SOLUTIONS MANUAL forAccounting What the Numbers Mean 13e David Marshall, Wayne McManus, Daniel Viele by StudyGuide

CHAPTER

Accounting—Present and Past

CHAPTER OUTLINE: I. What Is Accounting? A. Definition B. Uses of Accounting Information C. Classifications 1. Financial Accounting 2. Managerial Accounting / Cost Accounting 3. Auditing — Public Accounting 4. Internal Auditing 5. Governmental and Not-for-Profit Accounting 6. Income Tax Accounting II. How Has Accounting Developed? A. Early History B. The Accounting Profession in the United States C. Financial Accounting Standard Setting at the Present Time 1. Financial Accounting Standards Board 2. Standards are Evolving D. Standards for Other Types of Accounting 1. Managerial Accounting / Cost Accounting 2. Auditing 3. Governmental and Not-for-Profit Accounting 4. Income Tax Accounting E. International Accounting Standards F. Ethics and the Accounting Profession III. The Conceptual Framework A. Context B. Summary of Concepts Statement No. 8, Chapter 1 — The Objective of General Purpose Financial Reporting C. Objectives of Financial Reporting for Nonbusiness Organizations IV. Plan of the Book

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To present a definition of accounting. 2. To identify and describe different classifications of accounting. 3. To emphasize that financial accounting standards are not a “fixed code of rules,” but are established in response to user needs and business developments. Accountants need to apply professional judgment in the application of accounting principles. 4. To emphasize the role and sources of ethics for the accounting profession. Supporting: 5. To summarize how accounting has evolved over time. 6. To identify sources of standards for other types of accounting and to contrast these with financial accounting standards. 7. To introduce the issues associated with the development of international accounting standards. 8. To describe the context of the FASB Conceptual Framework project. 9. To summarize Concepts Statement No. 8, Chapter 1 — The Objective of General Purpose Financial Reporting. 10. To relate the objectives of financial reporting for nonbusiness organizations to those of business enterprises. TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. Students should be put on notice about the jargon of accounting, the use of synonymous terms, the importance of the context within which a term is used, and the need for precision in the use of terminology. The first example of jargon is the term entity. 2. When discussing "Auditing — Public Accounting," have students find the auditors' opinion in the Campbell Soup Company 2020 Annual Report (see pages 87-88 of the Appendix). Emphasize that a "clean opinion" is not a "clean bill of health." 3. Discuss the Summary of Concepts Statement No. 8, Chapter 1 — The Objective of Financial Reporting, in detail.

Instructor’s Manual / Solutions Manual 4. Assign Exercise 1-1. Encourage students to experiment with websites that are of interest. In addition, or as an alternative to having students request their own annual reports, distribute reports that have been obtained by the instructor. 5. Use Exercise 1-5 to generate discussion about the importance of ethical standards in general and independence (in both appearance and fact) in particular. Follow up with a brief look at Exercise 1-7 concerning audit independence standards.

SOLUTIONS: E1.3.

This exercise provides an opportunity to gauge where the students are in terms of their prior background in accounting, be it practical or educational, and to clear up some of the common misconceptions (i.e., to explain that accounting goes beyond the “how to” aspects of bookkeeping and involves the use of judgment).

E1.4.

This exercise provides an opportunity to align student and instructor expectations. For first-time instructors in this course, or for those having a diverse student group, you will get a glimpse at the common perceptions students have concerning the course content, level of difficulty, and methods of presentation, testing/evaluation, and grading.

E1.5.

The principal factors Jim Sandrolini must consider are his competence and independence. Is he competent to prepare financial statements for a company that operates in a different industry than the one in which he works? Accepting a contingent fee arrangement would normally cause an impairment of his independence because he would directly benefit if the loan were to be approved.

E1.6.

Suggested discussion strategy: Q: Why does a business have value? A: It provides the owners an opportunity to earn a profit, an opportunity for personal fulfillment from being in charge, and an opportunity to provide a product or service that is useful to others. Q: How can this value be measured? A: Financial information will have the most to do with evaluating the firm’s profitability, and the financial statements include this information. Q: How is an asking price for the sale of a business established? A: The asking price should be a function of the profit, resources, and obligations related to the business as shown in the financial statements. Note: This exercise also provides an opportunity to point out some of the basic limitations of the data provided by the accounting process (e.g., historical cost information — how useful are past earnings results in predicting future earnings and cash flows?). Be careful not to get too carried away with details. Let the students lead this discussion.

Instructor’s Manual / Solutions Manual

E1.7.

Answers will vary depending on the search engines used by students to locate the requested information.

E1.8.

Answers will vary depending on the company selected. Note that requirement d provides an opportunity to discuss some of the financial statement terms that are introduced in Chapter 2, for those instructors wishing to get a head start.

Instructor’s Manual / Solutions Manual

CHAPTER

Financial Statements and Accounting Concepts/Principles

CHAPTER OUTLINE: I. Financial Statements A. From Transactions to Financial Statements B. Financial Statements Illustrated 1. Explanations and Definitions a. Balance Sheet b. Income Statement c. Statement of Changes in Stockholders' Equity d. Statement of Cash Flows 2. Comparative Statements in Subsequent Years 3. Illustration of Financial Statement Relationships II. Accounting Concepts and Principles A. Schematic Model of Concepts and Principles B. Concepts/Principles Related to the Entire Model C. Concepts/Principles Related to Transactions D. Concepts/Principles Related to Bookkeeping Procedures and the Accounting Process E. Concepts/Principles Related to Financial Statements F. Limitations of Financial Statements III. The Corporation’s Annual Report

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To illustrate the four principal financial statements and their basic form. 2. To introduce students to the terminology of financial statements. 3. To present the accounting equation. 4. To explain several of the concepts of financial accounting and financial statement presentation. Supporting: 5. To explain that financial statements are the product of financial accounting and that the statements represent a historical summary of transactions. 6. To explain some of the limitations of financial statements. 7. To illustrate that the financial statements are included in the corporation’s annual report. 8. To introduce and explain several business procedures and their terminology.

TEACHING OBSERVATIONS: 1. This is the keystone chapter of the text, and the material presented here becomes a foundation for all subsequent financial accounting topics. The instructor must resist trying to teach the entire course from this one chapter! Instead, try to help students sort out the key ideas that must be learned now from those that they should be acquainted with, but that will really be learned when subsequent material is covered. Items to be learned now include: a. What a transaction is. b. The name of each financial statement and what it shows. c. The accounting equation. d. Financial statement relationships. e. Limitations of financial statements. 2. A significant amount of time should be spent illustrating and explaining the purpose and content—by account category (asset, liability, stockholders' equity, revenue, expense)—of each financial statement, and how the financial statements tie together. Some instructors may wish to discuss gains and losses at this point, but the key is to keep it as simple as possible!

Instructor’s Manual / Solutions Manual 3. It is recommended that the following models be emphasized: a. Balance Sheet: Assets Beginning of Period $ Changes During Period End of Period b. Income Statement:

+/-

= Liabilities $ +/-

+ Stockholders' Equity $ +/$

Revenues - Expenses = Net Income

c. Statement of Changes in Stockholders’ Equity:

+ + =

Beginning Balance of Stockholders' Equity Stockholders' Investment Net Income Dividends Ending Balance of Stockholders' Equity

(As with the discussion of gains and losses, some instructors may wish to acknowledge “other” sources of changes in stockholders’ equity such as treasury stock, accumulated other comprehensive income, prior period adjustments, etc. This is a function of instructor preference and the extent to which students have been previously exposed to real world financial statements. An early dose of “reality” can be refreshing for graduate students, but might be distracting to a younger, less experienced audience.) d. Statement of Cash Flows:

+/+/+/=

Net Income Net cash provided (used) by operating activities Net cash provided (used) by investing activities Net cash provided (used) by financing activities Net increase (decrease) in cash for the year

4. It is helpful to spend time with the concepts and principles model, explaining what each concept/principle means and showing how it relates to the "Transactions to Financial Statements" process. 5. It is appropriate to emphasize the limitations of financial statements now, because they can create a mindset that helps students understand more specific accounting principles when they are covered later. 6. The Business In Practice boxes are designed to enhance student understanding by removing some jargon and explanation from the flow of the text material, while providing a context for that material. These provide good class discussion topics. 2-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: This chapter provides a wide variety of assignments to choose from—ranging from the basic association-type mini-exercises and exercises, to the more challenging, analytical-type problems. Be careful not to over-assign or under-assign homework from this chapter. NO. M2.1. M2.2. M2.3.

LEARNING OBJECTIVES 2, 3 2, 3 2, 3

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 3-5 min. Med., 7-10 min.

M2.4.

2, 3

Med., 7-10 min.

M2.5. M2.6. M2.7. M2.8. E2.9. E2.10. E2.11.

2. 4 2, 4 2, 4 2, 4 2, 4 2, 4 2, 3

Easy, 3-5 min. Easy, 3-5 min. Easy, 2-3 min. Easy, 2-3 min. Easy, 3-5 min. Easy, 3-5 min. Med., 5-8 min.

E2.12. E2.13.

2, 3 2, 3

Med., 5-8 min. Easy, 3-5 min.

E2.14. E2.15.

2, 3 2, 3

Easy, 3-5 min. Med., 5-10 min.

E2.16. P2.17.

2, 3 2, 3, 6

Med., 5-10 min. Med., 7-10 min.

P2.18. P2.19.

2, 3, 6 2, 3, 4

Hard, 15-20 min. Med., 15-20 min.

P2.20. P2.21.

2, 3, 4 2, 3, 4

Med., 15-20 min. Med., 20-25 min.

P2.22. P2.23. P2.24. P2.25. P2.26. P2.27.

2, 3, 4 2, 3 2, 3, 6 2, 3, 5 2, 3, 5, 6 2, 4

Med., 20-25 min. Med., 5-8 min. Med.-Hard, 15-20. Med., 7-10 min. Med., 10-12 min. Med., 10-12 min.

P2.28.

2, 4

Med., 10-12 min.

C2.29.

2, 4, 6, 7

Med., 15-20 min.

OTHER COMMENTS Similar to E2.11.-E2.16. See M2.1. Good in-class demo exercise. Challenging mini-exercise. Requires clear-cut understanding of income statement relationships. Encourage use of Exhibit 2-2 as a solution model. See M2.3. Good way to review and reinforce the structure of the income statement in class. Emphasize the structure of the statement of cash flows. See M2.5. Good in-class demo exercise. Refer to Exhibit 2-4. Basic identification of asset accounts. Basic identification of income statement accounts. Simple account identification exercise. See E2.9. Reinforces the balance sheet equation, and stresses the distinction between PIC and RE. See E2.11. Good homework assignment. “RE is affected only by net income (loss) and dividends.” This is a bit of a fiction, but it works effectively in the Chapter 2. Other effects on retained earnings (i.e., stock dividends, certain treasury stock transactions, and prior period adjustments) are not discussed until Chapter 8. See E2.13. Good homework assignment. The worksheet format is used to help students understand financial statement relationships. Explain that “net assets” = A-L = SE. See E2.15. Good in-class demonstration exercise. Not explicitly covered in Chapter 2. Most instructors omit P.2.17. and P2.18. Can be used to emphasize the difference between cash and stockholders’ equity. See P2.17. Interesting application of the accounting equation. Straight-forward problem emphasizing financial statement relationships. Students respond well. See P2.19. Similar to P2.17., P2.186. but requires the preparation of financial statements. Good for in-class demonstration. See P2.21. Good homework assignment. Can use later as a Chapter 4 assignment. Group learning problem. Good in-class demonstration problem. Stress the importance of the historical cost principle. Group learning problem. See P2.25. Group learning problem. Emphasizes the structure of the income statement. Explain why “Other Income, net” is excluded from operating income. Excellent conceptual case but be sure to relate student responses back to the terminology introduced in the chapter.

Instructor’s Manual / Solutions Manual SOLUTIONS: M2.1. A = L + SE Beginning: $58,000 = $35,000 + ? Changes: = +11,000 net income (increase to retained earnings) -3,000 dividends (decrease to retained earnings) Ending: = + ? . Solution approach: Beginning stockholders’ equity = $58,000 - $35,000 = $23,000. Net income increases retained earnings and dividends decrease retained earnings. Retained earnings are part of stockholders’ equity, so assuming no other changes occurred during the year, ending stockholders’ equity = $23,000 + $11,000 - $3,000 = $31,000. M2.2. SE Beginning: $246,000 Changes: +30,000 common stock issued at par value (increase to paid-in capital) +36,000 net income (increase to retained earnings) -9,000 dividends (decrease to retained earnings) Ending: ? . Solution approach: No information is given about assets or liabilities, so the focus is entirely on stockholders’ equity. Beginning stockholders’ equity +/- changes during the year = ending stockholders’ equity. $246,000 + $30,000 + $36,000 - $9,000 = $303,000. M2.3. Net sales ....... ........... ........... ........... ........... ........... ........... Cost of goods sold ... ........... ........... ........... ........... ........... Gross profit .. ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses ......... ........... Income from operations ....... ........... ........... ........... ........... Interest expense ....... ........... ........... ........... ........... ........... Income before taxes . ........... ........... ........... ........... ........... Income tax expense.. ........... ........... ........... ........... ........... Net income ... ........... ........... ........... ........... ........... ...........

$400,000 ? .= 240,000 (1) $160,000 73,000 ? = 87,000 (2) ? .= 12,000 (4) $ ? = 75,000 (3) 15,000 $ 60,000

Solution approach: Set up an income statement using the structure and format as shown in Exhibit 2-2, then solve for missing amounts. One possible calculation sequence: (1) $400,000 - $160,000 = $240,000 cost of goods sold. (2) $160,000 - $73,000 = $87,000 income from operations. (3) $60,000 + $15,000 = $75,000 income before taxes. (4) $87,000 - $75,000 = $12,000 interest expense

Instructor’s Manual / Solutions Manual M2.4. Net sales ....... ........... ........... ........... ........... ........... ........... Cost of goods sold ... ........... ........... ........... ........... ........... Gross profit .. ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses ......... ........... Income from operations ....... ........... ........... ........... ........... Interest expense ....... ........... ........... ........... ........... ........... Income before taxes . ........... ........... ........... ........... ........... Income tax expense.. ........... ........... ........... ........... ........... Net income ... ........... ........... ........... ........... ........... ...........

$ ? = 300,000 (4) 120,000. $ ? = 180,000 (3) 66,000 114,000 18,000. $ ? = 96,000 (1) 24,000 $ ? . = 72,000 (2)

Solution approach: Set up an income statement using the structure and format as shown in Exhibit 2-2, then solve for missing amounts. Calculation sequence: (1) $114,000 - $18,000 = $96,000 income before taxes. (2) $96,000 - $24,000 = $72,000 net income. (3) $114,000 + $66,000 = $180,000 gross profit. (4) $180,000 + $120,000 = $300,000 net sales. An alternative calculation sequence would have been to solve for gross profit and net sales first, and to then solve for income before taxes and net income.

M2.5.

Net cash provided by operating activities .... ........... ........... 201,000 Net cash used by investing activities........... ........... ........... (168,000) Net cash provided by financing activities ... ........... ........... . 47,000 Net increase in cash for the year ..... ........... ........... ........... $80,000 Solution approach: Set up a skeletal statement of cash flows using the structure and format as shown in Exhibit 2-4, then solve for the missing amount. $201,000 - $168,000 + $47,000 = $80,000 net increase in cash for the year.

M2.6. Net cash provided by operating activities ... ........... ........... 145,000 Net cash used by investing activities........... ........... ........... (96,000) Net cash used by financing activities .......... ........... ........... . ? . = (11,000) Net increase in cash for the year ..... ........... ........... ........... $ 38,000 Solution approach: Set up a skeletal statement of cash flows using the structure and format as shown in Exhibit 2-4, then solve for the missing amount. $145,000 - $96,000 - $38,000 = $(11,000) net cash used by financing activities.

Instructor’s Manual / Solutions Manual M2.7. Common stock and retained earnings are stockholders’ equity accounts; cost of goods sold and interest expense are expenses; sales is a revenue account; long-term debt and accounts payable are liabilities. The assets listed are: land, merchandise inventory, equipment, accounts receivable, supplies, cash, and buildings.

M2.8. Sales and service revenues are revenues accounts on the income statement; income tax expense, cost of goods sold, and rent expense are expenses on the income statement. Land, equipment, accounts receivable, supplies, buildings, and cash are assets on the balance sheet; accumulated depreciation is a contra-asset on the balance sheet; notes payable is a liability on the balance sheet; and common stock is a stockholders’ equity account on the balance sheet.

E2.9. Cash…………………………………………… Accounts payable…………….……………….. Common stock………………………………… Depreciation expense………………………….. Net sales……………………………………….. Income tax expense……………………………. Short-term investments………………………... Gain on sale of land……………………………. Retained earnings……………………………… Dividends payable…………………………….. Accounts receivable…………………………… Short-term debt…………………………………

Category A L SE E R E A G SE L A L

Financial Statement(s) BS BS BS IS IS IS BS IS BS BS BS BS

Instructor’s Manual / Solutions Manual E2.10. Accumulated depreciation……………………... Long-term debt………………………………… Equipment……………………………………… Loss on sale of investments…………..………... Net income……………………………………… Merchandise inventory………………………… Other accrued liabilities………………………… Dividends paid…………………………………. Cost of goods sold……………………………… Additional paid-in capital………………………. Interest income…………………………………. Selling expenses………………………………..

Category A L A LS SE* A L SE E SE R E

Financial Statement(s) BS BS BS IS IS BS BS Neither** IS BS IS IS

* Although net income appears as a caption on the income statement, it represents an increase to retained earnings, which is a stockholders’ equity account. ** Trick question! “Dividends paid” appears only on the Statement of Changes in Stockholders’ Equity. Dividends paid are distributions of earnings that reduce retained earnings on the balance sheet. Dividends paid are not expenses, and thus do not appear on the income statement.

