion of long-term note payable due within one year............................................ $30,000 Interest payable ($90,000 × .10) ....................... $9,000

Chapter 1

The Financial Statements 1-647

(30-40 min.) P 8-47A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDI T

2021 Mar. 3 Inventory ....................................... 65,000 Note Payable, Short-term ........... 65,00 0 May 31 Cash............................................... 105,00 0 Note Payable, Short-term ........... 105,0 00 Sept. 3 Note Payable, Short-term................ 65,000 Interest Expense ($65,000 × .08 × 6/12) .............................................. 2,600 Cash ..........................................

67,60 0

Dec. 31 Warranty Expense ($193,000 × .015) .............................................. 2,895 Accrued Warranty Payable..........

2,895

31 Interest Expense ($105,000 × .06 × 7/12) .............................................. 3,675 Interest Payable.........................

3,675

Chapter 1

The Financial Statements 1-648

Interest Expense ($105,000 × .06 × 5/12) .............................................. 2,625 Cash ..........................................

111,3 00

(20-30 min) P 8-48A

Req. 1 Current liabilities: Accounts payable

$225,000

4% Note payable due 4/30/22

150,000

5% Note payable due 12/31/22

200,000

Current portion of long-term bonds payable

100,000

Salaries payable

84,000

FICA tax payable

7,000

Employee income tax payable

27,000

Interest payable

29,000

Sales tax payable

67,000

Chapter 1

The Financial Statements 1-649

Unearned service revenue

48,000

Accrued warranty payable

29,000

Total current liabilities

$966,000

Students may list in a different order

(20-30 min.) P 8-49A

Req. 1 Journal DATE

Dec.

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

Accounts Receivable ..................... 10,000 1 Sales Revenue..........................

10,000

Cost of Goods Sold ........................ Inventory .................................

2,500

Accrued Warranty Payable ............

500

2,500

Chapter 1

500

The Financial Statements 1-650

Loss from Lawsuit ......................... 200,00 27 0 Accrued Liability from Lawsuit .. 200,00 0 Warranty Expense......................... 35,000 31 Accrued Warranty Payable ........

35,000

Req. 2 Dec. 5 transaction will be footnoted as a contingent liability. Dec. 22 transaction will not be footnoted because it is unlikely to be a loss. Dec. 27 transaction will be reported as a liability on the balance sheet and a loss on the income statement. Transaction will also be footnoted. Dec. 31 transaction will be reported as a liability on the balance sheet and an expense on the income statement. Transaction will also be footnoted.

Chapter 1

The Financial Statements 1-651

(15-20 min.) P 8-50B a. Sales tax payable ($110,000 × .07) .................

$7,700

b. Note payable, short-term................................

$94,000

Interest payable ($94,000 × .09 × 4/12) ..........

$2,820

c. Unearned service revenue ($3,600 × 2/6) ........

$1,200

d. Accrued warranty payable ($11,800 + $34,000 − $34,600) .................

$11,200

e. Portion of long-term note payable due within one year..........................................

$30,000

Interest payable ($100,000 × .10) ...................

$10,000

Chapter 1

The Financial Statements 1-652

(30-40 min.) P 8-51B Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

2021 Mar. 3 Inventory...................................... 45,000 Note Payable, Short-term ......... 45,000 May

Cash ............................................. 100,00 31 0 Note Payable, Short-term ......... 100,00 0

Sept . 3

Dec.

Note Payable, Short-term .............. 45,000 Interest Expense ($45,000 × .10 × 6/12) ............................................ Cash ........................................

2,250

Warranty Expense ($202,000 × 31 .02) .............................................. Accrued Warranty Payable ........

4,040

Interest Expense ($100,000 × .05 31 × 7/12) ......................................... Interest Payable .......................

2,917

47,250

4,040

2,917

2022 May Note Payable, Short-term .............. 100,00 31 0 Interest Payable ........................... 2,917 Interest Expense ($100,000 × 0.05 2,083 × 5/12) ......................................... Cash ......................................... 105,00 0

Chapter 1

The Financial Statements 1-653

(20-30 min) P 8-52B

Req. 1 Current liabilities: Accounts payable

187,000

3% Note payable due 4/30/22

180,000

4% Note payable due 12/31/22

150,000

Current portion of long-term bonds payable

200,000

Salaries payable

93,000

FICA tax payable

8,000

Employee income tax payable

23,000

Interest payable

23,000

Sales tax payable

41,000

Unearned service revenue

64,000

Accrued warranty payable

24,000

Total current liabilities

$993,000

Students may list in a different order

Chapter 1

The Financial Statements 1-654

(20-30 min.) P 8-53B

Req. 1 Journal DATE

Dec.

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

Accounts Receivable ..................... 13,200 1 Sales Revenue..........................

13,200

Cost of Goods Sold ........................ Inventory .................................

3,600

Accrued Warranty Payable ............

700

3,600

20 Cash ........................................

700

Loss from Lawsuit ......................... 100,00 27 0 Accrued Liability from Lawsuit .. 100,00 0 Warranty Expense......................... 32,000 31 Accrued Warranty Payable ........

32,000

Chapter 1

The Financial Statements 1-655

Dec. 27 transaction will be reported as a liability on the balance sheet and a loss on the income statement. Transaction will also be footnoted. Dec. 31 transaction will be reported as a liability on the balance sheet and an expense on the income statement. Transaction will also be footnoted.

Challenge Exercise (10-15 min.) E 8-54

Req. 1 Total current assets = Total current liabilities

Current ratio

$324,500 −X = $173,500 −X

3.00

Let X = amount of current liabilities to pay in order to achieve a current ratio of 3. Flashline Services should pay off $98,000* of current liabilities. Then the current ratio will be: $324,500 − $98,000* $173,500 − $98,000*

$226,500 =

$75,500

3.0

_____ *Computation:

$324,500 − X

= Chapter 1

3.0 The Financial Statements 1-656

$173,500 − X $324,500 − X

3 ($173,500 − X)

−X

$520,500 − 3X − $324,500

$98,000

Serial Case (15-20 min.) C8-55

Req. 1 1. Situation A must be accrued. The Cheesecake Factory’s legal counsel has indicated that it is probable that the company will settle the case and the amount of the liability can be reasonably estimated. When both of these factors are met, the contingent liability must be accrued. 2. The Cheesecake Factory should disclose the contingent liabilities related to Situation B and Situation D in its notes to the financial statements. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-657

Situation B should be disclosed rather than accrued because they cannot estimate the amount of the loss. The facts state that the loss will be most likely settled, meaning that there is a high probability of loss. Situation D should be disclosed because it is reasonably possible. This means that there is less than a probable chance but more than a remote chance that the expense will occur. 3. The Cheesecake Factory would not need to accrue or disclose Situation C. Situation C is unlikely to result in an expense or a loss, therefore there is no need to report it.

Chapter 1

The Financial Statements 1-658

Decision Cases C8-56

Req. 1 Hasbro, Inc. Selected financial data from Form 10-K

(in thousands) 12/25/201 6

12/31/201 7

12/30/2018

12/29/20 19

387,675

443,293

443,383

446,105

319,525

Inventory Accounts payable Cost of sales (for year)

348,476

333,521

343,927

1,905,47 4 2,033,693

1,850,678

1,807,84 9

Average AP

280,368

334,001

340,999

338,724

Purchases (calculated)

1,908,65 7 2,089,311

1,850,768

1,810,57 1

5.43

5.35

A/P turnover

6.81

6.26

Mattel, Inc. Selected financial data from Form 10-K

(in thousands) 12/31/20 16

12/31/20 17

12/31/20 18

12/31/20 19

Inventory Accounts payable

613,798

600,704

594,481

630,028

664,857

572,166

537,965

459,357

Cost of sales (for year)

2,902,25 9

3,056,92 2

2,716,12 7

2,523,79 2

Chapter 1

The Financial Statements 1-659

Average AP

658,269

618,512

555,066

498,661

Purchases (calculated)

2,928,53 6

3,043,82 8

2,709,90 4

2,559,33 9

A/P turnover

4.45

4.92

4.88

5.13

(continued) C8-56

Req. 2 Hasbro’s accounts payable turnover is decreasing or deteriorating over 2016-2019. This means that the company is slower in paying its suppliers which is unfavorable.

Req. 3 Mattel’s accounts payable turnover is increasing or improving over 2016-2019. This indicates that the company is paying its suppliers faster which is favorable.

Req. 4 A change in the turnover ratio may indicate altered payment terms with suppliers, but most likely it is an indicator of a change in liquidity. In the case of Mattel, the company’s liquidity appears to be improving because they are paying their suppliers faster. In contrast, Hasbro’s liquidity is deteriorating because they are paying their suppliers slower.

C8-57

Req. 1

Chapter 1

The Financial Statements 1-660

A contingent liability is a potential liability that depends on the future outcome of past events. In order to be transparent to the readers of the financial statements, possible future losses should be disclosed either in a footnote or among the liabilities on the balance sheet.

Req. 2 Ford should consider how likely (possible) it is that there could be an actual liability; discussions with their lawyers should help to discern whether or not there is likelihood of a loss from a lawsuit.

Req. 3 Student opinions will vary. Ethical Issues C8-58

Req. 1 A company would prefer not to disclose its contingent liabilities because they cast a shadow on the business and create a negative impression.

Req. 2 and 3 The potential parties and economic consequences of the decision not to disclose contingent liabilities are: 1.

The bank and its shareholders:

With misleading

Chapter 1

The Financial Statements 1-661

borrower assuming a better ability to pay back the funds than actually exists. A contingent liability creates risk for a company. If the contingent liability is not reported, the bank may view the company as low-risk. This may lead the bank to loan money at low interest rates and with easy payment

terms.

With

knowledge

the

contingent

liability, the bank might not have made the loan at all. Or the bank might have required a higher interest rate or more stringent payment terms. Making loans on too-easy terms robs the bank’s owners of their money. 2.

The company seeking the loan:

Might become

overextended in its borrowing and risk default on debt in the future. 3.

Microsoft stockholders.

4. Parties to the lawsuit.

Chapter 1

The Financial Statements 1-662

(continued) C8-58

Req. 3 Legal and ethical consequences Banks have legal requirements in loan agreements that require debtors to maintain certain ratios of assets and liabilities on their books or risk default.

Failure of a

company to report its contingent liabilities to a bank requesting this disclosure could subject the company to a lawsuit later on. From an ethical standpoint, reporting a contingent liability requires a delicate balancing act. Ethics require that outsiders’ interests be protected. The company must disclose

enough

information

give

outsiders

reasonable basis for making informed decisions about the company. At the same time, the company should avoid giving

away

secrets

that

could

damage

its

owners’

investment in the business. This dilemma is clear when a defendant fears losing an important lawsuit. Fortunately for accountants, most companies settle out of court those lawsuits that they expect to lose. In such cases, there are no contingent liabilities to disclose.

Req. 4

Chapter 1

The Financial Statements 1-663

As discussed in the chapter, changes are being discussed between the FASB and IASB about a new standard for reporting contingencies. more

losses

It is likely that, in the future,

resulting

from

lawsuits

and

other

contingencies are likely to be disclosed in the body and the footnotes of financial statements. Focus on Financials: Apple Inc. (20 min.)

Req. 1

Apple Inc.’s accounts payable decreased from $55,888 million in 2018 to $46,236 million in 2019, a decrease of about 17 percent. Accordingly, Account Payable Turnover is (using formula: purchases = cost of goods sold + ending inventory – beginning inventory; numbers in millions): Purchases Avg. Accts. Pay.

$144,996 + $4,106– $3,956

2.84

($55,888 +$46,236)/2 It takes Apple Inc. an average of (365/2.84) 128.5 days to pay its accounts payable. This length overall is fairly long given that typical credit terms are closer to 30 days.

$10,481 Chapter 1

million

The Financial Statements 1-664

Effective tax rate*

15.9%

*Income tax provision/ income before provision for income taxes = $10,481 million/$65,737 million Apple is not going to have to pay its provision for income taxes amount during 2019. Some of the items included in that amount are “deferred.” This means the activity that gave rise to the tax increase or decrease will be taxable in a future year. This is a result of tax and accounting rules resulting

different

income

tax

the

income

statement (provision for income taxes) than on the tax return (income tax paid). Sometimes the cash amount of taxes paidis more than the provision for income taxes, and sometimes it is less, because the time periods of the expenses (continued) Apple recognized and cash paid are different. In 2019, the cash income taxes paid were $15,263 million, according to the statement of cash flows, which is more than the income tax expense. Note 5 of the financial statements explains the provision for income taxes and the reconciliation of that amount with the cash taxes paid, as well as accrued current and deferred income taxes in much greater detail.

Chapter 1

The Financial Statements 1-665

Refer to Note 10—Commitments and Contingencies. The footnotes disclose commitments for accrued warranty, operating leases, commitments, and contingencies. Some of

these

commitments

will

already

reported

liabilities, such as material warranties and estimated probable contingencies, long-term leases, and finance leases.

However, depending on the probability of the

company eventually incurring a liability for these items, as well as whether they can be estimated as of the balance sheet date, some of these commitments may not be accrued as liabilities in the balance sheet, but only disclosed in the financial statement footnotes. Still other items

that

are

only

remotely

possible,

that

are

immaterial to total assets, might not be disclosed in the financial statements at all.

Chapter 1

The Financial Statements 1-666

Focus on Analysis: Under Armour, Inc. (20 min.)

Req. 1

 Accounts payable – the amount owed for products or services purchased on account  Accrued expenses – expenses that have been incurred but not yet paid for by the company  Customer refund liabilities – these are estimated obligations the company has to refund amounts to customers

for

defective

unsalable

products,

depending on terms of agreements made with those customers.  Operating lease liabilities – these are amounts that are due within the current year to landlords under operating lease arrangements.  Other current liabilities – other current liabilities owed that do not fit in the above categories

Req. 2 (In Thousands) AP Turnove r

Purchases* Avg. Accts. Pay. *COGS + End.Inv.Beg.Inv

$2,796,599 + $892,258 $1,019,496 ($618,194 + $560,884)/2

4.53

Days in AP

365 AP Turnover

365 4.53

80.57

Current Ratio

Current assets Current liabilities

$2,702,209 $1,422,009

1.90

Chapter 1

The Financial Statements 1-667

Quick Ratio

Cash + ST Inv. + Rec. Current Liabilities

$788,072 + $708,714 $1,422,009

1.05

AR Turnove r

Sales Avg. Accts. Rec.

$5,267,132 ($708,714 + $652,546)/2

7.74

Days in AR

365 AR Turnover

365 7.74

47.16

Inv. Turnove r

COGS Avg. Inventory

$2,796,599 ($892,258 + $1,019,496)/ 2

2.93

Days in Inv.

365 Inventory Turnover

365 2.93

124.6

 Accounts payable turnover measures the number of times a company pays its accounts payable in a year. Days’ payables outstanding measure the number of days it takes to pay accounts payable on average.  The company is currently able to pay its accounts payable within an average of about 81 days which is better than some other companies but slower than some others.

If we consider a 30 day net payment

period as normal, then this is more than twice that time, meaning that Under Armour is considered “slow paying” as a customer.  The company has a fairly strong Current Ratio of 1.90 and a Quick Ratio of 1.05 meaning that it does have

Chapter 1

The Financial Statements 1-668

the current and quick assets necessary to pay for its current liabilities.  The inventory turnover ratio is poor in that Under Armour is turning over its inventory every 125 days on average. This means that Under Armour waits 125 days after purchasing inventory to sell it.  Under Armour is in a comparatively weak position as it turns inventory purchases back into cash via sales and collections in 172 days (125+47) but pays for its purchases in 81 days.

actually

This means that

the company has to wait 3 months (91 days) after paying its payables to sell its inventories and collect its receivables. This (continued) Under Armour explains why the company has had to enter into agreements to sell some of its receivables to banks in order to get the cash earlier, so it can pay its creditors. Such a practice is quite expensive in terms of the fees that have to be paid to banks. previous

years

would

indicate

A comparison to if

this

trending

favorable or unfavorable. Industry averages would also be helpful.

Req. 3 In Note 8—Commitments and Contingencies, there is information about the company’s sports marketing

Chapter 1

The Financial Statements 1-669

commitments as well as quite a bit of pending or threatened litigation as of the end of 2019. Among the items of litigation the company is facing are lawsuits involving the following: 1. Infringement of intellectual property. The company believes there will be no material effect on the financial statements. Therefore, they are not included in the balance sheet. 2. Shareholders

cases

against

company

for

misrepresentation of expected revenue growth. The company believes the cases are “without merit” and do not provide an estimate of possible losses. They are not included in the balance sheet. However, since they are disclosed, this would imply that the company believes that the probability of loss is reasonably possible. 3. Rest of litigation concerning business endeavors. The company believes there will be no material effect on the financial statements. Therefore, they are not included in the balance sheet.

Req. 4 (Solution depends on financial statements selected. Student responses will vary. Group Project

Chapter 1

The Financial Statements 1-670

Chapter 9 Long-Term Liabilities Ethics Check a. Integrity b. Due care c. Integrity d. Objectivity and independence

Chapter 1

The Financial Statements 1-671

Short Exercises (5-10 min.) S 9-1 1. True – because interest expense includes both cash interest and amortization of the discount. 2. False – the maturity value is greater than the present value of future cash flows, which is why the bond was issued at a discount. 3. False – the contract (stated) rate, not the market rate, is always used to calculate the cash interest payment. 4. False – the cash received is equal to the present value of the future cash flows discounted at the market rate of interest on the date of issue. 5. True – as the balance in the discount account decreases (as it is amortized), the carrying value of the bonds increases. 6. True – the discount is amortized to interest expense over the life of the bond; the discount is actually additional interest expense that has to be paid (at maturity) because the bond’s contract rate was less than the market rate on the bond issue date.

(5 min.) S 9-2 a.

Discount

Chapter 1

The Financial Statements 1-672

Discount

Par (face) value

Premium

(5-10 min.) S 9-3 Journal DATE

ACCOUNT TITLES AND EXPLANATION

2021 a. July 1 Cash ...........................................

DEBIT

CREDI T

110,00 0

Bonds Payable .........................

110,0 00

To issue bonds at par. b. Dec. 31 Interest Expense ($110,000 × .06 ×

3,300

6/12) ...............................................

Interest Payable ...................... To accrue interest expense. 2022 c. Jan. 1 Interest Payable .......................... Cash........................................ To pay semiannual interest on bonds. 2028 d. July 1 Bonds Payable............................. Cash........................................

3,300

3,300 3,300

110,00 0 110,0 00

To pay bonds at maturity.

Chapter 1

The Financial Statements 1-673

(10-15 min.) S 9-4

Req. 1—Received $4,775,000: $5,000,000 x .955 = $4,775,000

Journal DATE

2021 July 1

ACCOUNT TITLES AND EXPLANATION

Cash ($5,000,000 × .955) ....... Discount on Bonds Payable..... Bonds Payable ...................

DEBIT

CREDIT

4,775,0 00 225,000 5,000,0 00

Req. 2—Pay back $5,000,000 at maturity, July 1, 2031. Req. 3—Cash interest is $175,000 ($5,000,000 × 7% × 6/12) each six months.

Chapter 1

The Financial Statements 1-674

Req. 4—Interest expense is $186,250 [$175,000 + ($225,000 / 20)]

Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

2021 Dec. 31 Interest Expense......................

186,25 0

Discount on Bonds Payable .. Interest Payable .................. 2022 Jan. 1 Interest Payable ...................... Cash....................................

Chapter 1

CREDIT

11,250 175,00 0 175,00 0 175,00 0

The Financial Statements 1-675

(10-15 min.) S 9-5

Req. 1—Received $3,087,000: $3,000,000 x 1.029 = $3,087,000

Journal DATE

2021 July 1

ACCOUNT TITLES AND EXPLANATION

Cash ($3,000,000 × 1.029)......

DEBIT

CREDIT

3,087,0 00

Premium on Bonds Payable 87,000 3,000,0 00

Bonds Payable ...................

Req. 2—Pay back $3,000,000 at maturity, July 1, 2026. Req. 3—Cash interest is $90,000 ($3,000,000 × 6% × 6/12) each six months.

Req. 4—Interest expense is $81,300 [$90,000 – ($87,000 / 10)]

Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

2021 Dec. 31 Interest Expense...................... Premium on Bonds Payable ...... Interest Payable .................. 2022 Jan. 1 Interest Payable ...................... Cash....................................

Chapter 1

CREDIT

81,300 8,700 90,000 90,000 90,000

The Financial Statements 1-676

(15-20 min.) S 9-6

Req. 1

Using the PV function in EXCEL, the bond price is $435,438.

Req. 2

Amortization table

Semiannual Interest Date

Mar. 31, 2022 Sept. 30, 2022 Mar. 31, 2023 Sept. 30, 2023

A B Interes Interest t Expense Payme (5% of nt (3% Precedin of g Bond Maturit Carrying y Amount) Value)

Discount Amortizati on (B – A)

Discount Account Balance (Precedi ng D – C)

Bond Carryin g Amount ($580,0 00 – D)

144,562 435,438 17,400

21,772

4,372

140,190 439,810

17,400

21,991

4,591

135,599 444,401

17,400

22,220

4,820

130,779 449,221

Req. 3

Chapter 1

The Financial Statements 1-677

Journal DATE

ACCOUNT TITLES AND EXPLANATION

2022 Mar. 31

Cash (from Req. 1) ................

DEBIT

CREDIT

435,438 Discount on Bonds Payable .... 144,562 Bonds Payable .................. Sept. 30

Interest Expense ................... Discount on Bonds Payable Cash .................................

580,00 0 21,772 4,372 17,400

Note: numbers may differ slightly due to rounding differences

(10 min.) S 9-7

Req. 1— Borrowed $435,438. Cash due at maturity is $580,000.

Req. 2—Cash interest each six months is $17,400. Req. 3—Interest expense September 30, 2022 is $21,772. Interest expense March 31, 2023 is $21,991. The amount of interest expense increases each period because the carrying value of the bonds increases over time and interest expense is based on the carrying value Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-678

of the bonds. As a result, interest expense increases each period.

(15-20 min.) S 9-8

Req. 1

Using the PV function in EXCEL, the bond price is $454,361.

Req. 2

Amortization table A

C Chapter 1

The Financial Statements 1-679

Interes t Payme nt (5% of Maturit y Value)

Semiannual Interest Date

Jan. 1, 2022 June 30, 2022 Dec. 31, 2022 June 30, 2023

20,000 20,000 20,000

Interest Expense (4% of Precedin g Bond Carrying Amount)

Premium Amortizati on (A – B)

18,174 18,101 18,025

Req. 3

1,826 1,899 1,975

Premium Account Balance (Precedin g D – C)

Bond Carrying Amount ($400,000 + D)

54,361 52,535 50,636 48,661

454,361 452,535 450,636 448,661

Journal

DATE

ACCOUNT TITLES AND EXPLANATION

2022 Jan. 1

Cash (from Req. 1) ................

DEBIT

CREDIT

454,361 Premium on Bonds Payable 54,361 400,00 0

Bonds Payable .................. June

Interest Expense ................... Premium on Bonds Payable.... Cash .................................

18,174 1,826 20,000

Note: numbers may differ slightly due to rounding differences

Chapter 1

The Financial Statements 1-680

(10 min.) S 9-9

Req. 1— Borrowed $454,361. Cash due at maturity is $400,000.

Req. 2—Cash interest each six months is $20,000. Req. 3—Interest expense June 30, 2022 is $18,174. Interest expense December 31, 2022 is $18,101. The amount of interest expense decreases each period because the carrying value of the bonds decreases over time and interest expense is based on the carrying value of the bonds.

As a result, interest expense decreases

each period.

(10 min.) S 9-10 Bonds payable $300,000,000 Less Discount on bonds payable

– 30,000,000

= Carrying value at retirement $270,000,000 Market price (cash paid to retire) ×

.98

$300,000,000

294,000,000

Chapter 1

The Financial Statements 1-681

Therefore, loss on retirement = $ 24,000,000 The loss is reported as Other Income (Loss) on the income statement.

(5-10 min.) S 9-11

1. Debt ratio 2. Deferred income taxes payable 3. Finance lease 4. Times-interest-earned ratio 5. Income taxes payable 6. Finance lease 7. Leverage ratio 8. Commitment

9. Lessee

Chapter 1

The Financial Statements 1-682

(5-10 min.) S 9-12 Leverage ratio

$150.0 / = 2.63 $57.0

This means that Tolbert has $2.63 of assets for every dollar of common stockholders’ equity.

Debt ratio

$93.0* / = .62 $150.0

*$150 – $57 = $93 This means that Tolbert has $.62 in liabilities (debt) for every dollar of assets.

Times-interestearned

$4.7 / $0.8 = 5.88 times

Chapter 1

The Financial Statements 1-683

This means that for every dollar of interest expense Tolbert has earned $5.88 of operating income.

Operating

expense

5.88

income

times.

The

covers

company

interest can

pay

interest 5.88 times with operating income.

Tolbert’s debt ratio is about average and the company can cover its existing interest expense. I would be willing to lend Tolbert $1 million.

(10-15 min.) S 9-13

Req. 1 The Deal Corp.

Simple Stores, Inc. 2.85

5. Leverage ratio

$16,870 / $3,080

5.48

$203,130 / $71,310

Total debt

$16,870 − $3,080

$13,790

$203,130 − $71,310

$131,820

Debt ratio

$13,790 / $16,870

.82

$131,820 / $203,130

.65

Times interest earned

$1,400 / $87

16.1 times

$26,930 / $2,050

13.1 times

Chapter 1

The Financial Statements 1-684

Req. 2 The Deal Corp. has a higher leverage ratio and a higher debt ratio than Simple Stores, Inc. Based on these ratios, the Deal Corp.’s long-term debt-paying ability is weaker than Simple Stores’. However, the Deal Corporation does have a higher times-interest-earned ratio than Simple Stores, and that is a good sign. Due to the Deal Corp.’s high debt ratio, its long-term debt paying ability is weak. Simple Stores appears to have a medium level of longterm debt paying ability. Their debt ratio is average. (Student responses may vary.)

Chapter 1

The Financial Statements 1-685

(10 min.) S 9-14 LIABILITIES Current: Accounts payable

$ 37,000

Current portion of bonds payable

51,000

Interest payable

2,000

Total current liabilities

90,000

Long term: Notes payable, long-term

275,000

Bonds payable

$400,000

Less: Discount on bonds payable

388,000 (12,000)

Total long-term liabilities Total liabilities ..................................

663,000 $753,000

(10 min.) S 9-15 Project 3 would be the only project that meets all three debt covenant requirements. Project 1’s 66.3% debt ratio violates the debt covenant requirement that the debt ratio must not go above 60%. Project 2’s 1.04 current ratio violates the debt covenant requirement that the current ratio must be 1.25 or higher.

(10-20 min.) S 9-16

Chapter 1

The Financial Statements 1-686

Each student’s solution will differ, based on the data set given in MyAccountingLab. Exercises (10-15 min.) E9-17A Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

a 202 31 Cash ($8,000,000 × 0.93) .......... 7,440,0 . 1 00 Jan. Discount on Bonds Payable ....... 560,000 Bonds Payable ..................... 8,000,00 0 To issue bonds at a discount. b July 31 Interest Expense ...................... 176,000 . Cash ($8,000,000 × .03 × 6/12) Discount on Bonds Payable ($560,000 / 10)................. To pay interest and amortize bond discount. c. Dec. 31 Interest Expense ...................... 146,667 Interest Payable ($8,000,000 × .03 × 5/12) . Discount on Bonds Payable ($560,000 / 10 × 5/6) ........ To accrue interest and amortize bond discount. Copyright © 2022 Pearson Education Inc.

Chapter 1

120,000 56,000

100,000 46,667

The Financial Statements 1-687

Chapter 1

The Financial Statements 1-688

(10-15 min.) E 9-18A 1. Cash received = $450,000 × 1.05 =

$ 472,500

2. Principal.................................................... Interest ($450,000 × .09 × 20) ................... Total cash paid ..........................................

$ 450,000 810,000 $1,260,000

3. Total cash paid .......................................... Less: Cash received ................................. Difference = Total interest expense............

$1,260,000 (472,500) $ 787,500

4. Annual interest expense by the straight-line amortization method: $450,000 × .09

$40,500

$450,000 × (1.05 − 1.00) 20 −

$1,125

= $ 39,375

sam e

Cash interest payment

Premium amortization × 20 years

Total interest expense over the life of the bonds

Chapter 1

$ 787,500

The Financial Statements 1-689

(15-20 min.) E 9-19A

Req. 1 Using the PV function in EXCEL, the issue price of the bonds is $1,844,108.

Req. 2 (amortization table) Semiannua l Interest Date

Dec. 31, 2021 June 30, 2022 Dec. 31, 2022 June 30, 2023 Dec. 31, 2023 June 30, 2024 Dec. 31, 2024 June 30, 2025 Dec. 31, 2025 June 30, 2026 Dec. 31, 2026 June 30, 2027 Dec. 31, 2027 June 30, 2028 Dec. 31, 2028 June 30,

Interest Paymen t (2% of Maturit y Value)

Interest Expense (2.5% of Precedin g Bond Carrying Amount)

Discount Amortizati on (B – A)

Discount Account Balance (Precedin g D – C)

Bond Carrying Amount ($2,000,00 0 – D)

155,892

1,844,108

40,000

46,103

6,103

149,789

1,850,211

40,000

46,255

6,255

143,534

1,856,466

40,000

46,412

6,412

137,122

1,862,878

40,000

46,572

6,572

130,550

1,869,450

40,000

46,736

6,736

123,814

1,876,186

40,000

46,905

6,095

116,910

1,883,090

40,000

47,077

7,077

109,832

1,890,168

40,000

47,254

7,254

102,578

1,897,422

40,000

47,436

7,436

95,143

1,904,857

40,000

47,621

7,621

87,521

1,912,479

40,000

47,812

7,812

79,709

1,920,291

40,000

48,007

8,007

71,702

1,928,298

40,000

48,207

8,207

63,494

1,936,506

40,000

48,413

8,413

55,082

1,944,918

40,000

48,623

8,623

46,459

1,953,541

Chapter 1

The Financial Statements 1-690

2029 Dec. 31, 2029 June 30, 2030 Dec. 31, 2030 June 30, 2031 Dec. 31, 2031

40,000

48,839

8,839

37,620

1,962,380

40,000

49,059

9,059

28,561

1,971,439

40,000

49,286

9,286

19,275

1,980,725

40,000

49,518

9,518

9,757

1,990,243

40,000

49,757

9,757

2,000,000

Note: numbers may differ slightly due to rounding differences

(continued) E 9-19A

Req. 3 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

2021 Dec. 31 Cash ....................................... Discount on Bonds Payable ......

CREDIT

1,844,1 08 155,89 2

Bonds Payable ....................

2,000,00 0

Chapter 1

46,103 40,000 6,103

The Financial Statements 1-691

Dec. 31 Interest Expense ..................... Cash................................... Discount on Bonds Payable.. To pay semiannual interest and amortize bond discount.

Chapter 1

46,255 40,000 6,255

The Financial Statements 1-692

(15-20 min.) E 9-20A

Req. 1 Using the PV function in EXCEL, the issue price of the bonds is $701,813.

Req. 2 (amortization table) A

Interes Interest t Expense Semiannu Payme (4.5% of al nt (6% Precedi Interest of ng Bond Date Maturi Carrying ty Amount Value) ) June 30, 2021 Dec. 31, 2021 June 30, 2022 Dec. 31, 2022 June 30, 2023 Dec. 31, 2023 June 30, 2024 Dec. 31, 2024 June 30, 2025 Dec. 31, 2025 June 30, 2026 Dec. 31, 2026 June 30, 2027 Dec. 31,

33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00

Premium Amortizati on (A – B)

Premium Account Balance (Precedi ng D–C)

Bond Carrying Amount ($550,000 + D)

151,813

701,813

31,582

1,418

150,395

700,395

31,518

1,482

148,912

698,912

31,451

1,549

147,363

697,363

31,381

1,619

145,745

695,745

31,309

1,691

144,053

694,053

31,232

1,768

142,286

692,286

31,153

1,847

140,439

690,439

31,070

1,930

138,508

688,508

30,983

2,017

136,491

686,491

30,892

2,108

134,383

684,383

30,797

2,203

132,180

682,180

30,698

2,302

129,879

679,879

30,595

2,405

127,473

677,473

Chapter 1

The Financial Statements 1-693

2027 June 30, 2028 Dec. 31, 2028 June 30, 2029 Dec. 31, 2029 June 30, 2030 Dec. 31, 2030 June 30, 2031 Dec. 31, 2031

0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0

30,486

2,514

124,959

674,959

30,373

2,627

122,333

672,333

30,255

2,745

119,588

669,588

30,131

2,869

116,719

666,719

30,002

2,998

113,721

663,721

29,867

3,133

110,589

660,589

29,726

3,274

107,315

657,315

29,579

3,421

103,894

653,894

(continued) E 920A June 30, 2032 Dec. 31, 2032 June 30, 2033 Dec. 31, 2033 June 30, 2034 Dec. 31, 2034 June 30, 2035 Dec. 31, 2035 June 30, 2036 Dec. 31, 2036 June 30, 2037

33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0

29,425

3,575

100,32

650,320

29,264

3,736

96,584

646,584

29,096

3,904

92,680

642,680

28,921

4,079

88,601

638,601

28,737

4,263

84,338

634,338

28,545

4,455

79,883

629,883

28,345

4,655

75,228

625,228

28,135

4,865

70,363

620,363

27,916

5,084

65,280

615,280

27,688

5,312

59,967

609,967

27,449

5,551

54,416

604,416

Chapter 1

The Financial Statements 1-694

Dec. 31, 2037 June 30, 2038 Dec. 31, 2038 June 30, 2039 Dec. 31, 2039 June 30, 2040 Dec. 31, 2040 June 30, 2041

33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0 33,00 0

27,199

5,801

48,614

598,614

26,938

6,062

42,552

592,552

26,665

6,335

36,217

586,217

26,380

6,620

29,597

579,597

26,082

6,918

22,679

572,679

25,771

7,229

15,449

565,449

25,445

7,555

7,894

557,894

25,105

7,895

550,000

Note: numbers may differ slightly due to rounding differences

(continued) E 9-20A

Req. 3 (journal entries) Journal DATE

ACCOUNT TITLES AND EXPLANATION

Chapter 1

DEBIT

CREDIT

701,81

The Financial Statements 1-695

3 Bonds Payable ........................ Premium on Bonds Payable ..... To issue bonds at a premium.

550,000 151,813

Dec. 31 Interest Expense ......................... 31,582 Premium on Bonds Payable.......... 1,418 Cash....................................... 33,000 To pay semiannual interest and amortize bond premium. 2022 June 30 Interest Expense ......................... 31,518 Premium on Bonds Payable.......... 1,482 Cash....................................... 33,000 To pay semiannual interest and amortize bond premium.

Chapter 1

The Financial Statements 1-696

(20-30 min.) E 9-21A

Req. 1

Journal ACCOUNT TITLES AND EXPLANATION

DATE

2020 Jan.

Cash ($2,500,000 × .95)

DEBIT

CREDIT

........

2,375,00 0 Discount on Bonds Payable .... 125,000 Bonds Payable ..................

2,500,0 00

Req. 2 July

Interest Expense .................. 1

62, 500 Discount on Bonds Payable ($125,000 / 10) ................. Cash ($2,500,000 × .04 × 6/12) .....................................

12,500 50, 000

Req. 3 Dec.

3 1

Interest Expense .................. 62, 500 Discount on Bonds Payable ($125,000 / 10) ..................

12,500

Interest Payable ($2,500,000 × .04 × 6/12) ...........................

Chapter 1

50,000

The Financial Statements 1-697

Req. 4 Carrying value on December 31, 2022: Bonds payable

$2,500,000

Remaining discount [$125,000 – ($12,500 × 6)] (50,000) = Carrying value, December 31, 2022

$2,450,000

(continued) E 9-21A

Req. 5 Cash paid to retire: Market price = $2,500,000 × .97 = $2,425,000 Since the carrying value ($2,450,000) is greater than the cash paid to retire the bonds ($2,425,000, the market price), the bonds are retired at a gain of $25,000. The gain appears on the income statement along with “Other income and expenses”.

Chapter 1

The Financial Statements 1-698

(15-20 min.) E 9-22A

Req. 1 GAAP Book value

$6,230,000

Tax Book value

5,610,000

Depreciation timing difference

620,000

Income tax rate

= Deferred tax liability

.40

248,000

Req. 2 Journal DATE

ACCOUNT TITLES AND EXPLANATION

2021 Dec.

Income Tax Expense .............

Chapter 1

DEBIT

CREDIT

The Financial Statements 1-699

2,588,00 0 Income Tax Payable ($6,400,000 × .40) .............................

Deferred Income Tax Payable ................................

2,560,00 0 28,000*

* Previous balance in Deferred Income Tax Payable $220,000 Plus adjustment to bring balance to Req. 1 total 28,000 Required balance per Req. 1 $248,000

(20-25 min.) E 9-23A

Amounts in millions or billions Ratio

Albertson Millstone

Chapter 1

Raleigh

The Financial Statements 1-700

Current

Total current assets ratio = Total current liabilities

Debt Total liabilities = ratio Total assets

¥4,832

€126,700

$247

¥2,237

€72,400

= 1.76

= 2.16

= 1.75

$344 $530

¥4,540 ¥5,405

€183,297 €194,997

= 0.65

= 0.84

= 0.94

$530 $186

¥5,405 ¥865

€194,997 €11,700

= 2.85

= 6.25

= 16.67

$291 $41

¥222 ¥26

€5,584 €655

= 7.1 times

= 8.5 times

Total assets Leverag Tot. common e = stockholders’ ratio equity

Timesinterest- Operating income = earned Interest expense ratio

$434

Student responses may vary, but based on the information given, Albertson looks the least risky, with relatively high current ratio and times-interest- earned ratio, and relatively low debt ratio. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-701

(10-20 min.) E 9-24A

Req. 1 Long-term bonds payable is the amount that the company expects to pay after the coming year; bonds payable result from the company borrowing money. Deferred

income

taxes

payable

result

from

timing

differences between GAAP and tax accounting methods (such as depreciation).

Income tax expense might differ

between GAAP book income (“Income Tax Expense”) and taxable income according to Internal Revenue regulations (“Income Tax Payable”). Leases payable result from the company entering into long-term equipment.

leases,

such

for

leasing

property

and

The account includes both operating and

finance leases that last longer than 12 months, and reflects the obligation for future lease payments.

Chapter 1

The Financial Statements 1-702

(continued) E 9-24A

Req. 2 Total assets =

$3,782 million, the sum of total liabilities and stockholders’ equity. 2021

(in millions)

Leverag e = ratio Debt ratio

Total assets ($3,782) Total common stockholders’ equity ($1,844) Total liabilities ($3,782 − $1,844)* Total assets ($3,782)

= 2.0 5 = 0.5 1 2020

Leverag e = ratio Debt ratio

Total assets ($3,462) Total common stockholders’ equity ($1,584) Total liabilities ($3,462 − $1,584) Total assets ($3,462)

= 2.1 9 = 0.5 4

Both the leverage ratio and debt ratio improved in 2021. Therefore, the company improved. *Or, $314 + $1,485 + $134 +$5 = $1,938

Chapter 1

The Financial Statements 1-703

(15-20 min.) E 9-25A

Req. 1 Journal DATE ACCOUNT TITLES AND EXPLANATION

DEBIT

July 1 Cash ($1,000,000 × 0.98) ....... Discount on Bonds Payable..... Bonds Payable...................

CREDIT

980,000 20,000 1,000,00 0

To issue bonds at a discount.

Req. 2 Dec 3 Interest Expense .................... . 1 Interest Payable

26,000 25,000

($1,000,000 × .05 × 6/12) ............................

Discount on Bonds Payable ($20,000 / 20) ................ To accrue interest and amortize bond discount.

1,000

$ Chapter 1

The Financial Statements 1-704

Long-term liabilities: Bonds payable $1,000,000 Less: Discount on bonds payable (19,000) 981,000

(10-15 min.) E 9-26B Journal DATE ACCOUNT TITLES AND EXPLANATION

DEBIT

202 a 1 3 Cash ($5,000,000 × 0.95) ....... . Jan. 1 Discount on Bonds Payable..... Bonds Payable...................

CREDIT

4,750,00 0 250,000 5,000,00 0

To issue bonds at a discount. b July 3 Interest Expense .................... . 1 Cash ($5,000,000 × .05 × 6/12) ..................................... Discount on Bonds Payable ($250,000 / 20) ............. To pay interest and amortize bond discount.

Chapter 1

137,500 125,000 12,500

The Financial Statements 1-705

c. Dec 3 Interest Expense .................... 114,584 . 1 Interest Payable ($5,000,000 × .05 × 104,167 5/12) ..................................... Discount on Bonds Payable ($12,500 × 5/6) ............. 10,417 To accrue interest and amortize bond discount.

Chapter 1

The Financial Statements 1-706

(10-15 min.) E 9-27B 1. Cash received = $100,000 × 1.06 =

$106,000

2. Principal....................................................

$100,000

Interest ($100,000 × .04 × 20) ...................

80,000

Total cash paid ..........................................

$180,000

3. Total cash paid ..........................................

$180,000

Less:

Cash received .................................

(106,000)

Difference = Total interest expense............

$ 74,000

4. Annual interest expense by the straight-line amortization method: $100,000 × .04

$4,000

$100,000 × (1.06 − 1.00) 20 −

$300

= $ 3,700

sam e

Cash interest payment

Premium amortization × 20 years

Total interest expense over the life of the bonds

Chapter 1

$ 74,000

The Financial Statements 1-707

(15-20 min.) E 9-28B

Req. 1 Using the PV function in EXCEL, the issue price of the bonds is $1,258,413.

Req. 2 (amortization table) A

Interes Interest t Expense Discount Payme Semiannual (4% of Discount Account nt (.5% Interest Precedin Amortizati Balance of Date g Bond on (B – A) (Precedi Maturit Carrying ng D – C) y Amount) Value) Dec. 31, 1,141,5 2021 87 June 30, 1,103,2 50,337 38,337 2022 12,000 50 Dec. 31, 1,063,3 12,000 51,870 39,870 2022 80 June 30, 1,021,9 12,000 53,465 41,465 2023 16 Dec. 31, 55,123 43,123 978,792 2023 12,000 June 30, 56,848 44,848 933,944 2024 12,000 Dec. 31, 58,642 46,642 887,302 2024 12,000 June 30, 60,508 48,508 838,794 2025 12,000 Dec. 31, 62,448 50,448 788,346 2025 12,000 June 30, 64,466 52,466 735,879 2026 12,000 Dec. 31, 66,565 54,565 681,315 2026 12,000 June 30, 68,747 56,747 624,567 2027 12,000 Copyright © 2022 Pearson Education Inc.

Chapter 1

E Bond Carrying Amount ($2,400, 000 – D)

1,258,4 13 1,296,7 50 1,336,6 20 1,378,0 84 1,421,2 08 1,466,0 56 1,512,6 98 1,561,2 06 1,611,6 54 1,664,1 21 1,718,6 85 1,775,4 33

The Financial Statements 1-708

Dec. 31, 2027 June 30, 2028 Dec. 31, 2028 June 30, 2029 Dec. 31, 2029 June 30, 2030 Dec. 31, 2030 June 30, 2031 Dec. 31, 2031

12,000

71,017

59,017 565,550

12,000

73,378

61,378 504,172

12,000

75,833

63,833 440,339

12,000

78,386

66,386 373,952

12,000

81,042

69,042 304,910

12,000

83,804

71,804 233,107

12,000

86,676

74,676 158,431

12,000

89,663

77,663

12,000

92,769

80,768

1,834,4 50 1,895,8 28 1,959,6 61 2,026,0 48 2,095,0 90 2,166,8 93 2,241,5 69 2,319,2 32 2,400,0 00

Note: numbers may differ slightly due to rounding differences

Chapter 1

The Financial Statements 1-709

(continued) E 9-28B

Req. 3 (journal entries) Journal DATE

ACCOUNT TITLES AND EXPLANATION

2021 Dec. 31 Cash ....................................... Discount on Bonds Payable ......

DEBIT

CREDIT

1,258,4 13 1,141,5 87

Bonds Payable ....................

2,400,00 0

To issue bonds at a discount. 2022 June 30 Interest Expense ..................... Cash................................... Discount on Bonds Payable.. To pay semiannual interest and amortize bond discount. 2022 Dec. 31 Interest Expense ..................... Cash................................... Discount on Bonds Payable.. To pay semiannual interest and amortize bond discount.

Chapter 1

50,337 12,000 38,337

51,870 12,000 39,870

The Financial Statements 1-710

(15-20 min.) E 9-29B

Req. 1 Using the PV function in EXCEL, the issue price of the bonds is $648,867.

Req. 2 (amortization table) A

Interest Interest Expense Premium Bond Semiannual Payment (4.5% of Premium Account Carrying Interest (5% of Preceding Amortization Balance Amount Date Maturity Bond (A – B) (Preceding ($600,000 Value) Carrying D–C) + D) Amount) June 30, 2021 Dec. 31, 2021 June 30, 2022 Dec. 31, 2022 June 30, 2023 Dec. 31, 2023 June 30, 2024 Dec. 31, 2024 June 30, 2025 Dec. 31, 2025 June 30, 2026 Dec. 31, 2026 June 30, 2027 Dec. 31, 2027

48,867

648,867

30,000

29,199

801

48,066

648,066

30,000

29,163

837

47,229

647,229

30,000

29,125

875

46,354

646,354

30,000

29,086

914

45,440

645,440

30,000

29,045

955

44,485

644,485

30,000

29,002

998

43,487

643,487

30,000

28,957

1,043

42,444

642,444

30,000

28,910

1,090

41,354

641,354

30,000

28,861

1,139

40,215

640,215

30,000

28,810

1,190

39,024

639,024

30,000

28,756

1,244

37,780

637,780

30,000

28,700

1,300

36,481

636,481

30,000

28,642

1,358

35,122

635,122

Chapter 1

The Financial Statements 1-711

June 30, 2028 Dec. 31, 2028 June 30, 2029 Dec. 31, 2029 June 30, 2030 Dec. 31, 2030 June 30, 2031 Dec. 31, 2031 June 30, 2032

30,000

28,580

1,420

33,703

633,703

30,000

28,517

1,483

32,219

632,219

30,000

28,450

1,550

30,669

630,669

30,000

28,380

1,620

29,049

629,049

30,000

28,307

1,693

27,356

627,356

30,000

28,231

1,769

25,588

625,588

30,000

28,151

1,849

23,739

623,739

30,000

28,068

1,932

21,807

621,807

30,000

27,981

2,019

19,789

619,789

(continued) E 929B Dec. 31, 2032 June 30, 2033 Dec. 31, 2033 June 30, 2034 Dec. 31, 2034 June 30, 2035 Dec. 31, 2035 June 30, 2036

30,000

27,890

2,110

17,679

617,679

30,000

27,796

2,204

15,475

615,475

30,000

27,696

2,304

13,171

613,171

30,000

27,593

2,407

10,764

610,764

30,000

27,484

2,516

8,248

608,248

30,000

27,371

2,629

5,619

605,619

30,000

27,253

2,747

2,872

602,872

30,000

27,129

2,872

600,000

Note: numbers may differ slightly due to rounding differences

Chapter 1

The Financial Statements 1-712

(continued) E 9-29B

Req. 3 (journal entries) Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

2021 June 30 Cash......................................... 648,867 Bonds Payable ..................... Premium on Bonds Payable... To issue bonds at a premium. Dec. 31 Interest Expense....................... 29,199 Premium on Bonds Payable ....... 801 Cash .................................... To pay semiannual interest and amortize bond premium. 2022 June 30 Interest Expense....................... 29,163 Premium on Bonds Payable ....... 837 Cash .................................... To pay semiannual interest and amortize bond premium.

Chapter 1

CREDIT

600,000 48,867

30,000

The Financial Statements 1-713

(20-30 min.) E 9-30B

Req. 1

Journal

DATE

ACCOUNT TITLES AND EXPLANATION

2020 Jan.

Cash ($3,500,000 × .96) .........

DEBIT

CREDIT

3,360,00 0 Discount on Bonds Payable .... 140,000 Bonds Payable ..................

3,500,0 00

Req. 2 July

Interest Expense .................. 1

119,000 Discount on Bonds Payable ($140,000 / 10) ................. Cash ($3,500,000 × .06 × 6/12) .....................................

14,000 105,000

Req. 3 Dec.

3 1

Interest Expense .................. 119,000 Discount on Bonds Payable ($140,000 / 10) ..................

14,000

Chapter 1

105,000

The Financial Statements 1-714

Req. 4 Carrying value on December 31, 2022: Bonds payable

$3,500,000

Remaining discount [$140,000 – ($14,000 × 6)] = Carrying value, December 31, 2022

56,000

$3,444,000

(continued) E 9-30B

Req. 5 Cash paid to retire: Market price = $3,500,000 × .99 = $3,465,000 Since the cash paid to retire the bonds ($3,465,000) is greater than the carrying value of the bonds ($3,444,000), the bonds are retired at a loss of $21,000. The loss appears on the income statement along with “Other income and expenses”.

Chapter 1

The Financial Statements 1-715

(15-20 min.) E 9-31B

Req. 1 GAAP Book value

$7,680,000

Tax Book value

6,980,000

Depreciation timing difference

700,000

Income tax rate

= Deferred tax liability

.40

280,000

Req. 2 Journal DATE

2021 Dec. 31

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Income Tax Expense .............

412,000 Chapter 1

The Financial Statements 1-716

Income Tax Payable ($950,000 × .40) .............................

380,000 32,000*

Deferred Income Tax Payable ................................ * Previous balance in Deferred Income Tax Payable $248,000 Plus adjustment to bring balance to Req. 1 total 32,000 Required balance per Req. 1 $280,000

(20-25 min.) E 9-32B

Amounts in millions or billions Biltmore

Mackey

Victory

$422

¥5,774

€160,560

$187

¥2,187

€72,000

Ratio Current ratio

Total current assets = Total current liabilities

Chapter 1

The Financial Statements 1-717

= 2.26

Debt Total liabilities = ratio Total assets

Leverag e = ratio

Total assets Tot. common stockholders’ equity

= 2.64

= 2.23

$294 $520

¥4,500 ¥6,338

€182,507 €214,714

= 0.57

= 0.71

= 0.85

$520 $226

¥6,338 ¥1,838

€214,714 €32,207

= 2.30

= 3.45

= 6.67

$292 $41

¥222 ¥30

€5,603 €655

= 7.12 times

= 7.40 times

Timesinterest-

Operating income = = earned Interest expense ratio

= 8.55 times

Student responses may vary, but based on the information given, Biltmore looks the least risky, with relatively high current ratio and times-interest- earned ratio, and relatively low debt ratio and leverage ratio.

(10-20 min.) E 9-33B

Chapter 1

The Financial Statements 1-718

Req. 1 Long-term bonds payable is the amount that the company expects to pay after the coming year; bonds payable result from the company borrowing money. Deferred

income

taxes

payable

result

from

timing

differences between GAAP and tax accounting methods (such as depreciation).

Income tax expense might differ

leases,

such

for

leasing

property

and

The account includes both operating and

finance leases that last longer than 12 months, and reflects the obligation for future lease payments.

Chapter 1

The Financial Statements 1-719

(continued) E 9-33B

Req. 2 Total assets = $4,453 million, the sum of total liabilities and stockholders’ equity. 2021 Leverag e = ratio Debt ratio

Total assets ($4,453) Total common stockholders’ equity

= 1.84

($2,420) Total liabilities ($4,453 – $2,420)* Total assets ($4,453)

= 0.46

2020 Leverag e = ratio Debt ratio

Total assets ($3,102) Total common stockholders’ equity

= 2.44

($1,273) Total liabilities ($3,102 − $1,273) Total assets ($3,102)

= 0.59

Both the leverage ratio and debt ratio improved. Therefore, the company improved. ____ *Or, $308 + $1,578 + $129 + $18 = $2,033

Chapter 1

The Financial Statements 1-720

(15-20 min.) E 9-34B

Req. 1 Journal DATE ACCOUNT TITLES AND EXPLANATION

DEBIT

July 1 Cash ($2,000,000 × 0.96) ....... Discount on Bonds Payable..... Bonds Payable...................

CREDIT

1,920,00 0 80,000 2,000,00 0

To issue bonds at a discount.

Req. 2 Dec 3 Interest Expense .................... . 1 Interest Payable ($2,000,000 × .08 × 6/12) ...........................

Discount on Bonds Payable ($80,000 / 20) ................ To accrue interest and amortize bond discount.

84,000 80,000 4,000

Chapter 1

The Financial Statements 1-721

Current liabilities: Interest payable 80,000

Long-term liabilities: Bonds payable $2,000,000 Less: Discount on bonds payable (76,000) 1,924,000

Chapter 1

The Financial Statements 1-722

Quiz Q9-35

Q9-36

Q9-37

Q9-38

Q9-39

Q9-40

Q9-41

Q9-42

Q9-43

Q9-44

Q9-45

Q9-46

Q9-47

Q9-48

Q9-49

Q9-50

Q9-51

Chapter 1

The Financial Statements 1-723

Problems (20-25 min.) P 9-52A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 a. May 31 Cash ($9,000,000 × 1/2) ........ 4,500,00 0 Bonds Payable .................. 4,500,00 0 To issue bonds at par. b. Nov. 30 Interest Expense ................... 157,500 Cash ($4,500,000 × .07 × 6/12)..................................... To pay interest on bonds.

157,500

c. Dec. 31 Interest Expense ($4,500,000 × .07 × 1/12) ...... 26,250 Interest Payable ............... To accrue interest.

26,250

2022 d. May 31 Interest Payable.................... 26,250 Interest Expense ($4,500,000 × .07 × 5/12) ...... 131,250 Cash ($4,500,000 × .07 × 157,500 6/12)..................................... To pay interest on bonds.

Req. 2 (reporting the liabilities on the balance sheet at Dec. 31, 2021)

Chapter 1

The Financial Statements 1-724

Current liabilities: Interest payable .............................

26,250

Long-term liabilities: Bonds payable ................................

$4,500,00 0

(30-40 min.) P 9-53A

Req. 1 The 10% bonds issued when the market interest rate is 9% will be priced at a premium. They are relatively attractive in this market, so investors will pay a price above par value to acquire them.

Req. 2 The 10% bonds issued when the market interest rate is 11% will be priced at a discount. They are relatively unattractive in this market, so investors will pay less than par value to acquire them.

Chapter 1

The Financial Statements 1-725

(continued) P 9-53A

Req. 3 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 a. Feb. 28 Cash ($2,100,000 × .94) ..............1,974,0 00 Discount on Bonds Payable .......... 126,000 Bonds Payable ........................ 2,100,0 00 To issue bonds at a discount. b. Aug. 31 Interest Expense ......................... 108,150 Cash ($2,100,000 × .10 × 105,00 6/12)........................................... 0 Discount on Bonds Payable ($126,000 / 40) .................... 3,150 To pay interest and amortize bond discount. c. Dec. 31 Interest Expense ......................... 72,100 Interest Payable ($105,000 × 4/6) ............................................ Discount on Bonds Payable ($3,150 × 4/6)...................... To accrue interest and amortize bond discount.

70,000 2,100

2022 d. Feb. 28 Interest Payable (from Dec. 31) ... 70,000 Interest Expense ......................... 36,050 Cash ($2,100,000 × .10 × 6/12)........................................... Discount on Bonds Payable Copyright © 2022 Pearson Education Inc.

Chapter 1

105,00 0

The Financial Statements 1-726

($3,150 × 2/6)...................... To pay interest and amortize bond discount.

1,050

Req. 4 (reporting the liabilities on the balance sheet at Dec. 31, 2021) Current liabilities: Interest payable ..........................

$ 70,000

Long-term liabilities: Bonds payable ............................. $2,100,00 0 Less: Discount on bonds payable ($126,000 − $3,150 − $2,100)

1,979,25 (120,750) 0 (30-40 min.) P 9-54A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 Jan. 1 Cash ($4,000,000 × .94) ................ 3,760,0 00 Discount on Bonds Payable ........... 240,000 Bonds Payable ......................... 4,000,00 0 To issue bonds at a discount. July

1 Interest Expense........................... 152,000 Cash ($4,000,000 × .07 × 6/12) . 140,000 Discount on Bonds Payable ($240,000 / 20) ...................... 12,000

Chapter 1

The Financial Statements 1-727

To pay interest and amortize bond discount. Dec 31 Interest Expense........................... 152,000 . Interest Payable ($4,000,000 × .07 × 6/12) ...... 140,000 Discount on Bonds Payable ..... 12,000 To accrue interest and amortize bond discount. 2022 Jan. 1 Interest Payable........................... 140,000 Cash ....................................... 140,000 To pay interest. 2031 Jan. 1 Bonds Payable .............................. 4,000,0 00 Cash ........................................ 4,000,00 0 To pay bonds at maturity.

Chapter 1

The Financial Statements 1-728

(continued) P 9-54A

Req. 2 Carrying amount at Dec. 31, 2021:

Bonds payable, net ($4,000,000 − $240,000 + $12,000 + $12,000) ..$3,784,000

Req. 3 a.

Interest expense

Cash interest paid

$152,000 =

$140,000

Interest expense exceeds cash interest paid because the company issued the bonds at a discount and must pay back the full face value of the bonds at maturity. Amortization of the bond discount causes the interest expense on the bonds to exceed the amount of cash interest paid.

Chapter 1

The Financial Statements 1-729

(30-45 min.) P 9-55A

Req. 1

a. Using the PV function in EXCEL, the issue price of the bonds is $2,413,286. b.

Maturity value is $3,500,000.

Annual cash interest payment is $35,000. ($3,500,000 × .01).

Carrying amount is $2,523,083

Req. 2 (amortization table) A

Annual Interest Date

Interes Interest t Expense Discount Payme (6% of Discount Account nt (1% Precedin Amortizati Balance of g Bond on (B – A) (Precedi Maturit Carrying ng D – C) y Amount) Value)

1,086,7 14

Jan. 1, Yr. 1 Dec. 31, Yr. 1 35,000 144,797

109,797

976,917

Dec. 31, Yr. 2 35,000 151,385

116,385

860,532

Dec. 31, Yr. 3 35,000 158,368

123,368

737,164

Dec. 31, Yr. 4 35,000 165,770

130,770

606,393

Dec. 31, Yr. 5 35,000 173,616

138,616

467,777

Chapter 1

E Bond Carrying Amount ($3,500, 000 – D)

2,413,2 86 2,523,0 83 2,639,4 68 2,762,8 36 2,893,6 07 3,032,2 23

The Financial Statements 1-730

Dec. 31, Yr. 6 35,000 181,933

146,933

320,844

Dec. 31, Yr. 7 35,000 190,749

155,749

165,094

Dec. 31, Yr. 8 35,000 200,094

165,094

3,179,1 56 3,334,9 06 3,500,0 00

Note: numbers may differ slightly due to rounding differences

Interest expense for the year ended Dec. 31, Year 4, is $165,770.

Chapter 1

The Financial Statements 1-731

(continued) P 9-55A

Req. 3 (reporting the liabilities at Dec. 31, Year 4) Current liabilities: Current installment of notes payable .........................................................

$ 45,000

Long-term liabilities: Bonds payable ................................ $3,500,00 0 Less: Discount on bonds payable...

2,893,60 (606,394) 6

Note payable ($270,000 – $45,000) ..

225,000

Total long-term liabilities ...................

3,118,60 6

Total liabilities……………………………………..

$3,163,6 06

Chapter 1

The Financial Statements 1-732

(40-50 min.) P 9-56A

Req. 1 Using the PV function in EXCEL, the issue price of the bonds is $3,456,387.

Req. 2 (amortization table) A

Interes Interest t Expense Discount Bond Payme Semiannual (4% of Discount Account Carrying nt (3% Interest Precedin Amortizati Balance Amount of Date g Bond on (B – A) (Precedi ($4,000,0 Maturit Carrying ng D – C) 00 – D) y Amount) Value) Dec. 31, 3,456,38 2021 543,613 7 June 30, 2022 120,00

0 138,255 Dec. 31, 2022 120,00

0 138,986 June 30, 2023 120,00

0 139,745 Dec. 31, 2023 120,00

0 140,535 June 30, 2024 120,00

0 141,356 Dec. 31, 2024 120,00

3,474,64 18,255 525,358 2 3,493,62 18,986 506,372 8 3,513,37 19,745 486,627 3 3,533,90 20,535 466,092 8 3,555,26 21,356 444,735 5 3,577,47 22,211 422,525 5 23,099 3,600,57 Chapter 1

The Financial Statements 1-733

2025 120,00 143,099

399,426

0 Dec. 31, 2025 120,00

0 144,023 June 30, 2026 120,00

0 144,984 Dec. 31, 2026 120,00

0 145,983 June 30, 2027 120,00

0 147,023 Dec. 31, 2027 120,00

0 148,103 June 30, 2028 120,00

0 149,228 Dec. 31, 2028 120,00

0 150,397 June 30, 2029 120,00

0 151,613 Dec. 31, 2029 120,00

0 152,877 June 30, 2030 120,00

3,624,59 24,023 375,403 7 3,649,58 24,984 350,419 1 3,675,56 25,983 324,436 4 3,702,58 27,023 297,413 7 3,730,69 28,103 269,310 0 3,759,91 29,228 240,082 8 3,790,31 30,397 209,685 5 3,821,92 31,613 178,073 7 3,854,80 32,877 145,196 4 3,888,99 34,192 111,004 6 3,924,55 35,560 75,444 6 Chapter 1

The Financial Statements 1-734

0 June 30, 2031 120,00

0 156,982

36,982

3,961,53 38,461 9

38,461

4,000,00 0 0

Dec. 31, 2031 120,00

0 158,462

Note: numbers may differ slightly due to rounding differences

Chapter 1

The Financial Statements 1-735

(continued) P 9-56A

Req. 3 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 a. Dec. 31 Cash ....................................... 3,456,38 7 Discount on Bonds Payable...... 543,613 Convertible Bonds Payable . 4,000,0 00 To issue bonds at a discount. 2022 b. June 30 Interest Expense ..................... 138,255 Cash .................................. 120,000 Discount on Bonds Payable . 18,255 To pay interest and amortize bond discount. c. Dec. 31 Interest Expense ..................... 138,986 Cash .................................. 120,000 Discount on Bonds Payable . 18,986 To pay interest and amortize bond discount. 2023 d. July 1 Convertible Bonds Payable ...... 1,600,00 0 Discount on Bonds Payable ($486,627 × .40) ............ 194,651 Common Stock (80,000 × 80,000 $1) ......................................... Paid-in Capital in Excess of Par — Common .............. 1,325,3 49 To record conversion of bonds.

Chapter 1

The Financial Statements 1-736

Convertible bonds payable ($4,000,000 − $1,600,000) ........... $2,400,00 0 Less: Discount on bonds payable ($466,092 × 3/5*) ......................... (279,655) 2,120,345 *3/5 (or .60) of the bonds are outstanding, so 3/5 of the discount remains.

(20-30 min.) P 9-57A

Req. 1

Burgess Foods, Inc. Partial Balance Sheet Dec. 31, 2021

Total Current Assets Long-term Investmts Property, plant, and equipment:

$400,000 Current liabilities:*

Equipment .......... $747,000

Mortgage note

Accumulated

payable, current ....

depreciation .... (162,000)

$ 86,000

Bonds payable, current portion ......

300,000

Interest payable .......

70,000

Total current liabilities

456,000

585,000

Chapter 1

$315,000

The Financial Statements 1-737

Bonds payable…. $250,000 Discount on bonds payable... (21,000)* Leases payable .........

229,000 445,000

Total long-term liabilities ..................... $989,000 Total liabilities………………..

$1,445,000

Total stockholders’ equity….

$3,955,000

Total liabilities and Total Assets………..

$5,400,0 stockholders’ 00 equity……….

$5,400,000

Notes:

* The order of listing current liabilities and long-term liabilities is optional. However, Discount on Bonds Payable should come immediately after Bonds Payable. Also, it is customary to report Interest Payable after the related liability accounts, Mortgage Note Payable and Bonds Payable, Current Portion.

Chapter 1

The Financial Statements 1-738

(continued) P 9-57A

Req. 2

a. Carrying amount of bonds payable: Current portion..................................... Long-term portion ($250,000 − $21,000)

$300,000 229,000

Carrying amount...................................

$529,000

b. Interest payable is the amount of interest that Burgess owes at year end. Interest expense is the company’s cost of borrowing for the full year. Interest expense includes the amortization of discount so the interest expense exceeds the cash payment of interest.

Req. 3 Operating $360,000 income = = Interest expense $227,000

Times-interest-earned ratio

= 1.59 times

Req. 4 Leverag e = ratio

Debt ratio

Total assets ($5,400,000) Total common stockholders’ equity ($3,955,000)*

1.3 = 7

Total liabilities [$1,445,000 = $989,000 + 0.2 = $456,000] 7 Total assets ($5,400,000)

Chapter 1

The Financial Statements 1-739

With this limited information, the company appears to be low risk from a leverage point of view.

Additional

information from prior years and competitors, as well as industry averages, would also be helpful. *$5,400,000 – $989,000 – $456,000 = $3,955,000

Chapter 1

The Financial Statements 1-740

(continued) P 9-57A

Chapter 1

The Financial Statements 1-741

(20-25 min.) P 9-58B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 a. May 31 Cash ($8,000,000 × 1/2)........ 4,000,000 Bonds Payable ................. 4,000,0 00 To issue bonds at par. b. Nov. 30 Interest Expense .................. Cash ($4,000,000 × .06 × 6/12) .................................... To pay interest on bonds.

120,000 120,000

c. Dec. 31 Interest Expense ($4,000,000 × .06 × 1/12) ..... Interest Payable .............. To accrue interest.

20,000 20,000

2022 d. May 31 Interest Payable ................... Interest Expense ($4,000,000 × .06 × 5/12) ..... Cash................................ To pay interest on bonds.

20,000 100,000 120,000

Req. 2 (reporting the liabilities on the balance sheet at Dec. 31, 2021) Current liabilities: Interest payable ...............................

Long-term liabilities: Bonds payable..................................

$4,000,000

Chapter 1

20,000

The Financial Statements 1-742

(30-40 min.) P 9-59B

Chapter 1

The Financial Statements 1-743

(continued) P 9-59B

Req. 3 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 a. Feb 28Cash ($1,500,000 × 0.94) ................ 1,410,0 . 00 Discount on Bonds Payable.............. 90,000 Bonds Payable ........................... 1,500,0 00 To issue bonds payable at a discount. b. Aug 31Interest Expense ............................. . Discount on Bonds Payable

79,500 4,500

($90,000 / 20) .........................................

Cash ($1,500,000 × .10 × 6/12) ... To pay interest and amortize bond discount. c. Dec 31Interest Expense ............................. . Discount on Bonds Payable

75,000

53,000 3,000

($4,500 × 4/6) .......................................

Interest Payable ($75,000  4/6) To accrue interest and amortize bond discount. 2022 d. Feb 28Interest Payable (from Dec. 31) ....... . Interest Expense ............................. Discount on Bonds Payable

50,000

50,000 26,500 1,500

($4,500 × 2/6) .......................................

Chapter 1

75,000

The Financial Statements 1-744

Req. 4 (reporting the liabilities on the balance sheet at Dec. 31, 2021) Current liabilities: $

Interest payable ............................

50,000

Long-term liabilities: Bonds payable ............................... $1,500,000 Less: Discount on bonds payable ($90,000 − $4,500 − $3,000) .......

1,417,500 (82,500)

Chapter 1

The Financial Statements 1-745

(30-40 min.) P 9-60B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 Jan. 1 Cash ($3,000,000 × .95) ................ 2,850,0 00 Discount on Bonds Payable............ 150,000 Bonds Payable........................... 3,000,00 0 To issue bonds at a discount. July 1 Interest Expense ........................... Cash ($3,000,000 × .06 × 6/12) .. Discount on Bonds Payable ($150,000 / 20) .......................... To pay interest and amortize bond discount.

97,500 90,000 7,500

Dec.31 Interest Expense ........................... 97,500 Interest Payable ($3,000,000 × .06 × 6/12) .......................................... Discount on Bonds Payable ($150,000 / 20)....................... To accrue interest and amortize bond discount. 2022 Jan. 1 Interest Payable ........................... Cash ......................................... To pay interest.

90,000 7,500

90,000 90,000

Chapter 1

The Financial Statements 1-746

To pay off bonds at maturity.

Chapter 1

The Financial Statements 1-747

(continued) P 9-60B

Req. 2 Carrying amount at Dec. 31, 2021: Bonds payable, net ($3,000,000 − $150,000 + $7,500 + $7,500) = $2,865,000

Req. 3 a.

Interest expense

Cash interest paid

$97,500 =

$90,000

Chapter 1

The Financial Statements 1-748

(30-45 min.) P 9-61B

Req. 1 a. Using the PV function in EXCEL, the issue price of the bonds is $1,522,296. b. Maturity value is $2,000,000. c. Annual cash interest payment is $60,000 ($2,000,000 × .03). d. Carrying amount is $1,568,857.

Req. 2 (amortization table)

Annual Interest Date

Jan. 1, Yr. 1 Dec. 31, Yr. 1 Dec. 31, Yr. 2 Dec. 31, Yr. 3 Dec. 31, Yr. 4 Dec. 31, Yr. 5 Dec. 31, Yr. 6 Dec. 31, Yr. 7 Dec. 31,

A Interes t Payme nt (3% of Maturit y Value)

Interest Expense (7% of Preceding Bond Carrying Amount)

Discount Amortizati on (B – A)

Discount Account Balance (Precedin g D – C)

Bond Carrying Amount ($2,000,000 – D)

477,704

1,522,296

60,000

106,561

46,561

431,143

1,568,857

60,000

109,820

49,820

381,323

1,618,677

60,000

113,307

53,307

328,016

1,671,984

60,000

117,039

57,039

270,977

1,729,023

60,000

121,032

61,032

209,945

1,790,055

60,000

125,304

65,304

144,641

1,855,359

60,000

129,875

69,875

74,766

1,925,234

60,000

134,766

74,766

2,000,000

Chapter 1

The Financial Statements 1-749

Yr. 8

Note: numbers may differ slightly due to rounding differences

Interest expense for the year ended Dec. 31, Year 4 is $117,039.

Chapter 1

The Financial Statements 1-750

(continued) P 9-61B

Req. 3 (reporting the liabilities at Dec. 31, Year 4) Current liabilities: Current portion of notes payable.... $ 50,000 Long-term liabilities: Bonds payable............................... $2,000,00 0 Less: Discount on bonds 1,729,02 payable……….. (270,977) 3 Notes payable ($300,000 – 250,000 $50,000) .......................................... 1,979,02 3 Total long-term liabilities……………………… $2,029,0 23 Total liabilities……………………………………

Chapter 1

The Financial Statements 1-751

(40-50 min.) P 9-62B

Req. 1 Using the PV function in EXCEL, the issue price of the bonds is $928,938.

Req. 2 (amortization table)

Semiannual Interest Date

Dec. 31, 2021 June 30, 2022 Dec. 31, 2022 June 30, 2023 Dec. 31, 2023 June 30, 2024 Dec. 31, 2024 June 30, 2025 Dec. 31, 2025 June 30, 2026 Dec. 31, 2026 June 30, 2027 Dec. 31, 2027

Interes t Payme nt (3% of Maturit y Value)

Interest Expense (3.5% of Precedin g Bond Carrying Amount)

Discount Amortizati on (B – A)

Discount Bond Account Carrying Balance Amount (Precedin ($1,000,000 – g D – C) D)

71,062

928,938

30,000

32,513

2,513

68,549

931,451

30,000

32,601

2,601

65,948

934,052

30,000

32,692

2,692

63,257

936,743

30,000

32,786

2,786

60,471

939,529

30,000

32,884

2,884

57,587

942,413

30,000

32,984

2,984

54,603

945,397

30,000

33,089

3,089

51,514

948,486

30,000

33,197

3,197

48,317

951,683

30,000

33,309

3,309

45,008

954,992

30,000

33,425

3,425

41,583

958,417

30,000

33,545

3,545

38,038

961,962

30,000

33,669

3,669

34,370

965,630

Chapter 1

The Financial Statements 1-752

June 30, 2028 Dec. 31, 2028 June 30, 2029 Dec. 31, 2029 June 30, 2030 Dec. 31, 2030 June 30, 2031 Dec. 31, 2031

30,000

33,797

3,797

30,573

969,427

30,000

33,930

3,930

26,643

973,357

30,000

34,068

4,068

22,575

977,425

30,000

34,210

4,210

18,365

981,635

30,000

34,357

4,357

14,008

985,992

30,000

34,510

4,510

9,498

990,502

30,000

34,668

4,668

4,831

995,169

30,000

34,831

4,831

1,000,000

Note: numbers may differ slightly due to rounding differences

(continued) P 9-62B

Req. 3 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

2021 a. Dec. 3 Cash.......................................... 1 Discount on Bonds Payable ........

CREDIT

928,938 71,062

Convertible Bonds Payable ....

1,000,00 0

To issue bonds at a discount. 2022 b. June 3 Interest Expense........................ 0 Cash .................................... Discount on Bonds Payable ... To pay interest and amortize bond Copyright © 2022 Pearson Education Inc.

Chapter 1

32,513 30,000 2,513

The Financial Statements 1-753

discount. c. Dec. 3 Interest Expense........................ 1 Cash ..................................... Discount on Bonds Payable.... To pay interest and amortize bond discount. 2023 d. July

Convertible Bonds Payable .........

32,601 30,000 2,601

400,000

1 Discount on Bonds Payable ($63,257 × .40) .................. Common Stock (120,000 × $1) ................................................. Paid-in Capital in Excess of Par — Common ................... To record conversion of bonds.

25,303 120,000 254,697

Req. 4 (balance sheet presentation of bonds payable at Dec. 31, 2023) Convertible bonds payable ($1,000,000 − $400,000).....................$600,000 Less: Discount on bonds payable ($60,471 × 3/5)*…………………………….…. (36,283)

$563,717

_____ *3/5 (or .60) of the bonds are outstanding, so 3/5 of the discount remains.

Chapter 1

The Financial Statements 1-754

(20-30 min.) P 9-63B

Req. 1 Brigham Foods, Inc. Partial Balance Sheet Dec. 31, 2021 Current Assets Long-term Investmts Property, plant, and equipment: Equipment ....

$400,00 0 Current liabilities:* $744,00 0

Bonds payable,

Accumulated Depreciation .......................

current portion..........

$ 50,000

(163,00 Mortgage note 0) payable, 581,000

current portion......... 98,000 Interest payable......... 76,000 Total current liabilities .. 224,000 Long-term liabilities: Mortgage note payable ....................

$ 311,000

Bonds payable $325,000

Less: Discount on bonds payable (21,000)

304,000

Chapter 1

The Financial Statements 1-755

liabilities ...................... 1,060,00 0 Total liabilities…………………

1,284,00 0

Total stockholders’ equity

3,216,00 0

Total liabilities and stock-

$4,500,0 00

holders’ equity……………….

_____

Notes:

* The order of listing long-term liabilities is optional. However, Discount on Bonds Payable should come immediately after Bonds Payable. Also, it is customary to report Interest Payable after the related liability accounts.

(continued) P 9-63B

Req. 2 a. Carrying amount of bonds payable: Current portion .......................................... Long-term portion ..................................... Carrying amount.........................................

$ 50,000 304,000 $354,000

b. Interest payable is the amount of interest that Brigham owes at year-end. Interest expense is the company’s cost of borrowing for the full year.

Req. 3 Times-interest-earned ratio

Operating income

Chapter 1

$360,000

The Financial Statements 1-756

Interest expense $229,000 =

1.57 times

Req. 4 Leverag e = ratio Debt ratio

Total assets ($4,500,000) Total common stockholders’ equity

1.4 = 0

($3,216,000)* Total liabilities [$1,284,000 = $224,000 + $1,060,000] Total assets ($4,500,000)

0.2 9

The company’s debt ratio and leverage ratios are low, and operating income covers interest payments 1.57 times. With this limited information, the company appears to be low risk from a leverage point of view.

Additional

information from prior years, competitors, and industry averages would also be helpful. * $4,500,000 – $224,000 – $1,060,000 = $3,216,000

Chapter 1

The Financial Statements 1-757

(continued) P 9-63B

Chapter 1

The Financial Statements 1-758

Challenge Exercises and Problem (10-15 min.) E 9-64

Req. 1 Total current assets = Total current liabilities

Current ratio

$324,500 −X = $173,500 −X

3.00

Let X = amount of current liabilities to pay in order to achieve a current ratio of 3.00. Palermo Marketing Services should pay off $98,000* of current liabilities within the next two days. Then the current ratio will be: $324,500 − $98,000* $173,500 − $98,000* *Computation:

$226,500 =

$75,500

3.00

$324,500 − X $173,500 − X

3.00

$324,500 − X

3.00 ($173,500 − X)

−X

$520,500 – 3.00X − $324,500

$98,000

Req. 2

Chapter 1

The Financial Statements 1-759

Leverag e = ratio Debt ratio

Total assets ($1,410,500) Total common stockholders’ equity

1.4 = 3

($983,600) Total liabilities ($426,900)

0.3 0

Total assets ($1,410,500) The leverage ratio and debt ratio are low. The debt position is low. Other helpful information would be the leverage and debt ratios from prior years and comparative ratios from competitors.

(20-30 min.) P 9-65

Req. 1 a.

Current ratio 2021

Current ratio

b. Debt ratio

Current assets Current liabilities

2020

$21,100 = $18,500 1.14

$16,800 = $13,100 1.28

Debt ratio Total liabilities Total assets

2021

2020

$71,800 – $30,300 $71,800

$47,800 – $24,600 $47,800

=.58

=.49

$21,100 Chapter 1

= 1.05

The Financial Statements 1-760

ratio

b. Debt ratio

assets Current liabilities

$18,500 + $1,640

Debt ratio Total liabilities Total assets

$41,500 + $1,640 – $1,640 = .58

$71,800

Chapter 1

The Financial Statements 1-761

Serial Case (15-20 min.) C9-66

1. No. The Cheesecake Factory had not actually borrowed any funds, therefore, there is nothing to report on the balance sheet. No journal entries were made for the loan commitment. A footnote that details the long-term credit agreement and the terms of the agreement would be added to the financial statements. 2. Cash

30,000,000 30,000,000

Note Payable

This new borrowing would increase the Cheesecake Factory’s assets by $30 million and increase its liabilities by $30 million as well. Equity is not impacted by this event. 3. The Cheesecake Factory would have to accrue $37,500* of interest expense for the month of December. Since interest payments are due monthly, only one month’s worth of interest must be accrued. The adjusting entry would increase the Company’s liabilities with a credit to Interest Payable, and decrease stockholders’ equity due to a debit to Interest Expense. Assets would not be impacted by this entry. *$30,000,000 x 1.5% x 1/12 = $37,500 4. $225,000 30,000,000 x 1.5% x 6/12 = $225,000 5. The hypothetical borrowing would cause the Net Adjusted Leverage Ratio to increase. The borrowing Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-762

increases the Company’s debt which leads to an increase in the Ratio. 6. The hypothetical borrowing would cause the EBITDAR ratio to decrease. The borrowing increases the Company’s interest expense, which leads to a decrease in the ratio.

Decision Cases (15-20 min.) C9-67

Req. 1 As Reported

Debt ratio

Total $54,033 = liabilities = Total assets $65,503 =

Return on Assets (ROA)

0.82

Net income $979 = Total assets $65,503 =

1.5%

Net income Revenue = Revenue XTotal assets =

$979 $100,789

$100,789 X $65,503

0.0097

1.5%

1.54

Chapter 1

The Financial Statements 1-763

Req.2 Leverage ratio

Total assets $65,503 Total $11,470 = common = stockholders ’ equity = 5.71

Return on Equity (ROE) =

ROA x Leverage ratio

=1.5% x 5.71 = 8.6%

(continued) C9-67 The ROE is greater than the ROA because the leverage ratio is extremely high which magnifies the ROA. The debt ratio is also extremely high and indicates that 82% of the assets were financed with debt. The high leverage ratio and debt ratio should have made investors question the soundness of Enron.

Req. 3 After Including the Special-Purpose Entities

Debt ratio

Total = liabilities = Total assets

$54,033 + $6,900 $65,503 + $500* – $600 =

0.93

Chapter 1

The Financial Statements 1-764

Return on assets

Net income Total assets

$979 – $300* $65,503 + $500 – $600 = 1.0%

*The SPEs’ income was nearly wiped out due to the restatement meaning that the SPE did not earn a net income but had a loss, of which $300 applies to 2000; they did have assets with a market value of $500.

LLeverage L ratio

Total assets Total = common stock. equity

$65,503 + $500 – $600 ($65,503 + $500 – $600) – ($54,033 + + $6,900) = 14.63

(continued) C9-67

Timesinterest= earned ratio

Operating Income Interest

After Including the

Reporte d

Special-Purpose Entities

$1,953

$1,953 + ($300)

$838

$838 + ($6,900 × .10)

2.3 times

= 1.1 times

expense =

Chapter 1

The Financial Statements 1-765

Req. 4 It

appears

that

Enron

excluded

the

special-purpose-

entities (SPEs) from its financial statements in order to hide their debt from Enron’s investors and creditors. The purpose was to understate Enron’s liabilities. We would view Enron as much more risky after including the SPEs in Enron’s financial statements. So did their banks, which is why they stopped lending money to them, causing them to have to file for bankruptcy.

Chapter 1

The Financial Statements 1-766

Focus on Financials: Apple Inc. (20 min.)

Req. 1

The “statutory rate” is the maximum federal tax rate for taxable income of corporations specified by the Internal Revenue Code.

The effective tax rate is the actual

computed rate of tax on each corporation’s income statement found by dividing the provision for income tax expense by net income before taxes. As stated in Note 5, on December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”), which significantly changed U.S. tax law. The Act lowered the Company’s U.S. statutory federal income tax rate from 35% to 21% effective January 1, 2018, while also imposing a deemed repatriation tax on previously deferred foreign income.

On the other hand,

the company’s effective tax rate as of September 28, 2019, is computed as follows: Provision for income taxes $10,481 million/Net income before federal income tax $65,737 million = 15.9%. For the year ending September 28, 2019, the income before the provision for income taxes is $65,737 million. This is the amount of income before the consideration of income taxes. According to Note 5, the pretax earnings of foreign subsidiaries were $44.3 billion for the year ending September 28, 2019.

Chapter 1

The Financial Statements 1-767

As shown in the reconciliation schedule in Note 5, the principal

reconciling

item

between

the

company’s

hypothetical tax at the statutory rate ($13,805 million) and the actual tax provision ($10,481 million) is the reduction in tax allowed by IRS law due to the earnings of Apple’s foreign subsidiaries ($2,625 million).

Under IRS

law, the company is also entitled to tax credits for research and development ($548 million) and excess tax benefits from equity awards ($639 million). (continued) Apple Inc.

Req. 2 Refer to Note 6—Debt.

Based on this information, the

company’s total term debt as of September 28, 2019 was $101,679 million. This compares to total term debt as of September 29, 2018, of $104,193 million.

Therefore, it

appears that in fiscal 2019, the company paid off more of its term debt than it borrowed. According to the statement of cash flows, for the year ending September 28, 2019, the company issued $6,963 million of term debt and paid $8,805 million of term debt. At September 28, 2019, the maturity dates and amounts of term debt were as follows: Term Debt Floating

Maturity Dates rate 2020-2022

Chapter 1

Amounts $4,250 million The Financial Statements 1-768

notes Fixed rate 0.35%- 2019-2047

$90,429 million

4.65% notes Fixed

rate

1.7%- 2022-2049

$7,000 million

2.95% notes According to the balance sheet at September 28, 2019, the total amount of term debt was $102,067 million. The current portion of term debt (due within the next fiscal year) was $10,260 million.

The remainder ($91,807

million) was due in subsequent years.

These amounts

agree with the captions entitled ”Term Debt” in the current liability section of the balance sheet and ”Term Debt” in the non-current portion of the balance sheet. The difference between the total term debt in the balance sheet ($102,067

(continued) Apple Inc. million) and Note 6 ($101,679 million) is due to small adjustments for premium/discount amortization and hedge accounting. The effective interest rates on this debt ranged from 0.28% to 4.78%.

This reflects the market for interest

Chapter 1

The Financial Statements 1-769

rates on borrowed funds during this time period, which were quite favorable. There are several possible reasons for the low interest rates, including: (1) there is a low market interest rate, (2) the low interest rates stimulate the economy and keep economic recovery alive, and (3) Apple has an excellent credit rating with the bank as seen by healthy liquidity and debt paying ability.

Req. 3 Ratio

2019

Debt ratio

$248,028 $338,516

2018 $258,578 $365,725 =

73.3% Times interest earned

70.7% $63,930* $3,576**

17.88

Current ratio

$70,898 $3,240

$131,339 $115,929

= 1.13

21.88 $162,819 $ 105,718

1.54 Leverage ratio

($338,516 + $365,725)/2 = 3.56 ($90,488 + $107,147)/2

($365,725 + $375,319)/2 = 3.07 ($107,147 + $134,047)/2

*Operating income for 2019 and 2018, respectively, per Consolidated Statements of Operations **Interest expense recognized in 2019 and 2018, respectively, per Note 4 of Consolidated Financial Statements

Chapter 1

The Financial Statements 1-770

Apple Inc.’s debt ratio increased during 2019, as reflected in the increase of its debt to total asset ratios from 2018 to 2019. It is trending upward. (continued) Apple Inc. Because of new debt, the times interest earned (operating income/interest expense) ratio declined. [Note, Interest Expense

can

found

Financial

Statement

under

Details,

Note

Other

4—Consolidated

Income/(Expense),

Net]. The current ratio has increased and is average. The company’s leverage position is headed higher, although it is probably still quite acceptable, given the company’s reputation. The financial ratios all look safe with the exception of the debt ratio. It is increasing each year and it is currently 73.3%. This should be closely monitored in the future.

Chapter 1

The Financial Statements 1-771

Focus on Analysis: Under Armour, Inc. (20 min.)

Req. 1

Following Note 7, the weighted-average interest rate on revolving credit facility borrowings for 2019 is 3.6%. The company also had senior notes outstanding for $600 million with 3.25% stated interest. The senior notes are due June 15, 2026. At December 31, 2019, Under Armour has no current maturities of long-term debt for 2020, but has long-term debt due in years after 2020.

Req. 2 In Note 8—Commitments and Contingencies, there is information about sports marketing and other contracts and

agreements.

Company’s

brand

Contractual and

products.

commitments

promote

They

sponsorship

Chapter 1

include

the

The Financial Statements 1-772

agreements

with

teams

and

athletes

the

collegiate

and

professional levels, official supplier agreements, athletic event sponsorships and other marketing commitments. The company estimates such commitments total $679 million over the six-year period from 2020 through 2025, and thereafter. The commitment is not reported on the balance sheet, but rather disclosed in Note 8. Under Armour only records a liability for a contingency if a loss is “probable and reasonably estimable”. At December 31, 2019, Under Armour lists several pending lawsuits which involve: 4. Infringement of intellectual property. The company believes there will be no material effect on the financial statements. Therefore, they are not included in the balance sheet. (continued) Under Armour, Inc. 5. Shareholders’

cases

against

company

for

misrepresentation of expected revenue growth. The company believes the cases are “without merit.” They are not included in the balance sheet. 6. Rest of litigation concerning business endeavors. The company believes there will be no material effect on the financial statements. Therefore, they are not included in the balance sheet. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-773

Req. 3 The operating lease arrangements involve warehouse space, office facilities, space for its brand and factory house stores, and certain equipment.

Under Armour has

to pay a rent to the owner of the property subject to the agreement and reports that amount as rent expense on its income statement. The company has a current operating lease liability (due during 2020) of $125,900,000 as of December 31, 2019.

It has non-current operating lease

liability of $580,635,000 for amounts due after 2020.

The

balance sheet includes “right to use assets” in both the current and non-current category for assets acquired under operating lease arrangements. Included in selling, general and administrative expenses were operating lease costs of $166.4 million, including $12.9 million in variable lease payments, for the year ended December 31, 2019, under non-cancelable operating lease agreements.

The

schedule in note 6 discloses that operating cash outflows for operating lease costs were $116,811,000 in 2019. Operating lease costs (rent expense) for 2018 and 2017 were $152,700,000 and $141,200,000, respectively.

(continued) Under Armour, Inc.

Chapter 1

The Financial Statements 1-774

Req. 4 (In Thousands) Debt Ratio

Total debt Total assets

$2,693,444 $4,843,531

Leverag e Ratio

Total assets Total common stockholders’ equity

($4,843,531 + $4,245,022)/2 ($2,150,087 + $2,016,871)/2

Times Interest Earned

Operating income Interest expense

$236,770 $21,240

The times interest earned ratio is strong.

= 0.56

= 2.18

= 11.15

Under Armour

has a relatively low debt ratio (compared to an overall average

about

60-70%).

This

good

for

equity

investors upon liquidation. Under Armour appears to be relatively safe in terms of these ratios.

Req. 5 The solution to this requirement will depend on the financial statements selected. Student responses will vary.

Chapter 1

The Financial Statements 1-775

Group Projects Student responses will vary.

Chapter 10 Stockholders’ Equity Ethics Check (5-10 min.) EC 10-1 a. Due care b. Objectivity and independence c. Objectivity and independence d. Integrity

Chapter 1

The Financial Statements 1-776

Short Exercises (5-10 min.) S 10-1 Corporation’s advantages:  Continuous life  Transferability of ownership  Limited liability of the stockholders  Ease of raising capital Corporation’s disadvantages:  Double taxation of distributed profits  Government regulation  Separation of ownership and management The authority structure of a corporation begins with shareholders, who hold ultimate power.

Shareholders

elect the board of directors who in turn appoint officers. The board elects a chairperson (CEO), who is usually the most powerful person in the organization.

Chapter 1

The board

The Financial Statements 1-777

designates

the

president

(COO)

and

various

vice

presidents.

Student responses may vary.

(5-10 min.) S 10-2 1. The common stockholders are the real owners of a corporation. 2. Preferred

stockholders

have

priority

over

common

stockholders in (1) receipt of dividends and (2) receipt of assets if the corporation liquidates. 3. Common stockholders benefit more from a successful corporation dividends

because

are

limited

the to

preferred

stockholders’

specified

amount.

The

Chapter 1

The Financial Statements 1-778

(5-10 min.) S 10-3 The $11,488,500 was paid-in capital in excess of par – common. It was not a profit and therefore had no effect on net income. The par value per share of stock has no effect on total paid-in capital. Total paid-in capital is the total amount that

stockholders

have

invested

(paid

into)

corporation, including the par value of stock issued plus any additional paid-in capital.

Chapter 1

The Financial Statements 1-779

(5 min.) S 10-4

Millions

Hammond Legal Services:

Cash .................................................. 17,426 Common Stock................................ Additional Paid-in Capital ................

26 17,400

Delectable Doughnuts: Cash .................................................. Common Stock................................

296 296

(5-10 min.) S 10-5 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Jan 2 9

Legal Expense ..........................

20,400

CREDIT

Common Stock (1,500 × $0.01)

Paid-in Capital in Excess of Par – Common................................ Issued stock for services.

20,385

Chapter 1

The Financial Statements 1-780

(5-10 min.) S 10-6

Case A — Issue stock and buy the assets in separate transactions: Journal DATE

ACCOUNT TITLES AND EXPLANATION

Cash .........................................

Chapter 1

DEBIT

CREDIT

950,00 0

The Financial Statements 1-781

Common Stock (12,000 × $35)

420,00 0

Paid-in Capital in Excess of Par – Common................................

530,00 0

Issued stock. Building .................................... 560,00 0 Equipment ................................ 390,00 0 Cash .....................................

950,00 0

Purchased plant assets.

Case B — Issue stock to acquire the assets: Building .................................... 560,00 0 Equipment ................................ 390,00 0 Common Stock (12,000 × $35)

420,00 0

Paid-in Capital in Excess of Par – Common................................

530,00 0 Issued stock to acquire building and equipment. The balances in all accounts are the same.