Instructor’s Manual / Solutions Manual E2.11. Use the accounting equation to solve for the missing information: Firm A: A = L + PIC + ( Beg. RE + NI - DIV = End. RE) $405,000 = $295,000 + $42,000 + ( $26,000 + ? - $18,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $405,000 = $295,000 + $42,000 + End. RE Retained earnings, 12/31/22 = $68,000 Once the ending balance of retained earnings is known, net income can be determined within the parenthetical portion of the expanded balance sheet equation above, which represents the statement of stockholders’ equity: $26,000 + NI – $18,000 = $68,000 Net income for 2022 = $60,000 Firm B: A = L + PIC + ( Beg. RE + NI DIV = End. RE ) $190,000 = $55,000 + ? + ( ? + $33,000 - $11,000 = $108,000 )

$190,000 = $55,000 + PIC + $108,000 Paid-in capital, 12/31/22 = $27,000 Beg. RE + $33,000 - $11,000 = $108,000 Retained earnings, 1/1/22 = $86,000 Firm C: A = L + PIC + ( Beg. RE + NI - DIV = End. RE ) $202,000 = ? + $30,000 + ( $44,000 + $71,000 - $24,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $44,000 + $71,000 - $24,000 = End. RE Retained earnings, 12/31/22 = $91,000 Once the ending balance of retained earnings is known, liabilities can be determined: $202,000 = L + $30,000 + $91,000 Total liabilities, 12/31/22 = $81,000

Instructor’s Manual / Solutions Manual Use the accounting equation to solve for the missing information: Firm A: A = L + PIC + ( Beg. RE + NI - DIV = End. RE ) $ ? = $160,000 + $110,000 + ($100,000 + 136,000 - $24,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $100,000 + $136,000 - $24,000 = End. RE Retained earnings, 12/31/22 = $212,000 Once the ending balance of retained earnings is known, total assets can be determined: A = $160,000 + $110,000 + $212,000 Total assets, 12/31/22 = $482,000 Firm B: A = L + PIC + ( Beg. RE + NI - DIV = End. RE ) $870,000 = ? + $118,000 + ( $248,000 + $220,000 - ? = $372,000 )

$870,000 = L + $118,000 + $372,000 Total liabilities, 12/31/22 = $380,000 $248,000 + $220,000 - DIV = $372,000 Dividends declared and paid during 2022 = $96,000 Firm C: A

PIC

+ ( Beg. RE +

$310,000 = $150,000 + $90,000 + (

- DIV = End. RE ) + $50,000 - $32,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $310,000 = $150,000 + $90,000 + End. RE Retained earnings, 12/31/22 = $70,000 Once the ending balance of retained earnings is known, the beginning balance of retained earnings can be determined: Beg. RE + $50,000 - $32,000 = $70,000 Retained earnings, 1/1/22 = $52,000

Instructor’s Manual / Solutions Manual

E2.13. Prepare the retained earnings portion of a statement of changes in stockholders' equity for the year ended December 31, 2022: Retained Earnings, December 31, 2021………………………………… Less: Net loss for the year ended December 31, 2022………………….. Less: Dividends declared and paid in 2022…..…………………………. Retained Earnings, December 31, 2022…………………………………

$ 453,400 (13,700) (28,300) $411,400

Retained Earnings, December 31, 2021……………………………….… Add: Net income for the year ended December 31, 2022……………….. Less: Dividends declared and paid in 2022…..………………………….. Retained Earnings, December 31, 2022………………………………….

? 67,800 (13,500) $630,900

E2.14.

Solving the model, retained earnings at December 31, 2021 was $576,600. E2.15.

Beginning: Changes: Ending:

SE . A = L + PIC + RE $67,600 = $33,000 + $ 0 + $34,600 ? = -5,000 + 0 + 20,400 (net income) ? (dividends) ? = ? + 0 + $48,000

Solution approach: (Remember that net assets = Assets - Liabilities = Stockholders’ equity = PIC + RE ). Since paid-in capital did not change during the year, assume that the beginning and ending balances are $0. Thus, beginning retained earnings = $67,600 - $33,000 = $34,600, and ending retained earnings = net assets at the end of the year = $48,000 (again, assuming ending paid-in capital = $0). By looking at the RE column, it can be seen that dividends must have been $7,000. This is calculated as: $34,600 + $20,400 = 55,000 - $48,000 = $7,000). Also by looking at the liabilities column, it can be seen that ending liabilities are $28,000, and therefore ending assets must be $76,000 which is equal to sum of the ending balances on the right-hand side of the balance sheet ($28,000 + $0 + $48,000 = $76,000). Thus, total assets increased by $8,400 during the year ($76,000 - $68,600), which is equal to the net increase on the right-hand side of the balance sheet (-$5,000 liabilities + $20,400 net income - $7,000 dividends = $8,400 net increase in assets).

Instructor’s Manual / Solutions Manual

E2.16.

Beginning: Changes:

SE A = L + PIC + ? = $160,000 + $15,000 + +33,000 = -9,000 + ? +

Ending:

RE ? ? (net income or loss) -12,000 (dividends) + $ 96,000 + ? ($215,000 total SE)

Solution approach: Ending retained earnings = $215,000 total stockholders’ equity - $96,000 paid-in capital = $119,000. Ending liabilities = $160,000 beginning liabilities - $9,000 decrease = $151,000. Thus, ending assets = $151,000 liabilities + $215,000 stockholders’ equity = $366,000. Beginning assets = $366,000 ending assets $33,000 increase = $333,000. Beginning retained earnings = $333,000 assets $160,000 liabilities - $15,000 paid-in capital = $158,000. Once the beginning and ending retained earnings balances are known, the net income or loss for the year can be determined as follows: Retained earnings, beginning ........... ........... ........... ........... ........... $158,000 Less: Net income or loss for the year ........... ........... ........... ........... ? Less: Dividends declared and paid during the year .. ........... ........... (12,000) Retained earnings, ending ..... ........... ........... ........... ........... ........... $119,000 Solving the model, the net loss of the year = $(27,000).

P2.17.

Note to Instructors: P2.17 and P2.18 are presented as interesting applications of the accounting equation. Calculating cash available upon liquidation of a business is not a learning objective of Chapter 2 and thus is not explicitly covered in the chapter. Solutions approach: Set up the accounting equation and show the effects of the transactions described. Since total assets must equal total liabilities and stockholders’ equity, the unadjusted stockholders’ equity can be calculated by subtracting liabilities from the total of the assets given. A

Accounts Plant & Stockholders’ Cash + Receivable + Inventory + Equipment = Liabilities + Equity Data given

$ 50,000 + 240,000

+ 110,000 + 500,000 = 620,000 + 280,000

Collection of accounts receivable

+216,000 - 240,000

-24,000

Inventory liquidation

+77,000

Sale of plant & equipment

+360,000

Payment of liabilities

-620,000

Balance

$ 83,000

- 110,000

-33,000 - 500,000

-140,000 -620,000

$ 83,000

*The effects of these transactions on stockholders’ equity represent losses from the sale (or collection) of the non-cash assets. 2-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

P2.18. a. The solution approach is similar to that shown in Problem 2-17. Gains or losses can be calculated for the sale (or collection) of each of Kimber Co.’s non-cash assets, as follows: Cash received upon Gain (loss) recorded and sale or collection of asset effect on Stockholders’ Equity Accounts receivable . . . . $90,000 * 80% = $ 72,000 Merchandise inventory . . $150,000 * 70% = 105,000 Buildings & Equipment . . BV^ + $60,000 = 340,000 Land. . . . . . . . . . . . . . . . . Appraised amount = 85,000 Total cash received $602,000

$90,000 * 20% = $150,000 * 30% = Amount above BV = $85,000 - $50,000 = Net gain

$(18,000) (45,000) 60,000 35,000 $ 32,000

^ $400,000 - $120,000 accumulated depreciation = $280,000 book value of buildings & equipment. The $602,000 cash received from the liquidation of non-cash assets would be added to the beginning cash balance of $30,000, and $632,000 is the amount of cash available to pay the claims of creditors and stockholders. Liabilities would be paid first (including the amounts that are not shown on the balance sheet), and the balance would be paid to the stockholders: Total cash available ... ........... ........... ........... ........... ........... $632,000 Accounts payable ...... ........... ........... ........... ........... ........... $ 80,000 Notes payable ........... ........... ........... ........... ........... ........... 110,000 Wages payable (not shown on balance sheet) ........... ........... 5,000 Interest payable (not shown on balance sheet) .......... ........... 10,000 Long-term debt .......... ........... ........... ........... ........... ........... 130,000 (335,000) Total cash available to stockholders .......... ........... ........... $297,000 The total cash available to stockholders upon liquidation can be verified, as follows: Total stockholders’ equity (unadjusted, from balance sheet) ........... Add: Gain on sale of buildings & equipment ........... ........... ........... Add: Gain on sale of land ...... ........... ........... ........... ........... ........... Less: Loss on collection of accounts receivable ....... ........... ........... Less: Loss on liquidation of merchandise inventory . ........... ........... Less: Unrecorded wages expense ...... ........... ........... ........... ........... Less: Unrecorded interest expense .... ........... ........... ........... ........... Total stockholders’ equity, as adjusted ...... ........... ........... ...........

$280,000 60,000 35,000 (18,000) (45,000) (5,000) (10,000) $297,000

A summary reconciliation is as follows: Total stockholders’ equity (unadjusted, from balance sheet) ........... Add: Net gain from liquidation of all assets (see calculations above)…. Less: Unrecorded liabilities for wages and interest………………… Total stockholders’ equity, as adjusted ...... ........... ........... ...........

$280,000 32,000 (15,000) $297,000

Instructor’s Manual / Solutions Manual

P2.18.

(continued) b. As shown in the schedule in part a), total stockholders’ equity on the balance sheet had not been adjusted for the gains and losses from the sale (or collection) of the non-cash assets; nor was it adjusted for the effects of the expense/liability accruals for wages and interest.

P2.19. a. Cash .. ........... ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... ........... Supplies ........ ........... ........... ........... ........... ........... ........... ........... Merchandise inventory .......... ........... ........... ........... ........... ........... Total current assets .... ........... ........... ........... ........... ........... ...........

$ 54,000 218,000 36,000 180,000 $488,000

b. Accounts payable ..... ........... ........... ........... ........... ........... ........... Long-term debt .......... ........... ........... ........... ........... ........... ........... Common stock........... ........... ........... ........... ........... ........... ........... Retained earnings ...... ........... ........... ........... ........... ........... ........... Total liabilities and stockholders’ equity ..... ........... ........... ...........

$138,000 240,000 70,000 370,000 $818,000

c. Net Sales ........ ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit .... ........... ........... ........... ........... ........... ........... ........... Service revenue ......... ........... ........... ........... ........... ........... ........... Depreciation expense ........... ........... ........... ........... ........... ........... Supplies expense ....... ........... ........... ........... ........... ........... ........... Earnings from operations (operating income) ........... ........... ...........

$890,000 (590,000) $300,000 120,000 (72,000) (84,000) $264,000

d. Earnings from operations (operating income) ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Earnings before taxes ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ...........

$264,000 (24,000) $240,000 (84,000) $156,000

e. $84,000 income tax expense / $240,000 earnings before taxes = 35% average tax rate f. Retained earnings, January 1, 2022 .. ........... ........... ........... ........... Net income for the year ......... ........... ........... ........... ........... ........... Dividends declared and paid during the year ........... ........... ........... Retained earnings, December 31, 2022 ......... ........... ........... ...........

? $156,000 (96,000) $370,000

Solving the model, the beginning retained earnings balance must have been $310,000, because the account balance increased by $60,000 during the year to an ending balance of $370,000.

Instructor’s Manual / Solutions Manual

P2.20. a. Cash ... ........... ........... ........... ........... ........... ........... ........... ........... $ 20,000 Accounts receivable .. ........... ........... ........... ........... ........... ........... 28,000 Merchandise inventory .......... ........... ........... ........... ........... ........... 106,000 Total current assets .... ........... ........... ........... ........... ........... ........... $ 154,000 Less: Accounts payable * ...... ........... ........... ........... ........... ........... (13,000) Current assets less current liabilities . ........... ........... ........... ........... $ 141,000 * No other current liabilities are included in the problem. b. Total current assets .... ........... ........... ........... ........... ........... ........... $ 154,000 Land ... ........... ........... ........... ........... ........... ........... ........... ........... 19,000 Equipment ..... ........... ........... ........... ........... ........... ........... ........... 10,000 Accumulated depreciation ..... ........... ........... ........... ........... ........... (3,000) Total assets .... ........... ........... ........... ........... ........... ........... ........... $ 180,000 c. Net Sales ........ ........... ........... ........... ........... ........... ........... ........... $ 310,000 Cost of goods sold ..... ........... ........... ........... ........... ........... ........... (220,000) Gross profit .... ........... ........... ........... ........... ........... ........... ........... $ 90,000 Rent expense . ........... ........... ........... ........... ........... ........... ........... (9,000) Depreciation expense ........... ........... ........... ........... ........... ........... (1,500) Earnings from operations (operating income) ........... ........... ........... $ 79,500 d. Earnings from operations (operating income) ........... ........... ........... $ 79,500 Interest expense ......... ........... ........... ........... ........... ........... ........... (4,500) Earning before taxes .. ........... ........... ........... ........... ........... ........... $ 75,000 Income tax expense ... ........... ........... ........... ........... ........... ........... (30,000) Net income .... ........... ........... ........... ........... ........... ........... ........... $ 45,000 e. $30,000 income tax expense / $75,000 earnings before taxes = 40% average tax rate f. Retained earnings, January 1, 2022 ... ........... ........... ........... ........... Net income for the year ......... ........... ........... ........... ........... ........... Dividends declared and paid during the year ........... ........... ........... Retained earnings, December 31, 2022 ......... ........... ........... ...........

? $ 45,000 (32,000) $122,000

Solving the model, the beginning retained earnings balance must have been $109,000, because the account balance increased by $13,000 during the year to an ending balance of $122,000.

Instructor’s Manual / Solutions Manual P2.21. a.

BREANNA, INC. Income Statement For the Year Ended December 31, 2022 Net Sales ........ ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit .... ........... ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses .......... ........... ........... Earnings from operations (operating income) ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Earnings before taxes ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ...........

$420,000 (280,000) $140,000 ( 59,000) $ 81,000 ( 6,000) $ 75,000 (15,000) $ 60,000

BREANNA, INC. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2022 Paid-in capital: Common stock .......... ........... ........... ........... ........... ........... $180,000 Retained earnings: Beginning balance ..... ........... ........... ........... ........... ........... $ 34,000 Net income for the year ........ ........... ........... ........... ........... 60,000 Less: Dividends declared and paid during the year ... ........... (24,000) Ending balance ......... ........... ........... ........... ........... ........... 70,000 Total stockholders’ equity ..... ........... ........... ........... ........... $250,000 BREANNA, INC. Balance Sheet December 31, 2022 Assets: Cash .. ........... ........... ........... ........... ........... ........... ........... $130,000 Accounts receivable .. ........... ........... ........... ........... ........... 40,000 Merchandise inventory .......... ........... ........... ........... ........... 54,000 Total current assets .... ........... ........... ........... ........... ........... $224,000 Equipment ..... ........... ........... ........... ........... ........... ........... 240,000 Less: Accumulated depreciation ....... ........... ........... ........... (104,000) 136,000 Total assets .... ........... ........... ........... ........... ........... ........... $360,000 Liabilities: Accounts payable ...... ........... ........... ........... ........... ........... $ 30,000 Long-term debt .......... ........... ........... ........... ........... ........... 80,000 Total liabilities........... ........... ........... ........... ........... ........... $110,000 Stockholders’ Equity: Common stock .......... ........... ........... ........... ........... ........... $180,000 Retained earnings ..... ........... ........... ........... ........... ........... 70,000 Total stockholders’ equity ..... ........... ........... ........... ........... $250,000 Total liabilities and stockholders’ equity ...... ........... ........... $360,000

Instructor’s Manual / Solutions Manual 2.21.

(continued) b. $15,000 income tax expense / $75,000 earnings before taxes = 20% average tax rate. c. $6,000 interest expense / $80,000 long-term debt = 7.5% interest rate. This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year. d. $180,000 common stock / 36,000 shares = $5 per share par value. e. $24,000 dividends declared and paid / $60,000 net income = 40%. This assumes that the board of directors has a policy to pay dividends in proportion to earnings.

P2.22. a.

SHAE, INC. Income Statement For the Year Ended December 31, 2022 Net Sales ....... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses ......... ........... ........... Earnings from operations (operating income) .......... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Earnings before taxes ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ...........

$300,000 (180,000) $120,000 (24,000) $ 96,000 (16,000) $ 80,000 (28,000) $ 52,000

SHAE, INC. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2022 Paid-in capital: Common stock ......... ........... ........... ........... ........... ........... $ 70,000 Retained earnings: Beginning balance ..... ........... ........... ........... ........... ........... $ 43,000 Net income for the year ........ ........... ........... ........... ........... 52,000 Less: Dividends declared and paid during the year .. ........... (13,000) Ending balance ......... ........... ........... ........... ........... ........... 82,000 Total stockholders’ equity..... ........... ........... ........... ........... $152,000

Instructor’s Manual / Solutions Manual P2.22. (continued) a.

SHAE, INC. Balance Sheet December 31, 2022

Assets: Cash .. ........... ........... ........... ........... ........... ........... ........... $ 64,000 Accounts receivable . ........... ........... ........... ........... ........... 40,000 Merchandise inventory .......... ........... ........... ........... ........... 88,000 Total current assets ... ........... ........... ........... ........... ........... $192,000 Buildings and equipment ...... ........... ........... ........... ........... 168,000 Less: Accumulated depreciation ....... ........... ........... ........... (72,000) 96,000 Total assets .... ........... ........... ........... ........... ........... ........... $288,000 Liabilities: Accounts payable ...... ........... ........... ........... ........... ........... $ 30,000 Accrued liabilities ..... ........... ........... ........... ........... ........... 6,000 Notes payable (long term) ..... ........... ........... ........... ........... 100,000 Total liabilities .......... ........... ........... ........... ........... ...........

$136,000

Stockholders’ Equity: Common stock ......... ........... ........... ........... ........... ........... $ 70,000 Retained earnings ..... ........... ........... ........... ........... ........... 82,000 Total stockholders’ equity..... ........... ........... ........... ........... Total liabilities and stockholders’ equity ...... ........... ...........