Chapter 1

The Financial Statements 1-782

(5 min.) S 10-7 Journal DATE

Jan .

1 0

ACCOUNT TITLES AND EXPLANATION

Treasury Stock............................

DEBIT

Millions

Cash....................................... Jul y

Cash ...........................................

CREDI T

26 11

3 Treasury Stock........................ Paid-in Capital from Treasury Stock Transactions .......................

4 7

Overall, stockholders’ equity decreased by $15 million ($26 million paid out minus $11 million received).

Chapter 1

The Financial Statements 1-783

(15-20 min.) S 10-8

Req. 1 MEMORANDUM TO:

Krugman Exports, Inc., Board of Directors

FROM:

Student Name

RE:

How the purchase of treasury stock will make it more difficult for outsiders to take over the company

Purchasing treasury stock decreases the amount of stock outstanding.

Krugman

Exports

holds

sufficient

quantity of company stock in the treasury, outsiders, such as the Creston investor group, may not be able to acquire a controlling interest (50+ percent) of the outstanding stock from the remaining stockholders. Because it takes cash to buy treasury stock, the purchase decreases the size of the corporation. Reducing the company’s cash position may make the company sufficiently unattractive to cause the outside investors to abandon their takeover plan.

Req. 2 Sales of treasury stock at prices above the purchase price increase company assets because of the greater amount of assets coming in from the sale than went out to buy the stock. Treasury stock transactions do not affect liabilities, so the sale of treasury stock also increases stockholders’ Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-784

equity. These sales of treasury stock will not affect net income because the company is dealing with its owners. Transactions between the corporation and its owners

cannot generate a profit or a loss that is reported on the income statement. Student responses may vary.

Chapter 1

The Financial Statements 1-785

(10 min.) S 109

DATE 2021 Feb. 5

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Retained Earnings (1,600,000 × $.30) ….. Dividends Payable .................. Declared a cash dividend.

480,000

Mar 18 Dividends Payable ...................... . Cash ...................................... Paid the cash dividend.

480,000

CREDIT

480,000

(10 min.) S 10-10 Journal ACCOUNT TITLES AND EXPLANATION

DATE a. 2021 Dec. 15 Retained Earnings ($130,000 × .01) + (65,000 × $.45).......................................... Dividends Payable .................. Declared a cash dividend. b. 2022 Jan. 4 Dividends Payable ...................... Cash ...................................... Paid the cash dividend.

Chapter 1

DEBIT

CREDIT

30,550 30,550

The Financial Statements 1-786

During 2021, Retained Earnings increased by $59,450 (net income of $90,000 − dividends of $30,550).

Chapter 1

The Financial Statements 1-787

(5-10 min.) S 10-11 1.

$35,000 (25,000 shares × $1.40 per share)

Preferred:

$ 35,000

Common:

$165,000

3. Cumulative, because it is not specifically designated as noncumulative. 4.

Preferred:

$105,000 ($35,000 × 3)

Common:

$695,000 ($800,000 – $105,000)

(5-10 min.) S 10-12

Req. 1 Journal DATE

Ma y

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

1 Retained Earnings (40,000 × .05 × 30,000 1 $15) .................................................. Common Stock (40,000 × .05 × $3)... 6,000 Paid-in Capital in Excess of ParCommon ............................................ 24,000

Chapter 1

The Financial Statements 1-788

No effect on total stockholders’ equity

(5-10 min.) S 10-13

Stockholders’ equity: Common stock, $.01 par, 600,000 shares issued and outstanding ..................................... $ 6,000 Paid-in capital in excess of par ................... 334,000 Total paid-in capital.……………………………………...

340,000

Retained earnings ..................................... 660,000 Total stockholders’ equity .......................... $1,000,0 00

Chapter 1

The Financial Statements 1-789

(15-20 min.) S 10-14

Amounts In Thousands a. Total revenues..............................................

$1,600

Total expenses .............................................

1,000

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

600

b. Accounts payable..........................................

100

Notes payable (short-term) ...........................

Other current liabilities .................................

200

Long-term debt.............................................

Total liabilities..............................................

375

Total liabilities (from Req. b) .........................

375

Total stockholders’ equity (from S 10-13).......

1,000

Total assets ..................................................

$1,375

d. Net profit = margin ratio

Net income Total revenues

$600 $1,600

= .375

e. Asset = turnover

Total revenues Total assets

$1,600 $1,375

= 1.164

Chapter 1

The Financial Statements 1-790

Leverage = ratio

Total assets Total stockholders’ equity

$1,375 $1,000

Net income Total stockholders’ equity

$600 $1,000

= 1.375

g. Return = on equity

.60

Prior year returns from the company and comparative data for competitors would also be helpful to make decisions.

(10 min.) S 10-15 Total stockholders’ equity................................ $4,375,000 Less: Preferred stock .....................................

(264,000)

Preferred dividends in arrears (33,000 × .07 × $8 x 3)....................... (55,440) Common equity ...............................................

$4,055,560

Number of common shares outstanding (62,000 − 1,200) ...................................

÷ 60,800

Book value per share of common stock .............

$ 66.70

Chapter 1

The Financial Statements 1-791

(10-15 min.) S 10-16 (a)

(b)

Rate of return on total assets (ROA) Rate of return on common stockholders' equity (ROE)

Net profit margin ratio x Asset turnover

ROA x Leverage ratio

Req. 1 The components of ROA are net profit margin ratio and asset turnover. Net profit margin ratio [(net income minus preferred dividends)/net sales] is a measure of operational effectiveness.

It measures the net profit generated for

each dollar of sales.

Generally, companies that can

differentiate a highly desirable product can sell the product for more, generating a higher profit. Asset turnover (net sales/average total assets) is a measure of efficiency in the use of assets. Generally, companies that can cut costs by reducing the amount invested in fixed assets and inventory without sacrificing sales revenue are more efficient. Asset turnover measures sales generated for each dollar of assets invested.

Req. 2 The leverage ratio (average total assets/average common stockholders’ equity) measures the impact of the use of borrowed capital on return on equity. It magnifies the ROA to make ROE larger. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-792

Req. 3 If ROA is positive, and the leverage ratio exceeds one, the leverage ratio makes ROE more positive. Then ROE will be higher than ROA. If ROA is negative, and the leverage ratio exceeds one, the leverage ratio makes ROE more negative. Then ROE will be lower than ROA.

(10-15 min.) S 10-17

Net profit margin =

Net income Net sales revenues

¥119 ¥7,635

.016

ratio Asset

Net sales revenues turnove = Average total r assets

¥7,635 =

Leverag Avg. total assets e = ratio = Avg. com. stkholders’ equity Net profit margin ratio .016

ROA 1.2%

¥7,635 = .759

(¥9,509 + ¥10,618)/2

= ¥10,06 4

¥10,064

¥10,06 = 3.301 4 = ¥3,049

(¥2,882 + ¥3,216)/2

Asset turnover .759

Leverage ratio 3.301

ROE = .04 (4%)

Chapter 1

ROA .012 (1.2%)

The Financial Statements 1-793

The company’s rate of return on total assets for 2021 is weak.

The

company’s

rate

return

stockholders’ equity for 2021 is also weak. helpful

know

the

company’s

prior

common

It would be year

income

information, as well as current year information for the industry for comparative purposes.

(10-15 min.) S 10-18 Plan A Plan B Issue $2,000,000 Issue of $2,000,000 6% Bonds of Common Payable Stock Net income before expansion ......

$500,0 00

Project income before interest and income tax ....................... $ 400,000 Less: interest expense (120,000 )

($2,000,000 × .06)

$400,00 0 0-

Project income before income tax 280,000

400,000

(84,000)

(120,00 0)

Less income tax expense (30%). ..

Chapter 1

The Financial Statements 1-794

Project net income......................

Total company net income ..........

196,00 0

280,00 0

$696,0 00

$780,0 00

Earnings per share including expansion: Plan A ($696,000 / 100,000 shares).......................................

$6.96

Plan B ($780,000 / 200,000 shares).......................................

$3.90

Recommendation: Plan A has a higher EPS. To increase earnings per share, Waketown Marina should borrow the money.

(20-30 min.) S 10-19 1. Common stock is the basic form of capital stock. Common shareholders are the owners of the corporation who have basic rights such as the right to vote. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-795

Preferred stock gives owners certain advantages over common stock, such as the right to receive dividends and

liquidation

shareholders.

payments

ahead

common

However, preferred stock is generally

non-voting. 2. We should first determine the market value of the land. Then divide the land’s value by the market value of each share of stock. The result will tell us how many shares of our stock to issue for the land. 3. Investors buy common stock in the hope of earning higher returns on their investment than are available on an investment in preferred stock. Investors in common stock expect higher dividends and capital gains than they would expect with preferred stock. 4. ROA measures profitability as a percentage of the company’s total asset investment by both creditors and shareholders,

while

ROE

measures

profitability

comparison with just the shareholders’ investment. The leverage ratio explains the difference between ROA and ROE. ROE equals ROA times the leverage ratio. 5. Some of the things Zanzibar Corporation can do to improve ROE would be to increase net income or decrease average common stockholders’ equity. Copyright © 2022 Pearson Education Inc.

Chapter 1

One

The Financial Statements 1-796

way to decrease average common stockholders’ equity would be to buy up treasury stock.

Chapter 1

The Financial Statements 1-797

(5-10 min.) S 10-20

Billions Cash flows from financing activities: Paid off long-term notes payable ....................

$(2.5)

Issued common stock .....................................

1.1

Purchased treasury stock ...............................

(3.7)

Paid cash dividends .......................................

(1.3)

Net cash used by financing activities .................

$(6.4)

Chapter 1

The Financial Statements 1-798

(10 min.) S 10-21 1.

$564,000

($64,000 + $500,000)

$27,000

The dividend:  decreased retained earnings by $27,000  had no effect on total paid-in capital  decreased total stockholders’ equity by $27,000  decreased total assets by $27,000

Cost of treasury stock purchased = $9,000

Cost of treasury stock sold = $8,500 Proceeds from sale of treasury stock = $9,500 ($1,000 + $8,500)

$70,000

$841,500

Chapter 1

The Financial Statements 1-799

(10 min.) S 10-22 1. $594,000

($64,000 + $530,000)

2. The stock dividend:  decreased retained earnings by $58,000  increased total paid-in capital by $58,000 ($8,400 + $49,600)  had no effect on total stockholders’ equity  had no effect on total assets 3. Cost of treasury stock purchased = $10,000 Cost of treasury stock sold = $3,000 Proceeds from sale of treasury stock = $9,000 ($6,000 + $3,000)

Chapter 1

The Financial Statements 1-800

8. False 9. True 10. False

(10-15 min.) S 10-24 Formatting changes include:

1. Centering and bolding the headings and column headings. 2. Wrap the column headings to fit the column width. 3. Use thousand separators and right-justify all the numbers. 4. Use a consistent number of decimals. 5. Place a dollar sign in the leftmost position for each cell containing the first number in each column, each subtotal number, and each total number. 6. Use dashes in place of zeros. 7. Place a single line above each cell containing a subtotal number. 8. Place a single line above and a double line below each cell containing a total number. 9. Use 11-point Calibri, Verdana, or Cambria font. 10. Use spell-check. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-801

Exercises (10-15 min.) E 10-25A a. Preemption b. Liquidation c. Stockholders’ equity d. Limited liability e. Charter f. Par value g. Preferred stock h. Common stock i. Board of directors j. Corporation k. Legal capital l. Retained earnings

Chapter 1

The Financial Statements 1-802

(10-15 min.) E 10-26A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Jan. 23 Cash............................................. 14,000 Common Stock (1,000 × $6.00) . Paid-in Capital in Excess of Par – Common ..................................

CREDIT

6,000 8,000*

Feb. 12 Inventory...................................... 11,000 Equipment .................................... 44,000 Common Stock (3,800 × $6.00) . 22,800 Paid-in Capital in Excess of Par – 32,200* Common...................................

Req. 2 Stockholders’ Equity Common stock, $6.00 par, 11,000 shares authorized, 4,800 shares issued and outstanding ............. Paid-in capital in excess of par – common............ Total paid-in

$ 28,800 40,200* 69,000

capital…………………………………………… Retained earnings ..............................................

41,000

Total stockholders’ equity..............................

$110,000

Chapter 1

The Financial Statements 1-803

___

*Computations: Jan. 23: 1,000 shares × ($14.00 − $6.00) = ……………………. Feb. 12: $11,000 + $44,000 − (3,800 shares × $6.00) =……….

$8,000 32,200 $40,200

Chapter 1

The Financial Statements 1-804

(10 min.) E 10-27A Paid-in capital consists of: Issued common stock for legal services ........

$ 24,000

Issued common stock for patent................... 80,000 Issued preferred stock (10,000 shares × $120) .......................................................

1,200,000 72,000

Issued common stock for cash (18,000 shares × $4)........................................................ Total paid-in capital .....................................

$1,376,00 0

Unused data: Net income Dividends declared Alternative short-cut solution: 1. $ 24,000 2. 80,000 3. 1,200,000 (10,000 × $120) 4. 72,000 (18,000 × $4) $1,376,000 = Total paid-in capital

Chapter 1

The Financial Statements 1-805

(10-15 min.) E 10-28A Stockholders’ Equity (Thousands) Common stock, $0.01 par, 1,100 shares issued and outstanding……………………………………………….....

$ 11

Paid-in capital in excess of par .......................... 197 Total paid-in capital .......................................... 208 Retained earnings ............................................. 648 Other stockholders’ equity ................................ (22) Total stockholders’ equity.............................

Req. 1

$834

(10-15 min.) E 10-29A Stockholders’ Equity (Thousands)

Common stock, $1.75 par, 1,000 shares authorized, 250 shares issued and 120 shares outstanding $ Paid-in capital in excess of par ..........................

438 902

Total paid-in capital………………………………………………

1,340

Retained earnings .............................................

2,222

Chapter 1

The Financial Statements 1-806

(730) Total stockholders’ equity............................. $1,012

Req. 2 Bretton Software paid a higher price to acquire treasury stock than the price Bretton received when it issued its stock. This explains why Treasury Stock has a greater balance than the sum of Common Stock plus Paid-in Capital in Excess of Par. (5-10 min) E 10-30A Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBI T

CREDI T

Millions Treasury Stock ..................................... Cash..................................................

Cash .................................................... Treasury Stock .................................. Paid-in Capital from Treasury Stock Transactions ...................................

Overall, stockholders’ equity decreased by $14 million (decrease of $28 million and increase of $14 million).

Chapter 1

The Financial Statements 1-807

5 9

(10 min.) E 10-31A

Req. 1 Journal DATE

c. d.

ACCOUNT TITLES AND EXPLANATION

DEBI T

Millions

Cash (4 million × $14.00) ...................... Common Stock (4 million × $3.00) ...... Paid-in Capital in Excess of Par Value .

Treasury Stock ..................................... Cash..................................................

Cash .................................................... Treasury Stock .................................. Paid-in Capital from Treasury Stock Transactions ...................................

Retained Earnings ................................ Dividends Payable .............................

Dividends Payable ................................ Cash..................................................

or one entry only:

Retained Earnings ................................ Cash..................................................

CREDI T

12 44 60 24* 4 32 32 32 32

*$60 /5 = $12 cost per share of treasury stock $12 x 2 = $24

Chapter 1

The Financial Statements 1-808

(10 min.) E 10-32A

Millions

Stockholders’ Equity: Common stock, $3.00 par value, 25 million shares issued, 22 million shares outstand-

ing ($63 + $12) .......................................... Paid-in capital in excess of par value ($32 + $44)

Paid-in capital from treasury stock transactions.......................................................

Total paid-in capital........................................

155

Retained earnings ($245 + $440 − $32) ...........

653

Treasury stock, 3 million shares, at cost ($20 + $60 − $24)

(56)

Total stockholders’ equity ...........................

$ 752

Chapter 1

The Financial Statements 1-809

(20-30 min.) E 10-33A

Req. 1 Possible causes for preferred stock decrease:  Conversion of preferred stock into common stock  Retirement of preferred stock

Req. 2 Possible causes for common stock increase:  Preferred stockholders converted their preferred into common  Issued stock for cash or other assets  Distributed stock dividend

Req. 3

(Millions of shares)

Dec. 31, 2022 Common shares issued ...................

300

Less: Treasury stock, number of shares............................................

(20)

Common shares outstanding ...........

280

Req. 4

Retained Earnings (Millions) Dec. 31, 2021

Dividends

110

Net income Chapter 1

Bal. 4,95 0 1,43 0

The Financial Statements 1-810

Dec. 31, 2022

Bal. 6,27 0

Req. 5 (All amounts in millions) December Purchases 31, 2022 2021 During 2022 Cost of treasury stock.................

$440

$180 = $ 260 −

Treasury stock, number of shares .................................................

10 =

÷ 10

−

Average price per share paid for treasury stock purchased during 2022

Chapter 1

$26.00

The Financial Statements 1-811

(15 min.) E 10-34A

Req. 1 Preferre d Commo n 2021 Total dividend

Total

$90,000

Preferred dividends in arrears: 2019: 70,000 shares × $4.00 (par) per share × .05 = $14,000 2020: 70,000 shares × $4.00 (par) per share × .05 =

14,000

Preferred dividends, current year : 2021: 70,000 shares × $4.00 (par) per share × .05 =

14,000

Total to preferred

$42,000

Remainder to common

$48,000

2022 Total dividend

$189,00 0

Preferred dividends, current year: 2022: 70,000 shares × $4.00 (par) per share × .05 = $14,000 Remainder to common

$175,00 0

Chapter 1

The Financial Statements 1-812

(15-20 min.) E 1035A

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

Aug 1 Retained Earnings (300,000 × .10 × 600,00 6 $20) ................................................. 0 Common Stock (300,000 × .10 × 15,000 $0.50) .............................................. Paid-in Capital in Excess of Par – Common .................................. 585,000 To declare and distribute a common stock dividend.

Req. 2 Stockholders’ equity: Common stock, $0.50 par, 2,700,000 shares authorized, 330,000 issued and outstanding (330,000 $ 165,000 x $0.50)… Paid-in capital in excess of par – common ($585,000 + $645,760)..........................

1,230,760

Retained earnings ($7,750,000 − $600,000) .....................................................................

7,150,000

Accumulated other comprehensive income (loss).............................................................

(185,000)

Total stockholders’ equity .....................

$8,360,760

Req. 3 The stock dividend did not change total stockholders’ equity because the company didn’t distribute assets to the shareholders as it would in a traditional cash dividend. The company merely transferred $600,000 from Retained Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-813

Earnings to Common Stock ($15,000) and Paid-in Capital in Excess of Par ($585,000).

Req. 4 Warren’s maximum cash dividend is limited to $530,000, the balance of its cash account.

Chapter 1

The Financial Statements 1-814

(15-20 min.) E 10-36A a. Decrease stockholders’ equity by $85 million. b. No effect. c. No effect. d. No effect. e. Decrease stockholders’ equity by $26,000 (1,600 × $16.25). f.

Increase stockholders’ equity by $14,400 (800 × $18).

g. No effect.

Chapter 1

The Financial Statements 1-815

(10-15 min.) E 10-37A

Req. 1 a. Net profit = margin ratio

$7,500 $100,000

b. Asset Net sales = turnover = Average total ratio assets

$100,000 $50,000

c. Leverage ratio

Net income Net sales

7.5%

2.0

Avg. total assets = = Avg. common stkholders’ equity

$50,000 $20,000

2.5

Net profit margin ratio 7.5%

Asset turnover 2.0

= ROA = 15.0%

x x

Leverage ratio 2.5

= ROE = 37.5%

e. ROA 15.0%

_____

Req. 2 ROE is higher than ROA. This makes sense because ROE equals ROA times the leverage ratio. As long as the leverage ratio exceeds one, ROE will exceed ROA. In this Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-816

case, the leverage ratio is 2.5, so the ROE will exceed ROA.

(15-20 min.) E 10-38A

Req. 1

PLAN B PLAN A BORROW $800,000 AT 10%

Net income before expansion ...........

ISSUE $800,000 OF COMMON STOCK

$500,000 $500,000

Project income before interest and income tax

$800,000

Less interest expense ($800,000 × .10) .................................................

$800,000 -0-

80,000

Project income before income tax ..... 720,000 Less: income tax expense (30%) .......

800,000

(216,000) (240,000)

Project net income ...........................

504,000 560,000

Total company net income ...........

$1,004,00 0 $1,060,00 0

Earnings per share including new project: Plan A ($1,004,000 / 200,000 shares) ............................................ Plan B ($1,060,000 / 400,000 shares) ............................................ Copyright © 2022 Pearson Education Inc.

Chapter 1

$5.02 $2.65

The Financial Statements 1-817

Plan A will result in higher EPS.

Req. 2 Plan A (borrowing) results in much higher earnings per share. Plan A also allows the existing stockholders to retain control of the company because the company issues no new stock. But Plan A also creates more financial risk because borrowing obligates the company to pay the interest and the principal of the debt. I prefer Plan A, assuming the company’s level of debt is not already too high. Students

can

defend

either

plan

based

their

preferences for control of the business, avoidance of risk, and higher earnings per share.

(10-15 min.) E 10-39A

Req. 1 Net profit = margin ratio

Net income Net sales

Asset Net sales turnove = Average total = r assets

$2,200 $60,000 $60,000 ($52,056* + $55,798**)/2

Chapter 1

3.7%

$60,000 1.11 = $53,927 = 3

The Financial Statements 1-818

Leverag Avg. total $53,927 e assets = =2.87 ($14,033 + $23,479) 5 ratio = Avg. common /2 stkholders’ equity Net profit margin ratio 3.7% ROA 4.12%

Asset turnover 1.113

= ROA = 4.12%

x x

Leverage ratio 2.875

= ROE = 11.8%

_____ Total assets = Total liabilities + Stockholders’ equity *Beginning of year = $52,056 ($38,023 + $14,033) **End of year = $55,798 ($32,319 + $23,479)

Chapter 1

The Financial Statements 1-819

(continued) E 10-39A

Req. 2

These rates of return suggest relative weakness. The company is generating a 3.7% net profit margin ratio (low effectiveness).

The company is generating an asset

turnover of 1.113 meaning they are generating $1.11 in sales for each dollar of assets invested (low efficiency). Finally,

the

company

has

relatively

high

leverage,

meaning they are utilizing debt effectively. This magnifies the relatively low ROA to an 11.8% ROE, which is below the cutoff of 20% for many industries. The ROA is also below the average of 10%.

Req. 3 Comparative data from prior years as well as industry competitors’ ROA and ROE measures would also be helpful when making this decision.

(10 min.) E 10-40A

Chapter 1

The Financial Statements 1-820

) Proceeds from issuance of common stock .... 8,500 Dividends paid ............................................ (215) Net cash used for financing activities $ (8,815)

Chapter 1

The Financial Statements 1-821

(20-25 min.) E 10-41A

Req. 1 (Thousands)

$3.50 Addition Accum. Total Par al Retaine Other Shareholde d rs’ Common Paid In Comprehensi Capital Earning Equity Stock ve s Income

Balance, Dec. 31, 2020

$370

$2,630 $6,000

$15

$9,015

1,370

Net earnings

1,370

Other comprehensive

Income Issuance of stock

245

155

400 (70)

Cash dividends Balance, Dec. 31, 2021

$615

$2,785

(70) $20

$10,720

$7,300

Req. 2 Debt ratio

Total liabilities Total assets

$7,800 =

= 42.1% $18,520*

*$7,800 + $10,720 = $18,520

Req. 3 The year was profitable, as indicated by net earnings.

Req. 4 Issue

Amount received

Chapter 1

$400

$5.71

The Financial Statements 1-822

price

Number of shares issued

70*

per share

*$245/$3.50 par = 70 shares issued

Chapter 1

The Financial Statements 1-823

(10-15 min.) E 10-42B a. Retained earnings b. Stockholders c. Double taxation d. Preferred stock e. Share of capital stock f. Charter g. Liquidation h. Corporation i. Paid-in capital j. Par value k. Limited liability l. Preemption

Chapter 1

The Financial Statements 1-824

(10-15 min.) E 10-43B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Apr. 23 Cash ............................................. Common Stock (3,200 × $2) ...... Paid-in Capital in Excess of Par – Common .................................

51,200

May 12 Inventory...................................... Equipment .................................... Common Stock (3,700 × $2) ...... Paid-in Capital in Excess of Par – Common ...................................

11,000 44,000

6,400 44,800*

7,400 47,600*

Req. 2 Stockholders’ Equity Common stock, $2.00 par, 16,000 shares authorized, $ 13,800

6,900 shares issued and outstanding………………………...

Paid-in capital in excess of par − common............. 92,400* Total paid-in capital…………………………………………….

106,200

Chapter 1

The Financial Statements 1-825

Total stockholders’ equity ............................... $157,20 0 _____ *Computations: Apr. 23: 3,200 shares × ($16.00 − $2.00) = $44,800 May 12: $11,000 + $44,000 − (3,700 shares × 47,600 $2.00) = ..................................................................... $92,400

Chapter 1

The Financial Statements 1-826

(10 min.) E 10-44B Paid-in capital consists of: Issued common stock for legal services..........

$ 25,000

Issued common stock for patent ....................

75,000

Issued preferred stock (10,000 shares × $100) ........................................................

1,000,00 0

Issued common stock for cash (21,000 shares × $5) ....................................................

105,000

Total paid-in capital ......................................

$1,205,0 00

Unused data: Net income Dividends declared

Alternative short-cut solution: 1. $ 25,000 2. 75,000 3. 1,000,000 (10,000 × $100) 4. 105,000 (21,000 × $5) $ 1,205,000 = Total paid-in capital

Chapter 1

The Financial Statements 1-827

(10-15 min.) E 10-45B Stockholders’ Equity (Thousands) Common stock, $0.01 par, 800 shares issued and outstanding………………………………………………

Paid-in capital in excess of par .......................... 196 Total paid-in capital .......................................... 204 Retained earnings ............................................. 644 Other stockholders’ equity ................................ (22) Total stockholders’ equity.............................

Req. 1

$826

(10-15 min.) E 10-46B Stockholders’ Equity (Thousands)

Common stock, $1.50 par, 1,100 shares authorized, 360 shares issued, 200 shares outstanding ....

$ 540

Paid-in capital in excess of par .........................

901

Total paid-in capital……………………………………………..

1,441

Retained earnings ............................................

2,220

Treasury stock, common, 160 shares at cost .....

(2,560)

Chapter 1

The Financial Statements 1-828

Accumulated other comprehensive income (loss)

(727)

Total stockholders’ equity .............................

$ 374

Req. 2 Treasury Stock has a larger balance than the sum of Common Stock and Paid-in Capital in Excess of Par because Beluga Software paid a higher price to acquire treasury stock than the price Beluga received when it issued its stock. (5-10 min.) E 10-47B

Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBI T

CREDI T

Millions Treasury Stock ..................................... Cash..................................................

Cash .................................................... Treasury Stock .................................. Paid-in Capital from Treasury Stock Transactions ...................................

Overall, stockholders’ equity decreased by $12 million (decrease of $22 million and increase of $10 million).

Chapter 1

The Financial Statements 1-829

2 8

(10 min.) E 10-48B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

Cash (22 million × $14.50)................. Common Stock (22 million × $2.00)

DEBI T

CREDI T

Millions

319

44 Paid-in Capital in Excess of Par Value................................................ c.

Treasury Stock.................................. Cash .............................................

275 130 130

Cash ................................................. Treasury Stock .............................. Paid-in Capital from Treasury Stock Transactions..............................

Chapter 1

45 39* 6

The Financial Statements 1-830

Retained Earnings ............................. Dividends Payable.........................

Dividends Payable............................. Cash .............................................

or one entry only: Retained Earnings ............................. Cash .............................................

28 28 28 28

*$130 / 10 = $13 cost per share of treasury stock $13 x 3 = $39

Req. 2 The overall effect on stockholders’ equity = net increase of $657 [$451 + ($44 + $275) − $130 + ($39 + $6) − $28]

Chapter 1

The Financial Statements 1-831

(10 min.) E 10-49B

Millions

Stockholders’ Equity: Common stock, $2.00 par value, 45 million shares Issued, 38 million shares outstanding ($46 + $44)

Paid in capital in excess of par value ($58 + $275)................................................................

333

Paid-in capital from treasury stock transactions......................................................

Total paid-in capital ....................................... 429 Retained earnings ($285 + $451 − $28) ..........

708

Treasury stock, 7 million shares, at cost ($70 + $130 − $39)

(161)

Total stockholders’ equity...........................

$976

Chapter 1

The Financial Statements 1-832

(20-30 min.) E 10-50B

Req. 1 Possible causes for preferred stock decrease:  Conversion of preferred stock into common stock  Retirement of preferred stock

Req. 2 Possible causes for common stock increase: Common stock issued- To preferred stockholders who converted their preferred into common  For cash or other assets  In a stock dividend

Req. 3 (Millions of shares of stock) Dec. 31, 2022

Common shares issued……………………………..

300

Less: Treasury stock, number of shares………

(26)

Common shares outstanding……………………....

274

Chapter 1

The Financial Statements 1-833

(continued) E 10-50B

Req. 4 Retained Earnings (Millions) Dec. 31, 2021

Dividends

336

Bal. 5,06 6

Net income

1,47 0

Dec. 31, 2022

Bal. 6,20 0

Req. 5 (All amounts in millions) December 31, Purchases 2022 2021 During 2022 Cost of treasury stock ................ Treasury stock, number of shares .................................................

$546 − $102 = 26 −

$ 444 ÷ 20

Average price per share paid for treasury stock purchased during 2022

Chapter 1

$22.20

The Financial Statements 1-834

(15 min.) E 10-51B

Req. 1

Preferre d Commo n

2021 Total dividend

Total

$40,000

Preferred dividends in arrears: 2019: 55,000 shares × $3.00 (par) per share × .04 = $ 6,600 2020: 55,000 shares × $3.00 (par) per share × .04 =

6,600

Preferred dividends, current year : 2021: 55,000 shares × $3.00 (par) per share × .04 =

6,600

Total to preferred $19,80 0 Remainder to common

$20,200

2022 Total dividend $120,000

Preferred dividends, current year: 2022: 55,000 shares × $3.00 (par) per share × .04 = Remainder to common

$ 6,600 $113,40 0

Chapter 1

The Financial Statements 1-835

Chapter 1

The Financial Statements 1-836

(15-20 min.) E 1052B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Aug. 1 Retained Earnings (500,000 × .10 × 900,000 2 $18)............................................... Common Stock (500,000 × .10 × 10,000 $0.20) ............................................ Paid-in Capital in Excess of Par – Common ............................... 890,000 To declare and distribute a common stock dividend.

Req. 2 Stockholders’ equity: Common stock, $0.20 par, 2,600,000 shares authorized, 550,000 issued and outstanding (550,000 × $ $.20) ........................................................................... 110,000 Paid-in capital in excess of par − common ($1,076,267 + $890,000) .......................... 1,966,267 Retained earnings ($7,144,000 − $900,000)... 6,244,000 Accumulated other comprehensive income (loss) ................................................................ (180,000) Total stockholders’ equity ........................ $8,140,26 7

Req. 3

Chapter 1

The Financial Statements 1-837

The stock dividend did not change total stockholders’ equity because the company gave its stockholders no assets. The company merely transferred $900,000 from Retained Earnings to Common Stock ($10,000) and Paid-in Capital in Excess of Par ($890,000).

Req. 4 Yarrow’s maximum cash dividend is limited to $540,000, the balance of its cash account.

Chapter 1

The Financial Statements 1-838

(15-20 min.) E 10-53B a. Decrease stockholders’ equity by $75 million. b. No effect. c. No effect. d. No effect. e. Decrease stockholders’ equity by $24,225 (1,700 × $14.25). f.

Increase stockholders’ equity by $17,100 (900 × $19).

g. No effect.

Chapter 1

The Financial Statements 1-839

(10-15 min.) E 10-54B

Req. 1 a. Net profit = margin ratio

$9,000 $120,000

b. Asset Net sales = turnover = Average total ratio assets

$120,000 $60,000

c. Leverage ratio

Net income Net sales

7.5%

2.0

Avg. total assets = = Avg. common stkholders’ equity

$60,000 $25,000

2.4

Net profit margin ratio 7.5%

Asset turnover 2.0

= ROA = 15.0%

x x

Leverage ratio 2.4

= ROE = 36.0%

e. ROA 15.0%

_____

Req. 2 ROE exceeds ROA. This makes sense because ROE equals ROA times the leverage ratio. As long as the leverage ratio

Chapter 1

The Financial Statements 1-840

exceeds one, ROE will exceed ROA. In this case, the leverage ratio is 2.4, so the ROE will exceed ROA.

Chapter 1

The Financial Statements 1-841

(15-20 min.) E 10-55B

Req. 1 PLAN B PLAN A BORROW $500,000 AT 6%

Net income before expansion ...........

ISSUE $500,000 OF COMMON STOCK

$200,000 $200,000

Project income before interest and income tax

$400,000

Less interest expense ($500,000 × .06) .................................................

$400,000 -0-

30,000

Project income before income tax ..... 370,000 Less: income tax expense (30%) .......

400,000

(111,000) (120,000)

Project net income ...........................

259,000 280,000

Total company net income ...........

$459,000

$480,000

Earnings per share including new project: Plan A ($459,000 / 100,000 shares) ....................................................... Plan B ($480,000 / 200,000 shares) .......................................................

$4.59 $2.40

Plan A results in higher earnings per share.

Chapter 1

The Financial Statements 1-842

Plan A (borrowing) results in much higher earnings per share. Plan A also allows the existing stockholders to retain control of the company because the company issues no new stock. But Plan A also creates more financial risk because borrowing obligates the company to pay the interest and the principal of the debt. I prefer Plan A, assuming the company’s level of debt is not already too high. Students

can

defend

either

plan

based

their

preferences for control of the business, avoidance of risk, and higher earnings per share.

Chapter 1

The Financial Statements 1-843

(10-15 min.) E 10-56B

Req. 1 Net profit = margin ratio

Net income Net sales

Asset =

Net sales

turnove r

Average total

$6,488 $20,000 $20,000

($52,074* + $55,784**)/2

= 32.4%

$20,00 0 0.37 = = $53,92 1 9

assets = Leverag = Avg. total e assets ratio Avg. common stkholders’ equity Net profit x margin ratio 32.4% x ROA 12.0%

x x

$53,929

=2.875

($14,045 + $23,471) /2

Asset turnover 0.371

= ROA = 12.0%

Leverage ratio 2.875

= ROE = 34.5%

_____ Total assets = Total liabilities + Stockholders’ equity *Beginning of year = $52,074 ($38,029 + $14,045) **End of year = $55,784 ($32,313 + $23,471)

Chapter 1

The Financial Statements 1-844

(continued) E 10-56B

Req. 2

These rates of return suggest relative strength. The company is generating a 32.4% net profit margin ratio. The company is generating an asset turnover of only .371 meaning the company is generating $0.37 in sales for each dollar of assets invested (relative inefficiency). Finally,

the

company

has

relatively

high

leverage,

meaning they are utilizing debt effectively. This magnifies the ROA to a 34.5% ROE, which is considered outstanding because it is greater than 20%. The ROA is also considered strong because it exceeds 10%.

Req. 3 Comparative data from prior years as well as industry competitors’ ROA and ROE measures would also be helpful when making this decision.

(10 min.) E 10-57B Cash flows from financing activities:

(Millions)

Payment of long-term debt..........................$(17,045 ) Proceeds from issuance of common stock ....

8,475

Dividends paid ............................................

(225)

Chapter 1

The Financial Statements 1-845

Net cash used for financing activities ...............$ (8,795)

Chapter 1

The Financial Statements 1-846

(20-25 min.) E 10-58B

Req. 1 (Thousands) $3.50 Addition Accum. Other Total Par al Retaine Comprehensi Shareholde d ve rs’ Common Paid In Capital Earning Income Equity Stock s

Balance, Dec. 31, $400 2020 ......................

$2,200 $6,000

1,370

Net earnings...........

$8,608 1,370

Other comprehensive

income ................ Issuance of stock ....

140

160

300 (65)

Cash dividends ....... Balance, Dec. 31, $540 2021 ......................

$2,360

(65) $13

$10,218

$7,305

Req. 2 Debt ratio

Total liabilities Total assets

$7,000 =

= 40.7% $17,218*

* $7,000 + $10,218 = $17,218

Req. 3 The year was profitable, as indicated by net earnings.

Chapter 1

The Financial Statements 1-847

Issue price

Amount received Number of shares issued

$300 40*

$7.50 per share

*$140/$3.50 par = 40 shares issued

Chapter 1

The Financial Statements 1-848

Quiz

Q1059

Q1060

Q1061

Q1062

Q1063

Q1064

d $638,000)

Q1065

Q1066

Q1067

Q1068

Q1069

Q1070

Q1071

Q1072

Q1073

($313,000 + $240,000 + $85,000 =

Chapter 1

The Financial Statements 1-849

Q1074

Q1075

Q1076

Q1077

Chapter 1

The Financial Statements 1-850

Problems (30-45 min.) P 10-78A

Req. 1 Journal DATE

Jan.

ACCOUNT TITLES AND EXPLANATION

DEBIT

6 Organization Expense ..................... 27,000 Common Stock (900 × $15) ......... Paid-in Capital in Excess of Par – Common................................... Issued stock to promoter for assisting with issuance of stock.

CREDIT

13,500 13,500

9 Cash (18,000 × $20 per share) ........ 360,000 Common Stock (18,000 × $15) .... 270,000 Paid-in Capital in Excess of Par – Common................................... 90,000 Issued common stock for cash. 26 Cash (1,600 × $25) ......................... 40,000 Common Stock (1,600 × $15) ...... 24,000 Paid-in Capital in Excess of Par – Common................................... 16,000 Issued common stock for cash.

Chapter 1

The Financial Statements 1-851

(continued) P 10-78A

Req. 2 Jefferson Rafts Co. Balance Sheet (partial) March 31, 2022 Stockholders’ equity: Common stock, $15 par, 200,000 shares authorized, 20,500* shares issued and outstanding......

$307,500

Paid-in capital in excess of par – common**.....

119,500

Total paid-in capital……………………………………………

427,000

Retained earnings..........................................

55,000

Total stockholders’ equity .........................

$482,000

_____ *900 + 18,000 + 1,600 = 20,500 shares **$13,500 + $90,000 + $16,000 = $119,500

Chapter 1

The Financial Statements 1-852

(10-15 min.) P 10-79A

Req. 1

Lima’s Corp. Balance Sheet (partial) December 31, 2021

Stockholders’ equity: Preferred stock, 11%, $200 par, 4,000 shares authorized, 1,000 shares issued and outstanding ..............

$200,000

Common stock, no-par, 700,000 shares authorized, 350,000 shares issued and outstanding........... Total paid-in capital ..........................................

512,000 712,000

Retained earnings...............................................

96,000

Total stockholders’ equity .............................. _____

$808,000

Computations: Preferred stock: 1,000 × $200 = $200,000 Retained earnings: $75,000 + $100,000 − ($200,000 ×.11 × 2) − (350,000 × $.10) = $96,000

Chapter 1

The Financial Statements 1-853

(25-35 min.) P 10-80A

Req. 1 Seasonal

Outdoor

Furniture

Company

has

Class

cumulative preferred stock, Class B cumulative preferred stock, and common stock outstanding.

Req. 2 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash...................................... Class A Preferred Stock .......

700,000

Cash...................................... Class B Preferred Stock .......

980,000

Cash ($1,350,000 + $5,540,000) ........................... Common Stock.................... Additional Paid-in Capital – Common..........................

6,890,000

CREDIT

700,000

980,000

1,350,000 5,540,000

Req. 3 Seasonal

Outdoor

Furniture

would

have

pay

all

preferred dividends in arrears and pay the current year’s dividends

before

paying

dividends

common

Chapter 1

The Financial Statements 1-854

Chapter 1

The Financial Statements 1-855

(continued) P 10-80A

Req. 4 Seasonal must pay preferred dividends of $58,800* each year to avoid having preferred dividends in arrears.

Req. 5 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2022 Mar. 31 Retained Earnings .......................... 860,00 0 Dividends Payable, Class A Preferred ($24,500 × 2)............ 49,000 Dividends Payable, Class B Preferred ($34,300 × 2)............ 68,600 Dividends Payable, Common ........ 742,40 0** _____ Computations: * Class A Preferred: 70,000 shares × $10 (par) × 0.035 = $24,500 Class B Preferred: 98,000 shares × $10 (par) × 0.035 = 34,300 Total preferred dividends $58,800 **Common dividend: $742,400

$860,000 − $49,000 − $68,600 =

Chapter 1

The Financial Statements 1-856

(15-20 min.) P 10-81A

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

Feb. 13 Cash (5,400 × $9) ............................

DEBIT

48,6 00

Common Stock (5,400 × $6) .........

32,40 0

Paid-in Capital in Excess of Par − Common .................................. June

16,20 0

7 Retained Earnings ........................... Dividends Payable (800 × $0.70)..

560

24 Dividends Payable ........................... Cash ...........................................

560

9 Retained Earnings (12,100 × 0.20 × $12) Common Stock (12,100 × 0.20 × $6) Paid-in Capital in Excess of Par − Common ..................................

29,0 40

Oct. 26 Treasury Stock (600 × $14)..............

8,40 0

Aug .

560 560

14,52 0 14,52 0

Cash ........................................... Nov .

20 Cash (300 × $18) ............................. Treasury Stock (300 × $14).......... Paid-in Capital from Treasury Stock Transactions...................

Chapter 1

CREDI T

8,400 5,40 0 4,200 1,200

The Financial Statements 1-857

Dec. 31 Retained Earnings [(14,520* – 300) × $0.25] ............................................. Dividends Payable .......................

3,55 5 3,555

*6,700 + 5,400 + (12,100 × .20) = 14,520 common shares issued

Chapter 1

The Financial Statements 1-858

(continued) P 10-81A

Req. 2 Stockholders’ equity: $.70 cumulative preferred stock, $5 par, 800 shares issued and outstanding .......................................$

4,000

Common stock, $6 par, 14,520 shares issued (6,700 + 5,400 + 2,420) and 14,220 shares outstanding .....

87,120

Paid-in capital in excess of par − common ($18,500 + $16,200 +$14,520) ............................

49,220

Paid-in capital from treasury stock transactions ......

1,200

Total paid-in capital................................................ 141,540 Retained earnings ($22,000 + $23,000 – $560 – $29,040 − $3,555) ....................................................

11,845

Less: Treasury stock, 300 shares at cost ($8,400 − $4,200) .........................................

(4,200)

Total stockholders’ equity ...................................$149,185

Chapter 1

The Financial Statements 1-859

(20-30 min.) P 10-82A

Req. 1 and 2

ASSETS

Feb. 3

STOCKHOLDER LIABILITIE S’ = S + EQUITY

$ 0

$520,000

$+520,0 00

(55,100)

-55,100

80,000

+80,000

3,200

(3,200)

-0-

= (3,200)

-3,200

-0-

$520,00 0 Mar. 19 Apr. 24 Aug. 15 Sept. 1 Nov. 22

CASH FLOW

(55,100 ) 80, 000 0 (3,200) 0

Chapter 1

The Financial Statements 1-860

(40-50 min.) P 10-83A

Req. 1 Eagle Designers, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Current: Current: Cash ................... $ 45,000 Accounts payable ........ $130,000 Accounts rec., Accrued liabilities .......27,000 net ...................28,000 Dividends payable .......13,000 Inventory ............ 98,000 Total current 170,000 liabilities ...................... Prepaid expenses ..........20,000 Long-term note 90,000 payable ......................... Total current 191,000 Total liabilities.............. 260,000 assets................... STOCKHOLDERS’ Property, plant, EQUITY and equipment, net......................363,000 Common stock, Intangible $1 par, 700,000 assets: shares Goodwill .............. 17,000 authorized, 121,000 Trademarks, 5,000 shares issued, Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-861

net .......................

Total assets

95,000 $121,000 shares outstanding ................... Paid-in capital in excess of par – common..............17,000 Retained earnings......... 209,000* Less: Treasury stock, common, 26,000 shares at cost ........................ (31,000) Total stockholders’ 316,000 equity ........................... _______ Total liabilities and stockholders’ $576,000 $576,000equity ...........................

_____ *Retained earnings = Total assets − Total liabilities − Total paid-in capital + Treasury stock = $576,000 − $260,000 − $121,000 − $17,000 + $31,000 = $209,000

(continued) P 10-83A

Req. 2 Net Net income profit = = margin Net sales ratio Asset = turnove r

Net sales

$12,000 = 1.3% $900,000

$900,0 00 = = =1.678 Average total ($497,000+$576,0 $536,5 00)/2 00

$900,000

Chapter 1

The Financial Statements 1-862

assets Average total assets = =1.987 Leverag = $536,500 e ratio Avg. common ($224,000+$316,0 00) /2 stkholders’ equity Net profit x margin ratio 1.3% x

Asset turnover 1.678

= ROA = 2.2%

ROA 2.2%

Leverage ratio 1.987

= ROE = 4.4%

x x

Chapter 1

The Financial Statements 1-863

(continued) P 10-83A

Req. 3 These rates of return suggest weakness. The company is generating a 1.3% net profit margin ratio indicating poor effectiveness in achieving profit goals and most likely has little product differentiation.

The company is generating

an asset turnover of 1.678, meaning the company is generating $1.68 in sales for each dollar of assets invested, indicating some efficiency. Finally, the company has some leverage, which increases ROE. This magnifies ROA to a 4.4% ROE, which is considered weak. The ROE is considered strong when it exceeds 20%. ROA of 2.2% is considered weak. The ROA is considered strong when it exceeds 10%. Comparative data from prior years as well as industry competitors’ ROA and ROE measures would also be helpful when making this decision.