$152,000 $288,000

b. $28,000 income tax expense / $80,000 earnings before taxes = 35% average tax rate. c. $16,000 interest expense / $100,000 notes payable (long-term) = 16% interest rate. This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year. If large amounts of cash had been borrowed near the end of the year, then the interest rate charged on long-term debt would be greater than 16% because the average debt outstanding would have been less than $100,000. Likewise, if large repayments of long-term debt had occurred near year-end, then the interest rate was less than 16% because the average outstanding long-term debt would have been greater than $100,000. d. $70,000 common stock / 14,000 shares = $5 per share par value. e. $13,000 dividends declared and paid / $52,000 net income = 25%. This assumes that the board of directors has a policy to pay dividends in proportion to earnings.

Instructor’s Manual / Solutions Manual P2.23. a. b. c. d. e. f. g. h. i.

Assets = Liabilities + Borrowed cash on a bank loan + + Paid an account payable Sold common stock + NE Purchased merchandise inventory on account + + Declared and paid dividends NE Collected an account receivable NE NE Sold inventory on account at a profit + NE Paid operating expenses in cash NE Repaid principal and interest on a bank loan -

Stockholders’ Equity NE NE + NE NE + -

P2.24. a. August 1, 2022 totals....... ............. .............. ............. ............. August 3, borrowed $50,000 in cash from the bank ………….. New totals………………………………………………… August 7, bought merchandise inventory valued at $75,000 on account ........ ............. .............. ............. ……….. New totals .... ............. ............. .............. ............. ............. August 10, paid $25,000 cash operating expenses ...... ............. New totals .... ............. ............. .............. ............. ............. August 14, received $120,000 in cash from sales ...... ............. of merchandise that had cost $72,000 ........ ............. ............. New totals .... ............. ............. .............. ............. ............. August 17, paid $60,000 owed on accounts payable….. ........... New totals .... ............. ............. .............. ............. ............. August 21, collected $44,000 of accounts receivable…. ........... New totals ..... ............. ............. .............. ............. ............. August 24, repaid $30,000 to the bank, plus $1,000 interest ..... New totals ..... ............. ............. .............. ............. ............. August 29, paid Rudy Gandolfi a $15,000 cash dividend ........ August 31, 2022 totals..... ............. .............. ............. .............

Stockholder’s Assets = Liabilities + Equity $700,000 $500,000 $200,000 + 50,000 + 50,000 0 $750,000 $550,000 $200,000 +75,000 +75,000 0 $825,000 $625,000 $200,000 –25,000 0 –25,000 $800,000 $625,000 $175,000 +120,000 +120,000 –72,000 0 – 72,000 $848,000 $625,000 $223,000 –60,000 –60,000 0 $788,000 $565,000 $223,000 0 0 0 $788,000 $565,000 $223,000 –31,000 –30,000 –1,000 $757,000 $535,000 $222,000 – 15,000 0 –15,000 $742,000 = $535,000 + $207,000

b. Total revenues were $120,000 (from sales) and total expenses were $98,000 (which included $72,000 of cost of goods sold, $25,000 of operating expenses, and $1,000 of interest expense). Thus, net income was $22,000 ($120,000 - $98,000). Alternative calculation: Stockholder’s equity increased by $7,000 during the month of August (see answer to part c), even though a $15,000 cash dividend was declared and paid to Rudy Gandolfi. Since there were no capital stock transactions during the month, net income was $22,000. ($200,000 beginning stockholder’s equity, plus $22,000 net income, minus $15,000 dividends, equals $207,000 ending stockholder’s equity.) c. Total assets .... ........... ........... ........... Total liabilities........... ........... ........... Total stockholder’s equity ..... ...........

August 1 $700,000 500,000 200,000

August 31 $742,000 535,000 207,000

Net Change $42,000 35,000 7,000

Instructor’s Manual / Solutions Manual

P2.24. (continued) d. Rudy Gandolfi’s stockholder’s equity increased by $48,000 as a result of the sale on August 14th ($120,000 revenue - $72,000 cost of goods sold). His stockholder’s equity decreased by $25,000 for the operating expenses recorded on August 10th, by $1,000 for the interest expense recorded on August 24th, and by $15,000 for the cash dividend recorded on August 29th. In other words, his stockholder’s equity was increased by revenues, and it was decreased by expenses and dividends. e. Interest is an expense because it represents a necessary payment to others (i.e., creditors) for the use of their money—thus, it is a “cost” of doing business. Dividends are instead a distribution of profits to the owners/stockholders of the firm and thus represent a partial liquidation of the firm. A dividend is not an expense because it represents a profit distribution; it is not a “cost” of doing business. f. When money is borrowed from the bank, an asset (cash) is increased and a liability (notes payable) is also increased by an equal amount. Net income is increased only when revenue has been earned—and money borrowed from the bank represents a liability that must be repaid, not revenue that has been earned. g. Paying off accounts payable decreases an asset (cash) and decreases a liability (accounts payable) by an equal amount. Collecting an account receivable increases an asset (cash) and decreases another asset (accounts receivable) by equal amounts. In both cases, only balance sheet accounts are involved. Net income is increased by revenues and decreased by expenses. The expense associated with a cash payment of an account payable would have been recorded in an earlier transaction (when the expense was incurred and the account payable was established); by the same logic, the revenue associated with the collection of an account receivable would have been recorded in an earlier transaction (when the revenue was earned and the account receivable was established).

Instructor’s Manual / Solutions Manual P2.25. Amounts shown in the balance sheet below reflect the following use of the data given: a. An asset should have a "probable future economic benefit"; therefore the accounts receivable are stated at the amount expected to be collected from customers. b. Assets are reported at original cost, not current "worth." Depreciation in accounting reflects the spreading of the cost of an asset over its estimated useful life. c. Assets are reported at original cost, not at an assessed or appraised value. d. The amount of the note payable is calculated using the accounting equation, A = L + SE. Total assets can be determined based on items (a), (b), and (c); total stockholders' equity is known after considering item (e); and the note payable is the difference between total liabilities and the accounts payable. e. The retained earnings account balance represents the difference between cumulative net income and cumulative dividends. P2.25.

(continued) Assets: Cash ...... ............... ............... ............... $ 5,000 Accounts receivable .............. ............... 51,000 Land ...... ............... ............... ............... 75,000 Equipment ............. ............... ............... $160,000 Less: Accumulated depreciation ............ (40,000) 120,000 Total assets……………………………

$251,000

Liabilities and Stockholders’ Equity: Note payable .... ............... .............. $ 20,000 Accounts payable............. .............. 36,000 Total liabilities ............. .............. $ 56,000 Common stock ............... .............. 60,000 Retained earnings ........... .............. 135,000 Total stockholders’ equity .......... 195,000 Total liab.and stockholders’ equity.. $251,000

Instructor’s Manual / Solutions Manual P2.26. EPSICO, INC. Balance Sheets December 31, 2022 and 2021 (Amounts in thousands) Assets 2022 Current assets: Cash ....... ............... ............... $ 456 Accounts receivable .............. 1,512 Inventory ............... ............... 2,892 Total current assets ............. $4,860 Land ...... ............... ............... $ 300 Equipment ............. ............... 4,680 Less: Accum. depreciation… (2,160) Total land & equipment ...... $2,820 Total assets ............ ............... $7,680

2021

Liabilities 2022 Current liabilities: $ 360 Note payable ....... ............... ................. $ 588 1,440 Accounts payable …….………………. 1,476 2,760 Total current liabilities .... ………. … $2,064 $4,560 Long-term debt ... ............... …….… … $ 720 Total liabilities……………………… $2,784 $ 300 Stockholders’ Equity 4,500 Common stock.... ............... ……… … $2,400 (1,920) Retained earnings……………… …… 2,496 $2,880 Total stockholders’ equity. … ….… $4,896 $7,440 Total liabilities & stockholders’ equity. $7,680

2021 $ 480 1,320 $1,800 $ 960 $2,760 $2,400 2,280 $4,680 $7,440

Solution approach: 1. Retained earnings, 12/31/21 ......... ........... ........... ........... ........... ........... $2,280 Net income for 2022 (given) ........ ........... ........... ........... ........... ........... 312 Dividends for 2022 (given) .......... ........... ........... ........... ........... ........... (96) Retained earnings, 12/31/22 ........ ........... ........... ........... ........... ........... $2,496 2. Cash at 12/31/22 is $96 more than at 12/31/21. 3. Cost of equipment at 12/31/22 is $180 more than the balance at 12/31/21. 4. Land balance at 12/31/22 is the same as at 12/31/21. Fair market value is irrelevant. 5. Calculate total current assets, total land and equipment, and total assets. 6. Total assets can then be used for total liabilities and stockholders’ equity. 7. Total stockholders’ equity is calculated and added to total current liabilities. This amount is subtracted from total liabilities and stockholders’ equity to determine long-term debt. 8. Total liabilities is equal to total current liabilities plus long-term debt.

Instructor’s Manual / Solutions Manual P2.27. 2020

2019

For the years ended February 2 and 3, respectively: Net sales…...…………………...................................... Cost of sales……........………………........................... Gross profit…………………….................................... Total operating expenses……………………................ Operating income ……….……...….............................. Interest expense and other, net……………………....... Earnings before provision for income taxes.......……… Provision for income taxes………….............................. Net earnings…………………............................………

$110,225 72, 653 37,572 21,729* 15,843 1,128** 14,715 3,473 $ 11,242

$108,203 71,043 37,160 21,630* 15,530 974** 14,556 3,435 $ 11,211

* Includes the following items: Selling, general, and administrative ….……………. Depreciation and amortization……………………… Impairment loss……..……………………………….

$ 19,740 1,989 ---

$ 19,513 1,870 247

21,729

21,630

** Includes the following items: Interest and investment income ……………………. Interest expense…………………..………………… Other………………..………………………………. As at February 2 and 3, respectively: Total assets……............................................................... Total liabilities...……...................................................… Total stockholders' (deficit) equity...................................

(73) 1,201

1,128

(93) 1,051 16 974

$ 51,236 54,352 (3,116)

$ 44,003 45,881 (1,878)

Instructor’s Manual / Solutions Manual P2.28. a. Net sales ........ ........... ........... ........... ........... ........... Cost of sales .. ........... ........... ........... …………….. Gross profit .... ........... ........... ........... ........... ........... Gross profit/net sales . ........... ........... ........... ...........

2020 $274,515 (169,559) $104,956 38.2%

2019 $260,174 (161,782) $ 98,392 37.8%

Apple was able to achieve amazingly high sales growth rates for more than a decade since the introduction of the iPod in 2001, and in subsequent years with the introduction of the iPhone in 2007 and iPad in 2010. The company has now grown to a size and scale of operations where it has become difficult to maintain high sales growth rates on a percentage basis, although in absolute terms the $14.3 billion increase in net sales from 2019 to 2020 is still a remarkable achievement. The 0.4% increase in the gross profit/net sales ratio during the year ended September 26, 2020 was not terribly significant. For your reference, here is Apple’s remarkably consistent 5-year trend for these data: 2020 2019 2018 2017 2016 Net sales ........ ........... $274,515 $260,174 $265,595 $229,234 $215,639 Cost of sales .. ........... (169,559) (161,782) (163,756) (141,048) (131,376) Gross profit .... ........... $104,956 $ 98,392 $101,839 $ 88,186 $84,263 Gross profit/net sales . 38.2% 37.8% 38.3% 38.5% 39.1% b. Gross profit (from part a above) ....... ........... ........... Research and development expenses ........... ........... Selling, general, and administrative expenses .......... Operating income ...... ........... ........... ........... ...........

2020 $104,956 18,752 19,916 $66,288

2019 $98,392 16,217 18,245 $63,930

Operating income/net sales ... ........... ........... ...........

63.2%

65.0%

Operating income as a percentage of net sales decreased slightly (by only 1.8%) during the fiscal year ended on September 26, 2020, which reflects well on Apple’s consistency of operations and predictability of earnings. It’s also worth noting that Apple’s results for this measure are extraordinarily high relative to most companies due to their economies of scale and relative price inelasticity. c. Operating income (from part b above) ......... ........... Other income, net ..... ........... ........... ........... ........... Income before provision for income taxes .... ........... Provision for income taxes .... ........... ........... ........... Net income .... ........... ........... ........... ........... ...........

2020 $66,288 803 $67,091 (9,680) $57,411

2019 $63,930 1,807 $65,737 (10,481) $55,256

Solution approach: The “Income before provision for income taxes” (income before taxes) line has been added to emphasize the importance of understanding the difference between operating items and non-operating items on the income statement. The problem could be solved without calculating this number.

Instructor’s Manual / Solutions Manual C2.29. In parts a, b and d, if students are willing to share the different kinds of assets, liabilities, revenues, expenses, and cash flows they have identified, this case can be used to review the basic characteristics of the balance sheet, income statement, and statement of cash flows. In part c, the point is that projected income activity for the current period has a direct impact on the projected balance sheet. In part e, the point is that income and cash flow are two different things entirely. Possible explanations might include: •

Receipt of student loan proceeds (or scholarships, grants) towards the end of the semester.

•

Certain costs of attending college (i.e., tuition, room and board, meal plans) might be incurred by the student, but not yet paid.

•

A student may be employed on a part-time (or full-time) basis throughout the semester, which may generate more cash flow than she was able to accumulate during the summer preceding the fall semester.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ —CHAPTER 2

NAME______________________

Presented below is the Statement of Cash Flows for Marstore, Inc., for the year ended December 31, 2022. Also shown is a partially completed comparative balance sheet as of December 31, 2022 and 2021. MARSTORE, INC. Statement of Cash Flows For the Year Ended December 31, 2022 Cash flows from operating activities: Net Income ......... ........... ........... ........... ........... ........... ........... ........... $ 23,000 Add (deduct) items not affecting cash: Depreciation expense .. ........... ........... ........... ........... ........... ........... 6,000 Decrease in accounts receivable.......... ........... ........... ........... ........... 8,000 Decrease in accounts payable.. ........... ........... ........... ........... ........... (6,000) Net cash provided by operating activities ........... ........... ........... ........... $31,000 Cash flows from investing activities: Purchase of store fixtures ........... ........... ........... ........... ........... ...........

$(4,000)

Cash flows from financing activities: Repayment of long-term debt...... ........... ........... ........... ........... ........... $ (2,000) Payment of cash dividends on common stock .... ........... ........... ........... (5,000) Net cash used by financing activities ...... ........... ........... ........... ........... $(7,000) Increase in cash for the year ........ ........... ........... ........... ........... ........... $20,000 MARSTORE, INC. Balance Sheets December 31, 2022 and 2021 2022 2021 2022 2021 Current assets: Cash…………………….. $ 37,000 $______ Accounts payable……. $ ______ $18,000 Accounts receivable…….. ______ 39,000 Long-term debt………. 18,000 ______ Total current assets….. $ $ Total liabilities…….. $ ______ $______ Store fixtures…………… $______ $ 24,000 Common stock………. $ ______ $ 20,000 Less: Accumulated Retained earnings…….. ______ ______ depreciation………….. (13,000) ______ Total s’holders’ equity $ ______ ______ Net store fixtures……….. $______ $______ Total liabilities and Total assets……………… $______ $______ s’holders’ equity…… $ ______ $______

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ —CHAPTER 2 (continued) 1. Complete the balance sheets for Marstore, Inc., at December 31, 2022 and 2021. Identify your strategy by listing, in general, the sequence of steps you used to find the unknown amounts.

2. Does the amount shown on the balance sheet for Net Store Fixtures represent the current fair market value of the store fixtures? Explain your answer.

3. Prepare a Statement of Changes in Retained Earnings for the year ended December 31, 2022.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY—CHAPTER 2 1. • Use information in the statement of cash flows to determine either the beginning or ending amounts for assets and liabilities. For example, accounts receivable decreased $8,000, so at the end of 2022 the balance was $31,000. • Based on total assets and total liabilities at the beginning and end of the year, determine total stockholders' equity at each date. • Using total stockholders' equity at the end of 2021, solve for retained earnings at that date. • The cash flows from financing activities on the statement of cash flows does not show any cash from the sale of additional stock, so the ending balance is the same as the beginning balance. Knowing this, retained earnings at the end of the year can be determined. • Or, use information about net income and dividends from the statement of cash flows, and the beginning balance of retained earnings (as determined above) to calculate ending retained earnings. Then, capital stock at the end of the year can be determined. MARSTORE, INC. Balance Sheets December 31, 2022 and 2021 2022 Current assets: Cash…………………… $37,000 Accounts receivable…… 31,000 Total current assets…. $68,000 Store fixtures………….. $28,000 Less: Accumulated depreciation………… (13,000) Net store fixtures……… $15,000 Total assets……………. $83,000

2021

2022

2021

$17,000 Accounts payable…….. $12,000 $18,000 39,000 Long-term debt………. 18,000 20,000 $56,000 Total liabilities……….. $30,000 $38,000 $24,000 Common stock……….. $20,000 $20,000 Retained earnings……. 33,000 15,000 (7,000) Total s’holders’ equity.. $53,000 $35,000 $17,000 Total liabilities and $73,000 s’holders’ equity…... $83,000 $73,000

2. No. The balance sheet shows the original cost of assets, less accumulated depreciation, which for accounting purposes is that portion of the cost of the asset that has been "used up." 3. Retained earnings, 12/31/21 ........ ........... ........... ........... ........... ........... ........... Add: Net income for the year ...... ........... ........... ........... ........... ........... ........... Less: Dividends declared and paid .......... ........... ........... ........... ........... ........... Retained earnings, 12/31/22 ........ ........... ........... ........... ........... ........... ...........

$15,000 23,000 (5,000) $33,000

Instructor’s Manual / Solutions Manual

CHAPTER

Fundamental Interpretations Made From Financial Statement Data

CHAPTER OUTLINE: I. Financial Ratios and Trend Analysis A. Company Data Over Time B. Company Data Compared to Industry Data Over Time II. Return on Investment A. Significance B. Method of Calculating III. The DuPont Model—An Expansion of the ROI Calculation A. Margin and Turnover B. Significance of Model C. Rules of Thumb for ROI, Margin, and Turnover IV. Return on Equity and Rules of Thumb V. Working Capital and Measures of Liquidity A. Working Capital B. Current Ratio C. Acid-test Ratio D. Rules of Thumb for Current Ratio and Acid-test Ratio VI. Illustration of Trend Analysis A. Profitability and Liquidity Data B. Return on Investment and Return on Equity C. Margin and Turnover D. Working Capital and Current Ratio

Instructor’s Manual / Solutions Manual

PEDAGOGICAL NOTES: Chapter 3 introduces students to some fundamental financial statement analysis concepts that provide a framework for their understanding of financial accounting as they proceed through Chapters 4-10. Chapter 11 presents a comprehensive explanation of how to use financial statement data, including a full complement of financial ratios as well as common size analysis. Many instructors prefer to defer coverage of the ROI, ROE, and liquidity measures until students have a better understanding of financial accounting concepts, and therefore assign Chapters 3 and 11 concurrently. In our experience, front-loading profitability and liquidity measures in Chapter 3 has proven successful in the following ways: 1) it introduces students to the “big picture” of real-world financial reporting before they get caught up in accounting details, 2) it shows students the relevance of studying financial accounting, 3) it provides students with a perspective that can be used in subsequent chapters and homework assignments, and 4) it encourages students—early on—to think about the impact of transactions on the financial statements. Some instructors also cover the concept of financial leverage (including the debt ratio and the debt/equity ratio) when Chapter 3 is assigned—to emphasize the “magnification effect” that long-term debt has on ROE. In our opinion, this approach should be used with caution—while this provides an opportunity to emphasize the importance of a firm’s capital structure, and the risks/rewards of borrowing, it may be too much too soon for many students.

TEACHING/LEARNING OBJECTIVES: Principal: 1. To explain the return on investment (ROI) calculation, its significance as a measure of investment performance, and to emphasize that the expanded (DuPont) model using margin and turnover focuses on the two key components of investment performance—profitability and utilization of assets. 2. To explain the return on equity (ROE) calculation, and the significance of ROE. 3. To explain the calculation and significance of working capital, the current ratio, and the acid-test ratio. 4. To provide some broad "rules of thumb" so students can form a perspective about the ratio measurements of specific companies. Supporting: 5. To introduce some of the interpretations of financial statement data made by users to support their decisions and informed judgments.

Instructor’s Manual / Solutions Manual 6. To emphasize that trends of ratios are significant, and that ratio measurements at a single point in time are not very descriptive without reference to an external benchmark. 7. To illustrate trend analysis using the measurements introduced in this chapter.

TEACHING OBSERVATIONS: 1. In our opinion, the return on investment concept is one of the most important ideas that students should understand about business operations. The ROI concept (using the DuPont model) should be emphasized as a key tool for evaluating the results of any business activity. The concept is introduced at this early point in the text because it is so important, and because it represents a key use of financial statement data. The ROI concept provides a context within which students will be able to evaluate the effects of alternative accounting methods as they are discussed in later chapters. Frequent reference is made to the ROI concept throughout the text with the assumption that the reader understands its significance. 2. The DuPont model can be used to contrast the profitability components of two or more industries that achieve comparable total profitability. For example: Grocery stores Heavy equipment manufacturers Retail jewelry outlets

Margin 1% 15% ?

* * *

Turnover = ROI 15 = 15% 1 = 15% ? ?

Get students involved in the discussion by asking them to make educated guesses about the industry averages for margin and turnover in the jewelry and computer industries. Balance sheet components affecting turnover can easily be identified by most students—but be sure to emphasize that the denominator used in the turnover (and ROI) calculation is average total assets—and not just inventory! Ask them, “Which of the firm’s assets really turn-over, as such?” Point out to students that manufacturers make substantial investments in long-term assets (such as property, plant, and equipment) that—although productive—are not expected to turn over. Thus, the firm’s gross margin from selling inventory will be substantially higher than its overall profit margin (which is what “margin” in the ROI calculation represents). Ask them to find and compare the gross margin and net income amounts in Campbell’s 2020 income statement. This should help them to understand the importance of earning a return on all assets employed by the firm. 3. The impact on an industry that achieves above average profitability can be used to illustrate the cyclical pattern of industry profitability over time. When industry profits are unusually high, more firms enter the industry. This leads to increased competition, which leads to lower ROI, which leads to a shakeout, which leads to less competition, which leads to rising ROI. Students' economic literacy can be increased by comparing the ROI for specific companies with the rules-of-thumb given in the text. Case 3-26 (Apple Inc.) provides an opportunity to illustrate this point, or you may wish to assign Case 3-25, which allows each student to evaluate the focus company that they selected in Exercise 1-1.

Instructor’s Manual / Solutions Manual 4. It should be emphasized that financial statements are the sources of data used in these ratios. As such, students should be alerted to the impact on the data and ratios of generally accepted accounting principles that have already been introduced (e.g., original cost principle, unit of measurement assumption). In other words, the quantitative results of ratio analysis should be interpreted with a basic understanding of the limitations of financial statement data (as discussed in Chapter 2).

ASSIGNMENT OVERVIEW: NO. M3.1. M3.2. M3.3. M3.4. M3.5 M3.6. M3.7. M3.8. E3.9. E3.10. E3.11. E3.12. E3.13. E3.14. E3.15.

L.O. 3 3 4 3, 4 6 6 6 6 2 2 2 2 3 3 4

LEVEL AND TIME Easy, 5-7 min. Easy, 5-7 min. Med., 5-8 min. Med., 5-8 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Med., 5-8 min. Med., 7-10 min. Med., 7-10 min. Med., 7-10 min. Easy, 3-5 min.

OTHER COMMENTS Quick in-class exercise to reinforce DuPont model. See M3.1. Students must calculate the average stockholders’ equity before ROE. Give students hint: “Divide sales by turnover for average total assets.” Straightforward working capital and current ratio exercise. See M. 3.5. Identification of current asset and current liability accounts. See M.3.7. Practical way to introduce the risk / return tradeoff. See E3.8. Emphasizes that ROI should exceed the cost of debt. See E3.11. Good homework assignment for basic spreadsheet skills. Good in-class demonstration of ROI using the DuPont model. See E3.13. Good homework assignment. Explain “net assets” as, NET ASSETS = A - L = SE.

E3.16. E3.17.

3, 4 6

Med., 5-10 min. Med., 7-10 min.

E3.18. P3.19.

6 3, 4, 6

Med., 7-10 min. Easy, 10-12 min.

P3.20. P3.21.

3, 4, 6 6

Med., 15-20 min. Easy, 5-8 min.

P3.22. P3.23.

6 3

Easy, 5-8 min. Med., 8-12 min.

P3.24.

Med.-Hard, 20-30 min.

C3.25.

3, 4, 6, 7

Med.-Hard, 20-40 min.

C3.26.

3, 4, 6, 7

Med.-Hard, 20-40 min.

See E3.15. Good homework assignment. Shows how liquidity measures can be manipulated. Can be used to emphasize the importance of accounting ethics and/or ratio trends. See E3.17. Straight-forward problem using Campbell’s financial statement data. Students respond well if supported with current data from Value Line or Bloomberg’s showing 5-year trends. Straight-forward. Good in-class demonstration problem. Shows that liquidity measures may send conflicting messages, and that cash and net income are not directly related. See P3.21. Good homework assignment. The key to part b is to see that the “investment” amount is reduced. Give this as a hint. Practical way to emphasize the importance of margin and turnover. Spreadsheet skills problem. Parts c-e can be used to generate class discussion, and to point out the importance of qualitative factors. Explain to students that C3.25. is the first of a series of short case assignments that require them to do some basic calculations and a “big picture” analysis of their focus company. Excellent capstone case. Optional continuation provides an opportunity for a good discussion of trend analysis without getting bogged down in computational details.

Instructor’s Manual / Solutions Manual SOLUTIONS: M3.1. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN

TURNOVER

NET INCOME SALES

SALES AVERAGE TOTAL ASSETS

$124,800 net income / $960,000 sales = 13% margin $960,000 sales / $640,000 average total assets = 1.5 turnover 13% margin * 1.5 turnover = 19.5% ROI, or $124,800 net income / $640,000 average total assets = 19.5% ROI M3.2. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN

TURNOVER

NET INCOME SALES

SALES AVERAGE TOTAL ASSETS

$4,000,000 sales * 9% margin = $360,000 net income $4,000,000 sales / 1.6 turnover = $2,500,000 average total assets 9% margin * 1.6 turnover = 14.4% ROI, or $360,000 net income / $2,500,000 average total assets = 14.4% ROI M3.3. Solution approach: Net assets = Assets – Liabilities = Stockholders’ Equity Thus, “net assets” at the end of the year = ending SE ROE = Net income / Average stockholders' equity Average stockholders’ equity = (beginning SE + ending SE) / 2 Thus, you need to calculate beginning stockholders’ equity in order to be able to determine the average stockholders’ equity. $660,000 ending SE - $162,000 net income + $42,000 dividends = $540,000 beginning SE ($540,000 beginning SE + $660,000 ending SE) / 2 = $600,000 average stockholders’ equity $162,000 net income / $600,000 average stockholders’ equity = 27% ROE

Instructor’s Manual / Solutions Manual

M3.4. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN

TURNOVER

NET INCOME SALES

SALES AVERAGE TOTAL ASSETS

$840,000 sales / 1.4 turnover = $600,000 average total assets $840,000 sales * 11% margin = $92,400 net income 11% margin * 1.4 turnover = 15.4% ROI, or $92,400 net income / $600,000 average total assets = 15.4% ROI $92,400 net income / $400,000 average stockholders' equity = 23.1% ROE

M3.5. $169,000 current assets / 2.6 current ratio = $65,000 current liabilities $169,000 current assets - $65,000 current liabilities = $104,000 working capital

M3.6. $56,000 current liabilities * 3.5 current ratio = $196,000 current assets $196,000 current assets - $56,000 current liabilities = $140,00 working capital M3.7. $11,000 cash + $19,000 accounts receivable + $26,000 inventory = $56,000 current assets $24,000 accounts payable + $16,000 other accrued liabilities = $40,000 current liabilities $56,000 current assets - $40,000 current liabilities = $16,000 working capital $56,000 current assets / $40,000 current liabilities = 1.4 current ratio

M3.8. $9,000 cash + $17,000 accounts receivable + $31,000 inventory = $57,000 current assets $16,000 accounts payable + $14,000 short-term debt = $30,000 current liabilities $57,000 current assets - $30,000 current liabilities = $27,000 working capital $57,000 current assets / $30,000 current liabilities = 1.9 current ratio

E3.9. a.

Amount of return ROI = Amount invested

$700 Simone: $5,000 = 14%

$780 Riley: $6,000 = 13%

Simone's investment is preferred because it has the higher ROI. b. Risk is a principal factor to be considered.

Instructor’s Manual / Solutions Manual

E3.10. a. Interest earned on the savings account: $5,000 * 3% * 6/12 = $75.00 b. Interest earned on loan to Victor: ($5,300 amount repaid - $5,000 loan) = $300.00 Rate of return for 6 months is $300 / $5,000 = 6% Rate of return on an annual basis = 6% * 2 = 12% c. The loan to Victor promises a much higher return than the rate earned on the savings account (12% versus 3%), but this may not be enough to compensate your friend for the risks and inconveniences involved with an unsecured personal loan. Query: Does Victor have a good credit history? Will he repay the 5,300 as promised? Will his repayment be on time? Will your friend incur any collection expenses? Is your friend willing to “tie up” his money for six months and lose the convenience of his bank (demand deposit) account?

E3.11. Solution approach: Calculate the amount of return from each alternative, then calculate the ROI of the additional return from the higher-yielding investment relative to the $3,000 that must be invested to get the higher amount of return. ROI * amount invested = amount of return Alternative # 1: 9% * $12,000 = $1,080 return Alternative # 2: 12% * $15,000 = $1,800 return The extra amount of return of $720 on an additional investment of $3,000 is an ROI of 24%. ($720 / $3,000 = 24%). Therefore, you should advise your friend not to pay an interest rate of more than 24% to borrow the additional $3,000 needed for the higher-yielding investment.

Instructor’s Manual / Solutions Manual

E3.12. a. $25,000 * 3% = $750 return b. Return on $30,000 at 6% = $1,800 Cost of $5,000 at 12% = $600 Net return = $1,800 – $600 = $1,200 c. Net return / Investment = ROI $1,200 / $25,000 = 4.8% d. Solution Approach: A “prudent investor” would be wise to take the following factors into consideration before choosing between alternative investment opportunities: 1. How long is the investing horizon of each investment? In this case, both investments were for one year. If this were not the case, the rate of return calculation would have to be "annualized" before a valid comparison could be made between the alternative investments. Rate of Return = Principal x Interest x Time. 2. How flexible is the investment? In this case, the savings account would be more flexible than the certificate of deposit because money can be withdrawn (or deposited) on a day-today basis in a savings account without penalty. 3. What is the relative risk of each investment? In this case, both investments would be considered "risk free" (i.e., certain) because bank savings accounts and certificates of deposit are both backed by the FDIC. If one of the investments were riskier than the other (i.e., an investment in a start-up corporation's common stock), then a prudent investor would demand a higher rate of return on the riskier investment as compensation for the additional risk inherent in the investment. 4. How does each alternative investment fit within the investor's investing objectives? Different people invest for different reasons. A young couple in their 20's or 30's may wish to save for their retirement or for the college education of their children. As such, they would be more inclined to invest in a "growth" portfolio than would be a couple in their 60's or 70's who would be more likely to invest in an "income" oriented portfolio. Subjective factors may also be taken into account, such as level of "social responsibility" taken on by each of the companies whose stock is being considered for investment.

Instructor’s Manual / Solutions Manual

E3.13. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN NET INCOME SALES

TURNOVER

SALES AVERAGE TOTAL ASSETS

a. 19.6% ROI = (7% Margin * Turnover) Turnover = (19.6% ROI / 7% Margin) = 2.8 Average total assets = ($980,000 Sales / 2.8 Turnover) = $350,000 b. ROI = ($259,200 Net income / $1,800,000 Average total assets) = 14.4% 0.9 Turnover = (Sales / $1,800,000 Average total assets) Sales = $1,620,000 Margin = ($259,200 Net income / $1,620,000 Sales) = 16% ROI = (16% Margin * 0.9 Turnover) = 14.4% c. 12.6% ROI = (Margin * 1.4 Turnover) Margin = 9% 9% Margin = ($45,360 Net income / Sales) Sales = $504,000 1.4 Turnover = ($504,000 Sales / Average total assets) Average total assets = $360,000

E3.14. a. Margin = ($54,000 Net income / $1,200,000 Sales) = 4.5% Turnover = ($1,200,000 Sales / $750,000 Average total assets) = 1.6 ROI = (4.5% Margin * 1.6 Turnover) = 7.2% b.

Margin * Turnover = ROI ($132,000 Net income / $2,200,000 Sales) * Turnover = 9.6% ROI (6% Margin * Turnover) = 9.6% ROI Turnover = 1.6 1.6 Turnover = ($2,200,000 Sales / Average total assets) Average total assets = $1,375,000

Instructor’s Manual / Solutions Manual E3.14. (continued) c. (Net Income / $1,500,000 Average total assets) = 12% ROI Net Income = $180,000 0.8 Turnover = (Sales / $1,500,000 Average total assets) Sales = $1,200,000 Margin = ($180,000 Net income / $1,200,000 Sales) Margin = 15% 12% ROI = (Margin * 0.8 Turnover) Margin = 15%

E3.15. Remember that "net assets" is the same as "stockholders' equity". Beginning net assets... ........... ........... ........... ........... ........... Add: Net income ........ ........... ........... ........... ........... ........... Less: Dividends.......... ........... ........... ........... ........... ........... Ending net assets ........ ........... ........... ........... ........... ...........

$492,600 70,200 (15,400) $547,400

ROE = Net income / Average stockholders' equity = $70,200 / (($492,600 + $547,400) / 2) = 13.5%

E3.16. a. 12.6% ROI / 2.8 Turnover = 4.5% margin Sales $120,000,000 * 4.5% margin = $5,400,000 net income b. $5,400,000 Net income / $25,000,000 Average stockholders' equity = 21.6%

E3.17. a. Current assets .......... ........... ........... ........... Current liabilities .... ........... ........... ........... Working capital....... ........... ........... ........... Current ratio ........... ...........………. ..........

Do Not Prepay Accounts Payable $300,000 (200,000) $100,000 1.5

Prepay Accounts Payable $225,000 (125,000) $100,000 1.8

Payment of the accounts payable does not affect working capital, but does improve the current ratio. Is this balance sheet "window dressing" worth the opportunity cost of not being able to invest the cash? Remember, once the payment is made, the cash is in someone else’s hands.

Instructor’s Manual / Solutions Manual

E3.17. (continued) b. Current assets ........... ........... ........... ........... Current liabilities ..... ........... ........... ........... Working capital........ ........... ........... ........... Current ratio . ........... ........... ...........………

Without Loan $300,000 (200,000) $100,000 1.5

With Loan $350,000 (250,000) $100,000 1.4

If the loan is taken after the end of the fiscal year, the current ratio on the year-end balance sheet will be higher than if the loan is taken before the end of the year. Working capital is not affected. Thus, it makes sense to wait until after the end of the year to borrow on a short-term basis, unless cash is needed immediately.

E3.18. a. 2.1 Current ratio = (Current assets / $275,000 Current liabilities) Current assets = $577,500 Working capital = $577,500 Current assets - $275,000 Current liabilities = $302,500 b. Both current assets and current liabilities would be $27,500 greater at April 30, if the payment on April 29 had not been made. Working capital = ($577,500 + $27,500) - ($275,000 + $27,500) = $605,000 - $302,500 = $302,500 Current ratio = $605,000 / $302,500 = 2.00 c. Working capital at April 30 is not affected because both current assets and current liabilities decreased by the same amount when the $27,500 payment was made on April 29. However, the current ratio was increased (from 2.0 to 2.1) as a result of the payment because the proportion of current assets to current liabilities changed. When the current ratio is greater than 1.0, any payments of accounts payable will increase the ratio because the denominator is decreased proportionately more than the numerator is decreased.