Chapter 1

The Financial Statements 1-864

(20-30 min.) P 10-84A

Req. 1

Alternative 1 Borrow $5.5

Net income 2 years from now

mil at 6%

Alternative 2 Issue 250,000 shares of stock

$4,840,00 0

$4,840,000

Less interest expense Projected net income before tax Less income tax expense (35%)

330,000

-0-

4,510,000

4,840,000

1,578,500

1,694,000

Projected net income 2 years from now

$2,931,50 0

$3,146,000

Earnings per share: $2,931,500/250,000 $3,146,000/(250,000 + 250,000)

$11.73 $6.29

Req. 2 TO: FROM:

Management of Sullivan Medical Goods Student Name

Chapter 1

The Financial Statements 1-865

SUBJECT: Advantages and disadvantages of borrowing versus issuing stock to raise cash for expansion Raising money by borrowing has at least two advantages over issuing common stock. Borrowing does not change the present ownership of the business. It enables the present owners to keep their proportionate interests in the business and to carry out their plans without interference from a new group of stockholders. Under normal conditions, borrowing results in a higher

(continued) P 10-84A earnings per share of common stock, because the interest expense on the debt is tax-deductible. And higher earnings per share usually lead to higher stock prices for company owners. The main disadvantage of borrowing is that the debt increases the financial risk of the company. The principal and the related interest expense must be paid whether the company is earning a profit or not. If times get sufficiently bad, the debt burden could threaten the ability of the business to continue as a going concern. The main advantage of issuing stock is that owners avoid the burden of making interest and principal payments on the debt. Issuing stock creates no liability to pay anything to the owners. If the directors consider it necessary, they can refuse to pay dividends in order to conserve cash. Therefore, it is safer to issue stock. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-866

One disadvantage of issuing stock is dilution of the ownership interests of existing stockholders if the purchasers of new stock are outsiders. The new stockholders may have different ideas about how to manage the business and that may pose difficulties

for

the

original

stockholder

group.

Another

disadvantage of issuing stock is that earnings per share are usually lower because of (1) the greater number of shares of stock

outstanding,

and

(2)

the

non-tax-deductibility

dividends paid on the stock. In summary, the analysis in Req. 1 illustrates the EPS advantage to borrowing over issuing stock. This appears to be the best option if the company wishes to maximize EPS.

Student responses may vary.

(15-20 min.) P 10-85A

Req. 1 Par value of common stock:

$10 million par value $0.10 per 100 million shares = Share issued

Req. 2 Price per share of stock issuance:

$330 million received $3.30 per = share 100 million shares issued

Chapter 1

The Financial Statements 1-867

Req. 3 Cost of treasury stock sold:

9 million

Selling price of treasury stock sold:$ 20 million Increase in total stockholders’ equity:$ 20 million

Req. 4 Stock dividend percentage:

$44 million $440 million

Chapter 1

= 10%

The Financial Statements 1-868

(30-45 min.) P 10-86B

Req. 1 DATE

Oct .

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

6 Organization Expense ....................... 12,000 Common Stock (600 × $15) ........... Paid-in Capital in Excess of Par – Common ..................................... Issued stock to promoter for assistance in Issuing common stock.

9,000 3,000

9 Cash (28,000 × $18) ......................... 504,000 Common Stock (28,000 × $15) ...... 420,000 Paid-in Capital in Excess of Par – Common ..................................... 84,000 Issued common stock for cash. 26 Cash (900 × $21) .............................. 18,900 Common Stock (900 × $15) ........... 13,500 Paid-in Capital in Excess of Par – Common ..................................... 5,400 Issued common stock for cash.

Req. 2

Crew Kayaks, Inc. Balance Sheet (partial) December 31, 2022

Stockholders’ equity: Common stock, $15 par, 125,000 shares authorized, 29,500* shares issued and outstanding.....................................................

$442,500

Chapter 1

The Financial Statements 1-869

Total paid-in capital……………………………………………

534,900

Retained earnings ........................................... 95,000 Total stockholders’ equity ............................

$629,900

_____ *600 + 28,000 + 900 = 29,500 shares **$3,000 + $84,000 + $5,400 = $92,400

(10-15 min.) P 10-87B

Req. 1

Doorman Corp. Balance Sheet (partial) December 31, 2021

Stockholders’ equity: Preferred stock, 8%, $120 par, 9,000 shares authorized, 1,800 shares issued and outstanding ............

$216,000

Common stock, no-par, 700,000 shares authorized, 140,000 shares issued and outstanding.........

513,000

Total paid-in capital.........................................

729,000

Retained earnings ...........................................

108,440

Total stockholders’ equity ............................

$837,440

_____ Computations: Preferred stock: 1,800 × $120 = $216,000 Retained earnings: $77,000 + $94,000 − $62,560 = $108,440

Chapter 1

The Financial Statements 1-870

(25-35 min.) P 10-88B

Req. 1 Superior

Outdoor

Furniture

Company

has

Class

cumulative preferred stock, Class B cumulative preferred stock, and common stock outstanding.

Req. 2 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

Cash ..................................... Class A Preferred Stock ......

1,975,000

Cash ..................................... Class B Preferred Stock ......

2,350,000

Cash ($2,600,000 + $5,580,000) .......................... Common Stock (260,000 × $10) ..................................... Additional Paid-in Capital – Common..........................

8,180,000

CREDIT

1,975,000

2,350,000

2,600,000

5,580,000

Req. 3 Superior

Outdoor

Furniture

would

have

pay

all

Chapter 1

The Financial Statements 1-871

common stockholders because the preferred stock is

cumulative.

Chapter 1

The Financial Statements 1-872

(continued) P 10-88B

Req. 4 Superior must pay preferred dividends of $324,375* each year to avoid having preferred dividends in arrears.

Req. 5 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2022 Feb. 28 Retained Earnings .......................... 900,00 0 Dividends Payable, Class A Preferred ($148,125 × 2).......... 296,250 Dividends Payable, Class B Preferred ($176,250 × 2).......... Dividends Payable, Common ........

352,500 251,250 **

_____ Computations: *Class A Preferred: 79,000 shares × $25 (par) per share × 0.075 = $148,125 Class B Preferred: 94,000 shares × $25 (par) per share × 0.075 = 176,250 Total preferred dividends................................ $324,375 **Common stock dividends ($900,000 − $296,250 − $352,500) = $251,250

Chapter 1

The Financial Statements 1-873

(15-20 min.) P 10-89B

Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

Feb.

13 Cash (5,300 × $12) .......................... 63,60 0 Common Stock (5,300 × $9).......... 47,70 0 Paid-in Capital in Excess of Par − Common.................................... 15,90 0

June

7 Retained Earnings............................ Dividends Payable (400 shares ×

320 320

$0.80).................................................

24 Dividends Payable ........................... Cash ............................................

320 320

Aug.

9 Retained Earnings (11,800* shares × .20 × $17) ............ 40,12 0 Common Stock (11,800 × .20 × 21,24 $9) 0 Paid-in Capital in Excess of Par − Common.................................... 18,88 0

Oct.

26 Treasury Stock, Common (700 × 14,00 $20) ................................................ 0 Cash ............................................ 14,00 0

Nov.

20 Cash (300 × $24) ............................. 7,200 Treasury Stock, Common (300 × $20) ................................................

Chapter 1

6,000

The Financial Statements 1-874

Dec.

Paid-in Capital from Treasury Stock Transactions ....................

1,200

31 Retained Earnings [(14,160** – 400) 3,440 × $0.25] .......................................... Dividends Payable........................

3,440

* 6,500 + 5,300 = 11,800 shares issued × .20 = 2,360 shares in stock dividend ** 11,800 + 2,360 = 14,160 shares issued

Chapter 1

The Financial Statements 1-875

(continued) P 10-89B

Req. 2 Stockholders’ equity: $0.80 cumulative preferred stock, $10 par, 400 shares issued and outstanding

4,000

Common stock, $9 par, 14,160 shares issued (6,500 + 5,300 + 2,360) and 13,760 shares outstanding

127,440

Paid-in capital in excess of par – common ($18,500 + $15,900 + $18,880)

53,280

Paid-in capital from treasury stock transactions Total paid-in capital

1,200 185,920

Retained earnings ($22,000 + $30,000 – $320 –

8,120

$40,120 – $3,440)

Less: Treasury stock, common, 400 shares at cost ($14,000 – $6,000)

(8,000)

Total stockholders’ equity .................................. $186,040

Chapter 1

The Financial Statements 1-876

(20-30 min.) P 10-90B

Req. 1 and 2 STOCKHOLDER LIABILITIE S’ ASSETS = S + EQUITY Feb. 3 Mar. 1 9 Apr.

2 4

$406,0 00

= $

$406,000

$+406,000

(47,500)

47,500

+47,500

1,900

(1,900)

-0-

(1,900)

-0-

(47,50 0) 47,500

Aug. 1 5

Sept . 1

( 1,900)

Nov. 2 2

CASH FLOW

Chapter 1

The Financial Statements 1-877

(40-50 min.) P 10-91B

Req. 1 Cardinal Designers, Inc. Balance Sheet December 31, 2021 ASSETS Current: Cash.....................

LIABILITIES Current: $ Accounts payable........... $135,0 45,000 00 Accounts Accrued liabilities .......... receivable, 29,000 net .................... 21,000 Dividends payable.......... 4,000 Inventory ............. 89,000 Total current liabilities..... 168,00 0 Prepaid expenses ........... Long-term note payable ... 24,000 90,000 Total current assets. 179,00 Total liabilities................. 258,00 0 0 Property, plant, STOCKHOLDERS’ and equipment, EQUITY net ....................... 358,00 Common stock, 0 Intangible assets: $1 par, 1,500,000 shares Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-878

Trademarks, net ... 9,000 Goodwill ............... 20,000

authorized, 117,000 shares issued and 97,000 shares outstanding ........ 117,00 0 Paid-in capital in excess of par— common ................ 16,000 Retained earnings............ 210,00 0* Less: Treasury stock, common, 20,000 shares at cost........................... (35,00 0) Total stockholders’ equity 308,00 0 Total liabilities and

Total assets............. $566,0 00

stockholders’ equity ...... $566,0 00

_____ *Retained earnings = Total assets − Total liabilities − Total paidin capital + Treasury stock = $566,000 − $258,000 − $117,000 − $16,000 + $35,000 = $210,000

(continued) P 10-91B

Req. 2 Net profit = margin ratio

Net income Net sales

$90,000 $750,000

Chapter 1

12%

The Financial Statements 1-879

Asset = turnove r

Net sales

$750,000

$750,0 00 1.41 = = = ($496,000+$566,0 Average total $531,0 2 00)/2 00 assets

Average total assets Leverag = $531,000 = =2.008 e ($221,000+$308,0 ratio Avg. common 00) /2 stockholders’ equity Net profit x margin ratio 12% x

Asset turnover 1.412

ROA 16.9%

= ROA 16.9%

Leverage ratio 2.008

ROE 33.9%

Chapter 1

The Financial Statements 1-880

(continued) P 10-91B

Req. 3 These rates of return suggest strength.

The company is

generating a 12% net profit margin ratio indicating some effectiveness in achieving profit goals and some product differentiation.

The company is generating an asset

turnover of 1.412, meaning $1.41 in sales for each dollar of assets invested, indicating some efficiency. Finally, the company has relatively moderate leverage, meaning they are utilizing debt somewhat effectively.

This magnifies

ROA to a 33.9% ROE, which is considered strong because it is more than 20%. The ROA is 16.9%, which is also considered to be strong because it is above 10%. Comparative data from prior years as well as industry competitors’ ROA and ROE measures would also be helpful when making this decision.

Chapter 1

The Financial Statements 1-881

(15-30 min.) P 10-92B

Req. 1 Alternative 1 Borrow $4.75

Net income 2 years from now Less interest expense Projected net income before tax Less income tax expense (30%) Projected net income 2 years from now

mil at 4%

Alternative 2 Issue 200,000 shares of stock

$8,450,000

190,000

-0-

8,260,000

8,450,000

2,478,000

2,535,000

$5,782,000

$5,915,000

Earnings per share: $5,782,000/200,000 $5,915,000/(200,000 + 200,000)

$28.91 $14.79

Req. 2 TO: FROM:

Management of Orchard Medical Goods Student Name

Chapter 1

The Financial Statements 1-882

Raising money by borrowing has at least two advantages over issuing common stock. Borrowing does not change the present ownership of the business. It enables the present owners to keep their proportionate interests

(continued) P 10-92B in

the

business

and

carry

out

their

plans

without

interference from a new group of stockholders. Under normal conditions, borrowing results in a higher earnings per share of common stock, because the interest expense on the debt is tax-deductible. And higher earnings per share usually lead to higher stock prices for company owners. The main disadvantage of borrowing is that the debt increases the financial risk of the company. The principal and the related interest expense must be paid whether the company is earning a profit or not. If times get sufficiently bad, the debt burden could threaten the ability of the business to continue as a going concern. The main advantage of issuing stock is that owners avoid the burden of making interest and principal payments on the debt. Issuing stock creates no liability to pay anything to the owners. If the directors consider it necessary, they can refuse to pay dividends in order to conserve cash. Therefore, it is safer to issue stock. One disadvantage of issuing stock is dilution of the ownership interests of existing stockholders if the purchasers of new stock are outsiders. The new stockholders may have different Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-883

ideas about how to manage the business and that may pose difficulties

for

the

original

stockholder

group.

Another

disadvantage of issuing stock is that earnings per share are usually lower because of (1) the greater number of shares of stock

outstanding,

and

(2)

the

non-tax-deductibility

(15-20 min.) P 10-93B

Req. 1 Par value of common stock:

$50 million par value 100 million shares issued

$0.50 per share

Req. 2 Price per share of stock issuance:

$270 million received 100 million shares issued

$2.70 per share

Req. 3 Cost of treasury stock sold:

$14 million

Chapter 1

The Financial Statements 1-884

Req. 4 Stock dividend percentage:

$45 million $450 million

Chapter 1

10%

The Financial Statements 1-885

Challenge Exercises and Problem (20-25 min.) E 10-94

Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

(a) Cash (59,000* × $9)........................ 531,000 Common Stock ........................... 59,000 Additional Paid-in Capital ........... 472,000 Issued stock. (b) Treasury Stock (800 × $12)............ Cash ......................................... Purchased treasury stock.

9,600

(c)

7,500

Cash ............................................. Treasury Stock ($9,600− $3,600) Additional Paid-in Capital ...........

9,600

6,000 1,500**

Resold treasury stock. (d)

Retained Earnings ($62,000 − $40,000) ....................................... Cash ......................................... Declared and paid dividends.

22,000 22,000

_____ *$59,000 ÷ $1 par value per share = 59,000 shares issued. **$473,500 – $472,000 = $1,500

Chapter 1

The Financial Statements 1-886

(20-25 min.) E 10-95 Statement of cash flows: Cash Flows from Financing Activities: Issuance of common stock

$531,000

Purchase of treasury stock

(9,600)

Sale of treasury stock

7,500

Payment of dividends

(22,000)

Net Cash Provided by Financing Activities

$506,900

(15 min.) E 10-96 Preferred stock: Hubble Corporation retired preferred stock of $132 million ($738 − $606) Common stock and Additional paid-in capital: Hubble issued 22 million shares of common stock for $66 million, computed as follows:

Millions

Common stock ($910 − $888) .......................

$22

Additional paid-in capital ($1,526 − $1,482) ..

Total received for issuance of common stock .

$66

Millions

Retained earnings: Beginning balance ...........................................

$19,112

Add: Net income ..............................................

2,930

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

(1,440)

Ending balance ................................................

$20,602

Chapter 1

The Financial Statements 1-887

Treasury stock: Hubble purchased treasury stock for $122 million ($2,765 − $2,643).

Chapter 1

The Financial Statements 1-888

(15 min.) E 10-97

Req. 1

Amounts in Millions

Additional Paidin Retained Common Stock + Capital

Balance, Dec. 31, 2021........................

$ 8.01

+ Earnings −

$16.0

Issuance of stock ..... 6.02

Treasury Total Stock = Equity

$38.0

$62.0

12.02

Stock dividend .........

18.0

16.85

(18.2)4

—

1.43 Purchase of treasury stock ...................

$(6.0)

(6.0)

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

26.0

Cash dividends.........

(15.0)

Balance, Dec. 31, 2022........................

$15.4

$44.8

$30.8

$(6.0)

$85.0

Computations: 1$8,000,000 ÷ $1 par=

8,000,000 shares

26,000,000 × $1 par

$6,000,000

6,000,000 × ($3 − $1)

$12,000,000

3(8,000,000 + 6,000,000) × .10 × $1 par

$1,400,000

4(8,000,000 + 6,000,000) × .10 × $13 market value

= $18,200,000

5$18,200,000 market value − $1,400,000 par value = $16,800,000

Chapter 1

The Financial Statements 1-889

(20-25 min.) P 10-98

Req. 1 $340,000 / 850,000 shares = $.40 per share

Req.2 800,000 (850,000 shares issued – 50,000 shares in treasury)

Req. 3 Common stock

340,000

Paid-in capital in excess of par34,170,000 $34,510,000 ÷ Number of shares = Average price

÷ 850,000 $40.60

Req. 4 Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Cash ............................................... 7,780,000 Common Stock ($340,000 – $260,000) Paid-in Capital in Excess of Par ($34,170,000 – $26,470,000) ... 7,700,000

Req. 5 Proceeds from issuance of stock during 2021 80,000

Chapter 1

The Financial Statements 1-890

80,

÷ Number of shares issued during 2021 ÷ = Average price

200,000 $38.90

(continued) P 10-98

Req. 6 Cost of treasury stock ÷ Number of shares = Average price

$2,290,000 ÷

50,000 $45.80

Req. 7 Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Cash ................................................. 230,000 Treasury Stock ($2,519,000 – $2,290,000)…… Paid-in Capital from Treasury Stock Transactions ($57,000 – $56,000)…………

229,0

1,000

Req. 8 Journal ACCOUNT TITLES AND EXPLANATION

DEBIT

Retained Earnings………………………….. Dividends Payable ...................

CREDIT

1,912,500 1,912,500

($60,000,000 + $13,000,000 – X = $71,087,500) X = $1,912,500

Chapter 1

The Financial Statements 1-891

Serial Case (15-20 min.) C10-99

q. 1

The

declaration

the

cash

dividend

would

reduce

stockholders’ equity (retained earnings) and increase liabilities (current liabilities:

cash dividend payable) by

$60.7 million. The payment of the dividend would reduce the current liability and reduce cash in the amount of $60.7

million.

Req. 2 The cash dividend has no impact on revenues or expenses.

Req. 3 The total amount of the cash dividends paid would be listed in the financing section of the statement of cash flows. The Retained Earnings column on the Statement of Stockholders’ Equity would also disclose the dividends declared during the year. The dividend per share is sometimes disclosed on the income statement under earnings per share. The dividend yield on common stock is computed as: share.

Dividend per share/Market price per

For The Cheesecake Factory, on December 31,

2019: Dividend yield: $1.38/$38.86 = .036 or 3.6%.

Total liabilities increased by Chapter 1

The Financial Statements 1-892

$1,526 million [305%, or ($2,269 million/$743 million]. This was largely due to two events: (1) the company was forced to capitalize its operating leases on buildings and equipment, which had previously been merely expensed and disclosed (off-balance sheet); and (2) the company drew down a substantial amount on its “New (continued) C10-99 Facility” in long-term debt, in order to finance the acquisition

some

other

companies

long-term

investments.

Net Profit Margin Ratio Asset Turnover ROA Leverage Ratio

127,293 2,482,692

= 5.13%

99,035 2,332,331

= 4.25%

2,482,692 (2,840,593+1,314,13 3)/2

= 1.195

2,332,331 (1,314,133+1,33 3060)2

= 1.762

5.13% x 1.195

= 6.13%

4.25% x 1.762

= 7.49%

= 3.636

(1,314,133+1,333 ,060)2 (613,530+571,05 9)/2

= 2.235

6.13% x 3.636

= 22.29%

7.49% x 2.235

= 16.74%

2,268,851 2,840,593

= 79.9%

743,074 1,314,133

= 56.5%

(2,840,593+1,314,13 3)/2 (571,742+571,059)/2

ROE

Debt Ratio

Chapter 1

The Financial Statements 1-893

Due to the capitalization of operating leases and the borrowing on credit facility, the debt ratio rose from 56.5% to 79.9%, and the leverage ratio grew from 2.235 to 3.636.

ROA declined from .0749 to .0613.

However,

because of the company’s greatly increased leverage ratio (equity multiplier), ROE grew from 16.74% to 22.29%

Req. 5 The repurchase of common stock has no impact on revenues or expenses.

(continued) C10-99

Req. 6 The repurchase of common stock would be shown on the balance sheet in the stockholders’ equity section and the statement of cash flows in the financing activities section. The treasury stock purchase would also be reported on the statement of stockholders’ equity.

Req. 7 During March and April 2020, a pandemic of the COVID-19 Coronavirus spread across the entire world.

Most state

governments in the United States mandated the closing of all restaurants, except for very limited take-out services. This triggered an unprecedented decline in the stock Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-894

market. Prices of all stocks of publicly held companies fell by as much as 35%, but restaurants in particular were hard hit.

Cheesecake Factory's stock was trading at

$25.21 on March 11th, 2020 when COVID-19 (Coronavirus) reached pandemic status according to the World Health Organization. The stock dropped to as low as $14.52 but has recovered somewhat.

At April 27, 2020 Cheesecake

Factory’s stock was trading at around $20.00 per share. On December 31, 2019, before the pandemic, the stock was trading for $38.86 per share. The market capitalization of the company on December 31, 2019 and April 27, 2020 follows: Market capitalization = Fair market value of 1 share of stock x # shares outstanding: 12/31/2019

= $38.86 x 43,949,000 =

$1,707,858,140 04/27/2020

= $20.00 x 43,949,000 =

878,980,000 Loss in market capitalization $828,878,140 (continued) C10-99 The large loss in market capitalization can be attributed to COVID-19. Market capitalization constantly fluctuates with market prices, which have experienced unprecedented volatility during the COVID-19 pandemic. Copyright © 2022 Pearson Education Inc.

Chapter 1

It is expected

The Financial Statements 1-895

that, over, time, stock prices will recover as businesses adjust to a “new normal.”

Fortunately, businesses such

as The Cheesecake Factory have excellent reputations, so hopefully, in time, with help from the government and other external sources, the business can recover and return to more normal levels.

Chapter 1

The Financial Statements 1-896

Decision Cases (30-45 min.) C10-100

Req. 1 Journal DAT E

ACCOUNT TITLES AND EXPLANATION

DEBIT

Sullivan, Capital ............................... 25,000 James, Capital .................................. 25,000 Common Stock .............................. To incorporate the business, close the capital accounts of Sullivan and James, and issue common stock to them.

CREDIT

50,000

Req. 2 Journal DAT E

ACCOUNT TITLES AND EXPLANATION

DEBIT

Plan 1: Cash ................................................ 80,000 Preferred Stock (800 × $100) ........ To issue preferred stock to outside investors. Plan 2: Cash ................................................ 55,000 Preferred Stock............................. To issue preferred stock to outside investors. Cash ................................................ 35,000 Common Stock .............................. To issue common stock to outside investors. Copyright © 2022 Pearson Education Inc.

Chapter 1

CREDIT

80,000

55,000

35,000

The Financial Statements 1-897

(continued) C10-100

Req. 3 Plan 1:

Stockholders’ Equity

Preferred stock, 6%, $100 par, nonvoting, 10,000 shares authorized, 800 shares issued and outstanding.................................................

$ 80,000

Common stock, $1 par, 500,000 shares authorized, 50,000 shares issued and outstanding..........

50,000

Retained earnings ($120,000 − $30,000) .......... 90,000 Total stockholders’ equity ...........................

Plan 2:

$220,000

Stockholders’ Equity

Preferred stock, $5, no-par, 10,000 shares authorized, 500 shares issued and outstanding ..............

$ 55,000

Common stock, $1 par, 500,000 shares authorized, 85,000 shares issued and outstanding..........

85,000

Retained earnings ($120,000 − $30,000) .......... 90,000 Total stockholders’ equity ...........................

Chapter 1

$230,000

The Financial Statements 1-898

(continued) C10-100

Req. 4 Plan 1 appears to fit the plans of Sullivan and James better than Plan 2 because:  Their primary goal is to raise as much capital as possible without giving up control of the business. Under Plan 2, the outside stockholders would have 60,000

votes

[35,000

common

votes

25,000

preferred votes (500 shares × 50 votes per share)]. Sullivan and James would lose control of the business because they would have only 50,000 votes.  Under Plan 1 preferred stockholders have no votes. Sullivan and James would have complete control since they would hold all the voting shares.  Plan 2 would raise only $10,000 more than Plan 1.

Chapter 1

The Financial Statements 1-899

(30-40 min.) C10-101

Req. 1 (Analysis of financing plans) PLAN A

PLAN B

BORROW AT 6%

ISSUE COMMON STOCK

PLAN C ISSUE $3.75 NONVOTING PREFERRED STOCK

Net income before expansion $3,500,00 $3,500,00 $3,500,000 0 0 Project income before interest and income tax

$1,500,00 $1,500,00 $1,500,000 0 0

Less interest expense ($5,000,000 × .06) 300,000 Project income before income tax

-0-

1,200,000 1,500,000 1,500,000

Less income tax expense (35%)

525,000 420,000

525,000

Project net income

780,000

975,000

375,000

Less preferred dividends (100,000 × $3.75) Additional net income available to common stockholders

600,000 780,000

Total company net income

975,000

$4,280,00 $4,475,00 $4,100,000 0 0

Chapter 1

The Financial Statements 1-900

new project: Plan A ($4,280,000 / 1,000,000 shares)

$ 4.28

Plan B ($4,475,000 / 1,100,000 shares)

$ 4.07

Plan C ($4,100,000 / 1,000,000 shares)

Chapter 1

4.10

The Financial Statements 1-901

(continued) C10-101

Req. 2 (Recommendation) The best choice appears to be Plan A — borrowing at 6% — because: (1) Borrowing allows the family to maintain control of the

business;

(2) EPS is higher under borrowing than under issuing preferred stock

(which

would

also

maintain

family

control); and (3) EPS under borrowing is higher than it would be if common stock were issued. Also, cash flow under Plan A (borrowing) may be almost as good as under Plan B (issuing common stock) after considering stockholders’ demands for dividends.

Chapter 1

The Financial Statements 1-902

Ethical Issue 1 C10-102

Req. 1

The ethical issue is, “What is the correct amount at which to record and disclose the value of the franchise on Campbell’s balance sheet?”

Req. 2 and Req. 3 The stakeholders in the transaction include Campbell, the potential buyers of the franchises, and potential lenders who loan them the money to buy the franchises in the future.

Campbell and the corporation are effectively the

same entity. The third party serves no purpose other than as an accomplice to overvalue the franchise. Analysis of the decision to overvalue the franchise: (a) Economic:

Campbell is better off temporarily, unless

potential buyers sue him for damages, in which case he could be worse off.

Potential buyers of the individual-

language franchises can be harmed. Campbell’s balance sheet overstates his assets. If outsiders believe his balance sheet, they may be induced to pay Campbell more than

the

individual-language

franchises

are

worth.

Chapter 1

The Financial Statements 1-903

(b) Legal: If potential buyers are damaged by Campbell’s actions,

they

might

sue

him

for

recovery

those

damages. In this situation, the public is also defrauded if Campbell amortizes the cost of the franchise for income tax purposes. Basing amortization on $500,000 overstates tax deductions and understates Campbell’s income. As a result, his tax

Chapter 1

The Financial Statements 1-904

(continued) C10-102

payments are lower than they should be.

This could

expose Campbell to future investigations from the IRS. (c)

Ethical:

involved.

This type of scheme is harmful to everyone

It is not truthful, and it violates the rights of

individuals and business entities to full and complete disclosure of the proper valuation of a business. It is an example of the type of transaction that meets the letter of the law without meeting the spirit of the law.

Req. 4 The franchise should be valued at its true value, which is $50,000.

Campbell should focus his time and energy on

ways to make the business profitable in the long run in other ways, rather than focusing on turning a quick buck and playing legal games that could well get him into trouble with a lot of other parties.

Note: One of the authors experienced this actual situation in his first job after college.

Chapter 1

The Financial Statements 1-905

Ethical Issue 2 C10-103

Req. 1 The ethical issue is whether the company acted properly in purchasing their shares on the open market based on inside information known only to them.

Req. 2 and Req. 3 Stakeholders

include

the

company,

its

officers

and

directors, the shareholders from whom the stock was purchased, and the general public. (a)

Economic analysis:

The company, and likely its

officers and directors, benefitted temporarily at the other shareholders’ expense.

The managers purchased the

stock at $6 and could sell it for $27. Thus, the managers enriched themselves at the expense of the stockholders who sold company stock at $6. Had the stockholders known of the oil discovery, those stockholders who sold shares probably would have held their St. Genevieve stock. Stockholders wanting to sell company stock would have demanded a price based on all relevant information about the company, including news of the discovery. Copyright © 2022 Pearson Education Inc.

Chapter 1

The Financial Statements 1-906

(b) Legal analysis: If St. Genevieve is a public company, their actions are illegal.

The Securities Exchange Act of

1934 prohibits insider trading. It imposes stiff penalties for unethical conduct of this type. The SEC will (continued) C10-103 prosecute them for insider trading, probably fine them, and possibly send the officers and directors responsible for the decision to prison.

In addition, actions such as

these have been the basis for numerous civil stockholder lawsuits, to recover monetary damages suffered because of the actions of the company. (c) Ethical analysis: The managers clearly did not behave ethically, violating the rights of existing shareholders as well as the good faith of the investing public. Managers defrauded the stockholders by withholding important information prior to buying company stock.

Req. 4 The correct way to handle this transaction is never to have proposed it in the first place. However, if it did happen, the disclosure principle is relevant to the situation.

The

Chapter 1

The Financial Statements 1-907

or others is probable and can be estimated, a loss should be disclosed in the income statement and a liability should be accrued on the balance sheet.

Chapter 1

The Financial Statements 1-908

Focus on Financials: Apple Inc. (20-30 min.)

Req. 1

Apple Inc. has only one class of stock authorized at September 28, 2019: Common stock, $.00001 par value, 12.6 billion shares authorized, 4,443,236,000 shares issued and outstanding (from balance sheet). The company has no preferred stock.

Req. 2 Repurchase of common stock during 2019

$66,897

million* ÷ Number of shares purchased

= Average cost per share

345.2 million** =

$193.79

*From Statement of Cash Flows **From Footnote 7

Req. 3 An analysis of changes in Retained Earnings for the year ended September 28, 2019 follows (in millions): Retained Earnings 70,400 September 29, 2018 Dividends and dividend 55,256 Net Income equivalents declared 2,501 Cumulative 14,129 effects of Common stock withheld related to net share settlement of equity awards

changes in accounting principle

Chapter 1

The Financial Statements 1-909

1,029 Common stock repurchased

67,101 45,898 2019

September 28,

(continued) Apple Inc. The company earned and reported net income of $55,256 million. It appears first in the Consolidated Statements of Operations. All the changes shown above in the Retained Earnings

account

are

reported

the

Statement

Stockholders’ Equity. Net income is also reported in the operating activities section of the Statement of Cash Flows.

The

dividends

paid

and

the

common

stock

repurchased are reported in the financing section of the Consolidated Statements of Cash Flows.

The beginning

and ending balances in Retained Earnings can be found on the Balance Sheet and the Statement of Stockholders’ Equity. Net income is a good thing and so are dividends because it signifies financial health for the company and its shareholders.

Chapter 1

The Financial Statements 1-910

Chapter 1

The Financial Statements 1-911

(continued) Apple Inc.

Req. 4 Apple Microsoft (for year ending Sept. 28, 2019) (for year ending June 30, 2019) Net Profit Margin Ratio

55,256 260,174

Asset Turnover

260,174

ROA Leverage Ratio

(338,516+365,725)/2 21.2% x 0.739

= 21.2%

39,240 125,843

= 31.2%

= 0.739

125,843 (286,556+258,84 8)/2

= 0.461

= 15.7%

31.2% x 0.461

= 14.4%

= 3.563

(286,556+258,84 8)/2 (102,330+82,718 )/2

= 2.947

(338,516+365,725)/2 (90,488+107,147)/2

ROE

15.7% x 3.563 = 55.9%

14.4% x 2.947=42.4%

55,256

39,240 (102,330+82,718 )/2

(90,488+107,147)/2

= 55.9%

= 42.4%

Apple has positive and outstanding ROA and ROE ratios in 2019. While both companies have a similar leverage ratio, Microsoft has a higher net profit margin ratio. Apple has a higher asset turnover than Microsoft. Apple is obviously more profitable based on ROA and ROE than Microsoft. Student answers may vary if another company is chosen for Copyright © 2022 Pearson Education Inc.

comparison. Chapter 1

The Financial Statements 1-912

Focus on Analysis: Under Armour, Inc. (20-30 min.)

Req. 1

Under Armour, Inc. has 400,000,000 shares of Class A Common

Stock

authorized,

with

188,289,680

issued and outstanding. It also has 34,450,000 shares of Class B Convertible Common Stock authorized, issued, and outstanding. It also has 400,000,000 shares of Class C Common

Stock

authorized,

with

229,027,730

issued and outstanding.

Req. 2 The differences between the two classes of stock are the voting rights, ownership requirements, and conversion feature.

Class B Common Stock are entitled to 10 votes

per share on all matters submitted to stockholder vote while Class A Common Stock is only entitled to 1 vote per share.

Additionally, Class B Common Stock can only be

held by the founder and CEO Kevin Plank, or any related party of Kevin Plank as defined in the charter. Finally, Class B Common Stock is convertible into Class A Common Stock and Class A Common Stock is not convertible.

Req. 3 Under Armour, Inc. issued around 154,000 new shares of Class A common stock.

They also issued 441,000 shares

Chapter 1

The Financial Statements 1-913

of Class A common stock for the exercise of stock options. This information is found in the consolidated statement of stockholders’ equity in the Class A common stock shares column.

(continued) Under Armour, Inc.

Req. 4 (in thousands) Retained Earnings 1,139,082 Beg. Balance Dividends declared 92,139 Comprehensive 0 Income Shares withheld in consideration of tax obligations related to stock-based compensation arrangements

4,235 1,226,986 Balance

Chapter 1

End.

The Financial Statements 1-914

Chapter 1

The Financial Statements 1-915

Chapter 11 The Statement of Cash Flows Ethics Check (5-10 min.) EC 11-1 a. Integrity b. Due care c. Integrity d. Integrity

Appendix E

Investments

Short Exercises (10 min.) S 11-1 The statement of cash flows helps investors and creditors: a.

Predict future cash flows by reporting past cash receipts and payments, which are reasonably good predictors of future cash receipts and payments.

Evaluate management decisions by reporting on how managers got cash and how they used cash to run the business.

Appendix E

Investments

(5-10 min.) S 11-2 Three things that could cause operating cash flows to be positive (under the indirect method) are: 1.

Increase in net income

Decreases rather than increases in current assets other than

cash 3.

Increases rather than decreases in current liabilities

Depreciation and amortization

Loss on the sale of long-term assets

Students need to identify 3 items.

Appendix E

Investments

(15-30 min.) S 11-3 DATE:

_______________

TO:

Managers of Lawrence Hotels, Inc.

FROM:

Student Name

SUBJECT:

Assessment of 2021 and Outlook for the Future

2021 was not a good year. Most of the increase in net income resulted from the gain on the insurance proceeds from fire damage to a building, which means that normal operations were not very profitable. This is confirmed by the increase in receivables, which hints that collections are lagging. The cash-flow data paint a similar picture. Operating activities used cash, which is bad news. Over the long run, operations should provide the bulk of the cash if the business expects to succeed. During 2021, the insurance recovery helped investing activities produce a net cash inflow. Ordinarily, investing activities should produce net cash outflows as the business invests in new assets. Growth is usually indicated by investments in new assets, but during 2021 net cash flows from

investing

activities

were

positive,

which

means

that

net

investments were negative. Although the net cash flow provided by investing activities may be temporary, it does not reflect especially well on the company. It means that, in part at least, the company is maintaining its cash position by liquidating fixed assets. This is a bad sign.

Appendix E

Investments

(continued) S 11-3 Financing activities provided a net cash inflow, which is normal. However, if the cash provided by financing activities is from debt, the additional debt could be difficult to repay since operating activities did not generate cash. Unless next year turns out to be much better than 2021, the outlook for the company is not bright. Student responses may vary. The key conclusion is that 2021 was not a good year, and the outlook is not bright.

Appendix E

Investments

(5-10 min.) S 11-4 Cash flows from operating activities: Net income .............................................................................

$81,000

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense.......................................................

8,000

Loss on sale of land .........................................................

4,000

Decrease in accounts receivable, inventory, and prepaid expenses ($50,000 − $48,000) ................

2,000

Increase in current liabilities ($40,000 − $36,000) ..........

4,000

Net cash provided by operating activities ..........................

$99,000

(10 min.) S 11-5 O−

Increase in inventory

N** h.

Retained earnings

Issuance of common stock

Payment of dividends

O+ j.

Increase in accounts payable

O−

Decrease in accrued liabilities

O+

Net income

O+ k.

Decrease in accounts receivable

O+

Decrease in prepaid expenses

O− l.

Gain on sale of building

Collection of cash from O+ m. Loss on sale of land customers

Purchase of equipment with cash

O+ n.

Depreciation expense

** Students might also say O+ (for net income) and F- (for dividends) Appendix E

Investments

(10 min.) S 11-6 Elan Corporation Statement of Cash Flows (partial) Year ended June 30, 2021 Cash flows from operating activities: Net income ............................................................

$55,000*

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .....................................

$12,000

Increase in current assets other than cash ..............................................................

(37,000)

Increase in current liabilities ..........................

6,000

Net cash provided by operating activities ......... _____

(19,000) $36,000

*$223,000 − $115,000 − $41,000 − $12,000 = $55,000

Appendix E

Investments

(15 min.) S 11-7 Elan Corporation Statement of Cash Flows Year ended June 30, 2021 Cash flows from operating activities: Net income ............................................................

$ 55,000*

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .....................................

$12,000

Increase in current assets other than cash ..............................................................

(37,000)

Increase in current liabilities ..........................

6,000

Net cash provided by operating activities .........

(19,000) 36,000

Cash flows from investing activities: Purchase of equipment........................................

$(36,000)

Proceeds from sale of land .................................

34,000

Net cash used for investing activities ................

(2,000)

Cash flows from financing activities: Proceeds from issuance of common stock .......

$ 20,000

Payment of note payable .....................................

(31,000)

Payment of dividends ..........................................

(6,300)

Purchase of treasury stock .................................

(8,000)

Net cash used for financing activities................

(25,300)

Net increase in cash ................................................. _____

$ 8,700

*$223,000 − $115,000 − $41,000 − $12,000 = $55,000

Appendix E

Investments

(10 min) S 11-8 a.

Acquisitions of plant assets = $51,000, as follows: Plant assets, net Beg. Book value of + Acquisitions − Depreciation − = bal. assets sold

$182,000 +

−

$10,000

−

$223,000 − $182,000 + $10,000

$51,000

Plant Assets, net 182,000 51,000 Depreciation Expense 223,000

Beg. bal. Acquisitions End. bal.

End. bal.

= $223,000

10,000

b. Proceeds from the sale of long-term investments = $19,000, as follows: Long-term investments Beg. bal.

Purchases

−

Book value of investments sold

End. bal.

$80,000

−

$61,000

$80,000 − $61,000

$19,000

With no gain or loss, proceeds from the sale must be the same as the book value of the investments sold, $19,000. Long-Term Investments Beg. bal.

80,000 Book value of investments

19,000

sold Appendix E

Investments

End. bal.

Appendix E

Investments

61,000

(15 min.) S 11-9 a. New borrowing on long-term notes payable = $13,000 ($67,000 − $54,000) b.

Issuance of common stock = $10,000 ($48,000 − $38,000)

Payment (and declaration) of dividends = $163,000, as follows: Beginning Retained Earnings

−

Dividend declarations

Ending Retained Earnings

−

$232,000

Net Income

$245,000

$150,000

$245,000 + $150,000 − $232,000

$163,000 Retained Earnings Beg. bal.

Dividends declared (paid)

Appendix E

Investments

245,000

Net income

150,000

End. bal.

232,000

163,000

(15 min.) S 11-10 a.

Collections from customers = $785,000, as follows: Collections Service = − Increase in Accounts Receivable from customers Revenue = $790,000 − $5,000 ($53,000 − $48,000) = $785,000 Accounts Receivable

Beg. Bal.

48,000

Revenue

790,000 Collections

End. Bal.

53,000

785,000

Payments for inventory = $379,000, as follows:

Payments for = inventory

COGS

= $400,000

−

Increase in Accounts Payable

− $11,000 − ($86,000 − $75,000)

$10,000 ($56,000 − $46,000)

−

Decrease in Inventory

= $379,000 Inventory Beg. Bal.

86,000

Purchases

389,000 COGS

End. Bal.

75,000

400,000

Accounts Payable Payments for Inventory

Beg. bal. 379,000 Purchases End. bal.

Appendix E

Investments

46,000 389,000 56,000

(10-15 min.) S 11-11 a.

Payments to employees = $26,000, as follows: Payments to employees

Salary Expense

−

$30,000

−

$26,000

Increase in Salary Payable $4,000 ($29,000 − $25,000)

Salary Payable Payments to Employees

Beg. bal.

25,000

26,000 Salary expense

30,000

End. bal.

29,000

Payments for other expenses = $204,000, as follows: Payments of other expenses

Other Expenses

$200,000

Increase in Prepaid Expenses

Decrease in Accrued Liabilities

$1,000

$3,000

($12,000 − $11,000)

Appendix E

Investments

($16,000 − $19,000)

$204,000

(15 min.) S 11-12 Tally-Ho Horse Farms, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Collections from customers ............................

$ 590,000

Payments to suppliers and employees ..........

(380,000)

Net cash provided by operating activities......

$210,000

Cash flows from investing activities: Purchase of equipment ....................................

$(134,000)

Net cash used for investing activities ............

(134,000)

Cash flows from financing activities: Issued note payable to borrow money ...........

$ 20,000

Payment of dividends.......................................

(55,000)

Net cash used for financing activities ............ Net increase in cash..............................................

(35,000) $

41,000

Cash balance, beginning ......................................

170,000

Cash balance, ending ...........................................

$211,000

Appendix E

Investments

(5 min.) S 11-13

Middleburg Golf Club, Inc. Statement of Cash Flows (partial) Year ended September 30, 2021 Cash flows from operating activities: Collections from customers ..................................

$ 208,000

Payments to suppliers ...........................................

(113,000)

Payments to employees.........................................

(79,000)

Payment of income tax ..........................................

(17,000)

Net cash used for operating activities..................

Appendix E

Investments

$(1,000)

(15 min.) S 11-14 Middleburg Golf Club, Inc. Statement of Cash Flows Year ended September 30, 2021 Cash flows from operating activities: Collections from customers ..................................

$ 208,000

Payments to suppliers ...........................................

(113,000)

Payments to employees.........................................

(79,000)

Payment of income tax ..........................................

(17,000)

Net cash used by operating activities ..................

$ (1,000)

Cash flows from investing activities: Purchase of equipment..........................................

$(42,000)

Proceeds from sale of land....................................

47,000

Net cash provided by investing activities ............ 5,000 Cash flows from financing activities: Proceeds from issuance of common stock .........

$ 22,000

Payment of note payable .......................................

(23,000)

Payment of dividends ............................................

(6,500)

Purchase of treasury stock ...................................

(5,700)

Net cash used for financing activities ..................

(13,200)

Net decrease in cash ..................................................

$ (9,200)

Appendix E

Investments

(15 min.) S 11-15 a. 1. Select the data to be analyzed 2. Click on the box that appears on the lower right corner of the selected area 3. Click on the option top 10%

b. The four shaded cells after applying the specified format are cell B8, C3, E7, and F5 (Papperton Inc. Dec2015, Kent Limited Dec2016, Orlando-North Company Dec2018, and Mirebeth Inc. Dec2019).

Appendix E

Investments

(15 min.) S 11-16 a. The cells that contain a green up arrow are cell B5, C3, and D3 (Disnear Corp. Dec2015, Beatrice Inc. Dec2016, and Beatrice Inc. Dec2017).

b. The cells that contain a red down arrow are cell B2, B6, C5, C6, D4, D6, E2, E3, E5, E6, F4, F5, G4, and G5 (Allison Corp. Dec2015, Elliston Limited Dec2015, Disnear Corp. Dec2016, Elliston Limited Dec2016, Callogy Company Dec2017, Elliston Limited Dec2017, Allison Corp. Dec2018, Beatrice Inc. Dec2018, Disnear Corp. Dec2018, Elliston Limited Dec2018, Callogy Company Dec2019, Disnear Corp. Dec2019, Callogy Company Dec2020, and Disnear Corp. Dec2020).

Appendix E

Investments

Appendix E

Investments

Exercises (10-15 min.) E 11-17A

NIF a. Acquisition of equipment by issuance of note payable

F– k. Purchase of treasury stock

I–

O+ m. Increase in salary payable

b. Purchase of long-term investment with cash

F– l.

Payment of long-term debt

I+

n. Cash sale of land

I+

o. Sale of long-term investment

O– d. Increase in prepaid expenses

I–

p. Acquisition of building by cash payment

O– e. Decrease in accrued liabilities

O+ q. Net income

F+ c. Issuance of long-term note payable to borrow Cash

F+ r. O+ f. Loss on sale of equipment O+ g. Decrease in accounts receivable

Issuance of common stock for cash

F– s. Payment of cash dividend

O+ h. Depreciation on equipment O+ i. Increase in accounts payable O+ j. Amortization of intangible assets

Appendix E

Investments

(5-10 min.) E 11-18A

Financing

Investing

Financing

Investing

Operating

Noncash investing and financing

Operating

Financing m. Financing

Operating

Investing

Appendix E

Investments

(10-15 min.) E 11-19A Req. 1 Cash flows from operating activities: Net income ........................................................

$11,000

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense................................

$ 9,000

Loss on sale of land ..................................

28,000

Decrease in current assets other than cash..................................................

32,000

Decrease in current liabilities ...................

(19,000)

Net cash provided by operating activities......

50,000 $61,000

Req. 2 Operating cash flow is strong, as shown by the positive net cash flows from operating activities. Normally, net cash provided by operations is greater than net income because of the depreciation add-back.

Appendix E

Investments

(15-20 min.) E 11-20A Req. 1

Cash flows from operating activities: Net income .............................................................

20,000

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ....................................