Instructor’s Manual / Solutions Manual

P3.19. a. ROI = Margin * Turnover = (Net earnings attributable to Campbell Soup Company / Net sales) * (Net sales / Average total assets) = ($1,628 / $8,691) * ($8,691 / (($13,148 + $12,372) / 2)) = (18.7% Margin * 0.68 turnover) = 12.7% Note that a rounding error is introduced in by solving for ROI indirectly (Margin * Turnover) rather than directly: ROI = (Net earnings attributable to Campbell Soup Company / Average total assets) = $1,628 / (($13,148 + $12,372) / 2) = 12.8% For purposes of this problem, either answer is acceptable. b. ROE = Net earnings attributable to Campbell Soup Company / Average Campbell Soup Company shareholders' equity = $1,628 / (($1,103 + $2,563) / 2) = 88.8% Note: In the text, ROE in 2020 for Campbell’s is shown as 88.5% (see Table 3.1). The difference in results of 0.3% (88.8% - 88.5%) is attributable to the definition used for the denominator in P3.19. (average Campbell Soup Company shareholders’ equity) versus that used in Table 3.1 (average total equity). c. Working capital = Current assets - Current liabilities Current assets ......... ........... ........... ........... ........... ........... - Current liabilities .... ........... ........... ........... ........... ........... = Working capital ...... ........... ........... ........... ........... ...........

8/2/20 $2,385 3,075 $ (690)

7/28/19 $1,967 3,385 $(1,418)

7/30/17 $2,385 3,075 0.78

7/31/16 $1,967 3,385 0.58

d. Current ratio = Current assets / Current liabilities Current assets ......... ........... ........... ........... ........... ……… / Current liabilities .... ........... ........... ........... ........... ……… = Current ratio ........... ........... ........... ........... ........... ………

Instructor’s Manual / Solutions Manual

e. Acid-test ratio = (Cash + Short-term securities + Accounts and Notes receivable) Current liabilities 8/2/20 7/28/19 Cash and cash equivalents ..... ........... ........... ........... ……… $ 859 $ 31 Accounts receivable, net ....... ........... ........... ........... ........... 575 574 Total (quick assets) .... ........... ........... ........... ........... ……… $1,434 $ 605 Total (quick assets) . ........... ........... ........... ........... ……… / Current liabilities .... ........... ........... ........... ........... ........... = Acid-test ratio ......... ........... ........... ........... ........... ...........

$1,434 3,075 0.47

$ 605 3,385 0.18

P3.20. a. ROI = Margin * Turnover = (Net income / Sales) * (Sales / Average total assets) = ($102,000 / $1,700,000) * ($1,700,000 / (($802,000 + $898,000) / 2)) = (6% Margin * 2.0 Turnover) = 12% b. ROE = Net income / Average stockholders' equity = $102,000 / (($448,000 + $552,000) / 2) = 20.4% c. Working capital = $609,000 Current assets - $290,000 Current liabilities = $319,000 d. Current ratio = ($609,000 Current assets / $290,000 Current liabilities) = 2.10 e. Acid test ratio = (Cash + Accounts receivable) / Current liabilities = ($63,000 + $285,000) / $290,000 = 1.20 f. Solution approach: Think about the effects of this entry on the balance sheet, then indicate the impact of these effects on the respective ratios as either increase, decrease, or no effect. Finally, explain why each ratio is affected in the way that it is by reference to the impact on the numerator and denominator of each ratio. •

ROI for the year ended December 31, 2023: Increase. The payment of an account payable decreases current liabilities and also decreases current assets. This entry has no impact on the income statement, so the numerator of the ROI calculation (net income) is unaffected. However, now having less cash, Hames would also have a lower average total assets in the denominator of the ROI calculation. (Average total assets decrease from $850,000 to $800,000, thus causing the ratio to increase from 12% to 12.75%.

Instructor’s Manual / Solutions Manual •

ROE for the year ended December 31, 2023: No effect. In this case, both the numerator and the denominator are unaffected by the entry. Average stockholders’ equity does not change when an account payable is paid off — only current assets and current liabilities are affected.

•

Working capital as at December 31, 2023: No effect. Since working capital is the difference between current assets and current liabilities, a decrease of $50,000 to each category has no effect on the net amount.

•

Current ratio as at December 31, 2023: Increase. If the current ratio is greater than 1.0 to begin with, then the proportionate amount of current assets relative to current liabilities will increase as each category decreases by an equal dollar amount. In this case, the current ratio would increase from 2.10 to 2.33 ($559,000 current assets / $240,000 current liabilities).

P3.20.

(continued)

g. Solution approach: Same as part f above: •

ROI for the year ended December 31, 2023: No effect. The collection of an account receivable increases one current asset and decreases another current asset. This entry has no effect on either net income or average total assets.

•

ROE for the year ended December 31, 2023: No effect. This entry has no effect on either net income or average stockholders’ equity.

•

Working capital as at December 31, 2023: No effect. Although the composition of current assets changed (i.e., more cash and less accounts receivable), total current assets remained the same, and current liabilities are unaffected by the collection of accounts receivable.

•

Current ratio as at December 31, 2023: No effect. No change in total current assets or total current liabilities.

Instructor’s Manual / Solutions Manual P3.21. a. Working capital = Current assets - Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... - Current liabilities .... ........... ........... ........... ........... ........... ........... = Working capital ...... ........... ........... ........... ........... ........... ........... Current ratio = Current assets / Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... / Current liabilities .... ........... ........... ........... ........... ........... ........... = Current ratio ........... ........... ........... ........... ........... ........... ………

1/31/23 1/31/22 $ 90 $ 80 (60) (40) $ 30 $ 40 1/31/23 $ 90 60 1.5

1/31/22 $ 80 40 2.0

b. Even though the firm has more cash at January 31, 2023, it is less liquid based on the working capital and current ratio measures. The firm owes more on accounts payable, has less inventory to sell, and has fewer accounts receivable to collect, as compared to January 31, 2022. c. Accounts receivable were collected, inventories were reduced, and current liabilities increased. These changes all have a positive impact on cash, which are not reflected in a net loss because changes in a firm's cash position and its profitability are not directly related under accrual accounting.

P3.22. a. Working capital = Current assets - Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... - Current liabilities .... ........... ........... ........... ........... ........... ........... = Working capital ...... ........... ........... ........... ........... ........... ...........

8/31/23 $252 (180) $ 72

8/31/22 $273 (130) $143

8/31/23 $252 180 1.4

8/31/22 $273 130 2.1

Current ratio = Current assets / Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... / Current liabilities .... ........... ........... ........... ........... ........... ........... = Current ratio ........... ........... ........... ........... ........... ........... ………

Instructor’s Manual / Solutions Manual b. Although both working capital and the current ratio at August 31, 2023 are substantially lower than at August 31, 2022, the combined total of cash and marketable securities increased substantially (from $46 to $123). On the other hand, the combined total of accounts receivable and inventories decreased substantially (from $227 to $129) during the year ended August 31, 2023. Thus, in some ways, the firm is actually more liquid at August 31, 2023 than it was at August 31, 2022 due to these favorable shifts in the composition of current assets. The above observations can be seen by calculating the acid-test ratios for each year: Acid-test ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities Cash ........... ........... ........... ........... ........... ........... ........... ........... Marketable securities ......... ........... ........... ........... ........... ........... Accounts receivable ........... ........... ........... ........... ........... ........... Total quick assets ... ........... ........... ........... ........... ........... ........... / Current liabilities .... ........... ........... ........... ........... ........... ........... = Acid-test ratio ......... ........... ........... ........... ........... ........... ………

8/31/23 $ 51 72 75 $198 180 1.1

8/31/22 $ 12 34 58 $104 130 0.8

Note that the acid-test ratios calculated above were provided for illustration purposes only. P.3.22 does not require the calculation of acid-test ratios. However, it is certainly appropriate to observe the changes in the components of current assets when attempting to make an overall assessment of the change in a company’s liquidity from year to year. Note also that the dollar amounts used in P.3.22 were intentionally skewed to demonstrate how a dramatic shift in the composition of current assets may have the opposite impact on a company’s acid-test ratio than it has on the company’s working capital and current ratio. Aroundsquare, Inc. clearly has less overall liquidity on August 31, 2023 than it had on August 31, 2022. However, the bulk of the company’s current assets on August 31, 2022 were represented by inventory, which is the least liquid current asset. Thus, while working capital and the current ratio were considerably higher in 2022 than in 2023, the acid-test ratio was actually lower in 2022 due to the cash outflows required to build up the company’s inventory; as these inventory levels were lowered during 2023, cash, marketable securities, and accounts receivables increased accordingly.

P3.23. a. 15% ROI = (Margin * 2.0 Turnover) Margin required as a manufacturer = 7.5% 2.0 Turnover = (Sales / $12,000,000 Average total assets) Sales required as a manufacturer = $24,000,000 7.5% Margin = (Net Income / $24,000,000 Sales) Net Income required as a manufacturer = $1,800,000

Instructor’s Manual / Solutions Manual b. 15% ROI = (Net Income / $5,000,000 Average total assets) Net Income required as a service firm = $750,000 15% ROI = (3% Margin * Turnover) Turnover required as a service firm = 5.0 5.0 Turnover = (Sales / $5,000,000 Average total assets) Sales required as a service firm = $25,000,000

P3.24. a. ROI = (40% Margin * 0.6 Turnover) = 24% 0.6 Turnover = (Sales / $3,000,000 Average total assets) Sales = $1,800,000 b. 24% ROI = (30% Margin * Turnover) Turnover = 0.8 0.8 Turnover = (Sales / $3,000,000 Average total assets) Sales = $2,400,000 c. If margin were reduced from 40% to 30% via the price lowering strategy, sales would have to increase by $600,000 (from $1,800,000 to $2,400,000) for Charlie to earn the same 24% ROI. This represents a 33.3% increase over the original sales volume, which is not quite as severe as Charlie makes it sound with his 50% estimate, but his point is certainly well taken. d. By increasing marketing efforts (i.e., kicking off a new advertising campaign, or conducting more extensive market research), Charlie would also be increasing the operating expenses of his business, which would reduce margin. However, successful marketing efforts are likely to increase sales volume enough to cause the resulting increase in turnover to more than offset the decrease in margin. As a result, ROI would be likely to increase.

Instructor’s Manual / Solutions Manual P3.24.

(continued) e. Solution approach: The following strategies may be worth considering for a "high-price, high-service" retail furniture store when faced with new competition: •

Reduction in inventory carrying costs via careful screening of existing inventory. For a furniture store, the inventory available for sale and the building the store is located in are normally the largest assets on the balance sheet. In the short-term, there is probably not much that Charlie can do to control building occupancy costs. However, if Charlie were to limit his inventory to those product lines that generate the highest margins and/or highest turnover, this may allow him to substantially reduce average total assets. By reducing average assets, turnover increases, thereby increasing ROI. An important point to remember when considering the DuPont model of ROI analysis is that asset utilization (i.e., turnover) is just as important as generating high profit margins.

•

Labor saving strategies might also be worth considering. Although the problem does not give much information to work from, one might infer that a "high service" furniture store would be likely to have a large sales force relative to its total floor space. If this were the case, then Charlie might benefit by restructuring his sales force (i.e., pay based on commissions only, and/or reducing staff numbers during non-peak hours). If this could be done without compromising Charlie's "high service" competitive advantage (i.e., no sales lost due to "lower service"), then the labor cost savings would increase the company's margin, and thereby increase ROI.

C3.25. a. It should be possible for most students to find the 5-year trend data for ROE within the “Selected Financial Data” section of the annual report. Net income, net sales, and total assets will ordinarily be presented within the 5-year summary as well, thus making it possible to quickly calculate margin, turnover, and ROI. Total current assets or total current liabilities may or may not be disclosed within the trend data, but these numbers can be found easily enough by looking at prior year balance sheets. Encourage students to download the Adobe Acrobat annual report files for each of the past 3 years for their focus companies; they will need to make reference to some prior year data in subsequent-chapter focus company case assignments. b. The answers will obviously vary depending on the focus company selected by each student. The idea of this particular case isn’t to have students do in-depth analysis, but to demonstrate to them that it’s easy to see the “big picture” of a company’s recent profitability and liquidity trends by quickly evaluating these key measures.

Instructor’s Manual / Solutions Manual

C3.26. 2020 a. Cash and cash equivalents ..... ........... ........... ........... ........... ........... $ 38,016 Short-term marketable securities ....... ........... ........... ........... ........... 52,927 Accounts receivable, net ....... ........... ........... ........... ........... ........... 16,120 Total quick assets for acid-test ratio (A) ....... ........... ........... ........... $107,063 Inventories ..... ........... ........... ........... ........... ........... ........... ........... 4,061 Vendor non-trade receivables ........... ........... ........... ........... ........... 21,325 Other current assets ... ........... ........... ........... ........... ........... ........... 11,264 Total current assets (B) ......... ........... ........... ........... ........... ........... $143,713

2019 $ 48,844 51,713 22,926 $123,483 4,106 22,878 12,352 $162,819

Accounts payable ...... ........... ........... ........... ........... ........... ........... $ 42,296 Other current liabilities.......... ........... ........... ........... ........... ........... 42,684 Deferred revenue ....... ........... ........... ........... ........... ........... ........... 6,643 Commercial paper ..... ........... ........... ........... ........... ........... ........... 4,996 Current portion of term debt.. ........... ........... ........... ........... ........... 8,773 Total current liabilities (C) .... ........... ........... ........... ........... ........... $105,392

$ 46,236 37,720 5,522 5,980 10,260 $105,718

Working capital (B - C) ......... ........... ........... ........... ........... ........... $ 38,321 Current ratio (B / C) .. ........... ........... ........... ........... ........... ……… 1.36 Acid-test ratio (A / C) ........... ........... ........... ........... ........... ……… 1.02

$ 57,101 1.54 1.17

b. Common stock and additional paid-in capital, $0.00001 par value .. $ 50,799 $ 45,174 Retained earnings ...... ........... ........... ........... ........... ........... ........... 14,966 45,898 Accumulated other comprehensive income/(loss)…………………. (406) (584) Total shareholders’ equity ..... ........... ........... ........... ........... ........... $ 65,339 $ 90,488 ROE = Net income / Average shareholders’ equity 2020 = $57,411 / (($90,488 + $65,339) / 2) = 73.7% 2019 = $55,256 / (($107,147 + $90,488) / 2) = 55.9%

Instructor’s Manual / Solutions Manual C3.26. (continued) c. ROI = Margin * Turnover = (Net income / Net sales) * (Net sales / Average total assets) 2020 = ($57,411 / $274,515) * ($274,515 / (($338,516 + $323,888) / 2)) = (20.9% Margin * 0.83 Turnover) = 17.3% ROI In 2020, no rounding error results: ROI = Net income / Average total assets = $57,411 / ($338,516 + $323,888) / 2)) = 17.3% 2019 = ($55,256 / $260,174) * ($260,174 / (($365,725 + $338,516) / 2)) = (21.2% Margin * 0.74 Turnover) = 15.7% ROI Likewise in 2020, no rounding error results: ROI = Net income / Average total assets = $55,256 / ($365,725 + $338,516) / 2)) = 15.7%

Instructor’s Manual / Solutions Manual C3.26. (continued) d. Apple’s liquidity position decreased noticeably but not dramatically in fiscal 2020, with working capital decreasing by $19 billion. This was due almost entirely to a net decrease in current assets with total current liabilities remaining virtually unchanged. The current ratio and acid-test ratio results declined in 2020 (falling from 1.54 to 1.36 and from 1.17 to 1.02, respectively). Highlights of these changes include a significant reduction in cash (from $49 billion to $38 billion), accompanied with reduction in accounts receivable (from $23 billion to $16 billion). The changes in current liability balances from the 2019 balance sheet to the 2020 balance sheet were slight and largely offsetting (i.e., accounts payable decreased by $4 billion while other accrued liabilities increased by $5 billion). Notice that Apple also invested $101 billion in long-term marketable securities in 2020 (and $105 billion in 2019). These investments, although not technically current assets in the sense that they are not expected to be converted back to cash within one year, are likely to be readily available sources of cash should the company need to obtain funds in the intermediate term (2 to 4 years). The only reason that such investments are listed as long-term assets rather than current assets is that management intends to hold them for more than one year after the balance sheet date. Essentially, Apple generates more cash from operations than the company can possibly redeploy in its core businesses and product markets. Thus, nearly one-third of the company’s total assets (in both years) are invested in long-term marketable securities (i.e., stock market investments in other non-related companies). This is an extremely unusual situation to observe on any corporate balance sheet, and is the result of Apple’s enormous, ongoing record of business success. Apple’s profitability trends have been extremely strong as well. An ROI of 17.3% (for 2020) is certainly above average for a major corporation, and the 2019 result of 15.7% was quite respectable as well, especially when considering that Apple has been maintaining high levels of ROI for many consecutive years. ROE was dramatically higher than ROI in both 2020 (73.7%) and 2019 (also 55.9%), indicating that the company is making highly effective use of borrowed funds—that is, the company is using borrowed funds to increase the return to its owners/shareholders. (The idea of financial leverage will be introduced in Chapter 7 and expanded upon in Chapter 11.) It should be noted, however, that in Apple’s case, the company does not have a long history of “borrowing” money in the traditional sense. Until 2013, Apple had no long-term debt whatsoever, and most of its liabilities were current liabilities such as accounts payable and accrued expenses (reported as “other current liabilities”) that would then be settled with current assets in the normal course of business. Even in 2020 and 2019 relative to most major companies, Apple’s total non-current liabilities were at modest to average levels in proportion to the company’s total assets. Thus, in Apple’s case, the magnification of ROE (73.7%) relative to ROI (17.3%) in 2020 is likely to be more of an artifact of the calculation process than a true effort on the company’s part to strategically utilize financial leverage to enhance shareholder value. To make a more complete assessment, it would be appropriate to look at the trends of ROI and ROE for Apple, Inc. as compared to the computer industry trends of these measures for at least 5 years.

Instructor’s Manual / Solutions Manual C3.26.