$ 7,000

Increase in accounts receivable ...................

(1,000)

Increase in inventory......................................

(3,000)

Increase in accounts payable........................

110,000

Decrease in accrued liabilities ......................

(2,000)

111,000

Net cash provided by operating activities..................................................................

$ 131,000

A troublesome sign for the company is that accounts payable have increased substantially, indicating that Porter may have trouble paying off its creditors. Overall, operations generated a positive net cash flow when operations are supposed to be the major source of cash for a healthy company. This is a favorable sign. In addition, net cash provided by operating activities is substantially larger than net income, which is a favorable sign. (While not a part of Operating Activities, students may also address or question the large increase in cash.)

Appendix E

Investments

(20-30 min.) E 11-21A Req. 1 Barnaby Travel Products, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income .............................................................

$ 39,000

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .....................................

$ 28,000

Decrease in accounts receivable ...................

16,000

Decrease in inventory .....................................

42,000

Increase in prepaid expenses ........................

(200)

Increase in accounts payable.........................

15,000

Increase in accrued liabilities.........................

55,000

Net cash provided by operating activities ....

155,800 194,800

Cash flows from investing activities: Acquisition of plant assets................................... $(104,000) Proceeds from sale of land ..................................

39,000

Net cash used for investing activities ...........

(65,000)

Cash flows from financing activities: Proceeds from issuance of common stock ........

$ 31,000

Payment of long-term note payable ....................

(16,000)

Payment of dividends ...........................................

(8,000)

Net cash provided by financing activities .....

7,000

Net increase in cash .................................................

$ 136,800

Cash balance, December 31, 2020 ..........................

33,200

Cash balance, December 31, 2021 ..........................

$ 170,000

Noncash investing and financing activities: Acquisition of plant assets by issuing note payable Appendix E

Investments

$ 52,000

(continued) E 11-21A Req. 2 Barnaby’s cash flows look strong. Operations are the main source of cash. The company is investing in new plant assets. It was able to issue stock, pay dividends, and pay off a long-term note payable — all financing transactions. All of these signs are favorable.

(5-10 min.) E 11-22A Case A — Issuing stock and the sale of plant assets generated the cash to acquire plant assets. Operations did not provide a positive cash flow. Case B — A combination of operations and issuing stock generated most of the cash for acquisition of plant assets. The company also sold plant assets for cash. Case C — The sale of plant assets generated the cash needed to acquire new plant assets. Operations provided a positive cash flow. The company also issued stock.

Most healthy financially Mid-range —

— Case B

Case C

Least healthy financially — Case A

Appendix E

Investments

(10-15 min.) E 11-23A a. Cash proceeds of sale

= Book value of asset sold, $20,000* + Gain on sale, $6,000 = $26,000

_____ *$115,000 + $25,000 − $11,000 − Book value sold (X) = $109,000 Book value sold = $20,000

Plant Assets, Net

Beginning balance

115,000 Depreciation expense

11,000

Purchases

25,000 Book value sold*

20,000

Ending balance

109,000

Cash dividend declared = $19,000*

_____ *$37,000 + $63,000 − $9,000 − Cash dividends (X) = $72,000 Cash dividends = $19,000

Retained Earnings Stock dividends

9,000

Beginning balance

37,000

Cash dividends*

19,000

Net income

63,000

Ending balance

72,000

Appendix E

Investments

(10-15 min.) E 11-24A Req. 1 Cash flows from operating activities: Receipts: Collections from customers ($115,000 + $35,000) ...........................

$ 150,000

Collection of dividend revenue ..............

11,000

Total cash receipts .............................

161,000

Payments: To suppliers .............................................

$(59,000)

To employees...........................................

(33,000)

For interest...............................................

(17,000)

For income tax .........................................

(13,000)

Total cash payments ..........................

(122,000)

Net cash provided by operating activities .

$ 39,000

Operating cash flow is strong as shown by the net cash provided by operating activities. It is positive, resulting in a net inflow of cash.

Appendix E

Investments

(5-10 min.) E 11-25A Req. 1 Salary Payable — Report cash payments to employees as operating cash flows. Buildings — Report acquisitions of buildings and the proceeds from sales of buildings as investing cash flows. Notes Payable — Report issuance and payments of notes payable as financing cash flows.

Appendix E

Investments

(20-30 min.) E 11-26A Req. 1 Hapland Light, Inc. Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Receipts: Collections from customers ($225,000 − $15,500) ...................................... $ 209,500 Dividends received ............................................ 11,000 Total cash receipts........................................ 220,500 Payments: To suppliers ($101,000 + $11,500 + $1,500) ..... $(114,000) To employees ($42,000 + $2,400) ..................... (44,400) For income tax ................................................... (10,000) For interest ......................................................... (4,000) Total cash payments..................................... (172,400) Net cash provided by operating activities....... 48,100 Cash flows from investing activities: Acquisition of plant assets.................................... $(108,000) Proceeds from sale of land.................................... 26,000 Net cash used for investing activities.............. (82,000) Cash flows from financing activities: Proceeds from issuance of common stock ......... $ 86,000 Payment of long-term note payable...................... (29,000) Payment of dividends ............................................ (9,000) Net cash provided by financing activities ....... 48,000 Net increase in cash ................................................... $ 14,100 Cash balance, June 30, 2020...................................... 38,000 Cash balance, June 30, 2021...................................... $ 52,100 Noncash investing and financing activities: Acquisition of plant assets by issuing note payable

Appendix E

Investments

$ 48,000

(continued) E 11-26A Req. 2 Hapland Light’s cash flows look strong. Operations are the main source of cash. The company invested in new plant assets. The company is investing into the future. The company was able to issue stock, pay dividends, and pay off a long-term note payable — all financing transactions. All of these signs are favorable.

Appendix E

Investments

(10-15 min.) E 11-27A

$1,000 decrease in a. Cash collections = $66,000

+ Accounts Receivable ($28,000 − $27,000)

Cash payments for inventory

$67,000

= $75,000

–

$1,000 decrease in

$3,000 decrease in

Inventory

+ Accounts Payable

($25,000 − $24,000)

($16,000 − $13,000)

= $77,000

Appendix E

Investments

(10-15 min.) E 11-28B

F+ a. Issuance of long-term note payable to borrow cash

O– k. Increase in prepaid Expenses

F– b. Purchase of treasury stock

O+ l.

O+ c. Net income

O+ m. Depreciation of equipment

O+ d. Loss on sale of equipment

I+

Increase in salary payable

n. Sale of long-term Investment

O+ e. Decrease in accounts receivable

F+ o. Issuance of common stock for cash

NIF f. Acquisition of equipment by issuance of note payable

O– p. Decrease in accrued liabilities

O+ g. Increase in accounts payable

O+ q. Amortization of intangible Assets

F– h. Payment of cash dividend

I–

Acquisition of building by cash payment

I–

i. Purchase of long-term Investment with cash

I+

F– s. Payment of long-term debt

j. Cash sale of land

Appendix E

Investments

(5-10 min.) E 11-29B

Investing

Financing

Investing

Operating

Noncash investing and financing

m. Investing

Investing

Appendix E

Investments

(10-15 min.) E 11-30B Req. 1 Cash flows from operating activities: Net income..........................................................

$38,000

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ..................................

$ 13,000

Loss on sale of land.....................................

20,000

Increase in current assets other than cash ....................................................

(24,000)

Increase in current liabilities.......................

15,000

Net cash provided by operating activities.......

24,000 $62,000

Req. 2 Operating cash flow is good, as shown by the positive net cash flows from operating activities. Normally, net cash provided by operations is more than net income because of the depreciation add-back.

Appendix E

Investments

(15-20 min.) E 11-31B Req. 1

Cash flows from operating activities: Net income .......................................................

$ 17,000

Adjustments to reconcile net income to net cash used for operating activities: Depreciation expense................................

$ 11,000

Increase in accounts receivable...............

(130,000)

Increase in inventory .................................

(90,000)

Increase in accounts payable ...................

68,000

Decrease in accrued liabilities .................

(5,000)

Net cash used for operating activities .............

(146,000) $(129,000)

Ashby Trading Post Company shows signs of trouble collecting receivables and selling inventory. There is a large build-up in both Accounts Receivable and Inventory. The large increase in Accounts Payable implies that the company is having trouble paying their bills. The net cash flows from operating activities are negative which is an unfavorable sign. In addition, the net cash used for operating activities is smaller than net income, when the opposite situation is expected.

Appendix E

Investments

(20-30 min.)

E 11-32B

Req. 1 Casey Travel Products, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income ............................................................

$ 48,400

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ...................................

$ 26,000

Decrease in accounts receivable.................

18,000

Decrease in inventory ...................................

22,000

Increase in prepaid expenses ......................

(1,100)

Increase in accounts payable ......................

20,000

Decrease in accrued liabilities .....................

(58,000)

26,900

Net cash provided by operating activities...... Cash flows from investing activities:

75,300

Acquisition of plant assets.................................. $(102,000) Proceeds from sale of land .................................

45,000

Net cash used for investing activities ............ Cash flows from financing activities:

(57,000)

Proceeds from issuance of common stock .......

$ 80,000

Payment of long-term note payable ...................

(18,000)

Payment of dividends ..........................................

(14,000)

Net cash provided by financing activities ......

48,000

Net increase in cash .................................................

$ 66,300

Cash balance, December 31, 2020 ..........................

8,700

Cash balance, December 31, 2021 ..........................

$ 75,000

Noncash investing and financing activities: Acquisition of plant assets by issuing note payable Appendix E

Investments

$ 51,000

(continued) E 11-32B Req. 2 Casey’s cash flows look strong. Operations are the main source of cash. The company is investing in new plant assets. It was able to issue stock, pay dividends, and pay off a long-term note payable — all financing transactions. All of these signs are favorable.

(5-10 min.) E 11-33B Case A —

Issuing stock generated the cash to acquire plant assets. Operations used cash while in cases B and C operations provided cash. They also could have used cash from the sale of plant assets.

Case B —

A combination of operations and issuing stock generated most of the cash for acquisition of plant assets. The company also sold plant assets for cash.

Case C —

The sale of plant assets generated the cash needed to acquire new plant assets. They could also have used cash from the stock issue or cash from operations. Operations provided more cash than did cases A or B.

Most healthy financially — Case B Mid-range — Case C Least healthy financially — Case A Appendix E

Investments

(10-15 min.) E 11-34B a. Cash proceeds of sale = =

Book value of asset sold, $21,000* – Loss on sale, $3,000 $18,000

_____ *$101,000 + $38,000 − $20,000 − Book value sold (X) = $98,000 Book value sold = $21,000

Plant Assets, Net Beginning balance

101,000

Depreciation expense

20,000

Purchases

38,000

Book value sold*

21,000

Ending balance

98,000

b. Cash dividend declared = $24,000* _____ *$46,000 + $63,000 − $15,000 − Cash dividends (X) = $70,000 Cash dividends = $24,000*

Retained Earnings Stock dividends

15,000 Beginning balance

46,000

Cash dividends*

24,000

Net income

63,000

Ending balance

70,000

Appendix E

Investments

(10-15 min.) E 11-35B Req. 1 Cash flows from operating activities: Receipts: Collections from customers ($117,000 + $20,000).............................

$ 137,000

Collection of dividend revenue ...............

4,000

Total cash receipts...............................

141,000

Payments: To suppliers ..............................................

$(55,000)

To employees............................................

(31,000)

For interest ................................................

(19,000)

For income tax ..........................................

(11,000)

Total cash payments............................

(116,000)

Net cash provided by operating activities..

$ 25,000

Operating cash flow is strong, as shown by the net cash provided by operating activities.

Appendix E

Investments

(5-10 min.) E 11-36B Req. 1 Salaries Payable — Report cash payments to employees as operating cash flows. Buildings — Report acquisitions of buildings and the proceeds from sales of buildings as investing cash flows. Notes Payable — Report issuances and payments of notes payable as financing cash flows.

Appendix E

Investments

(20-30 min.) E 11-37B Req. 1 Jubilee World, Inc. Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Receipts: Collections from customers ($222,000 + $15,500).........................................

$ 237,500

Dividends received ...............................................

11,500

Total cash receipts ..........................................

249,000

Payments: To suppliers ($102,000 + $8,000 – $1,700) ..........

$(108,300)

To employees ($42,000 − $2,200) ........................

(39,800)

For income tax ......................................................

(10,500)

For interest ............................................................

(2,500)

Total cash payments .......................................

(161,100)

Net cash provided by operating activities..........

87,900

Cash flows from investing activities: Acquisition of plant assets .......................................

$(122,000)

Proceeds from sale of land.......................................

24,000

Net cash used for investing activities ................

(98,000)

Cash flows from financing activities: Proceeds from issuance of common stock ............

$ 39,000

Payment of long-term note payable.........................

(20,000)

Payment of dividends ...............................................

(7,000)

Net cash provided by financing activities .......... Net increase in cash.......................................................

12,000 $

1,900

Cash balance, June 30, 2020.........................................

32,000

Cash balance, June 30, 2021.........................................

$ 33,900

Noncash investing and financing activities: Acquisition of plant assets by issuing note payable

Appendix E

Investments

$ 54,000

(continued) E 11-37B Req. 2 Jubilee World cash flows look strong. Operations are the main source of cash. The company is investing in new plant assets. Jubilee World was able to issue stock, pay dividends, and pay off a long-term note payable — all financing transactions. All of these signs are favorable.

Appendix E

Investments

(10-15 min.) E 11-38B

$1,000 decrease in a. Cash collections = $69,000 + Accounts Receivable ($25,000 − $24,000) = $70,000

$4,000 increase in b.

Cash payments = $71,000 + for inventory

Inventory ($29,000 − $33,000)

$3,000 increase in – Accounts Payable ($16,000 − $19,000)

= $72,000

Appendix E

Investments

Quiz Q11-39

Q11-40

Q11-41

Q11-42

Q11-43

Q11-44

Q11-45

Q11-46

Receiving dividends – operating

Paying dividends – financing

[Book value = $12,000 ($19,000 − $7,000); Gain =

Q11-47

$1,000; Q11-48

Q11-49

Q11-50

Q11-51

Proceeds = $13,000 ($12,000 + $1,000)]

Net inc. − Gain + Depr. + A/R dec − Inv. inc − A/P dec + Acc Liab

inc

($35,500 − $10,000 + $7,500 + $5,000 − $1,000 − $1,000 + $8,000)

Q11-52

Q11-53

Q11-54

Q11-55 Q11-56

b c

Q11-57

($750,000 − $40,000 = $710,000)

Q11-58

[$58,900 − ($6,500 − $3,100) = $55,500]

Appendix E

Investments

Cash flow from stock issuance ($20,000 – $10,000) $10,000 Cash dividends paid ($72,000 + $35,500 − $X = $70,500) (37,000) Net cash used $(27,000)

Problems (45-60 min.) P 11-59A Req. 1 Coleman Motors, Inc. Income Statement Year Ended December 31, 2021 Sales revenue ......................................................................... Cost of goods sold [$175,000 + $47,000] ............................. Salary expense ....................................................................... Depreciation expense ($140,000 / 5) ..................................... Rent expense .......................................................................... Income tax expense ............................................................... Net income ..............................................................................

$426,000 222,000 90,000 28,000 19,000 14,000 $ 53,000

Req. 2 Coleman Motors, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Current: Current: Cash......................................... $ 74,000* Accounts payable Accounts receivable ($282,000 − $197,400)... $ 84,600 ($426,000 × .10)..................... 42,600 Salary payable................. 5,000 Inventory (5 × $47,000)........... 235,000 Total current liabilities ... 89,600 Total current assets ............... 351,600 STOCKHOLDERS’ EQUITY Property, plant, and equipment: Common stock.................... 350,000 Equipment ............. $140,000 Retained earnings Less: Accumulated ($53,000 − $29,000) ........... 24,000 depreciation....... (28,000) 112,000 Total stockholders’ equity . 374,000 Total liabilities and Total assets ................................ $463,600 stockholders' equity......... $463,600 *$350,000 (stock) − $140,000 (equipment) − $175,000 (inventory) − $19,000 (rent) –$197,400 (inventory) + $383,400 (sales) – $85,000 (salaries) – $14,000 (taxes) – $29,000 (dividends) = $74,000

Appendix E

Investments

(continued) P 11-59A Req. 3 Coleman Motors, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income........................................................... $ 53,000 Adjustments to reconcile net income to net cash used for operating activities: Depreciation expense................................ $ 28,000 Increase in accounts receivable............... (42,600) Increase in inventory ................................. (235,000) Increase in accounts payable ................... 84,600 Increase in salary payable ........................ 5,000 (160,000) Net cash used for operating activities.......... (107,000) Cash flows from investing activities: Purchase of equipment ...................................... $(140,000) Net cash used for investing activities .......... (140,000) Cash flows from financing activities: Issuance of common stock ................................ Payment of dividend ........................................... Net cash provided by financing activities.... Net increase in cash ................................................ Cash balance, January 1, 2021............................... Cash balance, December 31, 2021 .........................

Appendix E

Investments

$350,000 (29,000) 321,000 $ 74,000 0 $ 74,000

(45-60 min.) P 11-60A Req. 1 Coleman Motors, Inc. Income Statement Year Ended December 31, 2021 Sales revenue ......................................................................... Cost of goods sold [$175,000 + $47,000] ............................. Salary expense ....................................................................... Depreciation expense ($140,000 / 5) ..................................... Rent expense .......................................................................... Income tax expense ............................................................... Net income ..............................................................................

$426,000 222,000 90,000 28,000 19,000 14,000 $ 53,000

Req. 2 Coleman Motors, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Appendix E

Investments

(continued) P 11-60A Req. 3 Coleman Motors, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Receipts: Collections from customers ($426,000 x 90%)............................................ $ 383,400 Total cash receipts ................................................. 383,400 Payments: To suppliers ($175,000 + $197,400 +$19,000) .... $(391,400) To employees ($90,000 – $5,000)...................... (85,000) For income tax ................................................... (14,000) Total cash payments..................................... (490,400) Net cash used for operating activities .............

(107,000)

Cash flows from investing activities: Purchase of equipment.......................................... $(140,000) Net cash used for investing activities..............

(140,000)

Cash flows from financing activities: Issuance of common stock ................................... Payment of dividend .............................................. Net cash provided by financing activities ....... Net increase in cash ................................................... Cash balance, January 1, 2021 .................................. Cash balance, December 31, 2021.............................

321,000 $ 74,000 0 $ 74,000

Appendix E

Investments

$350,000 (29,000)

(35-45 min.) P 11-61A Req. 1 Smither Software Corp. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income .............................................................. $ 66,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ..................................... $ 21,000 Amortization expense ..................................... 5,100 Loss on sale of equipment ............................. 4,000 Decrease in accounts receivable ................... 43,300 Increase in inventories.................................... (10,500) Increase in prepaid expenses ........................ (1,300) Increase in accounts payable......................... 2,800 Increase in income tax payable...................... 2,300 Decrease in accrued liabilities ....................... (2,100) 64,600 Net cash provided by operating activities ........ 130,600 Cash flows from investing activities: Purchase of building .............................................. Purchase of long-term investment ....................... Proceeds from sale of equipment......................... Collection of loan ................................................... Net cash used for investing activities............... Cash flows from financing activities: Issuance of common stock ................................... Issuance of long-term note payable ..................... Payment of cash dividends ................................... Purchase of treasury stock ................................... Net cash provided by financing activities ........ Net increase in cash and cash equivalents.............

$(97,000) (44,700) 12,700 11,000 (118,000)

$ 37,000 24,400 (19,000) (14,500)

Cash and cash equivalents balance, December 31, 2020 Cash and cash equivalents balance, December 31, 2021

Appendix E

Investments

27,900 $ 40,500 26,000 $66,500

(continued) P 11-61A

Noncash investing and financing activities: Acquisition of land by issuing long-term note payable ...... Retirement of bonds payable by issuing common stock ... Total noncash investing and financing activities ....................

$204,000 60,000 $264,000

Appendix E

Investments

(35-45 min.) P 11-62A Req. 1 Bedford Movie Theater Company Statement of Cash Flows Year Ended November 30, 2021 Cash flows from operating activities: Net income ............................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................... $15,300 Amortization expense .................................... 7,000 Decrease in accounts receivable .................. 7,200 Increase in inventories................................... (3,000) Decrease in prepaid expenses ...................... 4,500 Increase in accounts payable........................ 1,500 Increase in accrued liabilities........................ 20,000 Decrease in income tax payable ................... (4,000) Net cash provided by operating activities.......

$ 11,000

48,500 59,500

Cash flows from investing activities: Purchase of equipment........................................ $(56,700) Purchase of building............................................ (50,000) Sale of long-term investment .............................. 16,300 Net cash used for investing activities..............

(90,400)

Cash flows from financing activities: Issuance of long-term note payable ................... $ 41,000 Issuance of common stock ................................. 13,000 Payment of cash dividend ................................... (25,000) Net cash provided by financing activities ....... Net decrease in cash and cash equivalents........... Cash and cash equivalents balance, Nov. 30, 2020 Cash and cash equivalents balance, Nov. 30, 2021

29,000 $ (1,900) 15,500 $ 13,600

Noncash investing and financing activities: Acquisition of land by issuing note payable .....

$96,000

Appendix E

Investments

(continued) P 11-62A Req. 2 Evaluation:

Bedford Movie Theater Company’s cash flows look strong. Operations are the main source of cash. The company is investing in new plant assets and therefore had a negative cash flow from investing activities. Bedford generated a positive cash flow from financing activities.

These

financing activities indicate that Bedford is considered credit-worthy to issue long-term notes. We also see that the company has sufficient funds to pay cash dividends. Overall, the company’s cash and cash equivalents balance decreased slightly during the year which is a negative sign.

Appendix E

Investments

(30-40 min.) P 11-63A Req. 1 Queen Supply Corp. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ......................................... Increase in accounts receivable ........................ Increase in inventories ....................................... Decrease in prepaid expenses........................... Increase in accounts payable ............................ Increase in salary payable……………………….. Decrease in other accrued liabilities................. Net cash provided by operating activities .......... Cash flows from investing activities: Purchase of land ....................................................... Purchase of equipment ($49,000 − depreciation expense of $16,800 = $32,200; $53,700 − $32,200) ................................................................ Net cash used for investing activities .................

$55,500

$ 16,800 (8,200) (13,400) 2,700 9,200 8,900 (2,700)

13,300 68,800

$(37,700)

(21,500) (59,200)

Cash flows from financing activities: Payment of dividends ($19,200 + $55,500 − $12,300).. $(62,400) Issuance of note payable ......................................... 38,000 Issuance of common stock...................................... 23,600 Net cash used for financing activities ................. (800) Net increase in cash and cash equivalents ................ $ 8,800 Cash and cash equivalents balance, December 31, 2020 9,000 Cash and cash equivalents balance, December 31, 2021 $ 17,800

Appendix E

Investments

(continued) P 11-63A Req. 2 This problem will help students learn how operating activities, investing activities, and financing activities generate cash receipts and cash payments. By solving this problem, students will learn how companies prepare the statement of cash flows and will thus be able to understand the meaning of cash flows from the three basic categories of business activities. This knowledge will aid their analysis of investments. For example, students should know that net cash provided by operating activities conveys a more positive signal about a company than net cash used for operations.

Student responses will vary.

Appendix E

Investments

(30-40 min.) P 11-64A Req. 1 Queen Supply Corp. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Receipts: Collections from customers ($439,000 – $8,200) ..........................................

$430,800

Total cash receipts .......................................... Payments: To suppliers ($186,600 + $13,400 – $9,200 + $49,600 – $2,700 + $2,700) .............................. (240,400) To employees ($77,000 – $8,900)....................... (68,100) For interest .......................................................... (24,800) For income tax..................................................... (28,700) Total cash payments ....................................... Net cash provided by operating activities ........

(362,000) 68,800

Cash flows from investing activities: Purchase of land ....................................................... $(37,700) Purchase of equipment ($49,000 − depreciation expense of $16,800 = $32,200; $53,700 − $32,200) ................................................................ (21,500) Net cash used for investing activities .................

(59,200)

Cash flows from financing activities: Payment of dividends ($19,200 + $55,500 − $12,300) $(62,400) Issuance of note payable ......................................... 38,000 Issuance of common stock...................................... 23,600 Net cash used for financing activities ................. Net increase in cash and cash equivalents ................ Cash and cash equivalents balance, December 31, 2020 Cash and cash equivalents balance, December 31, 2021

(800) $ 8,800 9,000 $ 17,800

Appendix E

Investments

430,800

(continued) P 11-64A Req. 2 This problem will help students learn how operating activities, investing activities, and financing activities generate cash receipts and cash payments. By solving this problem, students will learn how companies prepare the statement of cash flows and will thus be able to understand the meaning of cash flows from the three basic categories of business activities. This knowledge will aid their analysis of investments. For example, students should know that net cash provided by operating activities conveys a more positive signal about a company than net cash used for operations.

Student responses will vary.

Appendix E

Investments

(35-45 min.) P 11-65A Req. 1 Rourke Furniture Gallery, Inc. Statement of Cash Flows Year Ended March 31, 2022 Cash flows from operating activities: Receipts: Collections from customers ($421,000 + $199,400).................................. $620,400 5,100 Interest received ............................................. 8,900 Dividends received......................................... Total cash receipts ..................................... Payments: To suppliers .................................................... $(379,100) (78,500) To employees.................................................. (12,900) For interest...................................................... (38,100) For income tax ................................................ Total cash payments .................................. Net cash provided by operating activities ... Cash flows from investing activities: Purchase of plant assets................................... $ (89,300) 22,200 Sale of plant assets ........................................... 11,300 Collection of loans............................................. (10,000) Loan to another company ................................. 9,100 Sale of investments ........................................... Net cash used for investing activities .......... Cash flows from financing activities: Payments of long-term notes payable ............. $ (52,000) (48,500) Payment of dividends........................................ 24,500 Issuance of note payable .................................. 5,000 Issuance of common stock............................... Net cash used for financing activities .......... Net (decrease) in cash .......................................... Cash balance, March 31, 2021.............................. Cash balance, March 31, 2022.............................. Appendix E

Investments

$634,400

(508,600) 125,800

(56,700)

(71,000) $ (1,900) 89,900 $ 88,000

(continued) P 11-65A Noncash investing and financing transactions: Payment of short-term note payable by issuing long-term note payable ................................... Acquisition of equipment by issuing short-term note payable................................................ Total noncash investing and financing transactions..........

$60,000 16,700 $76,700

Req. 2 The fiscal year ending March 31, 2022 was a strong year from a cashflow standpoint. Operations provided the bulk of the company’s cash and the company was able to issue new stock and debt. This means stockholders and creditors have faith in the company. The business acquired additional plant assets, reduced their debt, and paid dividends which generally bodes well for the future. Overall, cash decreased $1,900 which is a negative sign.

Appendix E

Investments

(45-60 min.) P 11-66A Req. 1 Ronklin Electric Company Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Receipts: $661,900 Collections from customers ................................. 17,000 Dividends received ................................................ $678,900 Total cash receipts ............................................. Payments: To suppliers ($387,000 + $34,700) ........................ $(421,700) (143,100) To employees ......................................................... (23,100) For interest ............................................................. (18,400) For income tax ....................................................... (606,300) Total cash payments .......................................... 72,600 Net cash provided by operating activities ........... Cash flows from investing activities: Purchase of equipment ............................................. $ (31,500) 18,700 Sale of long-term investments ................................. (12,800) Net cash used for investing activities.................. Cash flows from financing activities: Issuance of common stock ...................................... $ 37,900 (41,500) Payment of long-term note payable......................... (27,000) Payment of dividends ............................................... (21,200) Purchase of treasury stock ...................................... (51,800) Net cash used for financing activities ................. $ 8,000 Net increase in cash ..................................................... 34,900 Cash balance, December 31, 2020............................... $ 42,900 Cash balance, December 31, 2021............................... Noncash investing and financing activities: Acquisition of land by issuing common stock Retirement of note payable by issuing common stock Total noncash investing and financing activities

Appendix E

Investments

$ 53,000 15,000 $68,000

(continued) P 11-66A Req. 2 Ronklin Electric Company Cash Flows from Operating Activities Year Ended December 31, 2021 Cash flows from operating activities: Net income .............................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ..................................... $ 19,400 Loss on sale of investments .......................... 20,300 Decrease in accounts receivable ................... 18,000 Decrease in inventories .................................. 11,800 Increase in prepaid expenses ........................ (200) Decrease in accounts payable ....................... (8,300) Decrease in interest payable .......................... (2,200) Decrease in salary payable............................. (7,800) Increase in other accrued liabilities............... 10,700 Decrease in income tax payable .................... (2,600) Net cash provided by operating activities ...........

Appendix E

Investments

$13,500

59,100 $72,600

(45-60 min.) P 11-67A Req. 1 American-Davis Design Studio, Inc. Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Net income .............................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense...................................... $ 13,000 7,100 Loss on sale of land ........................................ Increase in accounts receivable..................... (25,600) Increase in inventories.................................... (48,100) 1,100 Decrease in prepaid expenses ....................... Decrease in accounts payable ....................... (11,200) (2,300) Decrease in income tax payable .................... Increase in accrued liabilities......................... 46,400 600 Increase in interest payable............................ (700) Decrease in salary payable............................. Net cash provided by operating activities ........

$ 60,500

(19,700) 40,800

Cash flows from investing activities: Sale of land.............................................................. $ 39,900 Purchase of long-term investment........................ (15,800) Net cash provided by investing activities.........

24,100

Cash flows from financing activities: Payment of long-term note payable...................... $(60,800) (7,700) Payment of cash dividends ................................... 8,300 Issuance of common stock.................................... Net cash used for financing activities............... Net increase in cash .................................................. Cash balance, June 30, 2020 .................................... Cash balance, June 30, 2021 ....................................

(60,200) $ 4,700 19,000 $ 23,700

Appendix E

Investments

(continued) P 11-67A

Noncash investing and financing activities: Acquisition of equipment by issuing long-term note payable .................................................. Payment of short-term note payable by issuing common stock................................................... Total noncash investing and financing activities .................

$14,900 4,900 $19,800

Req. 2 American-Davis Design Studio, Inc. Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Receipts: Collections from customers .......................... $ 254,300 Interest received .............................................

2,000

Total cash receipts ....................................

$ 256,300

Payments: To suppliers .................................................... $(147,200) To employees..................................................

(49,200)

For income tax ................................................

(13,500)

For interest......................................................

( 5,600)

Total cash payments .................................

(215,500)

Net cash provided by operating activities ........

$ 40,800

Appendix E

Investments

(45-60 min.) P 11-68B Req. 1 Vintage Motors, Inc. Income Statement Year Ended December 31, 2021 Sales revenue................................................................

$504,000

Cost of goods sold [$234,000 + (1 × $48,000)] ...........

282,000

Salary expense..............................................................

60,000

Rent expense ................................................................

18,000

Depreciation expense ($160,000 / 5) ...........................

32,000

Income tax expense......................................................

22,000

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

$ 90,000

Req. 2 Vintage Motors, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Current: Current: Cash......................................... $234,000* Accounts payable Accounts receivable ($192,000 − $153,600).. $ 38,400 ($504,000 × .10) ................... 50,400 Salary payable................. 11,000 Inventory (3 × $48,000)........... 144,000 Total current liabilities ... 49,400 Total current assets ........... 428,400 STOCKHOLDERS’ EQUITY Property, plant, and equipment: Common stock.................... 430,000 Equipment ............. $160,000 Retained earnings Less:Accumulated ($90,000 − $13,000) ......... 77,000 depreciation....... (32,000) 128,000 Total stockholders’ equity . 507,000 Total liabilities and Total assets ................................ $556,400 stockholders' equity ....... $556,400

____ *$430,000 (stock) − $160,000 (equipment) − $234,000 (inventory) − $18,000 (rent) − $153,600 (inventory)+ $453,600 (sales) − $49,000 (salaries) − $22,000 (taxes) – $13,000 (dividends) = $234,000

Appendix E

Investments

(continued) P 11-68B Req. 3 Vintage Motors, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: $ 90,000 Net income................................................................. Adjustments to reconcile net income to net cash used for operating activities: Depreciation expense ..................................... $ 32,000 Increase in accounts receivable .................... (50,400) Increase in inventory....................................... (144,000) Increase in accounts payable......................... 38,400 Increase in salary payable .............................. 11,000 (113,000) (23,000) Net cash used for operating activities ............... Cash flows from investing activities: Purchase of equipment ............................................ $(160,000) Net cash used for investing activities ................

(160,000)

Cash flows from financing activities: Issuance of common stock...................................... $ 430,000 (13,000) Payment of dividend................................................. 417,000 Net cash provided by financing activities.......... $234,000 Net increase in cash...................................................... 0 Cash balance, January 1, 2021..................................... Cash balance, December 31, 2021 ............................... $234,000

Appendix E

Investments

(45-60 min.) P 11-69B Req. 1 Vintage Motors, Inc. Income Statement Year Ended December 31, 2021 Sales revenue................................................................

$504,000

Cost of goods sold [$234,000 + (1 × $48,000)] ...........

282,000

Salary expense..............................................................

60,000

Rent expense ................................................................

18,000

Depreciation expense ($160,000 / 5) ...........................

32,000

Income tax expense......................................................

22,000

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

$ 90,000

Req. 2 Vintage Motors, Inc. Balance Sheet December 31, 2021 ASSETS

LIABILITIES

Appendix E

Investments

(continued) P 11-69B Req. 3 Vintage Motors, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Receipts: Collections from customers ($504,000 x .90) .............................................. $ 453,600 Total cash receipts........................................ 453,600 Payments: To suppliers ($234,000 + $153,600 + $18,000) .... $(405,600) To employees ($60,000 – $11,000) .................. (49,000) For income tax .................................................. (22,000) Total cash payments..................................... (476,600) Net cash used for operating activities............ (23,000) Cash flows from investing activities: Purchase of equipment........................................ Net cash used for investing activities ............ Cash flows from financing activities: Issuance of common stock ................................. Payment of dividend ............................................ Net cash provided by financing activities ...... Net increase in cash ................................................ Cash balance, January 1, 2021............................... Cash balance, December 31, 2021 .........................

Appendix E

Investments

$(160,000) (160,000) $ 430,000 (13,000) 417,000 $234,000 0 $234,000

(35-45 min.) P 11-70B Req. 1 Fortune Software Corp. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income.......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................... Amortization expense................................ Gain on sale of equipment........................ Increase in accounts receivable .............. Decrease in inventories ............................ Increase in prepaid expenses .................. Increase in accounts payable................... Increase in income tax payable................ Decrease in accrued liabilities ................. Net cash provided by operating activities ... Cash flows from investing activities: Purchase of building.......................................... Purchase of long-term investment ................... Proceeds from sale of equipment .................... Collection of loan ............................................... Net cash used for investing activities..........

$ 19,000 4,200 (2,000) (5,500) 71,200 (1,000) 1,400 12,600 (12,900)

Cash and cash equivalents balance, December 31, 2020 Cash and cash equivalents balance, December 31, 2021

Investments

87,000 149,000

$(123,000) (45,300) 24,300 10,500

Cash flows from financing activities: Issuance of common stock ............................... Issuance of long-term note payable................. Payment of cash dividends............................... Purchase of treasury stock ............................... Net cash provided by financing activities ... Net increase in cash and cash equivalents...........

Appendix E

62,000

(133,500)

$ 36,700 50,600 (15,100) (11,800) 60,400 $ 75,900 20,000 $ 95,900

(continued) P 11-70B

Noncash investing and financing activities: Acquisition of land by issuing long-term note payable…. Retirement of bonds payable by issuing common stock.. Total noncash investing and financing activities…………….

Appendix E

Investments

$195,000 60,000 $255,000

(35-45 min.) P 11-71B Req. 1 Shaw Movie Theater Company Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Net income ............................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. Amortization expense.................................. Decrease in accounts receivable................ Increase in inventories ................................ Decrease in prepaid expenses.................... Increase in accounts payable ..................... Increase in accrued liabilities ..................... Decrease in income tax payable................. Net cash provided by operating activities ..... Cash flows from investing activities: Purchase of equipment… .................................... Purchase of building............................................ Sale of long-term investment .............................. Net cash used for investing activities… ........ Cash flows from financing activities: Issuance of common stock ................................. Issuance of long-term note payable ................... Payment of cash dividends ................................. Net cash provided by financing activities...... Net increase (decrease) in cash and cash equivalents

$ 44,000

$ 15,000 9,000 7,300 (3,100) 300. 1,900 7,000 (1,100)

36,300 80,300

$(79,000) (52,000) 12,300 (118,700)

$ 9,000 43,000 (25,000)

Cash and cash equivalents balance, June 30, 2020 Cash and cash equivalents balance, June 30, 2021

27,000 $ (11,400) 15,000 $ 3,600

Noncash investing and financing activities: Acquisition of land by issuing note payable .....

$ 96,000

Appendix E

Investments

(continued) P 11-71B Req. 2 Shaw’s cash flows look strong. Operations are a significant source of cash indicating that the company generated sufficient net income to cover operating activities for the year. Shaw had a negative cash flow from investing activities from the purchase of equipment and a building. Presumably these activities will help reduce costs or alternatively expand the company’s lines of business. In either case, it bodes well for the future when a company invests in new capital assets. Shaw generated a positive cash flow from financing activities. These financing activities indicate that the theater is considered credit-worthy to be able to issue stock and long-term notes. The company also has sufficient funds to pay cash dividends.

Appendix E

Investments

(30-40 min.) P 11-72B Req. 1 Mercedes Supply Corp. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income ............................................................. $ 58,800 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation................................................... $ 14,600 Decrease in accounts receivable................. 5,000 Increase in inventories ................................. (1,200) Decrease in prepaid expenses..................... 3,200 Increase in accounts payable ...................... 4,700 Increase in salary payable............................ 8,000 Decrease in other accrued liabilities ........... (3,200) 31,100 Net cash provided by operating activities...... 89,900 Cash flows from investing activities: Purchase of land ................................................... $(38,000) Purchase of equipment ($49,400 − depreciation expense of $14,600 = $34,800; $63,200 − $34,800)............................................. (28,400) Net cash used for investing activities ............ (66,400) Cash flows from financing activities: Payment of dividends ($2,900 + $58,800 − $8,000) .............................. $(53,700) Issuance of note payable...................................... 22,000 Issuance of common stock .................................. 24,800 Net cash used for financing activities ............ (6,900) Net increase in cash and cash equivalents............. $ 16,600 Cash and cash equivalents balance, December 31, 2020 1,000 Cash and cash equivalents balance, December 31, 2021 $ 17,600

Appendix E

Investments

(continued) P 11-72B Req. 2 This problem will help students learn how operating activities, investing activities, and financing activities generate cash receipts and cash payments. By solving this problem, students will learn how companies prepare the statement of cash flows and will thus be able to understand the meaning of cash flows from the three basic categories of business activities. This knowledge will aid their analysis of investments. For example, students should know that net cash provided by operating activities conveys a more positive signal about a company than net cash used for operations.

Student responses may vary.

Appendix E

Investments

(30-40 min.) P 11-73B Req. 1 Mercedes Supply Corp. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Receipts: Collections from customers ($440,000 + $5,000) ........................................ $445,000 Total cash receipts........................................ 445,000 Payments: To suppliers ($185,500 + $1,200 – $4,700 + $50,600 – $3,200 + $3,200) ............................ $(232,600) To employees ($76,700 – $8,000) .................... (68,700) For interest ........................................................ (25,000) For income tax .................................................. (28,800) Total cash payments..................................... (355,100) Net cash provided by operating activities...... 89,900 Cash flows from investing activities: Purchase of land ................................................... $ (38,000) Purchase of equipment ($49,400 − depreciation expense of $14,600 = $34,800; $63,200 − $34,800)............................................. (28,400) Net cash used for investing activities ............ (66,400) Cash flows from financing activities: Payment of dividends ($2,900 + $58,800 − $8,000) .............................. $ (53,700) Issuance of note payable...................................... 22,000 Issuance of common stock .................................. 24,800 Net cash used for financing activities ............ (6,900) Net increase in cash and cash equivalents............. $ 16,600 Cash and cash equivalents balance, December 31, 2020 1,000 Cash and cash equivalents balance, December 31, 2021 $ 17,600

Appendix E

Investments

(continued) P 11-73B Req. 2 This problem will help students learn how operating activities, investing activities, and financing activities generate cash receipts and cash payments. By solving this problem, students will learn how companies prepare the statement of cash flows and will thus be able to understand the meaning of cash flows from the three basic categories of business activities. This knowledge will aid their analysis of investments. For example, students should know that net cash provided by operating activities conveys a more positive signal about a company than net cash used for operations.

Student responses may vary.

Appendix E

Investments

(35-45 min.) P 11-74B Req. 1 Ballinger Furniture Gallery, Inc. Statement of Cash Flows Year Ended August 31, 2022 Cash flows from operating activities: Receipts: Collections from customers ($378,500 + $201,000) .................................... $ 579,500 Interest received ............................................... 4,600 Dividends received ........................................... 7,800 Total cash receipts ........................................ $ 591,900 Payments: To suppliers....................................................... $(368,400) To employees .................................................... (96,900) For income tax .................................................. (36,800) For interest ........................................................ (12,900) Total cash payments ..................................... (515,000) Net cash provided by operating activities...... 76,900 Cash flows from investing activities: Purchase of plant assets ..................................... Collection of loans ............................................... Proceeds from sale of plant assets .................... Loan to another company ................................... Proceeds from sale of investments.................... Net cash used for investing activities............. Cash flows from financing activities: Proceeds from issuance of common stock ....... Payments of long-term note payable ................. Payment of dividends .......................................... Proceeds from issuance of note payable .......... Net cash used for financing activities ............ Net decrease in cash ................................................ Cash balance, August 31, 2021 ............................... Cash balance, August 31, 2022 ............................... Appendix E

Investments

$ (37,600) 12,600 22,200 (13,000) 10,000 (5,800)

$ 8,000 (83,000) (47,700) 23,400 (99,300) $ (28,200) 89,900 $ 61,700

(continued) P 11-74B

Noncash investing and financing activities: Payment of short-term note payable by issuing long-term note payable..................................................... Acquisition of equipment by issuing short-term note payable ................................................... Total noncash investing and financing activities ...................

$ 78,000 16,500 $ 94,500

Req. 2 Year 2022 was a good year from a cash-flow standpoint. Operations provided cash and the company was able to issue long-term note payable and stock, which means the stockholders and creditors have faith in the company. The business invested in plant assets, reduced their debt, and paid dividends, which generally bodes well for the future. Overall, cash decreased during the year, so this is a negative sign.

Appendix E

Investments

(45-60 min.) P 11-75B Req. 1 Dartmouth Electric Company Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Receipts: Collections from customers ............................ $661,400 Dividends received ........................................... 17,000 Total cash receipts....................................... $ 678,400 Payments: To suppliers ($387,000 + $34,300) ................... $(421,300) To employees.................................................... (143,500) For interest ........................................................ (26,800) For income tax .................................................. (18,900) Total cash payments.................................... (610,500) Net cash provided by operating activities...... 67,900 Cash flows from investing activities: Purchase of equipment......................................... $ (31,900) Sale of long-term investments ............................. 32,400 Net cash provided by investing activities ...... 500 Cash flows from financing activities: Payment of long-term note payable .................... $ (41,700) Issuance of common stock .................................. 47,300 Purchase of treasury stock .................................. (28,900) Payment of dividends ........................................... (62,000) Net cash used for financing activities ............ (85,300) Net increase (decrease) in cash and cash equivalents $ (16,900) Cash and cash equivalents balance, December 31, 2020 90,100 Cash and cash equivalents balance, December 31, 2021 $ 73,200 Noncash investing and financing activities: Acquisition of land by issuing common stock .................... Retirement of long-term note payable by issuing common stock ...................................................... Total noncash investing and financing activities .................... Appendix E

Investments

$ 80,000 18,000 $ 98,000

(continued) P 11-75B Req. 2 Dartmouth Electric Company Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income .............................................................

$47,200

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ...................................

$17,500

Loss on sale of investments ........................

8,600

Increase in accounts receivable ..................

(27,400)

Decrease in inventories ................................

12,900

Decrease in prepaid expenses.....................

500

Decrease in accounts payable .....................

(8,500)

Increase in interest payable .........................

1,100

Increase in salary payable............................

7,600

Increase in other accrued liabilities ............

10,500

Decrease in income tax payable ..................

(2,100)

Net cash provided by operating activities ..........

Appendix E

Investments

20,700 $67,900

(45-60 min.) P 11-76B Req. 1 Mary McGuire Design Studio, Inc. Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Net income ............................................................. $ 71,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................... $ 14,000 Loss on sale of land ....................................... 7,000 Increase in accounts receivable ................... (7,000) Increase in inventories................................... (37,200) Increase in prepaid expenses ....................... (1,60 0) Decrease in accounts payable ...................... (7,200) Decrease in taxes payable............................. (1,400) Increase in accrued liabilities........................ 5,600 Increase in interest payable .......................... 1,000 Increase in salary payable ............................. 1,600 (25,200) Net cash provided by operating activities....... 45,800 Cash flows from investing activities: Sale of land ............................................................ $ 63,600 Purchase of long-term investments .................... (16,800) Net cash provided by investing activities ....... 46,800 Cash flows from financing activities: Payment of cash dividends .................................. $ (7,200) Issuance of common stock .................................. 500 Payment of long-term note payable .................... (58,600) Net cash used for financing activities ............. (65,300) Net increase in cash .................................................. $ 27,300 Cash balance, June 30, 2020 .................................... 1,600 Cash balance, June 30, 2021 .................................... $ 28,900

Appendix E

Investments

(continued) P 11-76B Req. 1 Noncash investing and financing activities: Acquisition of equipment by issuing long-term note payable .................................... Paid off short-term note payable by issuing common stock................................................... Total noncash investing and financing activities ...

$15,500 6,100 $21,600

Req. 2 Mary McGuire Design Studio, Inc. Statement of Cash Flows Year Ended June 30, 2021 Cash flows from operating activities: Receipts: Collections from customers ...........................

$ 260,000

Interest received ..............................................

1,900

Total cash receipts .....................................

$ 261,900

Payments: To suppliers ..................................................... $(158,600) To employees...................................................

(40,200)

For income tax .................................................

(12,600)

For interest .......................................................

(4,700)

Total cash payments ..................................

(216,100)

Net cash provided by operating activities .........

$ 45,800

Appendix E

Investments

Challenge Exercises and Problem (20-30 min.) E 11-77 Req. 1 (All amounts in thousands) a. Collections

Decrease in Sales + Accounts Receivable = $24,630 = $24,623 + ($606 − $599)

Cost Increase in b. Payments for of sales + Inventory inventory = $18,264 = $18,176 + $269* *$3,110 − $2,841 = $269

**$1,544 − $1,363 = $181

c. Payments for other = $3,580 = operating expenses d. Payment of income tax

= $529

e. Proceeds from issuance of stock = $73

Other Operating Expenses $3,888

= $1,150

Increase in − Accrued Liabilities −

Tax Expense $534

($939 − $631)

Increase in − Income Tax Payable − ($196 − $191)

Beg. Common End. Common Stock + Issuance = Stock = $445 + X = $518 X

f. Payment of dividends

Increase in − Accounts Payable − $181**

$73

Beg. Ret. Net End. Ret. Earnings + Income − Dividends= Earnings $3,786 + $1,759 − X = $4,395 X

Appendix E

Investments

= $1,150

(20 min.) E 11-78 Req. 1 a. (All in thousands) Gain on sale of property and equipment

Proceeds from sale of assets

−

Book values of assets sold

$300

$830

−

$530

Bal., 12/31/20 Capital expenditures

Bal., 12/31/21

Property & Equipment, Net 9,580 Depreciation exp. 4,100 Book value of property and equipment sold 11,200

1,950 X = 530

Repayment

Appendix E

Investments

Long-Term Notes Payable Bal., 12/31/20 110 Proceeds from Issuance LT debt issued for something other than cash Bal. 12/31/21

3,100 1,200 X = 210 4,400

(30-45 min.) P 11-79 Req. 1 Assets: Cash and cash equivalents

December 31, 2020 $17,000

December 31, 2021 $154,200 Given

Accounts receivable (net)

78,400

28,300 ($78,400 – $50,100)

Inventory

50,700

68,300 ($50,700 + $17,600)

Prepaid expenses

2,200

900 ($2,200 – $1,300)

Land

95,600

41,700 [$95,600 – ($61,000 – $7,100)]

Machinery and equipment (net)

73,500

42,600 [$73,500 + $15,000 – ($18,000 + $14,000) – $13,900]

Total assets

$317,400

$336,000

Accounts payable

$40,600

$41,800 ($40,600 + $1,200)

Unearned revenue

8,600

20,000 ($8,600 + $11,400)

Dividends payable

-0-

1,000 ($6,000 – $5,000)

Income taxes payable

5,500

1,400 ($5,500 – $4,100)

Long-term debt

86,000

65,000 ($86,000 – $21,000)

Total liabilities Stockholders’ equity: Common stock, no par

140,700

129,200

51,200

68,900 ($51,200 + 17,700)

Retained earnings

125,500

137,900 ($125,500 + $18,400 – $6,000)

Total stockholders’ equity

176,700

206,800

Total liabilities and stockholders’ equity

$317,400

$336,000

Liabilities:

Appendix E

Investments

Serial Case (15-20 min.) C11-80 Req 1 Operating Activities have generated the most cash flow for The Cheesecake Factory over 2017, 2018, and 2019. Investing activities have used cash rather than provided cash for the Company in all three years. Financing activities provided cash in 2019, but used cash in 2018 and 2017. Req. 2 By year: 2019: Investments in unconsolidated affiliates (investing) 2018: Treasury stock purchases (financing) 2017: Treasury stock purchases (financing) Req. 3 (in thousands) From 2017-2018, The Cheesecake Factory’s cash and cash equivalents increased by $20,570, from $6,008 to $26,578. The Cheesecake Factory’s cash and cash equivalents increased from 2018-2019. It increased by $31,838, from $26,578 to $58,416. Req. 4 Based on the statement of cash flows, The Cheesecake Factory appears to be a healthy company. The company has posted a steady net income and net cash provided by operating activities over each of the past three years. In addition, net cash provided by operating activities exceeds net income, and is increasing in two of the three years. The Cheesecake Factory has been investing its cash in property and equipment, indicating that the Company is expanding and opening new stores. Additionally, the company has been paying dividends each year, which signals the company has enough retained earnings and cash to distribute some to its stockholders. Appendix E

Investments

Student answers may vary.

Decision Cases (45-60 min.) C11-81 Req. 1 (indirect method for operating activities) Ghent River Camp, Inc. Statement of Cash Flows Year Ended December 31, 2021 Cash flows from operating activities: Net income ...................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense.............................................. Amortization of patents........................................... Increase in accounts receivable ($72 − $61) ......... Increase in inventories ($194 − $181) .................... Increase in accounts payable ($63 − $56) ............. Decrease in accrued liabilities ($17 − $12) ............ Net cash provided by operating activities ................

(Thousands) $ 97 $ 46 11 (11) (13) 7 (5)

35 132

Cash flows from investing activities: Purchase of property, plant, and equipment ($369 − $259)............................................. $(110) Purchase of long-term investments ($31 − $0) ............ (31) Net cash used for investing activities.......................

(141)

Cash flows from financing activities: Issuance of common stock ($149 − $61) ...................... Payment of cash dividends ($156 + $97 − $213).......... Payment of long-term notes payable ($264 − $179) .... Net cash used for financing activities....................... Net (decrease) in cash ....................................................... Cash balance, December 31, 2020 ................................... Cash balance, December 31, 2021 ...................................

(37) $ (46) 63 $ 17

Appendix E

Investments

$ 88 (40) (85)

(continued) C11-81 Req. 2 The cash balance at the end of 2021 is low because:  The camp paid $110,000 to buy new property, plant, and equipment.  The camp paid off $85,000 of notes payable. Also,  The camp paid dividends of $40,000.  The camp paid $31,000 to buy long-term investments.

Req. 3 Year 2021 was a good year. Net income was $97,000, and operations were the largest source of cash. Also, the company increased its property, plant, and equipment by $110,000 and paid off $85,000 of debt. On this basis, the business appears to have been successful. However, investing activities and financing activities both used cash which exceeded the net cash provided by operating activities. The company needs to evaluate the amount of investing and financing activities.

Appendix E

Investments

(15-25 min.) C11-82 Req. 1 Beaudoin Catering looks like the better investment because: 1. Operations provide far more cash for Beaudoin than for Thompson Technology. Operations should be the main source of cash for a healthy company. 2. Beaudoin is investing more in long-term plant assets than Thompson is. Beaudoin is laying a more solid foundation in revenue-producing assets than Thompson is. 3. One of Thompson Technology’s main source of cash is the sale of plant assets. This trend cannot continue for long without hurting the company’s ability to produce revenue. 4. Beaudoin is raising more cash by selling stock than Thompson is. This gives Beaudoin more cash to invest in research and development of new products and other innovations to enhance the company’s competitiveness. Thompson, on the other hand, is paying off debt. That is not necessarily bad for Thompson, but Beaudoin appears to be a step ahead in terms of financing its operations with stockholders’ equity and investing the cash in income-producing assets.

Appendix E

Investments

Ethical Issue Req. 1 Cash flows from operating activities: Net income............................. Increase in accounts receivable .............................. Net cash (used for) provided by operating activities...............

Without Reclassification $ 37,000

With Reclassification $37,000

(80,000)

—

$(43,000)

$37,000

Georgetown looks better with the reclassification because net cash flow from operations is positive. Req. 2 The issue is whether or not it is ethical to reclassify accounts receivable from current assets to long-term assets. Req. 3 and Req. 4 The stakeholders are Georgetown, its officers, directors and employees, as well as their present and future creditors and stockholders. Economic analysis: The plan to reclassify accounts receivable would have an immediate positive impact on Georgetown and its employees because it might enable Georgetown to obtain the loan it desperately needs. However, this might be to the detriment of present and future creditors, because if Georgetown can’t collect the receivables, it may not be able to pay off its loans to creditors.

Appendix E

Investments

(continued) Ethical case Legal analysis: To reclassify receivables when, in fact, they are not truly collectible, even in the long run, might leave the company open later to a lawsuit for damages suffered by creditors who loan Georgetown money based on false information. Ethical analysis: To reclassify receivables when, in fact, they are not truly collectible in the long run, deprives the banks of accurate information

they

need

make

sound

financial

decisions.

Reclassification would be unethical if Georgetown expects to collect within the current period. In that case, the reclassification would appear to be designed to create a false picture of cash flow from operations. It is not truthful and not ethical. In the long run, no one benefits from this short-sighted decision. Req. 5 The receivables should be classified in the way that best describes their collectability.

In reality, most bank loan officers who know financial

accounting (and most do) will closely examine these receivables and classify them as short-term for their own lender analysis. Req. 6 The reclassification would be ethical if Georgetown expects to collect the receivables beyond one year or the current operating cycle, if longer than one year. This would most likely be the case if Georgetown

Appendix E

Investments

received long-term notes receivable in place of the accounts receivable from the slow-paying clients.

Appendix E

Investments

Focus on Financials: Apple Inc. (40-50 min.) Req. 1 Apple uses the indirect method to report operating cash flows. You can tell because the operating section of the statement begins with net income. Req. 2 The main source of cash is operating activities ($69,391 million).

This

indicates that Apple Inc.’s basic operations are generating significant cash for the company to finance current operations. The main use of cash is financing activities ($90,976 million). The company used $66,897 million to purchase its own stock (almost as much as it generated in cash from operations!) Apple is a healthy company. In 2019, its cash and cash equivalents increased by about $24,311 million to $50,224 million.

In 2019, Apple’s

net cash from operating activities exceeds net income and is positive, or a net inflow of cash. One negative can be seen in 2019 because Apple did not generate enough cash from operations ($69,391 million) to support the net cash outflow for financing activities ($90,976 million). Apple relied on net cash inflows from investing activities to help fund the financing activities in 2019.

Appendix E

Investments

(continued) Apple Inc. Req. 3 a. The Balance Sheet provides the balance of Allowance for Doubtful Accounts. (Amounts in millions.) Collections from customers are $260,434 million.

Gross Accounts Receivable Beg. Bal.

23,186

Sales (income statement)

260,174 Collections ($23,186 + $260,174 –$22,926)

End. Bal.

Appendix E

22,926

Investments

260,434

(continued) Apple Inc. b. Using the format provided in Exhibit 11-15: (Amounts in millions) Payments for

inventory

Cost of Sales (products)

$154,798

$144,996

Increase in Inventory

Decrease in Accounts Payable

$150

$9,652

($4,106 − $3,956)

Payments for other = operating expenses***

Other operating expenses

$30,334

$34,462

($55,888- $46,236)

Increase in Increase in Prepaid Assets* Accrued Liabilities**

$265 ($12,352 − $12,087)

$4,393 ($37,720 - $33,327)

*Assume other current assets are prepaids **Assume other current liabilities are all accrued liabilities ***Other operating expenses include Depreciation and Amortization Expense of $12,547 million, so these expenses should be deducted. Payments for other operating expenses = $30,334 million – $12,547 million = $17,787 million.

Total payments to Suppliers 172,585

Appendix E

Payments for Payments for + other operating inventory expenses =

Investments

$154,798

$17,787

(continued) Apple Inc. 4. In 2019, for Apple Inc.,  Net income decreased from 2018 by $4,275 million. ($59,531 -$55,256)  Total assets decreased from 2018 by $27,209 million. ($365,725 - $338,516)  Total stockholders’ equity decreased from 2018 by $16,659 million. ($107,147 - $90,488)  Net cash flow from operating activities decreased from 2018 by $8,043 million. ($77,434 − $69,391) In 2018 to 2019, all four measures decreased. This is a bit troublesome but net income and net cash from operating activities are still positive and very strong.

Appendix E

Investments

Focus on Analysis: Under Armour, Inc. (20-30 min.) Req. 1 The main source of cash is operating activities in 2019 ($509,031 thousand). This is good news. This indicates that Under Armour, Inc.’s basic operations are generating significant cash for the company to finance current operations and acquire new fixed assets The main use of cash is investing activities in 2019 ($147,113 thousand). This is good news because the company is investing in the future. The company also made payments on long-term debt and revolving credit facility of $162,817 thousand. Req. 2 In 2019, the three most significant differences between net income and net cash provided by operations are: 1. Depreciation and amortization ($186,425 thousand) is an addition to net income because these expenses reduce net income but do not use cash. 2. Inventories decreased by $149,519 thousand, thus decreasing cash. 3. Customer refund liability decreased by $80,710 thousand, thus decreasing cash.

Appendix E

Investments

(continued) Under Armour, Inc. Req. 3 In 2019, Under Armour’s additions to property, plant, and equipment were less than previous years’ additions. This is evident in the investing section of the statement of cash flows where purchases of property plant and equipment in 2019 ($145,802 thousand) was less than in 2018 ($170,385 thousand) and 2017 ($281,339 thousand). No sales of property and equipment were reported in 2019. Approximately $11,285 thousand was reported as proceeds from the sale of these assets in 2018 Req. 4 In 2019, the largest item in Under Armour’s financing section of their consolidated statement of cash flows is repayment of its long-term debt and revolving credit facility in the amount of $162,817 thousand. This reveals the company’s revision of its operating plan to refinance its long-term debt. Req. 5 In 2019, Under Armour appears to have healthy cash flows indicating good performance. Net cash flows from operations have been positive overall from 2017 – 2019, although they dipped slightly in 2019. Although in a recovery mode for the past 3 years, the company has been able to spend cash on capital assets to support the business and repay of some of its debt. Information from the industry and the competition’s cash flows would be helpful in further evaluating Under Armour’s performance. The year 2019

Appendix E

Investments

was dramatically better than 2018. The company was profitable in 2019 for (continued) Under Armour, Inc. the first time in 3 years. Only time will tell whether this improvement was the start of a trend, or merely an aberration.

Appendix E

Investments

Group Projects (2-3 hours) Student responses will vary on this assignment.

Chapter 12 Financial Statement Analysis Ethics Check (5-10 min.) EC 12-1 a. Due care b. Integrity c. Integrity d. Objectivity and independence

Appendix E

Investments

Short Exercises (5-10 min.) S 12-1 Increase (Decrease) 2021 2020

(Dollars in thousands) 2021

2020

2019

Amount

Percent

Amount

Percent

Revenues $20,477

$20,997

$18,600

$(520)

(2.5)%

$2,397

12.9%

Expenses

10,915

10,238

10,100

677

6.6%

138

1.4%

Net income

$ 9,562

$10,759

$ 8,500

$(1,197)

(11.1)%

$2,259 26.6%

(5-10 min.) S 12-2 Trend percentages: Sales .................... Net income ..........

Appendix E

Investments

2021 122% 154%

2020 114% 120%

2019 108% 112%

2018 100% 100%

(10-15 min.) S 12-3 2021

2020

2019

Amount Percent

$ 10,000

2.0%

Receivables, net

35,000

Inventory

Cash

4,440

1.0%

3,990

1.0%

7.0

23,200

5.2

23,940

6.0

240,000

48.0

177,600

40.0

131,670

33.0

Prepaid expenses

15,000

3.0

21,200

4.8

15,960

4.0

Property, plant, and equipment, net

200,000

40.0

217,560

49.0

223,440

56.0

Total assets

$500,000 100.0%

$444,000 100.0%

$399,000 100.0%

Inventory, as a percent of total assets, has grown dramatically. Property, plant and equipment appears to be wearing out and is not being replaced due to the growth in inventory which has led to a tight cash position.

Appendix E

Investments

(10 min.) S 12-4 Madison Amount Percent

Orwell Amount Percent

Net sales

$17,000

100.0%

$10,000

100.0%

Cost of goods sold

10,166

59.8

6,540

65.4

4,828

28.4

2,220

22.2

Interest expense

0.4

0.8

Other expense

102

0.6

0.4

Income tax expense

748

4.4

320

3.2

800

8.0%

(Amounts in millions)

Selling and administrative expenses

Net income

$ 1,088

6.4%

Madison earned more net income, but Orwell’s net income was a higher percentage of net sales. Students can argue that Madison is more profitable because it earns more net income than Orwell.

Students

could also argue that Orwell is more profitable because it earns a higher percentage of profit on each dollar of sales than Madison does.

Appendix E

Investments

(5-10 min.) S 12-5 2021

2020

2019

$489 $326

$434 $350

Total current assets Total current liabilities

$712 $400

Current ratio

1.78

1.50

1.24

The company’s ability to pay its current liabilities is improving.

(5-10 min.) S 12-6 1. (Dollar amounts in millions) 2021 2020 Cash and cash equivalents + Short-term investments + Receivables, net Total current liabilities Quick (acid-test) ratio

= =

$1,210

$ 980

230

268

$1,202 1.21

$1,110 =

1.17

2. Metro’s 2021 quick (acid-test) ratio looks strong both because it is slightly above 1.0 and it is higher than the ratios of the other three companies. It also improved from 2020 to 2021. Metro’s 2020 and 2021 quick ratios are both higher than the other three companies.

Appendix E

Investments

(15-20 min.) S 12-7 (Dollar amounts in millions)

a. Inventory turnover =

Cost of goods sold = Average inventory

$4,589 ($70 + $102) / 2

$4,589 $86

= 53.4 times

Days’ inventory 365 = = outstanding (DIO) Inventory turnover

365 53.4

= 6.8 days

b. Days’ sales outstanding (DSO): One day’s sales

Days’ sales = outstanding (DSO)

$9,500 365

$26.0

Average net receivables One day’s Sales

$249* $26.0

= 9.6 days

____ *($268 + $230) / 2 = $249

c. Days’ payables outstanding: Accounts payable Cost of goods sold $4,589 = = = 5.0 times turnover Average accounts ($860 + $966) / 2 payable Days’ payables = 365 = outstanding (DPO) Accounts payable turnover

Appendix E

Investments

365 5

= 73 days

(continued) S 12-7 d. Cash conversion cycle (in days): Cash conversion Cycle = DIO + DSO – DPO = 6.8 + 9.6 – 73 = – 56.6

Inventory turnover and DSO look strong. Turning over inventory about 53 times per year (every 6.8 days) is fast, and collecting average receivables in only 9.6 days is also very fast. However, the company is taking 73 days to pay off its accounts payable.

This is quite slow,

indicative of a company that is having difficulty paying its trade creditors. Companies who continue to do this could face future credit problems if suppliers regard them as a high credit risk. The sum of the ratios in the cash conversion cycle (–56.6) tells us that on average the company sells inventory and collects the cash for those sales 56.6 days before it pays trade creditors. It is questionable whether a company can continue to take this long to pay off trade creditors without damaging its credit rating.

Appendix E

Investments

(5-10 min.) S 12-8 (Dollar amounts in millions) 1. Debt ratio

Total liabilities Total assets

$5,978 $7,354

0.813

Metro, Inc.’s debt ratio is 81.3%.

Times-interestIncome from operations = = earned ratio Interest expense

$1,304 $204

The debt ratio is high. The ability to pay off debt is weak. The

= 6.4

times-interest-earned ratio is high. The ability to pay interest expense is strong.

Overall, the company’s ability to pay its

liabilities and interest expense looks mixed.

Appendix E

Investments

(10-15 min.) S 12-9 (Dollar amounts in millions) a. Rate of return on net sales =

Net income Net sales

$711 $9,500

= 7.48%

Net sales $9,500 1.359 b. Asset turnover = Average = ($6,632 + $7,354) / 2 = Times total assets

Rate of return on total assets = (ROA)

Rate of return on sales 7.48%

x x

Asset turnover 1.359

10.17%

Average total assets ($6,632 + $7,354) / 2 d. Leverage ratio = Average common = ($1,456 + $1,376) / 2 = 4.939 stockholders’ equity e. Rate of return

Net Preferred on common income − dividends $711 − $0 = = = 50.2% stockholders' Average common ($1,456 + $1,376)/2 equity stockholders' equity (ROE) = ROA x Leverage ratio = 10.17% x 4.939 = 50.2%

f. The ROA is slightly above 10% which is considered satisfactory. On the other hand, ROE exceeds 20% which is outstanding.

Appendix E

Investments

(5-10 min.) S 12-10 (Amounts, except per-share amounts, in millions) 1. EPS =

Net income − Preferred dividends Number of shares of common stock outstanding

Price/earnings ratio

Market price per share of common stock EPS

$700 − $30* 500

$1.34

$18 $1.34

2. The stock market says that $1 of Salem Cars’ net income is worth $13.43. _____ *Preferred dividend = $30 ($1,000 × .03)

Appendix E

Investments

= 13.43

(10-15 min.) S 12-11 Income Statement Thousands Net sales

$7,100

Cost of goods sold

2,340 (a)

Selling expenses

1,513

Administrative expenses

1,334

Interest expense

716 (b)

Other expenses

151

Income before taxes

1,046

Income tax expense

407 (c)

Net income

(a)

$790 + $770 2

$ 639 (d)

× 3 = $2,340

(b)

$7,100 − $2,340 − $1,513 − $1,334 − $151 − $1,046 = $716

(d)

$7,100 × 0.09 = $639

(c)

$1,046 − $639 = $407

Appendix E

Investments

(15-20 min.) S 12-12 Balance Sheet (Dollars in thousands) Cash

$ 250

Total current liabilities

Receivables

1,283 (a)

Long-term debt

Inventories

1,364

Other long-term

Prepaid expenses

607 (b)

Total current assets

3,504 (c)

Plant assets, net

1,321 (d)

Other assets

2,275

Total assets

$7,100

$2,190 966 (e)

liabilities

820

Common stock

180

Retained earnings

2,944

Total liabilities and equity

$7,100 (f)

(f)

= $7,100 (same as total assets)

(e)

= $7,100 × 0.56 = $3,976 (total liabilities) $3,976 − $2,190 − $820 = $966 Or $7,100 − $2,190 − $820 − $180 − $2,944 = $966

(c)

= $2,190 × 1.60 = $3,504

(a)

= $2,190 × 0.70 = $1,533; $1,533 − $250 = $1,283

(b) = $3,504 − $250 − $1,283 − $1,364 = $607 (d) = $7,100 − $2,275 − $3,504 = $1,321

Appendix E

Investments

(15-20 min.) S 12-13 TO:

Investment Committee

FROM:

Student Name

SUBJECT:

Investment Recommendation

I recommend that we invest in Stellar Corporation for the following reasons: 1. Stellar Corporation’s. return on equity (ROE) is 5% higher than Abbott Company’s. An investment in Stellar Corporation should therefore produce a higher return than an investment in Abbott Company’s stock. 2. Stellar Corporation’s ROE exceeds its return on assets by a wider margin than does Abbott Company’s. This means that Stellar Corporation is earning more with its borrowed funds than Abbott Company is earning. 3. Stellar Corporation can cover its interest expense with operating income 19 times compared to 13 times for Abbott Company. 4. Stellar Corporation collects receivables faster than Abbott Company does. This suggests that cash flow is stronger at Stellar Corporation. 5. Stellar Corporation’s gross profit percentage is higher than Abbott Company’s. 6. Abbott Company is better than Stellar Corporation on inventory turnover and net income as a percentage of sales. These ratios provide insight about companies’ operations, but ROE and interest coverage are more “bottom-line” oriented. And days’ sales outstanding give an indication about cash flow. For these reasons, I place more importance on ROE, interest-coverage, and days’ sales outstanding, and Stellar Corporation outstrips Abbott Company on these measures. Student responses may vary. Appendix E

Investments

(10 min.) S 12-14 Req. 1 Gross profit = $760,212 thousand ($1,806,092 − $1,045,880) Income from continuing operations = $117,187 thousand Net income = $117,397 thousand

Req. 2 Income from continuing operations = $117,187 thousand. Continuing operations will continue from period to period. Their continuity makes income or loss from continuing operations a good predictor of future net income.

Appendix E

Investments

(5-10 min.) S 12-15 There are several ways that companies improperly recognize revenue which results in financial statement fraud whereby revenues are overstated. a. “Channel stuffing” where a company may ship inventory to regular customers in amounts in excess of the amounts ordered by the customer. This usually occurs near the end of the reporting period so that the excess merchandise cannot be returned to the seller prior to the preparation of the financial statements. b. Reporting revenue when a significant portion of the services are still to be performed or goods are still to be delivered. c. Providing incentives for customers to purchase more inventory than is needed in return for future discounts or other benefits. d. Reporting sales to fictitious or nonexistent customers; this may also include the falsification of shipping and inventory records.

(5-10 min.) S 12-16 a. Static data connection

e. Static data connection

b. Live data connection

f. Live data connection

c. Live data connection

g. Static data connection

Appendix E

Investments

d. Static data connection (10-15 min.) S 12-17 a. WALMART INC. b. New York Stock Exchange c. 702 SW 8th St, BENTONVILLE, AR, 72716-6209 US d. 1969

Appendix E

Investments

Exercises (10-15 min.) E 12-18A Norman Music Co. Horizontal Analysis of Comparative Income Statements Years Ended December 31, 2021 and 2020 INCREASE (DECREASE)

Total revenue...................

2021

2020

AMOUNT PERCENT

$1,080,000

$919,000

$161,000

17.5%

$479,000

$400,450

$ 78,550

19.6

289,000

260,000

29,000

11.2

14,500

10,000

69.0

Expenses: Cost of goods sold ...... Selling and general expenses ................... Interest expense .......... 24,500 Income tax expense.....

106,500

86,850

19,650

22.6

Total expenses.............

899,000

761,800

137,200

18.0

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

$181,000

$157,200

$ 23,800

15.1%

Appendix E

Investments

(5-10 min.) E 12-19A Trend percentages: Year 4

Year 3

Year 2

Year 1

Year 0

Total revenue ......

138%

123%

107%

100%

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

152

141

120

115

100

Net income grew by 52% during the period, compared to only 38% for total revenue. Net income grew faster than total revenue.

(10-15 min.) E 12-20A Beta Golf Company Vertical Analysis of Balance Sheet December 31, 2021 AMOUNT

PERCENT

Total current assets ..........................................

$ 44,100

14.70%

Property, plant, and equipment, net ................

213,600

71.20

Other assets .......................................................

42,300

14.10

Total assets ........................................................

$300,000

100.00%

Total current liabilities ......................................

$ 48,300

16.10%

Long-term debt ..................................................

113,100

37.70

Total liabilities....................................................

161,400

53.80

Total stockholders’ equity ................................

138,600

46.20

Total liabilities and stockholders’ equity ........

$300,000

100.00%

ASSETS

LIABILITIES

STOCKHOLDERS’ EQUITY

Appendix E

Investments

(10-15 min.) E 12-21A Norman Music Co. Comparative Common-Size Income Statements Years Ended December 31, 2021 and 2020 2021 Total revenue..............................................................

2020

100.00% 100.00%

Expenses: Cost of goods sold ................................................

44.35

43.57

Selling and general expenses ..............................

26.76

28.29

Interest expense ....................................................

2.27

1.58

Income tax expense ..............................................

9.86

9.45

Total expenses ......................................................

83.24

82.89

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

16.76%

17.11%

(5-15 min.) E 12-22A 2021

2020

2019

Total current assets

$424,950

$259,800

$260,000

Total current liabilities

410,000

200,000

130,000

Net working capital

$ 14,950

$ 59,800

$130,000

Decrease $44,850 (75.0)%

Decrease $70,200 (54.0)%

The continued decrease in 2021 net working capital is unfavorable.

Appendix E

Investments

(15-25 min.) E 12-23A Req. 1

Current ratio

Quick (acid-test) ratio

Inventory turnover

Days’ inventory outstanding (DIO)

Receivables turnover

Days’ sales outstanding (DSO)

Appendix E

Investments

2021

2020

$279,000 $130,000

$283,000 $97,000

= 2.15

= 2.92

$77,000 + $18,000 + $81,000 $130,000

$103,000 + $20,000 + $84,000 $97,000

= 1.35

= 2.13

$280,000 ($70,000 + $96,000) / 2

$278,000 ($58,000 + $70,000) / 2

= 3.37

= 4.34

365 3.37

365 4.34

= 108 days

= 84 days

$493,000 ($84,000 + $81,000) / 2

$507,000 ($35,000 + $84,000) / 2

= 5.98

= 8.52

365 5.98

365 8.52

= 61 days

= 43 days

(continued) E 12-23A f.

Payables turnover

$280,000 ($35,000 + $45,000) / 2

$278,000 ($40,000 + $35,000) / 2

= 7.00

= 7.41

365 7.00

365 7.41

= 52 days

= 49 days

108 + 61 – 52

84 + 43 – 49

= 117 days

= 78 days

Days’ payables outstanding (DPO)

Cash conversion cycle ( DIO + DSO – DPO)

Req. 2 a.

deteriorated

The company’s liquidity and current debt-paying ability deteriorated in 2021 when compared to 2020. Req. 3 The factors that need the most improvement are inventory turnover and collection of accounts receivable. The company needs to make more sales and keep less inventory on hand, as well as tighten collection policies.

This will provide more cash that can be used to pay off

payables more quickly. Appendix E

Investments

(15-20 min.) E 12-24A a.

Net working capital (Current assets – Current liabilities) 2021:

$461,000* – $217,000 = $244,000

2020:

$459,000* – $262,000 = $197,000

Current ratio (Current assets ÷ Current liabilities) 2021:

$461,000 = 2.12 $217,000

2020:

$459,000 $262,000

= 1.75

Quick (acid-test) ratio ([Cash + Short-term investments + Net receivables] ÷ Current liabilities) 2021:

$50,000 + $29,000 + $123,000 $217,000

0.93

2020:

$49,000 + $11,000 + $129,000 $262,000

0.72

Debt ratio (Total liabilities ÷ Total assets) 2021:

$294,000** $560,000

= 0.53

2020:

$366,000** = 0.78 $470,000

e. Times-interest-earned ratio (Income from operations ÷ Interest expense) 2021:

$250,000 $40,000

= 6.25

2020:

$148,000 $38,000

= 3.89

_____ * Current assets 2021 = $50,000 + $29,000 + $123,000 + $239,000 + $20,000 = $461,000 Current assets 2020 = $49,000 + $11,000 + $129,000 + $266,000 + $4,000 = $459,000 ** Total liabilities 2021 = $217,000 + $77,000 = $294,000 Total liabilities 2020 = $262,000 + $104,000 = $366,000 Appendix E

Investments

(continued) E 12-24A The company’s ability to pay current liabilities improved as evidenced by the improvement in items a. – c. The company’s ability to pay longterm debts improved as seen by the improvement in items d. and e. The company’s ability to cover interest expense improved as evidenced by item e.

Appendix E

Investments

(15-20 min.) E 12-25A a.

Return on net sales: ($38,000 – $2,000) $250,000

2021:

0.144

2020:

($18,000 – $1,000) $199,000

= 0.813

2020:

$199,000 $302,500**

0.085

= 0.658

b. Asset turnover: $250,000 $307,500*

2021: _____ _____

*($305,000 + $310,000) / 2 = $307,500

**($300,000 + $305,000) / 2 = $302,500

c. Return on assets (ROA): 2021:

0.144 × 0.813 = 0.117

2020:

0.085 × .658

= 0.056

2020:

$302,500 $193,000****

= 1.567

Leverage: 2021:

$307,500 $195,000***

= 1.577

_____ _____ ***($194,000 + $196,000) / 2 = $195,000 $193,000

Return on common stockholders’ equity (ROE): 2021:

****($192,000 + $194,000) / 2 =

0.117 × 1.577

= 0.185

2020:

0.056 × 1.567

Gross profit percentage:

Appendix E

Investments

= 0.088

2021:

Appendix E

$127,000 $250,000

Investments

0.51

2020:

$97,000 $199,000

0.49

(continued) E 12-25A g.

Operating income percentage: 2021:

0.29

2020:

$46,000 $199,000

0.23

Earnings per share of common stock: 2021:

$72,000 $250,000

$38,000 − $2,000 = $2.40 15,000

2020:

$18,000 − $1,000 = $1.21 14,000

DuPont Analysis: See parts (c) and (e).

The company’s operating performance improved during 2021. All profitability measures increased.

(10 min.) E 12-26A Net income – preferred dividends Common shares outstanding

$6,300,000 − ($500,000 × .10) 920,000*

$6.79

* 1,000,000 – 80,000 = 920,000

Appendix E

Investments

(10-15 min.) E 12-27A 2021

2020

a. Price/earnings ratio: $23.50 ($114,000 − $5,250*) / 43,500

= 9.40

$17.25 ($70,500 − $5,250*) / 43,500

= 11.50

_____ *$105,000 × .05 = $5,250

b. Dividend yield: $13,000 / 43,500 $23.50

= 0.013

$16,000 / 43,500 $17.25

= 0.021

The stock’s attractiveness decreased during 2021, as shown by the decreases in the price/earnings ratio and dividend yield. Overall, the common stock looks less attractive than it did a year ago.

Appendix E

Investments

(20-25 min.) E 12-28A Req. 1 Calloway Book Company Income Statement Year Ended December 31, 2021 Thousands Sales revenue

$129,000

Other revenues

2,300

Total revenues

131,300

Total operating expenses

104,800

Income tax expense

7,950

Total expenses

112,750

Net income

$ 18,550

Earnings per share (EPS): Net income ($18,550 / 1,000)

$18.55

Req. 2 The company’s quality of earnings would be considered to be good, based on its steady growth each year and no discontinued operations during recent years.

Appendix E

Investments

(10-15 min.) E 12-29B Monroe Music Co. Horizontal Analysis of Comparative Income Statements Years Ended December 31, 2021 and 2020 INCREASE (DECREASE) 2021

2020

AMOUNT

PERCENT

$844,000

$934,000

$(90,000)

(9.6)%

$404,000

$400,000

$ 4,000

1.0

expenses ...................

234,000

270,000

(36,000)

(13.3)

Interest expense ..........

9,300

12,000

(2,700)

(22.5)

Income tax expense.....

84,000

86,000

(2,000)

(2.3)

Total expenses.............

731,300

768,000

(36,700)

(4.8)

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

$112,700

$166,000

$(53,300)

(32.1)%

Total revenue................... Expenses: Cost of goods sold ...... Selling and general

(5-10 min.) E 12-30B Trend percentages: Year 4

Year 3

Year 2

Year 1

Year 0

Total revenue .....

137%

122%

107%

97%

100%

Net income .........

148

138

123

109

100

Net income grew by 48% during the period, compared to 37% for total revenue. Net income grew faster than total revenue.

Appendix E

Investments

(10-15 min.) E 12-31B Chapel Hill Golf Company Vertical Analysis of Balance Sheet December 31, 2021 AMOUNT

PERCENT

Total current assets............................................

$ 45,440

14.20%

Property, plant, and equipment, net .................

229,760

71.80

Other assets ........................................................

44,800

14.00

Total assets .........................................................

$320,000

100.0%

Total current liabilities .......................................

$ 53,440

16.70%

Long-term debt ...................................................

119,360

37.30

Total liabilities.....................................................

172,800

54.00

Total stockholders’ equity .................................

147,200

46.00

Total liabilities and stockholders’ equity .........

$320,000

100.00%

ASSETS

LIABILITIES

STOCKHOLDERS’ EQUITY

Appendix E

Investments

(10-15 min.) E 12-32B Monroe Music Co. Comparative Common-Size Income Statements Years Ended December 31, 2021 and 2020 2021 Total revenue ............................................................

2020

100.00% 100.00%

Expenses: Cost of goods sold...............................................

47.87

42.83

Selling and general expenses .............................

27.73

28.91

Interest expense ...................................................

1.10

1.28

Income tax expense .............................................

9.95

9.21

Total expenses .....................................................

86.65

82.23

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

13.35%

17.77%

(5-15 min.) E 12-33B 2021

2020

2019

Total current assets

$880,800

$395,000

$320,000

Total current liabilities

360,000

115,000

160,000

Net working capital

$520,800

$280,000

$160,000

Increase $240,800 86.0%

Increase $120,000 75.0%

The increase in net working capital is favorable. Appendix E

Investments

(15-25 min.) E 12-34B Req. 1 2021 a.

Current ratio

Quick (acid-test) ratio

Inventory turnover

Days’ inventory outstanding (DIO)

Receivables turnover

Days’ sales outstanding (DSO)

Appendix E

Investments

2020

$237,000 $134,000

$283,000 $91,000

= 1.77

= 3.11

$53,000 + $10,000 + $77,000 $134,000

$89,000 + $33,000 + $80,000 $91,000

= 1.04

= 2.22

$275,000 ($75,000 + $91,000) / 2

$286,000 ($58,000 + $75,000) / 2

= 3.31

= 4.30

365 3.31

365 4.30

= 110 days

= 85 days

$497,000 ($80,000 + $77,000) / 2

$503,000 ($35,000 + $80,000) / 2

= 6.33

= 8.75

365 6.33

365 8.75

= 58 days

= 42 days

(continued) E 12-34B f.

Payables turnover

Days’ payables outstanding (DPO)

Cash conversion cycle ( DIO + DSO – DPO)

$275,000 ($45,000 + $55,000) / 2

$286,000 ($50,000 + $45,000) / 2

= 5.50

= 6.02

365 5.50

365 6.02

= 66 days

= 61 days

110 + 58 – 66

85 + 42 – 61

= 102 days

= 66 days

Req. 2 a.

deteriorated

The company’s liquidity and current debt-paying ability deteriorated. Req. 3 The factors that need the most improvement are inventory turnover and collection of accounts receivable. The company needs to make more sales and keep less inventory on hand, as well as tighten collection policies.

This will provide more cash that can be used to pay off

payables more quickly.

Appendix E

Investments

(15-20 min.) E 12-35B a.

Net working capital (Current assets – Current liabilities) 2021:

$443,000* – $187,000 = $256,000

2020:

$461,000* – $252,000 = $209,000

Current ratio (Current assets ÷ Current liabilities) 2021:

$443,000 = 2.37 $187,000

2020:

$461,000 $252,000

= 1.83

Quick (acid-test) ratio ([Cash + Short-term investments + Net receivables] ÷ Current liabilities) 2021:

$35,000 + $32,000 + $115,000 $187,000

0.97

2020:

$47,000 + $4,000 + $128,000 $252,000

0.71

Debt ratio (Total liabilities ÷ Total assets) 2021:

$344,000** $510,000

= 0.67

2020:

$300,000** $500,000

= 0.60

e. Times-interest-earned ratio (Income from operations ÷ Interest expense) 2021:

$196,000 $59,000

= 3.32

2010:

$155,000 $46,000

= 3.37

_____ * Current assets 2021 = $35,000 + $32,000 + $115,000 + $240,000 + $21,000 = $443,000 Current assets 2020 = $47,000 + $4,000 + $128,000 + $270,000 + $12,000 = $461,000 ** Total liabilities 2021 = $187,000 + $157,000 = $344,000 Total liabilities 2020 = $252,000 + $48,000 = $300,000

Appendix E

Investments

(continued) E 12-35B

The company’s ability to pay current liabilities improved as evidenced by the increase in items a. – c. The debt ratio deteriorated as evidenced by the increase in item d. The company’s ability to cover interest expense declined only slightly from the prior year, as evidenced by item e. The company’s ability to pay long-term debts declined as seen by items d. and e.

Appendix E

Investments

(15-20 min.) E 12-36B a.

Return on net sales: 2021:

($23,000 – $15,000) $190,000

0.042

2020:

($34,000 – $14,000) $240,000

= 0.667

2020:

$240,000 $260,000**

$190,000 $285,000*

_____ *($270,000 + $300,000) / 2 = $285,000

= 0.923

_____ **($250,000 + $270,000) / 2 = $260,000

Return on assets (ROA): 2021:

0.083

Asset turnover: 2021:

0.042 × 0.667 = 0.028

2020:

0.083 × 0.923

= 0.077

2020:

$260,000 $102,500****

= 2.537

Leverage: 2021:

$285,000 $103,500***

= 2.754

_____ _____ ***($103,000 + $104,000) / 2 = $103,500 $102,500

Return on common stockholders’ equity (ROE): 2021:

****($102,000 + $103,000) / 2 =

0.028 × 2.754

= 0.077

2020:

0.077 × 2.537

2020:

$106,000 $240,000

= 0.195

Gross profit percentage: 2021:

Appendix E

$88,000 $190,000 Investments

0.46

0.44

Appendix E

Investments

(continued) E 12-36B g.

Operating income percentage: 2021:

$44,000 $190,000

0.23

$57,000 $240,000

2020:

0.24

Earnings per share of common stock: 2021:

$23,000 − $15,000 = $0.33 24,000

2020:

$34,000 − $14,000 = $0.87 23,000

DuPont Analysis: See parts (c) and (e).

The company’s operating performance deteriorated during 2021. The only ratio that improved (slightly) was the gross profit percentage. All other profitability measures decreased.

(10 min.) E 12-37B

Net income – preferred dividends Common shares outstanding

$6,200,000 − ($900,000 × .06) 830,000*

$7.40

* 900,000 – 70,000 = 830,000

Appendix E

Investments

(10-15 min.) E 12-38B 2021

2020

a. Price/earnings ratio: $23.50 ($114,000 − $5,250*) / 43,500

= 9.40

_____ *$105,000 × .05 = $5,250

$17.25 ($70,500 − $5,250*) / 43,500

= 11.50

_____ *$105,000 × .05 = $5,250

b. Dividend yield: $28,000 / 43,500 $23.50

= 0.027

$24,000 / 43,500 $17.25

= 0.032

The stock’s attractiveness decreased during 2021, as shown by the decrease in each item. Overall, the common stock looks less attractive than it did a year ago.

Appendix E

Investments

(15-20 min.) E 12-39B Req. 1 Hooper Book Company Income Statement Year Ended December 31, 2021 Thousands Sales revenue .....................................................................

$122,000

Other revenues ...................................................................

1,600

Total revenues ....................................................................

123,600

Total operating expenses ..................................................

104,800

Income tax expense ...........................................................

5,640

Total expenses………………………………………………..

110,440

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

$ 13,160

Earnings per share (EPS): Net income ($13,160 / 1,000) .....................................

$13.16

Req. 2 The company’s quality of earnings would be considered to be very good, based on its steady growth each year and no discontinued operations during recent years.

Appendix E

Investments

Quiz Q12-40

Q12-41

Q12-42

($2,170 / $2,500 × 100 = 87%)

Q12-43

($130 / $280 × 100 = 46%)

Q12-44

($19,311 − $15,047 = $4,264 increase; $4,264 / $15,047 = 0.283)

Q12-45

($10,649 / $11,384 = 0.935 ≈ .94

Q12-46

[($4,333 + $845 + $3,400) / $11,384 = 0.75]

Q12-47

Q12-48

($42,666 / $31,111 = 1.37 or 137%)

Q12-49

($35,147 / $42,666 = 0.824 or 82.4%)

Q12-50

($2,403 + $3,400) / 2 $42,666 / 365

Q12-51

$35,147 ($411 + $433) / 2

Q12-52

($3,634 / (long-term debt of $304 × .11) = 33.44 ($3,634 / $33.44) ≈ 109

Q12-53

2019: 2020: 2021:

Q12-54

EPS $1.41

= 25 days

= 83 times

$1,084 / $31,111 = 0.035 $1,418 / $35,220 = 0.040 $2,651 / $42,666 = 0.062 Net income $2,651 Shares outstanding*

Shares outstanding = 1,880 Q12-55

Appendix E

Investments

$5,922 2,163 – 183

= $2.99

*usually calculated based on weighted average

(continued) Quiz

Q12-56

Q12-57

Appendix E

Investments

Problems (20-30 min.) P 12-58A Req. 1 Trend percentages Azul Shipping, Inc. Trend Percentages 2021

2020

2019

2018

2017

Net revenues

168%

110%

119%

106%

100%

Net income

120

112

164

100

Total assets

154

130

122

110

100

Req. 2 Return on net sales thousands)

(Dollar amounts in

2021 Net income Net sales

$30 $498

= 6.0%

2020 $10 $327

2019 3.1%

$28 $352

8.0%

Return on sales measures the amount of net income for each dollar of net sales. Req. 3 Asset turnover

(Dollar amounts in thousands) 2021

Net sales Avg. total Assets

$498 $2901

= 1.72

1($266 + $314) / 2

2020 $327 $2572 =

2019 1.27

2 ($248 + $266) / 2

$352 $2363

1.49

3($224 + $248) / 2

Asset turnover measures the amount of net sales per dollar invested in assets. High ratios mean high efficiency (low cost). Appendix E

Investments

Appendix E

Investments

(continued) P 12-58A Req. 4 Return on assets

Asset turnover x Return on sales

(Dollar amounts in thousands)

2021

2020

2019

6.0% x 1.72 = 10.3%

3.1% x 1.27 = 3.9%

8.0% x 1.49 = 11.9%

Req. 5 Azul Shipping’s rate of return on net sales declined from 2019 to 2020, but increased in 2021. The return is below the industry average of 9%. Return on sales for all three years is below the 11% benchmark for outstanding companies.

Req. 6 Azul Shipping’s return on assets (ROA) compares unfavorably with the 18% industry benchmark for all three years. The ROA decreased in 2020 but increased in 2021; however, it is still well below the benchmark.

Appendix E

Investments

(20-30 min.) P 12-59A Req. 1 Caffrey Products, Inc. Common-Size Income Statement Compared to Industry Average Year Ended December 31, 2021 Caffrey Products

INDUSTRY AVERAGE

Net sales ..........................................................

100.0%

Cost of goods sold .........................................

69.0

57.3

Gross profit .....................................................

31.0

42.7

Operating expenses........................................

22.0

29.4

Operating income ...........................................

9.0

13.3

Other expenses ...............................................

1.5

2.5

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

7.5%

10.8%

Caffrey Products, Inc. Common-Size Balance Sheet Compared to Industry Average December 31, 2021 Caffrey Products

INDUSTRY AVERAGE

Current assets ..................................................

76.0%

72.1%

Plant assets, net...............................................

18.2

19.0

Intangible assets, net.......................................

3.4

4.8

Other assets .....................................................

2.4

4.1

Total assets ......................................................

100.0%

Current liabilities..............................................

39.0%

47.2%

Long-term liabilities .........................................

21.4

21.0

Stockholders’ equity........................................

39.6

31.8

Total liabilities and stockholders’ equity.......