(continued)

2020 2019 Total assets………………….. $323,888 $338,516 Shareholders’ equity..……….. 65,339 90,488 Total liabilities………………. $258,549 248,028

2018 $365,725 107,147 $258,578

2017 2016 $375,319 $321,686 134,047 128,249 $241,272 $193,437

f. Yes, the balance sheet trends in particular show great consistency from 2016 through 2020. Note that 1) total assets, 2) total shareholder’s equity, and 3) cash, cash equivalents, and marketable securities each trended upward from 2016 to 2017 and then downward for each subsequent year presented. This is true not only in absolute dollar terms but also relative proportions; each of these trends is portraying a very similar pattern. In a similar way, 1) net sales, 2) net income, 3) noncurrent portion of term debt, and 4) other non-current liabilities each exhibited consistent and steady growth patterns for all five years presented. However, there was a slight peak in sales and net income in 2018. The “big picture” is that the company has shown steady and consistent sales growth during this period (as well as prior periods, as Apple is well known for). The company’s growth in sales is generally reflected in earnings (net income) as sales levels continue to reach new heights. At the same time, Apple appears to be strategically reducing its investment in total assets and particularly in highly liquid assets (cash, cash equivalents, and marketable securities) while also demonstrating a stronger appetite for long-term debt to allow shareholders to benefit from their effective use of financial leverage. g. The net sales, net income, and total assets trends would each be meaningful to investors, in that they express important growth patterns. Most investors tend to focus on sales growth or earnings growth as opposed to asset growth because asset growth is sometimes financed by debt, as was clearly the case with Apple (the combined total of the non-current portion of term debt and other non-current liabilities trend saw consistent upward movements from $115 billion in 2016 to $153 billion in 2020). Thus, income statement measures tend to be better predictors of the future. Since sales growth patterns are likely to be more stable than earnings growth patterns (i.e., less likely to exhibit wild swings from year to year), the trend in net sales is arguably the most appropriate one for investors to focus on. The trend in shareholders’ equity is meaningful for Apple during the 2016-2020 period, and highly consistent with trend in total assets shown by the data. Yet, shareholders’ equity trends are often quite difficult to interpret for large, highly profitable companies, especially those that do not follow consistent dividend and stock repurchase patterns from year to year. Likewise, Apple’s trends in highly liquid current assets and non-current marketable securities are consistent with the other trends shown by the data, but these trends are not typically very useful as measures to facilitate the interpretation of operating results for most companies. The non-current portion of term debt and other non-current liabilities trends are also worth noting, although they are perhaps the least relevant trends in this case because Apple clearly has the ability to pay down on these debts at any time of their choosing.

Instructor’s Manual / Solutions Manual C3.26.

(continued)

h. Solution Approach: A “prudent investor” would be wise to take the following factors into consideration before choosing between alternative investment opportunities: 1. What is the relative risk of the investment? In this case, although Apple’s common stock may be considered an excellent investment, an investor would be interested in knowing how investment analysts regard the potential risks/rewards of ownership. 2. How does an investment in Apple’s common stock "fit" within the investor's overall portfolio? The text does not cover Modern Portfolio Theory or similar "Finance" topics, but it is worth noting that individual investments must be considered within the context of the investor's overall portfolio. An investment in Apple may appear to be "too risky" when analyzed in isolation, but it may in fact be risk-reducing and return-enhancing when viewed as "part of" an investor's overall portfolio. 3. How does an investment in Apple’s common stock fit within the investor's investing objectives? Different people invest for different reasons. A young couple in their 20's or 30's may wish to save for their retirement or for the college education of their children. As such, they would be more inclined to invest in a "growth" portfolio than would be a couple in their 60's or 70's who would be more likely to invest in an "income" oriented portfolio. 4. Additional historical data concerning Apple and its industry would be helpful in making a more complete trend analysis. These data might include line-item details from Apple’s past income statements, as well as trends in cash flows data, dividends data, stock price data, and price/earnings ratios. 5. It would be helpful to have an understanding of current events surrounding the company and its industry, as well as an understanding of general economic conditions at the time of the investment. This is particularly important for a company such as Apple, because of potential innovations and rapid change within the technology industry.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ —CHAPTER 3

NAME______________________

Attached are the financial statements and the ____-year summary from the 20__ Annual Report of ______________________________. REQUIRED: 1. Calculate ROI, showing margin and turnover, for 20__, 20__, and 20__. 2. Calculate the company's working capital, current ratio, and acid-test ratio at [balance sheet dates]. 3. Calculate ROE for as many of the past three years as you can. 4. Assume that you have $5,000 that you would like to invest in the common stock of a company. Evaluate the common stock of ______________________________ as a potential investment. From the data available on the attached financial statements, identify the five most important criteria that you would use to make your investment decision, and explain why each is important. Instructor’s Note: Use or adapt these questions for an annual report (or set of financial statements) that you provide to the students.

Instructor’s Manual / Solutions Manual

CHAPTER

The Bookkeeping Process and Transaction Analysis

CHAPTER OUTLINE: I. The Bookkeeping/Accounting Process II. The Balance Sheet Equation: A = L + SE A. Stockholders' Equity expanded: 1. SE = Paid-in Capital + Retained Earnings 2. Net income causes retained earnings to increase 3. Net income = Revenues - Expenses 4. SE = Paid-in Capital + Retained Earnings (beginning) + Revenues - Expenses B. The Balance Sheet Equation expanded: A = L + PIC + Retained Earnings (beginning) + Revenues - Expenses C. Equation stays in balance after every transaction D. Illustration of the effect of transactions on the equation III. Bookkeeping Jargon and Procedures A. Transactions recorded in a journal, then posted to an account in the ledger. B. Accounts use a "T" format 1. Left side of "T" is debit 2. Right side of "T" is credit C. Normal balances 1. Debit: Assets and expenses 2. Credit: Liabilities, stockholders' equity, and revenues D. Journal entries IV. Effect of Transactions on the Financial Statements (Horizontal Model) V. Adjustments A. Accruals B. Reclassifications C. Understanding cash leads and cash lags

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VI. Transaction Analysis Methodology A. Five questions: 1. What's going on? 2. What accounts are affected? 3. How are they affected? 4. Does the balance sheet balance? (Do the debits equal the credits?) 5. Does my analysis make sense? B. Illustration of applying the five questions C. Understanding the reasons for changes in account balances

TEACHING/LEARNING OBJECTIVES: Principal: 1. To have the student understand how transactions affect the financial statements. a. To accomplish this objective, a horizontal model of the effect of the bookkeeping process on the balance sheet and income statement is developed and presented. b. To understand and use the model, some bookkeeping jargon must be understood. 2. To have the student learn a five-question approach to transaction analysis. 3. To have the student learn to use the financial statement horizontal model to reason through the impact of transactions on the financial statements. Supporting: 4. To have the student learn to use the T-account model and understand the effect of a journal entry. 5. To have the student understand why adjusting entries are necessary, and to see that they result in more meaningful financial statements.

TEACHING OBSERVATIONS: 1. Develop the expanded balance sheet equation by relating net income to stockholders' equity (retained earnings) and explaining that income statement preparation is made easier if revenues and expenses are accumulated separately, rather than within stockholders' equity (retained earnings).

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Instructor’s Manual / Solutions Manual

2. Review Exhibit 4-1 in class to illustrate that the balance sheet equation remains in balance after every transaction is recorded. 3. Review the articulation of the income statement and balance sheet in Exhibit 4-2. 4. The normal balance and debit/credit behavior of T-accounts can be developed from the expanded equation: a. Assets = Liabilities + Stockholders’ Equity + Revenues - Expenses b. Remove the "- Expenses" by adding Expenses to both sides, giving: Assets + Expenses = Liabilities + Stockholders’ Equity + Revenue c. Put the vertical of the "T" under the equal sign: Assets + Expenses = Liabilities + Stockholders’ Equity + Revenues

d. Accounts to the left (or debit side) of the equal sign and vertical line have a normal balance that is a debit. If a debit balance is normal, increases will be debits, and decreases will be credits; it’s just the opposite for accounts on the right side. Mini Exercises M4-1 and M4-2 can be used to reinforce the basic debit/credit rules and account categorization. 5. Emphasize the format of the journal entry as a means of communication in accounting. 6. Explain that the horizontal model directly illustrates the effects of transactions on the balance sheet and income statement, without the use of debits and credits. This model is used in the text in addition to journal entries, allowing instructors to emphasize the effects of transactions on the financial statements. 7. Explain that in the horizontal model an increase in an expense is a negative amount because an expense reduces net income, which reduces retained earnings and stockholders' equity. 8. Introduce adjusting entries as changes in account balances needed to improve the accuracy of financial statements (i.e., to match revenues and expenses, and to adjust assets and liabilities). 9. It is recommended that the 5 questions of transaction analysis be drilled as a litany. These questions will be used to help students understand accounting issues in subsequent chapters. Problem 4-30 can be used as an in-class demonstration of the 5-question analytical process.

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10. Students are easily confused by alternative methods of recording certain transactions (e.g., the purchase of supplies can be debited either to supplies expense or the supplies asset). Students find it helpful if you carry them through the transaction and adjustment, demonstrating that the financial statements will be the same either way; this helps them to learn both transaction analysis and the adjusting entry process; it also provides an early opportunity to dispel the false notion that there is a single "correct" way to record every transaction. Problems 4-27 and 4-28 can be used to make these points. 11. It is recommended that the horizontal model and the T-account model be used to help students get a picture of the activity in an account, and/or to solve for the amount of an unknown transaction or adjustment. "T-account puzzles" help students understand the impact of transactions and adjustments on account balances. See Exercises 4-21 and 4-22. Other assignments that work well with T-accounts include: E4-14, E4-15, E4-20, P4-24, and P4-30. 12. "Matrix" assignments (see M4-3, M4-4, and E4-9 through E4-14) can be used to emphasize student understanding of the effect of transactions on the financial statements. The same format can be used on quizzes and exams. After subsequent chapters have been covered, column headings can be expanded to include financial statement components (e.g., current assets, paid-in capital, etc.) as those topics are covered in detail later in the course.

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ASSIGNMENT OVERVIEW: NO. M4.1. M4.2. M4.3. M4.4. M4.5. M4.6. E4.7. E4.8. E4.9. E4.10. E4.11. E4.12. E4.13.

LEARNING OBJECTIVES 1, 4 1, 3, 4 2, 6, 7 2, 6, 7 6, 7 6, 7 2, 6, 7 2, 6, 7 6 6 2, 6, 7 2, 6, 7 2, 6, 7

DIFFICULTY & TIME ESTIMATE Easy, 2-3 min. Easy, 7-10 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Med., 5-8 min. Med., 5-8 min. Med., 5-8 min.

E4.14. E4.15. E4.16. E4.17. E4.18. E4.19. E4.20. E4.21. E4.22. P4.23. P4.24.

2, 6, 7 3 6,7 6, 7 6, 7 6, 7 6, 7 6, 7 6, 7 2, 6, 7 1

Med., 5-8 min. Easy, 3-5 min. Easy, 3-5 min. Med., 10-12 min. Med., 10-12 min. Med., 5-8 min. Med., 5-8 min. Easy, 3-5 min. Med., 10-15 Med., 7-10 min. Med., 10-12 min.

P4.25.

6, 7

Med., 10-15 min.

P4.26. P4.27. P4.28. P4.29.

6, 7 6, 7 6, 7 6, 7

Med., 10-15 min. Med., 10-15 min. Med., 10-15 min. Med.-Hard, 10-20 min.

P4.30.

6, 7

Hard, 20-30 min.

C4.31. C4.32.

6, 7 6, 7

Hard, 25-35 min. Hard, 25-35 min.

OTHER COMMENTS Quick review of the basic debit/credit rules by account category. Account categorization and debit/credit normal balance rules. Basic transaction analysis without numbers. Continuation of M4.3. to show second month. Use to emphasize T-account analysis. See E4.21 and E4.22. for similar homework assignments. Basic transaction analysis. See E4.7. Alternative format to E4.7. Alternative format to E4.8. Emphasize the effects of transactions on financial statements. See E4.11. Good homework assignment. Parts d, e, and f can be demonstrated using a time-line approach. Emphasize the timing of expense recognition—i.e., the difference between incurring an expense versus making a cash payment for a previously incurred expense. Good in-class demonstration exercise. Emphasize the difference between income and cash flows. See E4.15. Easy way to introduce adjusting entries. See E4.17. Good homework assignment. Shows the effects of omitted adjusting entries. Shows the effects of omitted adjusting entries. See E4.22. Use to emphasize T-account analysis. Basic transaction analysis. Group learning problem. Assign with P4.23. Emphasize the need for liquidity and profitability planning. Ask “What went wrong with this company?” Emphasizes the form of income statement presentation. CAN USE LATER as a Chapter 9 assignment. See P4.25. Can assign part a. See P4.25. See P4.27. Good in-class demonstration problem. Group learning problem. Excellent way to stress the impact of transactions on the financial statements. Consider giving students some hints as suggested in the solution. Worksheet should be used to show students that transactions affect the financial statements. Emphasize the Balance Sheet— Income Statement link. Avoid getting into the “how to” details. Group learning case. Makes students think! Group learning case. Makes students think!

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SOLUTIONS: M4.1. a. b. c. d. e. f.

A, E A, E L, SE, R L, SE, R L, SE, R A, E

M4.2. a. Cash $21,000 + Property, plant, and equipment $300,000 + Interest receivable $3,000 + Accounts receivable $36,000 = $360,000 total assets. b. Interest payable $8,000 + Notes payable $80,000 + Accounts payable $22,000 = $110,000 total liabilities. c. Total assets of $360,000 (see answer to part a) + Interest expense $12,000 + Wages expense $28,000 = $400,000 total of all accounts with debit balances. d. Service revenues $76,000 + Interest revenue $14,000 = $90,000 total revenue. e. Total liabilities of $110,000 (see answer to part b) + Common stock $60,000 + Retained earnings $140,000 + Total revenues of $90,000 (see answer to part d) = $400,000 total of all accounts with credit balances. Note to Instructors: Although not required, this mini exercise could be expanded in class to illustrate calculations for net income, total stockholders’ equity, and the ending balance of Retained Earnings, as follows: Total revenues of $90,000 (see answer to part d) – Interest expense $12,000 – Wages expense $28,000 = $50,000 net income. Common stock $60,000 + Retained earnings* $140,000 + Net income of $50,000 (see above) = $250,000** total stockholders’ equity. $140,000 beginning balance of Retained Earnings + $50,000 Net income = $190,000 ending balance of Retained Earnings. * Since the account balances were taken from the company’s pre-closing trail balance, the Retained Earnings amount of $140,000 would represent the beginning balance of Retained Earnings. ** Total stockholders’ equity could also be calculated via the shortcut method: Total assets $360,000 (see answer to part a) – Total liabilities of $110,000 (see answer to part b) = $250,000.

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M4.3. Transaction/Adjustment

Net Income

a. Issued common stock to the initial stockholders in exchange for their cash investment……………………..

+ Cash

b. Signed a lease for office space and paid the first three months of rent in advance………………………………

+ Prepaid Rent – Cash

Purchased office equipment and shelving for cash………………….....

+ Equipment – Cash

d. Purchased merchandise inventory; made a partial payment in cash, and agreed to pay the balance within 30 days………………………………….

+ Merch. Inventory – Cash

e. Sold merchandise inventory on account for an amount greater than the cost of the inventory sold………...

+ Acc. Rec. – Merch. Inventory

+ Sales – Cost of Goods Sold

f. Paid employees for the first two weeks of the month…………………..

– Cash

– Wages Expense

At the end of the month, accrued wages owed to employees for the second two weeks of the month………

h. Recognized rent expense for one month of the payment of rent in advance in transaction b (as a reclassification adjusting entry)………

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+ Common Stock

+ Accounts Payable

+ Wages Payable – Prepaid Rent

– Wages Expense – Rent Expense

Instructor’s Manual / Solutions Manual

M4.4. Transaction/Adjustment

a. Paid wages that had been accrued at the end of the prior month…………

– Cash

b. Collected accounts receivable from sales recorded in the prior month……

+ Cash – Acc. Rec.

Paid accounts payable owed for purchases made in the prior month….

– Cash

– Accounts Payable

d. Borrowed cash from a local bank on a short-term promissory note…….

+ Cash

+ Notes Payable

e. Purchased merchandise inventory for cash………………………………

+ Merch. Inv. – Cash

f. Incurred and paid utilities expense for the month…………………………

– Cash

At the end of the month, accrued interest on the short-term promissory note recorded in transaction d……….

4-8

– Prepaid Rent

Net Income

– Wages Payable

– Utilities Expense + Interest Payable

h. Recognized rent expense for one month of the 3-month payment of rent in advance made in the prior month (as a reclassification adjusting entry)…….

– Interest Expense – Rent Expense

Instructor’s Manual / Solutions Manual

M4.5. a.

Accounts Payable

Payments to suppliers

Beginning balance . Purchases on account Ending balance

15,000 34,600 21,400

Solution: $15,000 + $34,600 - ? = $21,400 Payments to suppliers during the month = $28,200 b.

Accounts Receivable Beginning balance Credit sales Ending balance

23,400 ? 17,800

Collections from customers

77,000

Solution: $23,400 + ? - $77,000 = $17,800 Credit sales during the month = $71,400

M4.6. a.

Supplies Beginning balance Supplies purchased Ending balance

2,400 7,800 3,200

Supplies used

Solution: $2,400 + $7,800 - ? = $3,200 Supplies used during the month = $7,000 b.

Wages Payable

Wages paid

28,000

Beginning balance Wages accrued Ending balance

Solution: $ ? + $29,500 - $28,000 = $5,800 Wages Payable at the beginning of the month = $4,300

4-9

? 29,500 5,800

Instructor’s Manual / Solutions Manual

E4.7. Assets Accounts

Merchandise

Liabilities Notes

Accounts

Cash + Receivable + Inventory + Equipment = Payable + Payable

a. b. c. d. e. f. g. h. i. j. k. l.