100.0%

Appendix E

Investments

(continued) P 12-59A Req. 2 Caffrey Products’ common-size income statement shows that its ratios of gross profit to net sales, operating income to net sales, and net income to net sales are all worse than the industry averages. Overall, Caffrey Products’ profit performance is worse than average for the industry.

Req. 3 Caffrey Products’ common-size balance sheet shows that its ratios of current assets, current liabilities, and stockholders’ equity to total assets are better than the industry averages. Overall, the company’s financial position is better than average for companies in its industry.

Appendix E

Investments

(30-40 min.) P 12-60A Req. 1 (ratios before the transactions) (Dollar Amounts and Stock Quantities in Thousands) Current Ratio

Debt Ratio

$300

Earnings per Share

$385

$26 + $36 + $85 + $147 + $6 $188 + $163 + $34 $99 = 1.60 = 0.57 = $2.15* $49 + $107 + $32 $677 46 $188 ___ *Not in thousands.

Req. 2 (ratios after the transactions) (Dollar Amounts and Stock Quantities in Thousands) Transaction

Current Ratio

Debt Ratio

Earnings per Share

$300 + $105 $188

= 2.15

$385 + $105 = 0.63 $677 + $105

No effect

$300 + $360 $188

= 3.51

$385 = 0.37 $677 + $360

$99 46 + 40 = $1.15*

$300 – $28 $188 – $28

= 1.70

$385 – $28 $677 – $28

= 0.55

No effect

$300 + $43 $188 + $43

= 1.48

$385 + $43 $677 + $43

= 0.59

No effect

No effect No effect

*Not in thousands.

Appendix E

Investments

(40-50 min.) P 12-61A Req. 1 thousands)

(Dollar amounts and stock quantities in 2021

2020

a. Current ratio

$555 $261

2.13

$505 $293

1.72

b. Quick (acidtest) ratio

$39 + $214 $261

0.97

$43 + $152 $293

.67

c. Receivables Turnover

$673 = ($152 + $214) / 2

3.68

$595 = ($139 + $152) / 2

4.09

Days’ sales outstanding

365 3.68

365 4.09

$382 = ($280 + $293) / 2

1.33

$278 = ($188 + $280) / 2

1.19

365 1.33

274

365 1.19

307

$382 = ($98 + $120) / 2

3.50

$278 = ($108 + $98) / 2

2.70

d. Inventory Turnover Days’ inventory outstanding e. Accounts payable Turnover Days’ payables outstanding f. Cash conversion Cycle g. Times-interestearned ratio

Appendix E

Investments

365 3.50

104

365 2.70

135

99 + 274 – 104

269

89 + 307 – 135

261

$166 $35

4.74

$172 $49

3.51

(continued) P12-61A h. Return on Sales

$91 $673

= 0.135

Asset turnover

$673 = 0.828 ($784 + $842) / 2

Return on Assets

13.5% x 0.828

i. Leverage Return on Equity j. Earnings per share of common stock k. Price/earnings Ratio _____ *Not in thousands.

Appendix E

Investments

= 11.2%

($784 + $842) / 2 = 2.724 ($259 + $338) / 2

$71 $595

= 0.119

$595 = 0.802 ($700 + $784) / 2 11.9% x 0.802

= 9.5%

($700 + $784) / 2 = 3.254 ($197 + $259) / 2

11.2% x 2.724

= 30.5%

9.5% x 3.254

= 30.9%

$91 17

= $5.35*

$71 16

= $4.44*

$48.15* $5.35*

= 9.0

$39.96* $4.44*

= 9.0

(continued) P 12-61A Req. 2 Decisions: a. The company’s financial position improved during 2021 as shown by increases in the current ratio, the quick ratio, inventory turnover, accounts payable turnover, return on assets, earnings per share and the times-interest-earned ratio. However, the days’ sales outstanding and the cash conversion cycle both deteriorated.

It appears that

inventory is moving very slowly and the company is having trouble collecting their accounts receivable, thereby paying their accounts payable slowly. b. The common stock’s attractiveness increased slightly during 2021, as shown by the increase in the market price of the common stock and earnings per share. The price-earnings ratio stayed the same. Return on assets improved. Dividends per share also improved during 2021. Req. 3 This problem gives you practice in computing and evaluating several of the ratios used in investment analysis. By analyzing the two-year trends in the ratios, you can see whether the company’s abilities to pay its debts, sell its inventory, and generate profits have improved or deteriorated during this period. Improving ratio values generally indicate an attractive investment, and deteriorating ratio values usually signal an unattractive investment.

Student responses may vary.

Appendix E

Investments

(45-60 min.) P 12-62A Req. 1 (Dollar Amounts and Stock Quantities in Thousands) Edge Corporation

GoBee Company

a. Quick (acid-test) $21 + $4 + $186 = 0.57 ratio: $368

$35 + $18 + $167 = 0.66 $333

b. Inventory turnover:

$452 = 2.18 ($202 + $212) / 2

$388 = 2.04 ($199 + $181) / 2

c. Days’ sales in average receivables:

($142 + $186) / 2 = 101 $595 / 365

($198 + $167) / 2 = 127 $524 / 365

d. Debt ratio: e. Times-interestearned ratio:

Return on common stockholders' equity: Earnings per share of common stock:

h. Price/earnings ratio: _____

$663 $985

= 0.67

Ratio is not meaningful because Edge Corp. has no interest expense. $69 = 0.237 ($261 + $322) / 2

$69 150

= $0.46*

$5.52* $.46*

= 12

$689 $930 $73 $13

= 0.74 = 5.62

$36 − ($25 × .05) = 0.168 [($222 − $25) + ($241 − $25)] / 2 $36 − ($25 × .05) = $1.74* 20 $38.28* $1.74*

= 22

*Not in thousands.

Appendix E

Investments

(continued) P 12-62A Decision: Edge Corporation’s common stock seems to fit the investment strategy better. Its price/earnings ratio is lower than that of GoBee Company, and Edge Corporation appears to be in slightly better shape financially than GoBee Company, as indicated by all the ratio values except for earnings per share of common stock and the acid-test ratio (which is slightly lower than GoBee’s).

Appendix E

Investments

(60-90 min.) P 12-63A Req. 1 Tompkin Furniture, Inc. Trend Percentages 2021

2020

2019

2018

Net sales revenue

110%

105%

102%

100%

Inventory

200

140

107

100

Net receivables

140

131

106

100

The trend percentages for sales revenue are favorable. However, the trend percentage increase in inventory indicates a large buildup of inventory. The trend percentage increase in net receivables is greater than the increase in sales, which is not a favorable trend. The trend percentage increase in inventory is greater than the increase in sales, which is not a favorable trend.

Appendix E

Investments

(continued) P12-63A Req. 2 Liquidity: Current ratio (Current assets ÷ Current liabilities) 2021:

$15,900 $9,500

= 1.67

2020:

$14,100 $6,900

= 2.04

2019:

$13,000 $5,250

= 2.48

Quick (acid-test) ratio ([Cash + Short-term investments + Net receivables] ÷ Current liabilities) 2021:

$2,800 + $400 + $6,700 $9,500

= 1.04

2020:

$3,000 + $600 + $6,300 $6,900

= 1.43

2019:

$4,200 + $500 + $5,100 $5,250

= 1.87

Turnover: Inventory turnover (Cost of goods sold ÷ Average inventory) 2021:

$20,700 ($4,200 + $6,000)/2

= 4.06

2020:

$15,840 ($3,200 + $4,200)/2

= 4.28

2019:

$14,445 ($3,000 + $3,200)/2

= 4.66

Appendix E

Investments

(continued) P12-63A Days’ inventory outstanding (365 ÷ Inventory turnover) 2021:

365 4.06

= 89.9 (90 days)

2020:

365 4.28

= 85.3 (85 days)

2019:

365 4.66

= 78.3 (78 days)

Accounts receivable turnover (Net sales revenue ÷ Average net accounts receivable) 2021:

$34,500 ($6,300 + $6,700)/2

= 5.31

2020:

$33,000 ($5,100 + $6,300)/2

= 5.79

2019:

$32,100 ($4,800 + $5,100)/2

= 6.48

Days’ sales outstanding (365 ÷ Accounts receivable turnover) 2021:

365 5.31

= 68.7 (69 days)

2020:

365 5.79

= 63.0 (63 days)

2019:

365 6.48

= 56.3 (56 days)

(an alternative way of calculating this is illustrated on the next page)

Appendix E

Investments

(continued) P12-63A OR, alternatively (Average net accounts receivable ÷ One day’s sales) 2021:

($6,300 + $6,700)/2 $34,500/365

= 68.8

2020:

($5,100 + $6,300)/2 $33,000/365

= 63.0

2019:

($4,800 + $5,100)/2 $32,100/365

= 56.3

Accounts payable turnover (Cost of goods sold ÷ Average accounts payable) 2021:

$20,700 ($2,300 + $3,500)/2

= 7.14

2020:

$15,840 ($1,500 + $2,300)/2

= 8.34

2019:

$14,445 ($1,900 + $1,500)/2

= 8.50

Days’ payables outstanding (365 ÷ Accounts payable turnover) 2021:

365 7.14

= 51.1 (51 days)

2020:

365 8.34

= 43.8 (44 days)

2019:

365 8.50

= 42.9 (43 days)

Appendix E

Investments

(continued) P12-63A Cash conversion cycle (DIO + DSO – DPO) 2021: 2020: 2019:

89.9 + 68.7 – 51.1 = 107.5 85.3 + 63.0 – 43.8 = 104.5 78.3 + 56.3 – 42.9 = 91.7

Overall debt-payment ability: Debt ratio (Total liabilities ÷ Total assets) 2021:

$9,500 + $265 $22,800

= .43

2020:

$6,900 + $2,725 $21,900

= .44

2019:

$5,250 + $6,982 $22,200

= .55

Times-interest-earned ratio (Income from operations ÷ Interest expense) 2021:

$1,300* $150

2020:

$3,660* $255

= 14.35

2019:

$3,955* $300

= 13.18

8.67

* Income from operations = Net sales revenue – Cost of goods sold – Operating expenses

Appendix E

Investments

(continued) P12-63A Profitability: Gross profit (gross margin) percentage (Gross margin ÷ Net sales revenue) 2021:

$13,800* $34,500

= 40.0%

2020:

$17,160* $33,000

= 52.0%

2019:

$17,655* $32,100

= 55.0%

* Gross margin = Net sales revenue – Cost of goods sold Operating income percentage (Operating income ÷ Net sales revenue) 2021:

$1,300** $34,500

2020:

$3,660** $33,000

= 11.1%

2019:

$3,955** $32,100

= 12.3%

3.8%

** Operating income = Gross margin – Operating expenses

Appendix E

Investments

(continued) P12-63A

Tompkin’s performance over the past three years looks to be quite poor, and does not compare favorably to the industry averages. Most all the ratios showed declines over the three years. Some of the problems are: Declining earnings Decreased cash flow Inability to collect accounts receivable Buildup of inventories Decreasing gross margin percentage Operating income and net income percentages are decreasing Interest coverage is declining Payment of accounts payable taking longer The debt ratio did improve over the three years. Req. 3 Quality of earnings ratios: Ratio

2021

2020

2019

Gross

40%

52%

55%

2.2%

6.99%

7.69%

3.77%

11.09%

12.32%

36.23%

40.91%

42.68%

profit/sales Net income/ sales Operating income/sales Operating expenses/sales Appendix E

Investments

(continued) P12-63A

The first three ratios are declining over time, which suggest that the quality of earnings is declining. The final ratio, operating expenses over sales, is also declining over time but this is a favorable sign in favor of improving quality of earnings. Student responses will vary.

Appendix E

Investments

(20-30 min.) P 12-64B Req. 1 Suburban Shipping, Inc. Trend Percentages 2021

2020

2019

2018

2017

Net sales

205%

167%

118%

103%

100%

Net income

159

100

103

100

Total assets

152

134

127

114

100

Req. 2 Return on net sales

Dollar amounts in thousands

2021 Net income Net sales

$54 $616

= 8.8%

2020 $34 $502

2019 6.8%

$11 $354

3.1%

Return on sales measures the amount of net income for each dollar of net sales. Req. 3 Asset turnover

Dollar amounts in thousands 2021

Net sales Avg. total Assets

$616 $2901

= 2.12

1($272 + $308) / 2

2020 $502 $2652 =

2019 1.89

2 ($258 + $272) / 2

$354 $2453

1.44

3($232 + $258) / 2

Asset turnover measures the amount of net sales per dollar invested in assets. High ratios mean high efficiency (low cost). Appendix E

Investments

(continued) P 12-64B Req. 4 Return on assets 2021

Dollar amounts in thousands 2020

Return on sales x Asset 8.8% x 2.12 = 18.7% 6.8% x 1.89 = 12.9% turnover

2019 3.1% x 1.44 = 4.5%

Req. 5 Suburban Shipping’s rate of return on net sales has increased (improved) from 2019 to 2021.

However, the return compares

unfavorably with the industry average of 9%. Return on sales did approach the good industry average of 9% in 2021, but fell short of the excellent industry average of 11% in all three years.

Req. 6 Suburban Shipping’s return on assets (ROA) for 2021 compares favorably with the 18% industry benchmark. The ROA for the current year compares favorably with the prior two years, improving in each of those years.

Student responses may vary.

Appendix E

Investments

(20-30 min.) P 12-65B Req. 1 Ryan Products, Inc. Common-Size Income Statement Compared to Industry Average Year Ended December 31, 2021 Ryan INDUSTRY Products AVERAGE Net sales.............................................................. 100.0% 100.0% Cost of goods sold............................................. 71.0 57.3 Gross profit......................................................... 29.0 42.7 Operating expenses ........................................... 24.0 29.4 Operating income............................................... 5.0 13.3 Other expenses .................................................. 1.5 2.5 Net income .......................................................... 3.5% 10.8% Ryan Products, Inc. Common-Size Balance Sheet Compared to Industry Average December 31, 2021 Ryan INDUSTRY Products AVERAGE Current assets ..................................................... 73.0% 72.1% Plant assets, net .................................................. 17.8 19.0 Intangible assets, net .......................................... 4.0 4.8 Other assets......................................................... 5.2 4.1 Total assets.......................................................... 100.0% 100.0% Current liabilities ................................................. Long-term liabilities ............................................ Stockholders’ equity ........................................... Total liabilities and stockholders’ equity ..........

Appendix E

Investments

39.2% 21.2 39.6 100.0%

47.2% 21.0 31.8 100.0%

(continued) P 12-65B Req. 2 Ryan Product’s common-size income statement shows that its ratios of (a) gross profit to net sales, (b) operating income to net sales, and (c) net income to net sales are worse than the industry averages. Overall, the company’s profit performance is worse than the average for the industry.

Req. 3 Ryan Product’s common-size balance sheet shows that its (a) ratio of current assets to total assets is slightly better than the industry average. The ratio of current liabilities to total assets is better than the industry average. Ryan Product’s (b) ratio of stockholders’ equity to total assets is better than the industry average. Overall, the company’s financial position is better than the industry average.

Appendix E

Investments

(30-40 min.) P 12-66B Req. 1 (ratios before the transactions) (Dollar Amounts and Stock Quantities in Thousands) Current Ratio

Debt Ratio

$296

Earnings per Share

$377

$22 + $33 + $87 + $145 + $9 = 1.62 $44 + $102 + $37

$183 + $162 + $32 $95 = 0.56 = $1.90* $675 50

$183 Req. 2 (ratios after the transactions) (Dollar Amounts and Stock Quantities in Thousands) Transaction

Current Ratio

Debt Ratio

Earnings per Share

$296 + $140 $183

= 2.38

$377 + $140 = 0.63 $675 + $140

No effect

$296 + $367 $183

= 3.62

$377 = 0.36 $675 + $367

$95 50 + 30 = $1.19*

$296 – $27 $183 – $27

= 1.72

$377 – $27 $675 – $27

= 0.54

No effect

$296 + $41 $183 + $41

= 1.50

$377 + $41 $675 + $41

= 0.58

No effect

No effect No effect

*Not in thousands.

Appendix E

Investments

(40-50 min.) P 12-67B Req. 1 (Dollar Amounts and Stock Quantities in Thousands) 2021

2020

a. Current ratio

$565 $277

2.04

$552 $290

1.90

b. Quick (acidtest) ratio

$42 + $212 $277

0.92

$82 + $155 $290

0.82

c. Receivables Turnover

$686 = ($155 + $212) / 2

3.74

$595 = ($132 + $155) / 2

4.15

Days’ sales outstanding

365 3.74

365 4.15

$382 = ($288 + $299) / 2

1.30

$276 = ($180 + $288) / 2

1.18

365 1.30

281

365 1.18

309

$382 = ($114 + $140) / 2

3.01

$276 = ($108 + $114) / 2

2.49

365 3.01

121

365 2.49

147

98 + 281 – 121

258

88 + 309 – 147

250

$172 $38

4.53

$169 $45

3.76

d. Inventory Turnover Days’ inventory outstanding e. Accounts payable Turnover Days’ payables outstanding f. Cash conversion cycle g. Times-interestearned ratio

Appendix E

Investments

(continued) P12-67B h. Return on Sales

$94 $686

= 0.137

$78 $595

= 0.131

Asset turnover

$686 = 0.817 ($827 + $852) / 2

$595 = 0.777 ($704 + $827) / 2

Return on Assets (ROA)

13.7% x 0.817

13.1% x 0.777

i. Leverage Return on Equity (ROE) j. Earnings per share of common stock k. Price/earnings Ratio _____ *Not in thousands.

Appendix E

Investments

= 11.2%

= 10.2%

($827 + $852) / 2 = 2.648 ($303 + $331) / 2

($704 + $827) / 2 = 3.074 ($195 + $303) / 2

11.2% x 2.648

= 29.7%

10.2% x 3.074

= 31.4%

$94 13

= $7.23*

$78 8

= $9.75*

$122.91* $7.23*

= 17

$165.75* $9.75*

= 17

(continued) P 12-67B Req. 2 Decisions: a. The company’s financial position improved slightly during 2021 as shown by increases in the current ratio, the quick ratio, the inventory turnover, the accounts payable turnover, return on assets, and the times-interest-earned ratio. However, it is not a favorable trend that the receivables turnover decreased, and the cash conversion cycle is much too long. Inventory is moving very slowly and receivables are going far past due. b. The common stock’s attractiveness declined during 2021, as shown by the decrease in return on equity and earnings per share.

The

market price per share also decreased, as did dividends per share. There was only a small increase in the return on assets.

Req. 3 This problem gives you practice in computing and evaluating many of the ratios used in investment analysis. By analyzing the two-year trends in the ratios, you can see whether the company’s abilities to pay its debts, sell its inventory, and generate profits have improved or deteriorated during this period. Improving ratio values generally indicate an attractive investment, and deteriorating ratio values usually signal an unattractive investment.

Appendix E

Investments

(45-60 min.) P 12-68B Req. 1 (Dollar Amounts and Stock Quantities in Thousands) Border Corp.

Celebration Co.

a. Quick (acid-test) $26 + $9 + $185 = 0.60 ratio: $367

$35 + $18 + $167 = 0.64 $342

b. Inventory turnover:

$458 = 2.20 ($205 + $211) / 2

$388 ($199 + $187) / 2

= 2.01

c. Days’ sales outstanding:

($141 + $185) / 2 = 99 $601 / 365

($198 + $167) / 2 $517 / 365

= 129

$700 $933

= 0.75

$70 $10

= 7.00

d. Debt ratio:

$671 $985

= 0.68

e. Times-interest- Ratio is not meaningful earned ratio: because Border Corp. has no interest expense. f.

Return on common stockholders' equity:

= 0.218 $63 ($263 + $314) / 2

Earnings per share of common stock:

$63 115

= $0.55*

h. Price/earnings ratio:

$5.50* $.55*

= 10

$32 − ($35 × .09) [($219 − $35) + ($233 − $35)] / 2

$32 − ($35 × .09) 20

$30.24* $1.44*

*Not in thousands. Appendix E

Investments

= 0.151

= $1.44*

= 21

(continued) P 12-68B Decision: The common stock of Border Corporation seems to fit the investment strategy better. Its price/earnings ratio is lower than that of Celebration Company, and Border Corp. appears to be in slightly better shape financially than Celebration Co. On several of the ratios, the two companies are relatively close. The ratios that tip the decision in favor of Border Corp. are days’ sales outstanding, the debt ratio, inventory turnover, and the return on common stockholders’ equity.

Appendix E

Investments

(60-90 min.) P 12-69B Req. 1 Switzer Furniture, Inc. Trend Percentages 2021

2020

2019

2018

Net sales revenue

109%

106%

103%

100%

Inventory

210

148

114

100

Net receivables

139

131

106

100

The trend percentages for sales revenue are favorable. However, the trend percentage increase in inventory indicates a large buildup of inventory. The trend percentage increase in net receivables could be unfavorable if it is taking longer to collect the receivables. The trend percentage increase in net receivables is greater than the increase in sales, which is not favorable.

Appendix E

Investments

(continued) P12-69B Req. 2 Liquidity: Current ratio (Current assets ÷ Current liabilities) 2021:

$16,075 $9,700

= 1.66

2020:

$14,450 $7,200

= 2.01

2019:

$13,150 $5,325

= 2.47

Quick (acid-test) ratio ([Cash + Short-term investments + Net receivables] ÷ Current liabilities) 2021:

$2,750 + $425 + $6,800 $9,700

= 1.03

2020:

$3,200 + $550 + $6,400 $7,200

= 1.41

2019:

$4,100 + $550 + $5,200 $5,325

= 1.85

Turnover: Inventory turnover (Cost of goods sold ÷ Average inventory) 2021:

$20,755 ($4,300 + $6,100)/2

= 3.99

2020:

$16,195 ($3,300 + $4,300)/2

= 4.26

2019:

$14,812 ($2,900 + $3,300)/2

= 4.78

Appendix E

Investments

(continued) P12-69B Days’ inventory outstanding (365 ÷ Inventory turnover) 2021:

365 3.99

= 91.5 (91 days)

2020:

365 4.26

= 85.7 (86 days)

2019:

365 4.78

= 76.4 (76 days)

Accounts receivable turnover (Net sales revenue ÷ Average net accounts receivable) 2021:

$34,025 ($6,400 + $6,800)/2

= 5.16

2020:

$33,050 ($5,200 + $6,400)/2

= 5.70

2019:

$32,200 ($4,900 + $5,200)/2

= 6.38

Days’ sales outstanding (365 ÷ Accounts receivable turnover) 2021:

365 5.16

= 70.7 (71 days)

2020:

365 5.70

= 64.0 (64 days)

2019:

365 6.38

= 57.2 (57 days)

(an alternative way of calculating this is illustrated on the next page)

Appendix E

Investments

(continued) P12-69B OR, alternatively (Average net accounts receivable ÷ One day’s sales) 2021:

($6,400 + $6,800)/2 $34,025/365

= 70.8 (71 days)

2020:

($5,200 + $6,400)/2 $33,050/365

= 64.1 (64 days)

2019:

($4,900 + $5,200)/2 $32,200/365

= 57.2 (57 days)

Accounts payable turnover (Cost of goods sold ÷ Average accounts payable) 2021:

$20,755 ($2,450 + $3,750)/2

= 6.70

2020:

$16,195 ($1,700 + $2,450)/2

= 7.80

2019:

$14,812 ($1,800 + $1,700)/2

= 8.46

Days’ payables outstanding (365 ÷ Accounts payable turnover) 2021:

365 6.70

= 54.5 (54 days)

2020:

365 7.80

= 46.8 (47 days)

2019:

365 8.46

= 43.1 (43 days)

Appendix E

Investments

(continued) P12-69B Cash conversion cycle (DIO + DSO – DPO) 2021: 2020: 2019:

91.5 + 70.7 – 54.5 = 107.7 85.7 + 64.0 – 46.8 = 102.9 76.4 + 57.2 – 43.1 = 90.5

Overall debt-payment ability: Debt ratio (Total liabilities ÷ Total assets) 2021:

$9,700 + $551 $23,125

= .44

2020:

$7,200 + $2,933 $22,250

= .46

2019:

$5,325 + $6,958 $22,300

= .55

Times-interest-earned ratio (Income from operations ÷ Interest expense) 2021:

$1,295* $150

2020:

$3,365* $255

= 13.20

2019:

$3,738* $300

= 12.46

8.63

* Income from operations = Net sales revenue – Cost of goods sold – Operating expenses

Appendix E

Investments

(continued) P12-69B Profitability: Gross profit (gross margin) percentage (Gross margin ÷ Net sales revenue) 2021:

$13,270* $34,025

= 39.0%

2020:

$16,855* $33,050

= 51.0%

2019:

$17,388* $32,200

= 54.0%

* Gross margin = Net sales revenue – Cost of goods sold Operating income percentage (Operating income ÷ Net sales revenue) 2021:

$1,295** $34,025

2020:

$3,365** $33,050

= 10.2%

2019:

$3,738** $32,200

= 11.6%

3.8%

** Operating income = Gross margin – Operating expenses

Appendix E

Investments

(continued) P12-69B Switzer’s performance over the past three years looks to be quite poor, and does not compare favorably to the industry averages. Most all the ratios showed declines over the three years. Some of the problems are: Declining earnings Decreased cash flow Inability to collect accounts receivable Buildup of inventories Decreasing gross margin percentage Operating income percentage is decreasing The debt ratio did improve over the three years. Student responses will vary.

Req. 3 Quality of Earnings Ratios: Ratio Operating income/sales Net income/sales Gross margin/sales Operating expenses/sales

2021 3.8%

2020 10.2%

2019 11.6%

$757/$34,025= 2.22% 39%

$2,100/$33,050= 6.4% 51%

$2,317/$32,200= 7.2% 54%

$11,975/$34,025= $13,490/$33,050= $13,650/$32,200= 35.2% 40.8% 42.4%

The profitability ratios are declining over time, which suggests quality of earnings is declining. However, operating expenses to sales is decreasing over time, which suggests quality of earnings is improving.

Appendix E

Investments

Challenge Exercises and Problem (20-30 min.) E 12-70 Req. 1 ORDER OF COMPUTATION

Millions

Given Current assets..............................................................

$11,900

Property, plant, and equipment................. $19,700

Given Less Accumulated depreciation ...............

(2,100)

17,600

Total assets ($11,800 ÷ 0.40).......................................

$29,500

Current liabilities ($11,900 ÷ 1.70) ..............................

$ 7,000

Long-term liabilities ($11,800 − $7,000) .....................

4,800

Stockholders’ equity ($29,500 − $11,800) ..................

17,700

Total liabilities and stockholders’ equity...................

$29,500

Appendix E

Investments

(20-30 min.) E 12-71 Req. 1 ORDER OF COMPUTATION

Millions

Sales ($1,250 ÷ 0.25) ..................................................

$5,000

Operating expenses ($5,000 − $1,250).....................

3,750

Operating income ......................................................

1,250

Given Interest expense ........................................................

200

Pretax income [$735 ÷ (1 − 0.30)] .............................

1,050

Income tax expense ($1,050 × 0.30) .........................

315

Net income ($3,500 × .21)..........................................

$ 735

Appendix E

Investments

(30-40 min.) P 12-72 Req. 1 Ivy Corporation Comparative Income Statements Years Ended December 31, 2021 and 2020 2021 Sales revenue ........................................ Cost of goods sold (a) .......................... Gross profit (b) ...................................... Operating expense (d) .......................... Operating income (c) ............................ Interest expense .................................... Income before income tax (e) .............. Income tax expense (30%) (f) ............... Net income (g) .......................................

Appendix E

Investments

$2,300,000 1,610,000 690,000 502,500 187,500 15,300 172,200 51,660 $ 120,540

2020 $1,800,000 990,000 810,000 660,000 150,000 15,300 134,700 33,675 $ 101,025

(continued) P 12-72 Ivy Corporation Comparative Balance Sheets December 31, 2021 and 2020

ASSETS Current: Cash (l) ..................................................... Accounts receivable, net (k)................... Inventory (j) .............................................. Total current assets (h)...................... Plant and equipment, net ........................... Total assets .................................................

2021

2020

$265,000 110,000 37,500 412,500 2,617,500 $3,030,000

$ 37,000 120,000 190,000 347,000 303,000 $650,000

LIABILITIES Current liabilities......................................... $ 150,000 10% Bonds payable (r) ............................... 2,104,000 Total liabilities (q) ....................................... 2,254,000 STOCKHOLDERS’ EQUITY Common stock, $5 par (o) ...................... 606,000 Retained earnings (p).............................. 170,000 Total stockholders’ equity (n) .................... 776,000 Total liabilities and stockholders’ equity (m) $3,030,000

$160,000 90,000 250,000 154,700 245,300 400,000 $650,000

Computations (alternate order of calculations is possible) (a) Cost of goods sold ($1,610,000) = Sales x COGS % ($2,300,000 × 70%) (b) Gross profit ($690,000) = Sales – COGS ($2,300,000 – $1,610,000) (c) Operating income ($187,500) = Operating income in 2017 × 2017 Trend % ($150,000 × 125%) (d) Operating expenses ($502,500) = Gross profit – Operating Income ($690,000 – $187,500) Appendix E

Investments

(continued) P 12-72 (e) Income before income tax ($172,200) = Operating income – Interest expense ($187,500 – $15,300) (f) Income tax expense ($51,660) = Income before income tax × tax rate ($172,200 × 30%) (g) Net income ($120,540) = Income before income tax – Income tax expense ($172,200 – $51,660) (h) Current assets ($412,500) = Current ratio × Current liabilities (2.75 × $150,000) (i) Cash + Accounts receivable = Quick assets ($375,000) = Quick ratio × Current liabilities (2.50 × $150,000) (j) Inventory ($37,500) = (h) – (i) ($412,500 – $375,000) (k) Average accounts receivable ($115,000) = Sales ÷ Accounts receivable turnover ($2,300,000 ÷ 20) Average accounts receivable = (Beginning + Ending) ÷ 2; $115,000 = ($120,000 + Ending) ÷ 2; Ending = $110,000 (l) Cash ($265,000) = Quick assets – Accounts Receivable ($375,000 – $110,000) (m) Average total assets ($1,840,000) = Sales ÷ Asset turnover ($2,300,000 ÷ 1.25); Average Assets = (Beginning + Ending) ÷ 2; $1,840,000 = ($650,000 + Ending) ÷ 2; Ending = $3,030,000; this amount is also total liabilities and stockholders’ equity. (n) Return on equity = .205 = $120,540 /Average stockholders’ equity; Average stockholders’ equity = (Beginning + Ending) ÷ 2; .205 = $120,540/($400,000 + Ending) ÷ 2 Ending = $776,000 (o) Common stock ($606,000) = Common size % × total assets (20% × $3,030,000) (p) Retained earnings ($170,000) = Total stockholders’ equity – Common stock ($776,000 – $606,000) (q) Total liabilities ($2,254,000) = Total assets – Total stockholders’ equity ($3,030,000 – $776,000) (r) Bonds payable ($2,104,000) = Total liabilities – Current liabilities ($2,254,000 – $150,000)

Appendix E

Investments

Serial Case (30-40 min.) C12-73 Req. 1 (in thousands) The Cheesecake Factory’s net working capital decreased from ($221,270) in 2018 to ($370,072) in 2019. Net working capital measures the ability to pay current liabilities with current assets. Since the Company’s net working capital was negative in both years, this means it would not be able to pay off its current liabilities with its current assets. The Cheesecake Factory does not have strong net working capital. Current Assets

Current Liabilities =

Net working capital

2019

244,515

614,587

($370,072)

2018

195,230

416,500

($221,270)

Req. 2 (in thousands) The Cheesecake Factory’s current ratio decreased from 2018 to 2019. Current Assets - Current Liabilities = Current ratio 2019

244,515

614,587

.40

2018

195,230

416,500

.47

Req. 3 (in thousands) The Cheesecake Factory’s quick ratio decreased from 2018 to 2019. Cash & cash equivalents

Short-term investments

Net current receivables

Current liabilities

Quick ratio

2019

(58,416

*94,928)

614,587

.25

2018

(26,578

*89,121)

416,500

.28

*2019: 25,619 + 4,626 + 64,683 = $94,928 *2018: 20,928 + 68,193 = $89,121 Appendix E

Investments

(continued) C12-73 Req. 4 Students answers may vary. The Cheesecake Factory’s overall ability to pay its current liabilities appears poor. Its net working capital is negative, which indicates that it has more current liabilities than current assets. Additionally, its current ratio and quick ratio are both weak and deteriorating. A quick ratio of .90 to 1.00 is considered acceptable in most industries. The Cheesecake Factory’s is significantly below this, at around .25. We need industry averages because the restaurant industry has some special characteristics.

Req. 5 (in thousands) The Cheesecake Factory’s inventory turnover for 2019 was 13.05. Inventory turnover is the number of times the company sold its average level of inventory during the year. The Cheesecake Factory sold its average level of inventory 13.05 times in 2019. The Company’s days’ inventory outstanding was 27.97 in 2019. This measures turnover on a daily basis, meaning that every 27.97 days The Cheesecake Factory’s inventory turned over.

2019

Cost of / goods sold 561,783 /

2019

365 365

Appendix E

/ /

Investments

Beginning + inventory

Ending / inventory

Inventory turnover

[(38,886

47,225)

13.05

Inventory turnover 13.05

= =

Days’ inventory outstanding 27.97

(continued) C12-73 Req. 6 (in thousands) The Cheesecake Factory’s accounts receivable turnover was 106.7 times. This means that The Cheesecake Factory collected its average receivable balance 106.7 times throughout the year. The Company’s days’ sales outstanding was 3.42. This ratio shows how many days sales remain in accounts receivable before being turned into cash. The Cheesecake Factory’s sales remain in accounts receivable, on average, for 3.42 days. Net credit sales 2019 2,482,692 365 / 2019

365 /

Beginning accounts receivable [(20,928

Ending accounts receivable 25,619)

Accounts receivable turnover 106.7

= =

Accounts receivable turnover 106.7

Days sales outstanding (DSO) 3.42

Req. 7 (in thousands) The Cheesecake Factory’s accounts payable turnover was 10.12. This means that The Cheesecake Factory paid off its average payables balance 10.12 times throughout the year. The Company’s days’ payable outstanding was 36.07. This ratio shows how many days’ payable remain in accounts payable before they are paid off. The Cheesecake Factory’s payables remain in accounts payable, on average, for 36.07 days.

Cost of goods sold 2019 561,783 365 Appendix E

Beginning accounts payable [(49,071

/ /

Investments

+ +

Ending accounts payable 61,946)

Accounts payable turnover

10.12

Days’ payable outstanding

2019

365

10.12

36.07

(continued) C12-73 Req. 8 The Cash conversion is a measure of liquidity by comparing the number of days it takes a company to convert its inventory to receivables and back into cash, minus the days to pay off the balance owed to suppliers. The Cheesecake Factory’s negative cash conversion cycle means that it is able to sell inventory and convert its receivables to cash 4.68 days prior to having to pay back its suppliers. Days’ + inventory outstanding (DIO) 2019 27.97 +

Days’ sales outstanding (DSO) 3.42

Days’ = payable outstanding (DPO) 36.07 =

Cash conversion cycle (4.68)

Req. 9 (in thousands) The debt ratio increased dramatically from .5654 in 2018 to .7987 in 2019. This was largely due to the accounting change that took effect in 2019 that required the company to capitalize assets under operating lease arrangements and to also record the related liability for those leases.

2019 2018

Total liabilities 2,268,851 743,074

/ / /

Total assets 2,840,593 1,314,133

= = =

Debt ratio .7987 .5654

Req. 10 (in thousands) The times-interest earned ratio measures the number of times that a company’s operating income can cover its interest expense. The Cheesecake Factory’s operating income could cover its interest expense 41.49 times in 2019. Income from Appendix E

Investments

Interest

Times-interest-earned

2019

operations 103,598

expense 2,497

ratio 41.49 (continued) C12-73

Req. 11 (in thousands) a. Gross Margin Percentage 77.4% Sales - Cost of = Gross / Net sales = Gross sales margin revenue margin % 2019 2,482,692 - 561,783 = 1,920,909 / 2,482,692 = 77.4% b. Operating Income Percentage 4.17% Operating / Net sales = Operating income income % 2019 103,598 / 2,482,692 = 4.17% c. Return on Sales 5.13% Net - Preferred / Net sales = Rate of return on income dividends sales 2019 (127,293 0) / 2,482,692 = 5.13% d. Return on Assets 6.16% Net sales / Beginning + total assets 2019 2,482,692 / [(1,314,133 +

2019

Appendix E

Rate of return on sales 5.13%

Investments

Ending / total assets 2,840,593) /

Asset turnover

1.20

Asset turnover

Rate of return on assets (ROA)

1.20

6.16%

(continued) C12-73 Req. 12 The Cheesecake Factory’s profitability appears to be slipping based on these ratios. The Company’s gross margin percentage of 77.4% is very high. This ratio indicates the amount of profit that The Cheesecake Factory makes before other operating expenses are subtracted. The Company’s operating income percentage is weak at 4.17%. The operating income percentage indicates how much profit a company earns from each dollar from its core business. Additionally, the rate of return on sales is low at 5.13%. The Cheesecake Factory earns 5.13% of each sales dollar as net income. Finally, the rate of return on assets is only 6.16%. This ratio is slipping from previous years. Industry averages would be helpful. Req. 13 While some ratios are concerning and others are strong, we should examine trends in profitability ratios over time to assess earnings quality. 1. High and persistently improving gross margin percentages reflect increasing earnings quality. In the case of The Cheesecake Factory, the gross margin percentages have been steadily increasing over 2016-2019, and reflect increasing earnings quality.

2019 2018 2017 2016 Appendix E

Revenues - Cost of = sales

Gross margin

/ Revenues =

2,482,692 2,332,331 2,260,502 2,275,719

1,920,909 1,799,451 1,741,114 1,749,091

/ / / /

Investments

561,783 532,880 519,388 526,628

= = = =

2,482,692 2,332,331 2,260,502 2,275,719

= = = =

Gross margin % 77.4% 77.2% 77.0% 76.9%

(continued) C12-73 2. High and persistently improving operating income percentages reflect increasing earnings quality. For The Cheesecake Factory, the operating income percentages have been steadily decreasing over 2016-2019, and reflect worsening earnings quality.

2019 2018 2017 2016

Operating income 103,598 118,948 152,845 200,993

/ Revenues

/ / / /

= = = =

2,482,692 2,332,331 2,260,502 2,275,719

Operating income % 4.17% 5.10% 6.76% 8.83%

3. Declining or stable operating expenses as a percentage of sales reflect increasing earnings quality. The operating expenses percentage has decreased in 2019 which reflects favorably on earnings quality.

2019 2018 2017 2016

Appendix E

Total costs & expenses 2,379,094 2,213,383 2,107,657 2,074,726

Investments

- Cost of = Operating / Revenues = Operating sales expenses expenses % - 561,783 = 1,817,311 / 2,482,692 = 73.20% - 532,880 = 1,680,503 / 2,213,393 = 75.92% - 519,388 = 1,588,269 / 2,107,657 = 75.36% - 526,628 = 1,548,098 / 2,074,726 = 74.62%

(continued) C12-73 4.

Increasing profitability ratios such as return on sales are an indicator of increasing earnings quality. Return on sales dipped in 2018 but increased in 2019. The latter reflects favorably on earnings quality.

2019 2018 2017 2016

Net income 127,293 99,035 157,392 139,494

/ Revenues

/ / / /

= = = =

2,482,692 2,332,331 2,260,502 2,275,719

Return on Sales 5.13% 4.25% 6.96% 6.13%

Overall, three of the earnings quality measures are favorable and one is unfavorable.

Appendix E

Investments

Decision Cases (30 min.) C12-74 Req. 1

Transaction

Current Ratio

Debt Ratio

TimesInterestEarned Ratio

1 2 3 4 5 6

Increase Increase Decrease No effect Increase Decrease

Decrease Increase Increase Increase Decrease Increase

No effect No effect No effect No effect Increase No effect

Return on Equity Increase No effect Increase Decrease Increase No effect

Req. 2 Transaction

Overall Effect on the Company

1 2 3 4 5 6

Positive (due to gain) Unclear Unclear* Negative (due to loss) Positive (due to gross profit) Unclear

____ *May be negative because of decreasing assets that shrink the company.

Appendix E

Investments

(20-30 min.) C12-75 Req. 1 To reduce losses and establish profitable operations, High Peaks should take the following steps: 1. Make a dedicated effort to collect receivables and consider extending less credit to customers. Receivables make up 15.2% of assets, compared to 11.0% for the industry average. The company’s inability to collect its receivables may explain the shortage of cash (3.0% of total assets compared to 6.8% for the industry). 2. Reduce the amount of the company’s interest-bearing debt. The company’s short-term notes payable equal 17.1% of total assets, compared to 14.0% for the industry average. (Interest-bearing) longterm debt equals 19.7% of total assets, compared to 16.4% for the industry. High Peaks’s total interest-bearing debt is 36.8% of total assets, compared to only 30.4% for the industry. This debt burden causes the company to pay more interest expense than the norm for the industry (5.8% of net sales, compared to only 1.3% for the average company in the industry). The high level of interest expense drags profits down. 3. Sell higher profit-margin products. Cost of sales is 68.2% of sales, compared to 64.8% for the industry average. Consequently, gross profit is only 31.8% of net sales, which is less than the 35.2% industry average. 4. Cut operating expenses below their current level of 37.1% of sales by finding cheaper ways of doing business. The company should consider operating out of a less expensive building, spending less on advertising, laying off employees, and other cost-cutting measures to trim operating expenses. Appendix E

Investments

Ethical Issue (20-30 min.) C12-76 Req. 1 The ethical issue is:

Should Greensboro Golf reclassify its

investments from long-term to short-term? Req. 2 and Req. 3 The stakeholders in the decision are Greensboro Golf Corporation, its officers and directors, stockholders, and its current and future creditors. Economic analysis:

Reclassifying the long-term investments as

short-term will increase current assets and, therefore, increase the current ratio. Greensboro Golf’s financial position is not improved by this reclassification because the company’s asset position has not changed. However, its short-term debt paying ability will appear to be improved and thus might entice current or future creditors to loan money to the corporation that they would otherwise not lend, subjecting them to possible loan losses in the future, should Greensboro Golf prove unable to service their debt. Legal analysis: If Greensboro Golf’s management truly believes that they intend to sell the investments within a year, thus justifying reclassification of the investments to current assets, nothing illegal has happened. However, intentionally falsifying financial statements is considered illegal in all states, and is also a federal crime, with criminal or civil penalties, or both. Appendix E

Investments

(continued) C12-76 Ethical analysis: Reclassifying a long-term investment as current to meet a debt agreement does not, in itself, brand Greensboro Golf managers as unethical. The managers may have honestly intended to sell the investments in order to meet the company’s obligations. In that case, the managers took appropriate action. Req. 4 Reclassifying the investments from current back to long-term may suggest to some observers that managers are playing a shell game. However, the case states that sales subsequent to the first reclassification have improved the current ratio. Under these circumstances,

Greensboro

Golf

may

not

need

sell

the

investments. The managers may prefer to hold the investments beyond one year and, therefore, need to reclassify them as long-term. In that case, the managers’ action is appropriate. This case illustrates how gray accounting can be. Here the debt agreement depends on the current ratio, which is affected by an asset classification that managers control simply by their intentions. Because the managers’ intentions cannot be observed, it would be hard to prove that the managers are acting unethically.

Appendix E

Investments

Focus on Financials: Apple Inc. (1-2 hours) Req. 1 (in millions) 2019

2018

2019 Vertical Analysis

2018 Vertical Analysis

2019 Amount Net Sales

2018 Amount Net Sales

Dollar Horizontal Change Analysis Dollar Change 2018 Amount

$260,174

$265,595

100.00%

$(5,421)

(2.04%)

Gross Margin

$98,392

$101,839

37.82%

38.34%

$(3,447)

(3.38%)

Operating Income

$63,930

$70,898

24.57%

26.69%

$(6,968)

(9.83%)

Net Income

$55,256

$59,531

21.24%

22.41%

$(4,275)

(7.18%)

Net Sales

Based on the horizontal and vertical analyses, sales and the profit measures decreased from 2018 to 2019. Operating performance declined in

2019,

Appendix E

Investments

when

compared

2018.

(continued) Apple Inc. Req. 2 (in millions) - Assets 2019

2018

2019 Vertical Analysis

2018 Vertical Analysis

2019 Amount

2018 Amount

Dollar Change

2019 Assets

2018 Assets

2018 Amount

Dollar Change

Horizontal Analysis

Cash and Cash Equivalents

$48,844

$25,913

14.43%

7.09%

$22,931

88.49%

Marketable Securities

$51,713

$40,388

15.28%

11.04%

$11,325

28.04%

AR, net

$22,926

$23,186

6.77%

6.34%

$(260)

(1.12)%

Inventories

$4,106

$3,956

1.21%

1.08%

$150

3.79%

Vendor NonTrade Receivables

$22,878

$25,809

6.76%

7.06%

$(2,931)

(11.36)%

Other Current Assets

$12,352

$12,087

3.65%

3.30%

$265

2.19%

Total Current Assets

$162,819

$131,339

48.10%

35.91%

$31,480

23.97%

Marketable Securities

$105,341

$170,799

31.12%

46.70%

$(65,458)

(38.32)%

PPE, net

$37,378

$41,304

11.04%

11.29%

$(3,926)

(9.51)%

Other Non-current Assets

$32,978

$22,283

9.74%

6.09%

$10,695

48.0%

Total Assets

$338,516

$365,725

100.00%

$(27,209)

(7.44)%

Appendix E

Investments

(continued) Apple Inc. Req. 2 (in millions) – Liabilities & Stockholder’s Equity 2019

2018

2019 Vertical Analysis

2018 Vertical Analysis

2019 Amount

2018 Amount

Dollar Change

2019 Assets

2018 Assets

2018 Amount

Dollar Change

Horizontal Analysis

Accounts Payable

$46,236

$55,888

13.66%

15.28%

$(9,652)

(17.27)%

Other Current Liabilities

$37,720

$33,327

11.14%

9.11%

$4,393

13.18%

Deferred Revenue

$5,522

$5,966

1.63%

$(444)

(7.44)%

Commercial Paper

$5,980

$11,964

1.77%

3.27%

$(5,984)

(50.02)%

$10,260

$8,784

3.03%

2.40%

1,476

16.80%

$105,718 $115,929

31.23%

31.70%

$(10,211)

(8.81)%

$91,807

$93,735

27.12%

25.63%

$(1,928)

(2.06)%

$50,503

$48,914

14.92%

13.37%

$1,589

3.25%

$248,028 $258,578

73.27%

70.70%

$(10,550)

(4.08)%

Common Stock

$45,174

$40,201

13.34%

10.99%

$4,973

12.37%

Retained Earnings

$45,898

$70,400

13.56%

19.25%

$(24,502)

(34.80)%

$(584)

$(3,454)

(0.17)%

(0.94)%

$(2,870)

(83.09)%

$90,488 $107,147

26.73%

29.30%

$(16,659)

(15.55)%

$338,516 $365,725

100.00%

$(27,209)

(7.44)%

Term Debt Total Current Liabilities Term Debt Other Noncurrent Liabilities Total Liabilities

Accumulated OCI Total Stockholders’ Equity Total Liabilities & Equity Appendix E

Investments

(continued) Apple Inc.

Req. 2 (in millions) – Analysis The balance sheet reports that Apple increased cash and cash equivalents, and marketable securities substantially in 2019. Overall, total current assets increased 23.97%. This indicates an improvement in the company’s liquidity position. Total current liabilities decreased 8.81%, which further suggests an improvement in liquidity. Total liabilities also decreased by about $10 billion, which favorably indicates the company is paying off its debt. Common stock increased 12.37% so the company is issuing stock. Points of deterioration include: (1) a decrease in long-term assets such as property and equipment (9.51%) and long-term marketable securities (38.32%), (2) a decrease in retained earnings of 34.8%, (3) a decrease in total stockholders’ equity of 15.55%, and (4) a decrease in total assets of 7.44%. The company is not investing in property and equipment in 2019. Common stock repurchases are dragging down retained earnings and stockholders’ equity.

Appendix E

Investments

(continued) Apple, Inc. Req. 3 Line Item

Percentage Change: Dollar Amount of Change x 100 Base Year Amount

Net cash generated by operating activities Net cash generated by investing activities Net cash used in financing activities

Line Item

($69,391 – $77,434) x 100 =

(10.39)%

$77,434 ($45,896 – $16,066) x 100 =

185.67%

$16,066 ($90,976 – $87,876) x 100 =

3.53%

$87,876

Trend Percentage: 2019 Line Item x 100 2018 Line Item

Net cash generated by

$69,391 x 100 =

operating activities

$77,434

Net cash generated by

$45,896 x 100 =

investing activities

$16,066

Net cash used in

$90,976 x 100 =

financing activities

$87,876

89.61% 285.67% 103.53%

The trend percentages and percentage changes show that the net cash generated by operating activities declined slightly in 2019 whereas the Appendix E

Investments

net cash generated by investing activities increased substantially in 2019. (continued) Apple Inc. The net cash used in financing activities also increased slightly in 2019. Apple generates most of its cash from its operating activities. In 2019, Apple spent most of its cash in financing activities. In 2019, net cash used in financing activities was $90,976 million. As seen above, there was a 3.53% increase in net cash used in financing activities. Apple also spent a considerable amount of cash on investing activities involving the acquisition of marketable securities and property and equipment. In 2019, the line items on the statement of cash flows with the largest cash outflows are: Repurchases of common stock

$66,897 million

Purchases of marketable securities

$39,630 million

Dividends and dividend equivalents paid

$14,119 million

Acquisition of property and equipment

$10,495 million

Appendix E

Investments

(continued) Apple Inc. Req. 4 Earnings Quality Ratios Net income/sales Gross margin/sales Operating income/sales Operating expenses/sales

2019 21.2% 37.8% 24.6% 13.2%

2018 22.4% 38.3% 26.7% 11.6%

2017 21.1% 38.5% 26.8% 11.7%

To evaluate earnings quality, we can use return on sales, the gross margin percentage and the operating income percentage. All the profitability ratios are pretty stable but slightly declining over 2017-2019. The downward trend reflects unfavorably on earnings quality. Another measure of earnings quality is the operating expenses to sales ratio. The operating expenses to sales ratio is increasing in 2019, which also reflects unfavorably on earnings quality. Overall, all the earnings quality measures

Appendix E

are

Investments

trending

unfavorable

direction.

Focus on Analysis: Under Armour, Inc. (1-2 hours) Req. 1 (in millions) a. Ability to pay current liabilities; conflicting ratios; one improved in 2019 and one slightly deteriorated in 2019. Overall, fairly strong. Ratio

Computation

2019

2018

Interpretation

Current

CA CL

$2,702,209 $1,422,009 = 1.90

$2,593,628 $1,315,977 = 1.97

Slightly deteriorated; less liquid

Acid-test (Quick)

($788,072 + $0 +$708,714) $1,422,009 = 1.053

($557,403+ $0 +$652,546) $1,315,977 = .919

Slightly

QA CL

improved; more liquid

b. Ability to sell inventory and collect receivables; all ratios weakened in 2019. Ratio

Computation

2019

2018

Inventory Turnover

COGS Avg. Inventory

$2,796,599 $955,877

$2,852,714 $1,089,022

= 2.93

= 2.62

365

Turnover

2.93

2.62

= 124.6 days

= 139.3 days

Days Inventory Outstanding

Appendix E

Investments

Interpretation Increased slightly

Improved significantly

(continued) Under Armour, Inc. Ratio

Computation

2019

2018

Interpretation

AR Turnover

Net Sales Avg. receivables

$5,267,132 $680,630

$5,193,185 $631,108

Decreased slightly

= 7.74

= 8.23

365 7.74

365 8.23

Days Sales Outstanding

365 Turnover

AP Turnover

COGS Avg. payables

Days Payable Outstanding

365

Cash Conversion Cycle

Appendix E

Turnover

DIO +DSO -DPO

Investments

= 47.2 days

= 44.3 days

$2,796,599 $589,539 = 4.74

$2,852,714 $560,996 = 5.09

365 4.74

365 5.09

= 77 days

= 71.71 days

124.6 + 47.2 - 77

139.3 + 44.3 - 71.71

= 94.8 days

= 111.9 days

Unfavorable; lengthened

Decreased

Unfavorable; lengthened

Favorable; shortened

(continued) Under Armour, Inc. c. DuPont Analysis: Ratio

2019

2018

$92,139

$(46,302)

Net Sales

$5,267,132 =0.017

$5,193,185 =(0.009)

Asset Turnover

Net Sales Avg. assets

$5,267,132 $4,544,277 =1.159

$5,193,185 $4,125,695 =1.259

Return on Assets

ROS x Asset Turnover

0.017 x 1.159 =0.0197

(0.009) x 1.259= (0.011)

Leverage Ratio

Avg. assets Avg. equity

$4,544,277 $2,083,479 =2.18

$4,125,695 $2,017,757 =2.04

Return on Equity

Return on assets x Leverage ratio

0.0197 x 2.18 = .0429

(0.011) x 2.04 = (0.022)

Return on Sales

Computation Net Income

Interpretation

Improved

Decreased Slightly Improved

Increased Slightly

Improved

Req. 2 Students’ responses will vary for these answers. At time of printing, these figures were not available. Req. 3 Student views on this part will vary. Under Armour, Inc., is a company in the sports apparel industry. As of the end of 2019, the company was in “turnaround mode.” The world was hit by the Coronavirus pandemic in 2020, and among the hardest hit was the retail sector. As of Appendix E

Investments

(continued) Under Armour, Inc. September 30, 2020, the company had incurred cumulative losses of $733.6 million for the first nine months of the year. The outlook for Under Armour appears to be bleak given the pandemic and the company’s financial situation which has been downward trending. While there is some improvement in the financial ratios in 2019, the improvement is minimal. This is especially true for the profitability ratios. Return on assets of 1.97% and return on equity of 4.29% are very low returns. It would not be wise to purchase this company’s stock.

Appendix E

Investments

Group Projects (2-3 hours) Student responses will vary on this assignment.

Appendix E

Investments

Comprehensive Financial Statement Analysis Project (2-4 hours) The following answers come from the February 1, 2020 year end 10-K of Kohl’s Corporation. Req. 1 a. Two competitors of Kohl’s are The TJX Companies Inc and Macy’s, Inc. (Hoovers.com) b. Kohl’s Corporation operates approximately 1,159 stores, a website (www.Kohls.com), and 12 FILA outlets in the United States. Kohl’s sells moderately priced, private and national brand apparel, footwear, accessories, beauty and home products. Item 1A of Kohl’s Form 10-K lists the items the company sees as risks. Some of these factors are declines in economic conditions, decline in competitors’ prices, inability to offer merchandise inventory customers want and failure to successfully manage inventory levels, unable to source merchandise in a timely and cost-effective manner, increases in the price of merchandise, raw materials, fuel and labor could drive up the cost of goods sold, ineffective marketing, brand image could be damaged, concerns about safety of products that are sold, and inability to maintain and/or update technology platforms. c. Three of Kohl’s private brands are Apt. 9, Croft & Barrow, and Jumping Beans. d. Kohl’s largest asset is Property and Equipment, net. Its largest liability is Operating Leases.

Appendix E

Investments

e. Kohl’s has 800 million shares of common stock authorized, 375 million shares issued, and 156 million (375 million shares issued 219 million treasury shares) shares outstanding on February 1, 2020. (continued) Comprehensive Problem Kohl’s The company has 10 million shares of preferred stock authorized but has not issued any as of February 1, 2020. f. In

2019,

the

company

repurchased

treasury

stock

for

approximately $470 million. The company repurchased 8 million shares of common stock. g. Kohl’s records revenue from the sale of merchandise and shipping revenue, net of returns. Sales are recorded when merchandise is received by the customer and Kohl’s has fulfilled all performance obligations. Gift cards are only recorded as revenue when the gift cards are redeemed. h. Kohl’s uses the lower of cost or market using RIM (retail inventory method). i. Kohl’s does have business interests in foreign countries even though it does not operate outside the U.S. Some of its suppliers are located in foreign countries.

Appendix E

Investments

(continued) Comprehensive Problem Kohl’s Req. 2 (in millions) Ratio

Computation

2019

2018

Return on Sales

Net income Net sales

$691 $18,885 = 3.66%

$801 $19,167 = 4.18%

Asset Turnover

Net sales Avg. total assets

$18,885 ($14,555 + $12,469)/2 = 1.40

$19,167 ($12,469 + $13,389)/2 = 1.48

Return on Assets

Return on sales × Asset turnover

3.66% × 1.40 = 5.124%

4.18% × 1.48 = 6.1864%

($14,555 + $12,469)/2 ($5,450 + $5,527)/2 = 2.46

($12,469 + $13,389)/2 ($5,527 + $5,419)/2 = 2.36

Leverage Ratio

Avg. total assets Avg. equity

Return on Equity

Return on assets × Leverage ratio

5.124% × 2.46 = 12.61%

6.1864% × 2.36 = 14.60%

Gross Margin

Gross margin Net sales

$6,745 $18,885 = 35.7%

$6,968 $19,167 = 36.4%

Earnings Per Share

Net income – pfd. div. Avg. shares outstanding

$691- $0 157 = $4.40

$801 - $0 164 = $4.88

Appendix E

Investments

(continued) Comprehensive Problem Kohl’s From 2018 to 2019, return on sales, return on assets, return on equity, earnings per share, asset turnover, and gross margin percentage all deteriorated. But the leverage ratio increased slightly. The decline in all the profitability ratios indicates that the company’s profitability has declined to some extent. This is a disturbing result that we will have to monitor in the next few years to see if this continues. Req. 3 (in millions) Ratio

Computation

2019

2018

a. Inventory Turnover

Cost of goods sold Avg. inventory

$12,140 ($3,537 + $3,475)/2 =3.46

$12,199 ($3,475 + $3,542)/2 =3.48

Days’ Inventory

365/

365/3.46

Outstanding

Inventory turnover

= 105.5 days

365/3.48 = 104.9 days

Cost of goods sold Avg. acct. payable

$12,140 ($1,206 + $1,187)/2

$12,199 ($1,187 + $1,271)/2

=10.15

=9.93

365/ Accts. payable turnover

365/10.15 = 36.0 days

365/9.93 = 36.8 days

c. Cash Conversion Cycle

DIO – DPO

105.5 – 36.0 = 69.5 days

104.9 – 36.8 = 68.1 days

d. Current Ratio

Current assets Current liabilities

$4,649 $2,769 =1.68

$4,835 $2,730 =1.77

b. Accounts Payable Turnover

Days’ Payables Outstanding

Appendix E

Investments

(continued)

Ratio e. Quick (AcidTest) Ratio

Computation Cash + short-term investments + net current receivables Current liabilities

Kohl’s

2019

2018

723 2,769 =0.26

934 2,730 =0.34

Total liabilities Total assets

9,105 14,555 =0.63

6,942 12,469 =0.56

Income from operations

1,099

1,361

Interest expense

207 =5.31

256 =5.32

f. Debt Ratio

g.Times Interest Earned

Comp. Prob

Inventory turnover is very slow. In 2019, it took 105.5 days to sell the average inventory. In 2018, it took 104.9 days. Kohl’s’ ability to sell inventory on a timely basis is questionable. Industry averages would be helpful. In 2019, the days’ payables outstanding is 36.0 days which is close to the expected credit terms of 30 days. It appears that Kohl’s is paying most of their accounts payable on time. The current ratio of 1.68 is very strong in 2019. The quick ratio of 0.26 is low and concerning. The debt ratio is not high and is at an acceptable level of 63% in 2019. The times interest earned ratio of 5.31 in 2019 is also respectable. With the exception of the quick ratio, the liquidity at Kohl’s looks strong. Kohl’s should be able to pay their debts.

Appendix E

Investments

(continued) Comprehensive Problem Kohl’s Req. 4 a.

2019

2018

2017

2016

Net sales .........................

100%

Gross Margin ..................

35.7%

36.4%

36.0%

35.9%

Operating Income...........

5.8%

7.1%

7.4%

6.3%

Net Income......................

3.7%

4.2%

4.5%

3.0%

Gross margin and operating income decreased from 2016 to 2019. Gross margin, operating income, and net income all increased from 2016 to 2017. Operating income and net income decreased each year after 2017. Gross margin increased slightly from 2017 to 2018 and decreased from 2018 to 2019. The downward trend in the profitability measures over 2016 to 2019 is concerning, although the decline is of a small magnitude. b.

2019

2018

2017

2016

Net sales .........................

101.5% 102.8%

102.0% 100.0%

Net Income......................

124.3% 144.1%

154.5% 100.0%

Net sales increased from 2016 to 2017 and from 2017 to 2018. Net sales declined from 2018 to 2019, but still increased from 2016 to 2019. Net income quickly increased from 2016 to 2017. Net income declined yearover-year every year after 2017. However, net income had still increased from 2016 to 2019.

Appendix E

Investments

(continued) Comprehensive Problem Kohl’s Req. 5 a. The closing market price of Kohl’s stock on the trading day closest to the balance sheet date (February 1, 2020) is $42.88. The trading day closest to the balance sheet date is February 3, 2020. b. Price-earnings ratio: $42.88 / $4.40 = 9.75

Appendix E Investments

Short Exercises (10 min.) E-S-1 BALANCE SHEET Current assets: Investment in equity securities .......................................

$90,000

INCOME STATEMENT Other revenue and gains (losses): Unrealized gain on equity securities............................... Appendix E

Investments

$ 7,000*

_____ *$90,000 − $83,000 = $7,000

(10 min.) E-S-2 Req. 1 DATE

Journal ACCOUNT TITLES AND EXPLANATION

Unrealized Loss on Equity Securities ($110,000 − $88,000) Investment in Equity Securities........................... Adjusted investment to market value.

DEBIT

CREDIT

22,000 22,000

Req. 2 BALANCE SHEET Current assets: Investment in equity securities.............................................

$88,000

INCOME STATEMENT Other revenues and gains (losses): Unrealized loss on equity securities .................................... $(22,000)

Appendix E

Investments

(5-10 min.) E-S-3 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Mar. 23 Investment in Equity Securities (900 × 71,316 $79.24) .............................................................. Cash............................................................ 71,316 June 22 Cash (900 × $0.31)........................................... Dividend Revenue .....................................

279 279

(5-10 min.) E-S-4 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Dec. 31 Investment in Equity Securities [(900 × 8,001 $88.13) – $71,316]............................................ Unrealized Gain on Equity Securities...... 8,001

(5-10 min.) E-S-5 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2022 Nov. 22 Cash ................................................................. 67,050 Loss on Sale of Equity Securities ................. 12,267 Investment in Equity Securities ............... 79,317

Appendix E

Investments

(15-20 min.) E-S-6 Req. 1 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Apr. 10 Investment in Equity Securities (400 × $18) . 7,200 Cash............................................................ 7,200 July Dec.

22 Cash (400 × $1.21)........................................... Dividend Revenue .....................................

484 484

31 Unrealized Loss on Equity Securities ........... 2,300 Investment in Equity Securities ($7,200 − $4,900)……………………………………… 2,300

Req. 2 The income statement will report dividend revenue of $484 and unrealized loss on equity securities of $2,300.

Appendix E

Investments

Req. 3 ASSETS Total current assets…………………………………........

$ XXX

Long-term assets: Investment in equity securities....

4,900

Appendix E

Investments

(5-10 min.) E-S-7 Req. 1 Journal ACCOUNT TITLES AND EXPLANATION

DATE 2022 May 21 Cash (400 × $28) ........................................ Investment in Equity Securities.......... Gain on Sale of Equity Securities.......

DEBIT

CREDIT

11,200 4,900 6,300

Req. 2 This gain on sale of securities is a realized gain. The loss recorded at December 31, 2021, was unrealized because it resulted from a change in the investment’s market value, not from the sale of the investment.

Appendix E

Investments

(10-15 min.) E-S-8 Req. 1 Equity method is appropriate because the investor (Western Motors) holds a 40% investment in the investee company (Yaza Motors).

Req. 2 Journal ACCOUNT TITLES AND EXPLANATION

Equity-method Investment....................................... Cash ..................................................................... To purchase equity-method investment.

DEBIT

Millions 450 450

b. Equity-method Investment ($65 × .40) .................... Equity-method Investment Revenue ................. To record investment revenue.

Cash ($45 × .40) ........................................................ Equity-method Investment ................................. To receive cash dividend on equity-method investment.

CREDIT

Req. 3 Equity-method Investment (Amounts in millions) Purchase

450 Dividends received

Net income

Balance

458

Appendix E

Investments

(5 min.) E-S-9 Millions Sale proceeds .....................................................................

$ 135

− Carrying amount of the investment ($458 / 2)..................

(229)

= (Loss) on sale of investment .............................................

$ (94)

(10 min.) E-S-10 1. A parent company is a corporation that owns a controlling (more than 50%) interest in another company. A subsidiary company is a company that is controlled by another corporation. 2. Consolidated financial statements combine the balance sheets, income statements, statements of stockholders’ equity, and cash-flow statements of a parent company with those of its subsidiaries as if the parent and its subsidiaries were one company. 3. The parent company’s name appears on the consolidated financial statements. To consolidate, the parent company must own more than 50% of the subsidiary’s stock.

Appendix E

Investments

(5-10 min.) E-S-11 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Jan. 1 Held-to-Maturity Investment in Bonds .......... 8,000 Cash............................................................ 8,000 July

1 Cash ($8,000 × .04 × 6/12)............................... Interest Revenue........................................

160 160

(5-10 min.) E-S-12 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Jan. 1 Held-to-Maturity Investment in Bonds ($60,000 × .85)................................................. 51,000 Cash............................................................ 51,000 July

1 Cash ($60,000 × .10 × 6/12)............................. Interest Revenue........................................

3,000 3,000

(5-10 min.) E-S-13 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 July 1 Held-to-Maturity Investment in Bonds ($60,000 – $51,000)/40 interest periods) ...... 225 Interest Revenue........................................ 225 Total interest revenue = $3,000 + $225 = $3,225

Appendix E

Investments

(5-10 min.) E-S-14 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Dec. 31 Interest Receivable ($60,000 × .10 × 6/12) ....... 3, 000 Interest Revenue........................................ 3,000 31 Held-to-Maturity Investment in Bonds [($60,000 – $51,000)/40 interest periods] ..... 225 Interest Revenue........................................

225

Balance sheet reports Held-to-Maturity Investment in Bonds of $51,450 ($51,000 + $225 + $225) as a Long-term Asset. Also, the balance sheet will include the Interest Receivable of $3,000. Income statement reports Interest Revenue of $6,450 ($3,000 + $225 + $3,000 + $225).

(5-10 min.) E-S-15 Journal ACCOUNT TITLES AND EXPLANATION

DATE 2021 July 1 Interest Revenue ..................................................... Held-to-Maturity Investment in Bonds

DEBIT CREDIT 210

[($50,000 × 1.042) – $50,000]/10 interest periods.............................................................

July

1 Cash ($50,000 × .07 × 6/12) ............................... Interest Revenue........................................

Appendix E

Investments

210 1,750

1,750

Total interest revenue = ($50,000 × .07 × 6/12) – $210 = $1,540 (5-10 min.) E-S-16 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Dec. 31 Interest Receivable ($50,000 × .07 × 6/12) ....... 1, 750 Interest Revenue........................................ 1,750 31 Interest Revenue ............................................. Held-to-Maturity Investment in Bonds

210

[($50,000 × 1.042) – $50,000]/10 interest periods.............................................................

210

Balance sheet reports Held-to-Maturity Investment in Bonds of $51,680 ($52,100 – $210 – $210). Also interest receivable of $1,750. Income statement reports Interest Revenue of $3,080 [($1,750 – $210) + ($1,750 – $210)].

Appendix E

Investments

Exercises (10-15 min.) E-E-17A Req. 1 This is a short-term investment because Lancaster Corporation intends to sell the stock within a short time. It is an investment in equity securities with insignificant influence because Lancaster purchased less than 5% of Knight’s outstanding shares.

Req. 2 Dec. 15

Dec. 31

Investment in Equity Securities (500 × $40) ........................................................... Cash .................................................... Purchased investment. Investment in Equity Securities [(500 × $47) − $20,000] .......................... Unrealized Gain on Equity Securities Adjusted investment to market value.

20,000 20,000

3,500 3,500

Req. 3 BALANCE SHEET (partial) Current assets: Investment in equity securities..................................

$23,500

INCOME STATEMENT (partial) Other revenue and gains: Unrealized gain on equity securities .........................

Appendix E

Investments

$3,500

(10-15 min.) E-E-18A Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

a. Investment in Equity Securities (450 × $33).... Cash...............................................................

14,850

b. Cash (450 × $1.30) ............................................. Dividend Revenue ........................................

585

14,850

585

c. Investment in Equity Securities [450 × ($39 − $33)] 2,700 Unrealized Gain on Equity Securities......... d. Cash (450 × $28) ................................................ Loss on Sale of Equity Securities....................

12,600 4,950

Investment in Equity Securities..................

Appendix E

Investments

2,700

17,550

(15-25 min.) E-E-19A Req. 1 Stock

Cost

Fair Value

GermanaHall

(2,800 × $35.00) =

Barlengo

(590 × $45.50)

Frumley

$ 98,000

(2,800 × $28.13)

= $ 78,764

26,845

(590 × $48.00)

28,320

(1,000 × $70.00) =

70,000

(1,000 × $63.25)

63,250

Total ............................................

$194,845

................................ $170,334

Req. 2 Dec. 31

Unrealized Loss on Equity Securities ($194,845 − $170,334) ............................. Investment in Equity Securities…..

24,511 24,511

Req. 3 Income Statement (partial): Other revenues and expenses: Unrealized loss on equity securities.......................

$(24,511)

Balance Sheet (partial): ASSETS Long-term assets: Investment in equity securities ....................................

Appendix E

Investments

$170,334

(10-15 min.) E-E-20A Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

a. Equity-method Investment ............................ 1,600,000 Cash ........................................................... 1,600,000 Purchased equity-method investment. b. Equity-method Investment ($620,000 × .25). Equity-method Investment Revenue....... To record investment revenue.

155,000 155,000

c. Cash ($480,000 × .25) ..................................... 120,000 Equity-method Investment....................... 120,000 To receive cash dividend on equity-method investment. Req. 2 Ending balance in the investment account: $1,635,000 ($1,600,000 + $155,000 − $120,000)

Appendix E

Investments

(10-15 min.) E-E-21A Equity-method Investment a.

Purchase

Net income

Balance

1,600,000 c. Dividends 155,000 1,635,000

Carrying amount of investment .......................

$1,635,000

Proceeds from sale of investment ...................

(1,600,000)

Loss on sale of investment ..............................

$ (35,000)

Appendix E

Investments

120,000

(15-20 min.) E-E-22A Req. 1 The equity method is appropriate for a 30% investment in another company’s common stock. The equity method is used for 20-50% investments.

Req. 2 Balance sheet (partial): ASSETS Long-term assets: Equity-method investment.............................................

$629,000*

Income statement (partial): Other revenue Equity-method investment revenue..............................

$ 72,000

_____ *Explanation: Equity-method Investment Cost

590,000

Share of net income ($240,000 × 0.30) Balance

Appendix E

Share of dividends 72,000

($110,000 × .30)

33,000

629,000

Investments

(15-20 min.) E-E-23A Req. 1 Baytex, Inc., should use the amortized-cost method to account for the long-term investment in bonds. Req. 2 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Sept. 30 Held-to-Maturity Investment in Bonds ($35,000 × .98) ................................................. 34,300 Cash............................................................ 34,300 To purchase bond investment. Dec.

31 Interest Receivable ($35,000 × .068 × 3/12) ..... 595 Interest Revenue........................................ To accrue interest revenue.

59 5

31 Held-to-Maturity Investment in Bonds [($35,000 – $34,300) / 10 × 3/6) ...................... 35 Interest Revenue........................................ To amortize discount on bond investment.

Req. 3 Balance sheet (partial) ASSETS Current assets: Interest receivable ............................................................

Long-term assets: Held-to-maturity investment in bonds ($34,300 + $35)..................................................................

$34,335

Appendix E

595

(10-15 min.) E-E-24B Req. 1 This is a short-term investment because Amherst Corporation intends to sell the stock within a short time. It is an investment in equity securities with insignificant influence because Amherst purchased less than 5% of Hurricane’s outstanding shares.

Req. 2 Dec. 15

Dec. 31

Investment in Equity Securities (900 × $57) ........................................................... Cash .................................................... Purchased investment. Investment in Equity Securities [(900 × $58) − $51,300] .......................... Unrealized Gain on Equity Securities Adjusted investment to market value.

51,300 51,300

900 900

Req. 3 BALANCE SHEET (partial) Current assets: Investment in equity securities..................................

$52,200

INCOME STATEMENT (partial) Other revenue and gains: Unrealized gain on equity securities .........................

Appendix E

$900

(10-15 min.) E-E-25B Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT CREDIT

a. Investment in Equity Securities (420 × $35).... Cash...............................................................

14,700

b. Cash (420 × $1.90) ............................................. Dividend Revenue ........................................

798

c. Investment in Equity Securities [420 × ($37 − $35)] Unrealized Gain on Equity Securities.........

840

d. Cash (420 × $24) ................................................ Loss on Sale of Equity Securities.................... Investment in Equity Securities..................

Appendix E

14,700

798

840

10,080 5,460 15,540

(15-25 min.) E-E-26B Req. 1 Stock

Cost

Fair Value

German

(3,400 × $37.00) =

British

(630 × $47.00)

Milan

$125,800

(3,400 × $28.88)

$98,192

29,610

(630 × $49.00)

30,870

(1,400 × $76.00) =

106,400

(1,400 × $69.25)

96,950

Total ............................................

$261,810

................................ $226,012

Req. 2 Dec. 31

Unrealized Loss on Equity Securities ($261,810 − $226,012) ............................. Investment in Equity Securities…

35,798 35,798

Req. 3 Income Statement (partial): Other revenues and expenses: Unrealized (loss) on equity securities ....................

$(35,798)

Balance Sheet (partial): ASSETS Long-term assets: Investment in equity securities ....................................

Appendix E

$226,012

(10-15 min.) E-E-27B Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

a. Equity-method Investment ............................ 1,800,000 Cash ........................................................... 1,800,000 Purchased equity-method investment. b. Equity-method Investment ($660,000 × .30). Equity-method Investment Revenue....... To record investment revenue.

198,000 198,000

c. Cash ($460,000 × .30) ..................................... 138,000 Equity-method Investment....................... 138,000 To receive cash dividend on equity-method investment. Req. 2 Ending balance in the investment account: $1,860,000 ($1,800,000 + $198,000 − $138,000)

Appendix E

(10-15 min.) E-E-28B Equity-method Investment a.

Purchase

Net income

Balance

1,800,000 c. Dividends 198,000 1,860,000

Carrying amount of investment .......................

$1,860,000

Proceeds from sale of investment ...................

(1,400,000)

Loss on sale of investment ..............................

$ (460,000)

Appendix E

138,000

(15-20 min.) E-E-29B Req. 1 The equity method is appropriate for a 20% investment in another company’s common stock. The equity method is used for 20-50% investments.

Req. 2 Balance sheet (partial): ASSETS Long-term assets: Equity-method investment.............................................

$561,000*

Income statement (partial): Other revenue Equity-method investment revenue..............................

$ 54,000

_____ *Explanation: Equity-method Investment Cost

530,000

Share of net income ($270,000 × 0.20) Balance

Appendix E

Share of dividends 54,000

($115,000 × .20)

561,000

23,000

(15-20 min.) E-E-30B Req. 1 Rittex, Inc., should use the amortized-cost method to account for the long-term investment in bonds. Req. 2 Journal ACCOUNT TITLES AND EXPLANATION

DATE DEBIT CREDIT 2021 Sept. 30 Held-to-Maturity Investment in Bonds ($46,000 × .97) ................................................. 44,620 Cash............................................................ 44,620 To purchase bond investment. Dec.

31 Interest Receivable ($46,000 × .05 × 3/12) ....... 575 Interest Revenue........................................ To accrue interest revenue.

57 5

31 Held-to-Maturity Investment in Bonds [($46,000 – $44,620) / 10 × 3/6) ...................... 69 Interest Revenue........................................ To amortize discount on bond investment.

Req. 3 Balance sheet (partial) ASSETS Current assets: Interest receivable ............................................................

Long-term assets: Held-to-maturity investment in bonds ($44,620 + $69)..................................................................

$44,689

Chapter 11

The Statement of Cash Flows

575

11-1

Quiz E-Q-31

E-Q-32

E-Q-33

E-Q-34

[(1,000 × $77) + (200 × $10) + (700 × $30) = $100,000]

E-Q-35

[(1,000 x $2.20) + (200 x $1.70) + (700 x $1.20) = $3,380]

E-Q-36

E-Q-37

E-Q-38

Chapter 11

The Statement of Cash Flows

11-2

Problems (20-30 min.) E-P-39A Reqs. 1 and 2 Cash 23,000 420**

7,200*

Investment in Equity Securities 7,200* 2,400+ 4,800 Unrealized Loss on Equity Securities 2,400+

Dividend Revenue 420** _____ *1,200 × $6 = $7,200 **1,200 × $.35 = $420 +$7,200 − (1,200 × $4) = $2,400

Req. 2 Journal DATE

2021 Nov. 16

Dec. 16

ACCOUNT TITLES AND EXPLANATION

DEBIT

Investment in Equity Securities .................... Cash (1,200 × $6) ........................................ Purchased investment.

7,200

Cash (1,200 × $0.35) ....................................... Dividend Revenue ...................................... Received cash dividend.

420

Unrealized Loss on Equity Securities........... Investment in Equity Securities [$7,200 − (1,200 × $4)]............................... Adjusted investment to fair value.

2,400

Chapter 11

CREDIT

7,200

420

2,400

The Statement of Cash Flows

11-3

(continued) E-P-39A Req. 3 BALANCE SHEET Current assets: Investment in equity securities (1,200 × $4)……… $4,800

Req. 4 INCOME STATEMENT Other revenue and (expense): Dividend revenue....................................................

$ 420

Unrealized loss on equity securities ....................

(2,400)

Req. 5 Journal DATE

ACCOUNT TITLES AND EXPLANATION

2022 Jan. 14 Cash ............................................................... Investment in Equity Securities .............. Gain on Sale of Equity Securities ........... Sold investment at a gain.

Chapter 11

DEBIT

CREDIT

6,000 4,800 1,200

The Statement of Cash Flows

11-4

(20-30 min.) E-P-40A Req. 1 Current fair value is used to account for Columbus, Inc., which is considered to be an investment in an equity security. Oregon Exchange Company, the investor, expects to sell the stock at its market value. Fair value is clearly relevant to the investor’s decisions about this investment. Oregon Exchange Company purchased less than 5% of the outstanding stock of Columbus, Inc. and, thus, has insignificant influence over Columbus. The fair value method should therefore be used. Fair value is not used for the equity-method investment in Nashua Corp., because the investor holds the stock to influence the operations of the investee company, not to sell the stock. Oregon Exchange Company purchased 25% of the outstanding stock of Nashua Corp. and, thus, has significant influence over Nashua Corp. The equity method should therefore be used. `

Chapter 11

The Statement of Cash Flows

11-5

(continued) E-P-40A Req. 2 Balance sheet: ASSETS Total current assets.............................................................

XXX

Property, plant, and equipment, net...................................

XXX

Long-term assets: Equity-method investment................................................

452,614*

Investment in equity securities ........................................

30,100

Income statement: Income from operations ......................................................

XXX

Other revenue: Equity-method investment revenue ($540,000 × .25).....

135,000

Dividend revenue (1,000 × $.33).......................................

330

Unrealized (loss) on equity securities ...........................

(11,400)

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

XXX

_____

*Equity-method Investment Purchase

340,000

Net income ($540,000 × .25)

135,000

Balance

452,614

Dividends received (18,200 × $1.23)

Chapter 11

The Statement of Cash Flows

22,386

11-6

(45-60 min.) E-P-41A Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Mar. 16 Investment in Equity Securities (2,700 × $12.50) ................................................ 33,750 Cash.......................................................... 33,750 Purchased investment. May

21 Cash (2,700 × $2.25) ....................................... Dividend Revenue ................................... Received cash dividend.

6,075

Aug. 17 Cash................................................................. Equity-method Investment in Jasmine Software ................................................. Received cash dividend on equity-method investment.

83,000

Dec. 31 Equity-method Investment in Jasmine Software ($550,000 × .27) …………………. Equity-method Investment Revenue ..... To record investment revenue. 31 Investment in Equity Securities ($39,000 – $33,750)………………………………………. Unrealized Gain on Investment in Equity Securities. .............................................. Adjusted investment to market value.

Chapter 11

6,075

83,000

148,500 148,500

5,250 5,250

The Statement of Cash Flows

11-7

(continued) E-P-41A Req. 2 Equity-method Investment in Jasmine Software Jan.

Balance

618,000 Aug. 17

Dec. 31

Net income

148,500

Dec. 31

Balance

683,500

Dividends

83,000

Req. 3 Total current assets............................................................ Long-term assets: Investment in equity securities ...................................... Equity-method investment...............................................

Chapter 11

XXX

39,000 683,500

The Statement of Cash Flows

11-8

(45-60 min.) E-P-42A Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 Jan. 1 Held-to-Maturity Investment in Bonds ($2,000,000 × .96).........................................1,920,000 Cash ........................................................ 1,920,000 To purchase bond investment. July

1 Cash ($2,000,000 × .09 × 6/12).................... Interest Revenue .................................... To receive semiannual interest. 1 Held-to-Maturity Investment in Bonds [($2,000,000 − $1,920,000) / 48*] x 6......... Interest Revenue ................................... To amortize discount on bond investment.

90,000 90,000

10,000 10,000

Req. 2 Oct. 31 Interest Receivable ($2,000,000 × .09 × 4/12)............................... Interest Revenue ..................................... To accrue interest revenue. 1 Held-to-Maturity Investment in Bonds [($2,000,000 − $1,920,000) / 48*] x 4......... Interest Revenue ................................... To amortize discount on bond investment.

60,000 60,000

6,667 6,667

_____ *Amortization period: 48 months, from Jan. 1, 2021 to Jan. 1, 2025

Chapter 11

The Statement of Cash Flows

11-9

(20-30 min.) E-P-43B Reqs. 1 and 2 Cash 21,000 364**

7,800*

Investment in Equity Securities 7,800* 2,600+ 5,200 Unrealized Loss on Equity Securities 2,600+

Dividend Revenue 364** _____ *1,300 × $6 = $7,800 **1,300 × $.28 = $364 +$7,800 − (1,300 × $4) = $2,600

Req. 2 Journal DATE

2021 Nov. 17

Dec. 19

ACCOUNT TITLES AND EXPLANATION

DEBIT

Investment in Equity Securities .................... Cash (1,300 × $6) ........................................ Purchased investment.

7,800

Cash (1,300 × $0.28) ....................................... Dividend Revenue ...................................... Received cash dividend.

364

Unrealized Loss on Equity Securities........... Investment in Equity Securities [$7,800 − (1,300 × $4)]............................... Adjusted investment to fair value.

2,600

Chapter 11

CREDIT

7,800

364

2,600

The Statement of Cash Flows

11-10

(continued) E-P-43B Req. 3 BALANCE SHEET Current assets: Investment in equity securities (1,300 × $4)……… $5,200

Req. 4 INCOME STATEMENT Other revenue and (expense): Dividend revenue....................................................

$ 364

Unrealized loss on equity securities ....................

(2,600)

Req. 5 Journal DATE

ACCOUNT TITLES AND EXPLANATION

Chapter 11

DEBIT

CREDIT

6,500 5,200 1,300

The Statement of Cash Flows

11-11

(20-30 min.) E-P-44B Req. 1 Current fair value is used to account for Amsterdam, Inc., which is considered to be an investment in an equity security. Illinois Exchange Company, the investor, expects to sell the stock at its market value. Fair value is clearly relevant to the investor’s decisions about this investment. Illinois Exchange Company purchased less than 5% of the outstanding stock of Amsterdam, Inc. and, thus, has insignificant influence over Amsterdam. The fair value method should therefore be used. Fair value is not used for the equity-method investment in Exeter Corp., because the investor holds the stock to influence the operations of the investee company, not to sell the stock. Illinois Exchange Company purchased 45% of the outstanding stock of Exeter Corp. and, thus, has significant influence over Exeter Corp. The equity method should therefore be used.

Chapter 11

The Statement of Cash Flows

11-12

(continued) E-P-44B

Req. 2 Balance sheet: ASSETS Total current assets.............................................................

XXX

Long-term assets: Equity-method investment................................................

575,590*

Investment in equity securities ........................................

30,900

Property, plant, and equipment, net...................................

XXX

Income statement : Income from operations ......................................................

XXX

Other revenue: Equity-method investment revenue ($580,000 × .45)….

261,000

Dividend revenue (1,100 × $.34).......................................

374

Unrealized (loss) on investment in equity securities ....

(15,575)

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

XXX

*Equity-method Investment Purchase

340,000

Net income ($580,000 × .45) Balance

Dividends received 261,000

(21,000 × $1.21)

25,410

575,590

Chapter 11

The Statement of Cash Flows

11-13

(45-60 min.) E-P-45B Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

Mar. 16 Investment in Equity Securities (1,500 × $12.75) ................................................ 19,125 Cash.......................................................... 19,125 Purchased investment. May

21 Cash (1,500 × $2.50) ....................................... Dividend Revenue ................................... Received cash dividend.

3,750

Aug. 17 Cash................................................................. Equity-method Investment in Rockaway Software ................................................. Received cash dividend on equity-method investment.

88,000

Dec. 31 Equity-method Investment in Rockaway Software ($500,000 × .21) …………………. Equity-method Investment Revenue ..... To record investment revenue. 31 Investment in Equity Securities ($26,100 – $19,125)………………………………………. Unrealized Gain on Investment in Equity Securities. .............................................. Adjusted investment to market value.

Chapter 11

3,750

88,000

105,000 105,000

6,975 6,975

The Statement of Cash Flows

11-14

(continued) E-P-45B Req. 2 Equity-method Investment in Rockaway Software Jan.

Balance

615,000 Aug. 17

Dec. 31

Net income

105,000

Dec. 31

Balance

632,000

Dividends

88,000

Chapter 11

XXX

26,100 632,000

The Statement of Cash Flows

11-15

(45-60 min.) E-P-46B Req. 1 Journal DATE

ACCOUNT TITLES AND EXPLANATION

DEBIT

CREDIT

2021 Jan. 1 Held-to-Maturity Investment in Bonds ($1,500,000 × .95).........................................1,425,000 Cash ........................................................ 1,425,000 To purchase bond investment. July

1 Cash ($1,500,000 × .08 × 6/12).................... Interest Revenue .................................... To receive semiannual interest. 1 Held-to-Maturity Investment in Bonds [($1,500,000 − $1,425,000) / 48*] x 6......... Interest Revenue ................................... To amortize discount on bond investment.

60,000 60,000

9,375 9,375

Req. 2 Oct. 31 Interest Receivable ($1,500,000 × .08 × 4/12)............................... Interest Revenue ..................................... To accrue interest revenue. 1 Held-to-Maturity Investment in Bonds [($1,500,000 − $1,425,000) / 48*] x 4......... Interest Revenue ................................... To amortize discount on bond investment.

40,000 40,000

6,250 6,250

_____ *Amortization period: 48 months, from Jan. 1, 2021 to Jan. 1, 2025

Chapter 11

The Statement of Cash Flows

11-16

Decision Case (20-30 min.) E-C-47 1. The Ohio Office Systems investment cannot be used to generate the needed income because the appropriate way to account for this investment is the equity method. Under the equity method, Barham records dividends received not as income, but as a decrease in the investment carrying amount. 2. The bond investment cannot be used to generate the needed income because a sale of the bonds would increase net income by only $6,200, computed as follows: Sale price of the bond investment………………….. Less:

$380,000

Commission to sell ($380,000 × .01)………

(3,800)

Amortized carrying amount of the bond investment [$250,000 + ($400,000 − $250,000) × 8/10] Gain on sale of the bond investment………………..

(370,000) $

6,200

3. The Microsoft stock can be used to generate the needed income, as follows: Sale price of the investment in Microsoft stock (5,000 × $73)………………………………………… Less:

$365,000

Carrying value of the Microsoft stock

(5,000 × $54)………………………………………… Gain on sale of the Microsoft stock………………..

270,000 $ 95,000

Chapter 11

The Statement of Cash Flows

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Appendix F Time Value of Money Short Exercises (5-10 min.) F-S-1

$6,000 × .149 (PV of $1, 20 periods, 10%) = $894

$6,000 × 8.514 (PV of an ordinary annuity, 20 periods, 10%) = $51,084

(5-10 min.) F-S-2

$8,298.21

$11,808.74

EXCEL formula = PV(1.5%,36,-300) EXCEL formula = PV(1.5%,36,-300,-6000)

Chapter 11

The Statement of Cash Flows

11-18

Exercises (5-10 min.) F-E-3A $14,050.55

EXCEL formula =PV(4%,18,-525,-15000,0)

(5-10 min.) F-E-4B $10,701.97

EXCEL formula =PV(3%,8,-400,-10000,0)

Chapter 11

The Statement of Cash Flows

11-19

Quiz F-Q-5

F-Q-6

F-Q-7

($3,000 × .583)

=PV(2.5%,6,-210,-6000,0)

Chapter 11

The Statement of Cash Flows

11-20

Problems (15-20 min.) F-P-8A Req. 1 Investment Opportunity A

Year 1

Cash Flow × $11,000 ×

Factor .893

= =

PV of Cash Flow $ 9,823

6,000 ×

.797

4,782

25,000 ×

.712

17,800

$42,000

$32,405

Investment Opportunity B PV of cash flow = $14,000 × 2.402 = $33,628 Choose investment opportunity B because the present value of cash flows is higher than the present value of the cash flows from investment opportunity A.

Chapter 11

The Statement of Cash Flows

11-21

(15-20 min.) F-P-9B Req. 1 Investment Opportunity A

Year Cash Flow × 1 $10,000 ×

Factor .893

= =

PV of Cash Flow $ 8,930

13,000 ×

.797

10,361

16,000 ×

.712

11,392

$39,000

$30,683

Investment Opportunity B PV of cash flow = $13,000 × 2.402 = $31,226 Choose investment opportunity B because the present value of cash flows is higher than the present value of the cash flows from investment opportunity A.

Chapter 11

The Statement of Cash Flows

11-22

Challenge Exercises and Problem (20-25 min.) F-E-10 Req. 1 Amount of

6% Factor

Present Value

Cash Flow

from Table

of Cash Flow

$ 50,000

.943

$ 47,150

25,000

.890

22,250

55,000

.840

46,200

30,000

.792

23,760

40,000

.747

29,880

$200,000

$169,240

You should choose the option with the payments over the five years rather than the one payment of $160,000.

The present value of the

payments, $169,240, is higher than the present value of the single payment, $160,000.

Req. 2 Amount of

10% Factor

Present Value

Cash Flow

from Table

of Cash Flow

$ 50,000

.909

$ 45,450

25,000

.826

20,650

55,000

.751

41,305

30,000

.683

20,490

40,000

.621

24,840

$200,000

$152,735

If the interest rate is 10%, you should choose the single payment of $160,000 since that is higher than the present value of the payments over five years, $152,735. Copyright © 2022 Pearson Education Inc.

Chapter 11

The Statement of Cash Flows

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Chapter 11

The Statement of Cash Flows

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(continued) F-E-10 Req. 3

Total through Yr. 4 Amt. needed in Yr. 5 to bring PV to $160,000 ÷ PV factor for 5 yrs. _____

Amount of

10% Factor

Present Value

Cash Flow

from Table

of Cash Flow

$ 50,000

.909 =

$ 45,450

25,000

.826 =

20,650

55,000

.751 =

41,305

30,000

.683 =

20,490

$160,000

$51,699**

$127,895

.621

$32,105*

*$160,000 – $127,895 = $32,105 **$32,105 / 0.621 = $51,699

You would need a payment of $51,699 in Year 5 to make the present value of the five payments equal to the present value of the single payment, $160,000.

Chapter 11

The Statement of Cash Flows

11-25