+30,000

Stockholders’ Equity Paid-in

Retained

+ Capital + Earnings + Rev - Exp +30,000

+20,000

-16,800

+16,800

-4,500

-25,000

+40,000

+23,000

-16,000

+15,000 +23,000 -16,000 +300

-4,000 +13,300

+12,500 +27,700

-300

+8,500

-26,000

+41,000 - 26,000 +5,700 *

+18,400

-18,400

-11,600 ______ 42,800 +

-5,700

-11,600 ______ 9,300 +

______ 10,500

______ +

______

16,800 = 20,000

______

17,900

+ 30,000 +

_____

______

+ 64,000 - 52,500

Month-end totals: Assets $79,400 = Liabilities $37,900 + Stockholders' equity $41,500 Net income for the month: Revenues $64,000 - Expenses $52,500 = Net income $11,500 * Ordinarily, the Wages Payable account would be increased for employee wage expense that has been incurred but not yet paid. Optional Continuation: BLUE CO. STORES, INC. Income Statement Sales……………………………………………………………….. Cost of goods sold…………………………………………………. Gross profit………………………………………………………… Rent expense………………………………………………………. Wages expense…………………………………………………….. Advertising expense……………………………………………….. Net income (this exercise ignores income taxes)…………………..

4-10

$64,000 (42,000) $22,000 (4,500) (5,700) (300) $11,500

Instructor’s Manual / Solutions Manual

E4.7.

(continued) BLUE CO. STORES, INC. Balance Sheet Assets: Cash………………………………………………………………... Accounts receivable……………………………………………….. Merchandise inventory…………………………………………….. Total current assets………………………………………………… Equipment (this exercise ignores depreciation)…………………… Total assets…………………………………………………………

$42,800 9,300 10,500 $62,600 16,800 $79,400

Liabilities: Notes payable……………………………………………………… Accounts payable………………………………………………….. Total liabilities……………………………………………………..

$20,000 17,900 $37,900

Stockholders’ Equity: Paid-in Capital……………………………………………………... Retained earnings *………………………………………………... Total stockholders’ equity…………………………………………. Total liabilities and stockholders’ equity…………………………..

$30,000 11,500 $41,500 $79,400

* Since this was the first month of operations, the Retained Earnings account would have a $0 beginning balance. Thus, the net income for the month creates a positive balance in retained earnings. E4.8. Assets

Liabilities

Stockholders Equity

TransAccounts Notes Accounts Paid-in Retained action Cash + Receivable + Supplies + Equipment = Payable + Payable + Capital + Earnings + Rev - Exp a. +12,000 b. +18,000 c. -17,800 d. -1,800 e. f. +9,300 g. -8,400 h. -2,200 i. +7,500 j. k. l. +3,000

+12,000 +18,000 +17,800 +1,800 +3,400

-3,400

+4,800

+14,100 -8,400 +2,200

+10,900

+18,400 +10,200*

-10,200 -3,400

-3,400 -3,000 _____

19,600

+ 12,700

600

17,800

4-11

= 18,000 + 13,600 + 12,000 +

______ _____ + 32,500 – 25,400

Instructor’s Manual / Solutions Manual

E4.8.

(continued) Month-end totals: Assets $50,700 = Liabilities $31,600 + Stockholders' Equity $19,100 Net income (loss) for the month: Revenues $32,500 - Expenses $25,400 = Net Income $7,100 * Ordinarily, the Wages Payable account would be increased for employee wage expense that has been incurred but not yet paid.

Optional Continuation: GRAY MOWING SERVICES, INC. Income Statement Service revenue ......... ........... ........... ........... ........... ........... ........... Gasoline, oil, and trash bags (i.e, cost of services provided) ........... Wages expense .......... ........... ........... ........... ........... ........... ........... Advertising expense .. ........... ........... ........... ........... ........... ........... Net income (this exercise ignores income taxes) ...... ........... ...........

$32,500 (3,400) (18,600) (3,400) $ 7,100

GRAY MOWING SERVICES, INC. Balance Sheet Assets: Cash .. ........... ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... ........... Supplies ......... ........... ........... ........... ........... ........... ........... ........... Total current assets .... ........... ........... ........... ........... ........... ........... Equipment (this exercise ignores depreciation) ........ ........... ........... Total assets .... ........... ........... ........... ........... ........... ........... ...........

$19,600 12,700 600 $32,900 17,800 $50,700

Liabilities: Notes payable ........... ........... ........... ........... ........... ........... ........... Accounts payable ...... ........... ........... ........... ........... ........... ........... Total liabilities........... ........... ........... ........... ........... ........... ...........

$18,000 13,600 $31,600

Stockholders’ Equity: Paid-in Capital ........... ........... ........... ........... ........... ........... ........... Retained earnings * ... ........... ........... ........... ........... ........... ........... Total stockholders’ equity ..... ........... ........... ........... ........... ........... Total liabilities and stockholders’ equity ...... ........... ........... ...........

$12,000 7,100 $19,100 $50,700

* Since this was the first month of operations, the Retained Earnings account would have a $0 beginning balance. Thus, the net income for the month creates a positive balance in retained earnings.

4-12

Instructor’s Manual / Solutions Manual

E4.9. a. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Paid-In Capital........ ........... ........... ........... ........... ...........

30,000 30,000

b. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Note Payable .......... ........... ........... ........... ........... ...........

20,000

c. Dr. Equipment ......... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

16,800

d. Dr. Rent Expense ..... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

4,500

e. Dr. Merchandise Inventory . ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Payable ... ........... ........... ........... ........... ...........

40,000

f. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Sales Revenue ........ ........... ........... ........... ........... ........... Dr. Cost of Goods Sold ....... ........... ........... ........... ........... ........... Cr. Merchandise Inventory ....... ........... ........... ........... ...........

23,000

g. Dr. Advertising Expense ..... ........... ........... ........... ........... ........... Cr. Accounts Payable ... ........... ........... ........... ........... ...........

300

h. Dr. Merchandise Inventory . ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Payable ... ........... ........... ........... ........... ...........

12,500

i. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Dr. Accounts Receivable ..... ........... ........... ........... ........... ........... Cr. Sales Revenue ........ ........... ........... ........... ........... ........... Dr. Cost of Goods Sold ...... ........... ........... ........... ........... ........... Cr. Merchandise Inventory ....... ........... ........... ........... ...........

13,300 27,700

j. Dr. Wages Expense . ........... ........... ........... ........... ........... ........... Cr. Accounts (or Wages) Payable ....... ........... ........... ...........

5,700

k. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Receivable .......... ........... ........... ........... ...........

18,400

l. Dr. Accounts Payable ........... ........... ........... ........... ........... ……… Cr. Cash ........... ........... ........... ........... ........... ........... ………

11,600

4-13

20,000 16,800

4,500

25,000 15,000

23,000 16,000 16,000

300

4,000 8,500

41,000 26,000 26,000

5,700

18,400

11,600

Instructor’s Manual / Solutions Manual

E4.10. a. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Paid-in Capital ....... ........... ........... ........... ........... ...........

12,000 12,000

b. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Note Payable ......... ........... ........... ........... ........... ...........

18,000

c. Dr. Equipment ......... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

17,800

d. Dr. Supplies . ........... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

1,800

e. Dr. Advertising Expense ..... ........... ........... ........... ........... ........... Cr. Accounts Payable ... ........... ........... ........... ........... ...........

3,400

f. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Dr. Accounts Receivable ..... ........... ........... ........... ........... ........... Cr. Service Revenue ..... ........... ........... ........... ........... ...........

9,300 4,800

g. Dr. Wages Expense . ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

8,400

h. Dr. Supplies . ........... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

2,200

7,500 10,900

j. Dr. Wages Expense . ........... ........... ........... ........... ........... ........... Cr. Accounts (or Wages) Payable ....... ........... ........... ...........

10,200

k. Dr. Supplies Expense .......... ........... ........... ........... ........... ........... Cr. Supplies ...... ........... ........... ........... ........... ........... ...........

3,400

l. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Receivable .......... ........... ........... ........... ...........

3,000

4-14

18,000

17,800

1,800

3,400

14,100

8,400

2,200

18,400

10,200

3,400

3,000

Instructor’s Manual / Solutions Manual

E4.11. Transaction/Adjustment

Net Income

a. Example transaction……………………

Supplies -3,600

Supplies Exp -3,600

b. An insurance premium of $1,440 was paid for the coming year. Prepaid Insurance (an asset), was debited………

Prepaid Insurance +1,440 Cash -1,440

c. Wages of $9,600 were paid for the current month ... ............ ............ ………

Cash -9,600

Wages Exp -9,600

d. Interest revenue of $750 was received for the current month .... ............ ............

Cash +750

Interest Rev +750

e. Accrued $2,100 of commissions payable to sales staff for the current month .........

Commissions Payable +2,100

Commissions Expense -2,100

f. Accrued $600 of interest expense at the end of the month . ………… .........

Interest Pay +600

Interest Exp -600

g. Received $6,300 on accounts receivable Cash +6,300 accrued at the end of the prior month….. Accounts Rec -6,300 h. Purchased $1,800 of merchandise Merch inventory from a supplier on account….. Inventory +1,800 i. Paid $450 of interest expense for the month ......... ............ ............ ............

Cash -450

j. Accrued $2,400 of wages at the end of the current month...... ............ ............ k. Paid $1,500 of accounts payable……….

4-15

Accounts Payable +1,800 Interest Exp -450 Wages Pay +2,400

Cash -1,500

Accounts Pay -1,500

Wages Exp -2,400

Instructor’s Manual / Solutions Manual

E4.11.

(continued) Journal entries: a. Dr. Supplies Expense ........... ........... ........... ........... ........... ........... Cr. Supplies ....... ........... ........... ........... ........... ........... ……… b. Dr. Prepaid Insurance ........... ........... ........... ........... ........... ………

3,600 3,600 1,440

Cr. Cash .. ........... ........... ........... ........... ........... ........... ……… c. Dr. Wages Expense .. ........... ........... ........... ........... ........... ...........

1,440 9,600

Cr. Cash .. ........... ........... ........... ........... ........... ........... ........... d. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ...........

9,600 750

Cr. Interest Revenue ....... ........... ........... ........... ........... ........... e. Dr. Commissions Expense .. ........... ........... ........... ........... ...........

750 2,100

Cr. Commissions Payable .......... ........... ........... ........... ........... f. Dr. Interest Expense . ........... ........... ........... ........... ........... ...........

2,100 600

Cr. Interest Payable ........ ........... ........... ........... ........... ........... g. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ...........

600 6,300

Cr. Accounts Receivable ........... ........... ........... ........... ........... h. Dr. Merchandise Inventory .. ........... ........... ........... ........... ...........

6,300 1,800

Cr. Accounts Payable ..... ........... ........... ........... ........... ........... i. Dr. Interest Expense . ........... ........... ........... ........... ........... ...........

1,800 450

Cr. Cash .. ........... ........... ........... ........... ........... ........... ........... j. Dr. Wages Expense .. ........... ........... ........... ........... ........... ...........

450 2,400

Cr. Wages Payable ....... ........... ........... ........... ........... ........... k. Dr. Accounts Payable .......... ........... ........... ........... ........... ...........

Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

4-16

2,400 1,500 1,500

Instructor’s Manual / Solutions Manual

E4.12. Transaction/Adjustment a. Example transaction……………..

Cash -10,500

Net Income

Retained Earnings -14,400

Wages Exp -10,500 Wages Payable +3,600

Cash +9,300 Acc. Rec. +12,900

f. Newspaper ad costing $1,200 ran this month, but will not be paid for until next month ...... ............

Supplies Exp +700 Dividends Payable +14,400

d. Employee wages of $3,600 for the last week of the month have not been recorded ... ............ ............ e. Revenues of $22,200 were earned during the month. Cash of $9,300 was received, and the balance is due in 30 days .. ............ ............

Supplies +700

b. During the month, the board of directors declared a cash dividend of $14,400, payable next month. c. Employees were paid $10,5000 in wages for their work during the first three weeks of the month....

Wages Exp -3,600

Service Revenue +22,200

Accounts Payable +1,200

Advertising Expense -1,200

g. Merchandise costing $4,650 was sold for $8,800. Cash of $3,300 was received, and the balance is due within 30 days ........ ............

Cash +3,300 Acc. Rec. +5,500

h. During the month, supplies were purchased at a cost of $1,230, and debited to the Supplies account. $990 of supplies were used ........

Supplies -990

Supplies Expense -990

i. Interest of $540 has been earned on a note receivable, but has not yet been received .......... ............

Interest Receivable +540

Interest Revenue +540

Merch. Inv. -4,650

4-17

Sales +8,800 Cost Goods Sold -4,650

Instructor’s Manual / Solutions Manual

E4.12.

(continued) Transaction/Adjustment

j. Issued 1,200 shares of $10 par value Cash common stock for $26,400 in cash. +26,400

Net Income

Common Stock +26,400 *

* Alternative solution: The “Additional Paid-In Capital” account has not been introduced in Chapter 4 (our attempt to keep it as simple as possible), but this is an opportunity to discuss the concept (for instructors who are so inclined): j. Issued 1,200 shares of $10 par value Cash common stock for $26,400 in cash. +26,400

Common Stock +12,000 Additional Paid-In Capital +14,400

The point to emphasize at this early stage is the difference between the paid-in capital and retained earnings components of stockholders’ equity.

Journal entries: a. Dr. Supplies . ........... ........... ........... ........... ........... ........... ……… Cr. Supplies Expense..... ........... ........... ........... ........... ...........

700 700

b. Dr. Retained Earnings ......... ........... ........... ........... ........... ........... Cr. Dividends Payable ... ........... ........... ........... ........... ...........

14,400

c. Dr. Wages Expense .. ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

10,500

d. Dr. Wages Expense .. ........... ........... ........... ........... ........... ........... Cr. Wages Payable ........ ........... ........... ........... ........... ...........

3,600

e. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Dr. Accounts Receivable ...... ........... ........... ........... ........... ........... Cr. Service Revenue ...... ........... ........... ........... ........... ...........

9,300 12,900

f. Dr. Advertising Expense ...... ........... ........... ........... ........... ........... Cr. Accounts Payable .... ........... ........... ........... ........... ...........

1,200

4-18

14,400

10,500

3,600

22,200

1,200

Instructor’s Manual / Solutions Manual

E4.12. (continued) g. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Dr. Accounts Receivable ...... ........... ........... ........... ........... ........... Cr. Sales ........... ........... ........... ........... ........... ........... ……… Dr. Cost of Goods Sold ........ ........... ........... ........... ........... ........... Cr. Merchandise Inventory ........ ........... ........... ........... ...........

3,300 5,500 8,800 4,650 4,650

h. Dr. Supplies Expense .......... ........... ........... ........... ........... ........... Cr. Supplies ....... ........... ........... ........... ........... ........... ...........

990

i. Dr. Interest Receivable ......... ........... ........... ........... ........... ........... Cr. Interest Revenue ...... ........... ........... ........... ........... ...........

540

j. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Common Stock ....... ........... ........... ........... ........... ...........

26,400

990

540

26,400

Alternative solution: The “Additional Paid-In Capital” account has not been introduced in Chapter 4 (our attempt to keep it as simple as possible), but this is an opportunity to discuss the concept for instructors who are so inclined: j. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Common Stock ....... ........... ........... ........... ........... ........... Cr. Additional Paid-in Capital ... ........... ........... ........... ...........

4-19

26,400 12,000 14,400

Instructor’s Manual / Solutions Manual

E4.13. Transaction/Adjustment

a. Example transaction...... ............ ............ .

+1,600

b. Paid an insurance premium of $1,800 for the coming year. An asset, Prepaid Insurance, was debited…...........

-1,800 +1,800

c. Recognized insurance for one month from the above premium via a reclassification adjusting entry… ...........

-150

d. Paid $2,900 of wages accrued at the end of the prior month .. ............ ……….

-2,900

e. Paid $7,200 of wages for the current month ... ............ ............ ............

-7,200

f. Accrued $2,600 of wages at the end of the current month...... ............ ............ g. Received cash of $4,100 on accounts receivable accrued in prior month ..........

Net Income +1,600

-150

-2,900

-7,200

+2,600

-2,600

+4,100 -4,100

Journal entries: a. Dr. Accounts Receivable ...... ........... ........... ........... ........... ...........

1,600

Cr. Service Revenue ..... ........... ........... ........... ........... ........... b. Dr. Prepaid Insurance ........... ........... ........... ........... ........... ………

1,600 1,800

Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

1,800

c. Dr. Insurance Expense .......... ........... ........... ........... ........... ........... Cr. Prepaid Insurance .... ........... ........... ........... ........... ...........

150

d. Dr. Wages Payable ... ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

2,900

e. Dr. Wages Expense .. ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

7,200

f. Dr. Wages Expense .. ........... ........... ........... ........... ........... ........... Cr. Wages Payable ........ ........... ........... ........... ........... ...........

2,600

g. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Receivable ........... ........... ........... ........... ………

4,100

4-20

150 2,900 7,200 2,600 4,100

Instructor’s Manual / Solutions Manual

E4.14. Transaction/Adjustment

Net Income

a. Example transaction .. ........... ………

+1,400

b. During the month supplies was debited $5,200 for supplies purchased. The total cost of supplies actually used during the month was $3,800 ...........

-3,800

c. Received $3,400 of cash from clients for services provided during the current month ........... ........... ...........

+3,400

d. Paid $1,900 of accounts payable .......

-1,900

e. Received $1,500 of cash from clients for revenues accrued at the end of the prior month .......... ........... ...........

+1,500 -1,500

f. Received $800 of interest revenue accrued in prior month .......... ...........

+800 -800

g. Received $1,650 of interest revenue for the current month . ........... ...........

+1,650

h. Accrued $740 of interest revenue earned in the current month ... ...........

+740

i. Paid $4,200 of interest expense for the month . ........... ........... ...........

-4,200

-1,900

j. Accrued $1,480 of interest expense at the end of the month .......... ...........

+1,480

-1,480

k. Accrued $3,200 of commissions payable to sales staff for the current month . ........... ........... ........... ...........

+3,200

-3,200

4-21

Instructor’s Manual / Solutions Manual

E4.14.

(continued) Journal entries: a. Dr. Supplies . ........... ........... ........... ........... ........... ........... ........... Cr. Supplies Expense..... ........... ........... ........... ........... ...........

1,400 1,400

b. Dr. Supplies Expense ........... ........... ........... ........... ........... ……… Cr. Supplies ....... ........... ........... ........... ........... ........... ...........

3,800

c. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Service Revenue ...... ........... ........... ........... ........... ...........

3,400

d. Dr. Accounts Payable .......... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

1,900

e. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Receivable ........... ........... ........... ........... ………

1,500

f. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Interest Receivable .. ........... ........... ........... ........... ...........

800

g. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Interest Revenue ...... ........... ........... ........... ........... ...........

1,650

h. Dr. Interest Receivable ......... ........... ........... ........... ........... ........... Cr. Interest Revenue ...... ........... ........... ........... ........... ...........

740

i. Dr. Interest Expense . ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

4,200

j. Dr. Interest Expense . ........... ........... ........... ........... ........... ........... Cr. Interest Payable ......... ........... ........... ........... ........... ...........

1,480

k. Dr. Commissions Expense ... ........... ........... ........... ........... ........... Cr. Commissions Payable ......... ........... ........... ........... ...........

3,200

4-22

3,800

3,400

1,900 1,500

800

1,650

740

4,200

1,480

3,200

Instructor’s Manual / Solutions Manual

E4.15. Prepare an analysis of the change in stockholders' equity for the month, showing the effects of the net loss and dividends: Balance, February 1, 2022..... ........... ........... ........... ........... Revenues ....... ........... ........... ........... ........... ........... ........... Expenses ........ ........... ........... ........... ........... ........... ........... Net loss for February . ........... ........... ........... ........... ........... Dividends ...... ........... ........... ........... ........... ........... ........... Balance, February 28, 2022... ........... ........... ........... ...........

$132,000 $ 47,000 (54,000) (7,000) (4,000) $ 121,000

E4.16. a. (Revenues - $624,000 Expenses) = $218,000 Net income Revenues = $842,000 b. Cash receipts are not revenues. Revenues are earned from selling products or delivering services. The cash receipt from a revenue transaction may occur before the revenue has been earned (i.e., prepayments from customers for magazine subscriptions) or after the revenue has been earned (i.e., collection of an account receivable). E4.17. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. Receipt of note on May 1, 2022: Notes Receivable +21,000 Account Receivable -21,000 b. Accrual of 8 month's interest at December 31, 2022: Interest Receivable +1,260 c. Collection of note and interest at April 30, 2023: Cash +22,890 Note Receivable -21,000 Interest Receivable -1,260

4-23

Interest Revenue +1,260

Interest Revenue +630

Instructor’s Manual / Solutions Manual

E4.17.

(continued) Journal entries: a. 5/1/2022 Dr. Note Receivable ........... ........... ........... ........... ........... ……… Cr. Accounts Receivable ........... ........... ........... ........... ………

b. 12/31/2022 Dr. Interest Receivable ........ ........... ........... ........... ........... ........... Cr. Interest Revenue ($21,000 * 9% * 8/12) .... ........... ........... c. 4/30/2023 Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Note Receivable ..... ........... ........... ........... ........... ........... Cr. Interest Receivable . ........... ........... ........... ........... ……… Cr. Interest Revenue ..... ........... ........... ........... ........... ...........

21,000 21,000

1,260 1,260

22,890 21,000 1,260 630

In entry c, only $1,260 of the total interest of $1,890 had been accrued, so the Interest Receivable account is reduced by the $1,260 that had been accrued in 2022; the other $630 that is received is recorded as interest revenue for 2023, the year in which it was earned. E4.18. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. Converted account payable to a note payable on February 1: Accounts Payable -63,000 Note Payable +63,000 b. Accrued interest expense for February and March ($63,000 * 9% * 2/12) Interest Payable Interest +945 Expense -945 c. Paid note and accrued interest, including interest for April and May, on May 31: Cash Note Payable Interest -64,890 -63,000 Expense Interest Payable -945 -945

4-24

Instructor’s Manual / Solutions Manual

E4.18.

(continued) Journal entries: a. February 1 Dr. Accounts Payable .......... ........... ........... ........... ........... ........... Cr. Note Payable ......... ........... ........... ........... ........... ...........

63,000 63,000

b. March 31 Dr. Interest Expense ........... ........... ........... ........... ........... ........... Cr. Interest Payable ($63,000 * 9% * 2/12) ..... ........... ...........

945

c. May 31 Dr. Interest Expense ........... ........... ........... ........... ........... ……… Dr. Interest Payable ........... ........... ........... ........... ........... ……… Dr. Note Payable .... ........... ........... ........... ........... ........... ........... Cr. Cash .......... ........... ........... ........... ........... ........... ...........

945 945 63,000

945

64,890

E4.19. a. Net income for October would be overstated, because an expense was not recorded. b. Net income for November would be understated, because November expenses would include an expense from October. c. There wouldn't be any effect on net income for the two months combined, because the overstatement and understatement offset. d. To match revenues and expenses, which results in more accurate financial statements. E4.20. Net Income Amounts before adjustment .. ........... ........... ........... ........... $216,000 Revenue increase adjustment ........... ........... ........... ........... 60,000 Expense increase adjustment . ........... ........... ........... ........... (84,000) Amounts after adjustment ..... ........... ........... ........... ........... $192,000

4-25

Retained Earnings $810,000 60,000 (84,000) $786,000

Instructor’s Manual / Solutions Manual

E4.21. a. $18,000 + ? - $22,500 = $30,800. Thus, the February 28 adjustment = $35,300 b. The Cash account would most likely have been credited for the amount of the February transactions, and would represent the payment of previously accrued interest. c. The Interest Expense account would most likely have been debited for the February adjustment, and would represent the accrual of interest expense for February. d. The entry would have been made to make the income statement and balance sheet more accurate. The adjustment resulted in a better matching of revenue and expense for February. E4.22. a.

Accounts Receivable Beginning balance Sales revenue for month Ending balance

25,200 90,000 10,600

Collections from customers during month

Solution: $25,200 + $90,000 - ? = $10,600 Cash collected from customers during month = $104,600 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Revenue for credit sales: Accounts Receivable +90,000

Sales +90,000

Collections from customers: Cash +104,600 Accounts Receivable -104,600

Dr. Accounts Receivable ..... ........... ........... ........... ........... ……… Cr. Sales Revenue ........ ........... ........... ........... ........... ........... Revenue from credit sales.

90,000

Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Receivable .......... ........... ........... ........... ........... Collections from customers.

104,600

4-26

90,000

104,600

Instructor’s Manual / Solutions Manual

E4.22. (continued) b.

Supplies

Beginning balance 40,000 Cost of supplies purchased ? Ending balance 49,600

Cost of supplies used 157,200

Solution: $40,000 + ? - $157,200 = $49,600 Cost of supplies purchased during the month = $166,800 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Supplies purchased during month: Supplies +166,800 Cash Accounts -166,800 or Payable +166,800 Supplies used during month: Supplies -157,200

Supplies Expense -157,200

Dr. Supplies . ........... ........... ........... ........... ........... ........... ........... 166,800 Cr. Cash or Accounts Payable .. ........... ........... ........... ……… 166,800 Supplies purchased during month. Dr. Supplies Expense .......... ........... ........... ........... ........... ........... 157,200 Cr. Supplies ...... ........... ........... ........... ........... ……… .......... 157,200 Supplies used during month. c.

Wages Payable

Wages paid

30,200

Beginning balance Wages accrued Ending balance

Solution: $7,600 + $39,000 - $30,200 = ? Wages payable at the end of the month = $16,400

4-27

7,600 39,000 ? .

Instructor’s Manual / Solutions Manual

E4.22.

(continued) Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

c. Wage expense accrued during month: Wages Payable +39,000

Wages Expense -39,000

Wages paid during month: Cash Wages -30,200 Payable -30,200 Dr. Wages Expense ........... ........... ........... ........... ........... ……… Cr. Wages Payable ....... ........... ........... ........... ........... ........... Wage expense accrued during month.

39,000

Dr. Wages Payable . ........... ........... ........... ........... ........... ……… Cr. Cash ........... ........... ........... ........... ........... ........... ……… Wages paid during month.

30,200

39,000

30,200

P4.23. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. Cash +400,000

Common Stock +400,000

b. Cash Notes Payable +200,000 +200,000 c. Cash -160,000

Salaries Exp -160,000

d. Merch Accounts Inventory Payable +301,000 +301,000 e. Accounts Rec +250,000 Merch Inv -205,000

Sales +250,000

4-28

Cost of Goods Sold -205,000

Instructor’s Manual / Solutions Manual

P4.23.

(continued) Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

f. Cash -44,000

Rent Exp -44,000

g. Equip Accounts +60,000 Payable Cash +42,000 -18,000 h. Cash Accounts -269,000 Payable -269,000 i. Cash -15,000

Utilities Exp -15,000

j. Cash +221,000 Accounts Rec -221,000 k.

Interest Payable +16,000

Interest Exp -16,000

Rent Payable +4,000

Rent Exp -4,000

Journal entries: a. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Common Stock ........ ........... ........... ........... ........... ...........

400,000 400,000

b. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Notes Payable .......... ........... ........... ........... ........... ...........

200,000

c. Dr. Salaries Expense ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

160,000

d. Dr. Merchandise Inventory .. ........... ........... ........... ........... ........... Cr. Accounts Payable .... ........... ........... ........... ........... ...........

301,000

4-29

200,000

160,000

301,000

Instructor’s Manual / Solutions Manual

P4.23.

(continued) e. Dr. Accounts Receivable ...... ........... ........... ........... ........... ........... Cr. Sales ........... ........... ........... ........... ........... ........... ........... Dr. Cost of Goods Sold ........ ........... ........... ........... ........... ........... Cr. Merchandise Inventory .......... ........... ........... ........... ...........

250,000 250,000 205,000 205,000

f. Dr. Rent Expense...... ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

44,000

g. Dr. Equipment .......... ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Payable .... ........... ........... ........... ........... ...........

60,000

h. Dr. Accounts Payable ........... ........... ........... ........... ........... ……… Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

269,000

i. Dr. Utilities Expense ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

15,000

j. Dr. Cash ........ ........... ........... ........... ........... ........... ........... ........... Cr. Accounts Receivable ........... ........... ........... ........... ………

221,000

k. Dr. Interest Expense . ........... ........... ........... ........... ........... ........... Cr. Interest Payable ....... ........... ........... ........... ........... ...........

16,000

l. Dr. Rent Expense...... ........... ........... ........... ........... ........... ........... Cr. Rent Payable (or Accounts Payable) ........... ........... ………

4,000

44,000

18,000 42,000

269,000

15,000

221,000

16,000

4,000

P4.24. a. Solution approach: Prepare a T-account to determine the Cash account balance, and then review the results of the horizontal model representations (or journal entries above). Since there are a limited number of transactions in Problem 4.23, the balances of all of the other accounts should be easy to determine. Cash a. b. j.

400,000 200,000 221,000

c. f. g. h. i.

315,000

4-30

160,000 44,000 18,000 269,000 15,000

Instructor’s Manual / Solutions Manual

P4.24.

(continued) a.

KISSICK CO. Income Statement Sales .. ........... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit .... ........... ........... ........... ........... ........... ........... ........... Rent expense . ........... ........... ........... ........... ........... ........... ........... Utilities expense ........ ........... ........... ........... ........... ........... ........... Salaries expense ........ ........... ........... ........... ........... ........... ........... Loss from operations . ........... ........... ........... ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Net loss (the problem ignores income taxes) ........... ........... ...........

$ 250,000 (205,000) $ 45,000 (48,000) (15,000) (160,000) $(178,000) (16,000) $(194,000)

KISSICK CO. Balance Sheet Assets: Cash .. ........... ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... ........... Merchandise inventory .......... ........... ........... ........... ........... ........... Total current assets .... ........... ........... ........... ........... ........... ........... Equipment (the problem ignores depreciation) ......... ........... ........... Total assets .... ........... ........... ........... ........... ........... ........... ...........

$ 315,000 29,000 96,000 $ 440,000 60,000 $ 500,000

Liabilities: Accounts payable ...... ........... ........... ........... ........... ........... ........... Interest payable ......... ........... ........... ........... ........... ........... ........... Rent payable .. ........... ........... ........... ........... ........... ........... ........... Total current liabilities .......... ........... ........... ........... ........... ........... Notes payable ........... ........... ........... ........... ........... ........... ........... Total liabilities........... ........... ........... ........... ........... ........... ...........

$ 74,000 16,000 4,000 $ 94,000 200,000 $ 294,000

Stockholders’ Equity: Common stock .......... ........... ........... ........... ........... ........... ........... Accumulated deficit * ........... ........... ........... ........... ........... ........... Total stockholders’ equity ..... ........... ........... ........... ........... ........... Total liabilities and stockholders’ equity ...... ........... ........... ...........

$ 400,000 (194,000) $ 206,000 $ 500,000

* Since this was the first year of operations, the Retained Earnings account would have a $0 beginning balance. Thus, the net loss for the year creates an Accumulated Deficit.

4-31

Instructor’s Manual / Solutions Manual

P4.24. (continued) b. Note to Instructor: Students should be able to determine the net loss amount because there are so few transactions to analyze in Problem 4-23 (the solution to these transactions is provided on the text’s website). Begin the in-class discussion by asking, “What do you think went wrong that caused such a large net loss?”

•

Point out that it is not unusual for a start-up company to show a significant net loss in the first year of operations—because of the cost of organizing the business, and because the revenue-generating process may be delayed for several months (or longer) until the firm’s products can be successfully marketed.

•

Kissick Co. is a merchandising firm (not a manufacturer) because it has purchased $301,000 of Merchandise Inventory. The company must be renting its store location because it has incurred rent expense of $48,000, but owns no land or buildings.

•

Note that the Cash account represents 63% of Kissick Co.’s total assets!

•

Much of the firm’s cash was borrowed on a three-year, 8% note payable (as opposed to generating cash flows from operations). Thus, interest and principal payments will be substantial in the firm’s second and third year of operations— and this adds risk to the firm’s already shaky earnings prospects.

•

Some of the excess cash may be only temporarily available. For example, much of the excess cash is likely to be needed for the acquisition of sales facilities, so that the firm will be able to reduce its rent expense in future years.

•

Alternatively, if there are no immediate plans for long-term asset acquisitions, then most or all of the $200,000 note payable should be repaid to eliminate the interest obligation at 8%.

•

Any remaining excess cash that is not needed in the day-to-day operations of the firm should be invested in short-term securities (to earn a return on investment of some kind).

•

Salary expense of $160,000 is extremely high and unreasonable for a firm with only $250,000 in sales.

4-32

Instructor’s Manual / Solutions Manual

P4.25. a. Net sales ....... ........... ........... ........... ........... ........... ........... ........... ........... $188,000 Cost of goods sold ..... ........... ........... ........... ........... ........... ........... ........... (86,000) Gross profit .... ........... ........... ........... ........... ........... ........... ........... ……… $102,000 General and administrative expenses ........... ........... ........... ........... ……… (24,000) Advertising expense .. ........... ........... ........... ........... ........... ........... ……… (19,000) Other selling expenses ........... ........... ........... ........... ........... ........... ........... (11,000) Income from operations (operating income) . ........... ........... ........... ……… $ 48,000 b. Income from operations (operating income) . ........... ........... ........... ……… $ 48,000 Interest expense ......... ........... ........... ........... ........... ........... ........... ……… (14,000) Income before taxes . ........... ........... ........... ........... ........... ........... ……… $ 34,000 Income tax expense ... ........... ........... ........... ........... ........... ........... ……… (7,000) Net income .... ........... ........... ........... ........... ........... ........... ........... ........... $ 27,000 P4.26. a. Net sales ........ ........... ........... ........... ........... ........... ........... ........... ........... $110,000 Cost of goods sold ..... ........... ........... ........... ........... ........... ........... ........... (36,000) Gross profit .... ........... ........... ........... ........... ........... ........... ........... ........... $ 74,000 Selling, general and administrative expenses ........... ........... ........... ……… (21,000) Research and development expenses ........... ........... ........... ........... ……… (5,000) Income from operations (operating income) . ........... ........... ........... ……… $ 48,000 b. Income from operations (operating income) . ........... ........... ........... ……… $ 48,000 Interest expense ......... ........... ........... ........... ........... ........... ........... ........... (9,000) Income before taxes .. ........... ........... ........... ........... ........... ........... ……… $ 39,000 Provision for income taxes .... ........... ........... ........... ........... ........... ........... (7,000) Net income .... ........... ........... ........... ........... ........... ........... ........... ........... $ 32,000

4-33

Instructor’s Manual / Solutions Manual

P4.27. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. 1/10/22. Record as an expense the cost of paper napkins purchased for cash: Cash Supplies -3,600 (Note: An increase in Supplies Expense Expense decreases Net Income.) -3,600 b. 1/31/22. Remove from the expense account and set up as an asset the cost of the paper napkins on hand January 31. Supplies Supplies +2,950 (Note: A decrease in Supplies Expense Expense increases Net Income.) +2,950 c. 1/10/22. Set up as an asset the cost of paper napkins purchased for cash. Supplies +3,600 Cash -3,600 d. 1/31/22. Record the cost of paper napkins used in January. Supplies -650

Journal entries: a. 1/10/22 Dr. Paper Napkin Expense (or Supplies Expense) .. ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ……… To record as an expense the cost of paper napkins purchased for cash. b. 1/31/22 Dr. Paper Napkins on Hand (or Supplies) .. ........... ........... ……… Cr. Paper Napkin Expense (or Supplies Expense) ..... ........... To remove from the expense account and set up as an asset the cost of paper napkins on hand January 31. c. 1/10/22 Dr. Paper Napkins on Hand (or Supplies) .. ........... ........... ……… Cr. Cash ........... ........... ........... ........... ........... ........... ........... To set up as an asset the cost of paper napkins purchased for cash.

4-34

Supplies Expense -650

3,600 3,600

2,950 2,950

3,600 3,600

Instructor’s Manual / Solutions Manual

P4.27. (continued) d. 1/31/22 Dr. Paper Napkin Expense (or Supplies Expense) . ........... ........... Cr. Paper Napkins on Hand ..... (or Supplies) .. ........... ........... To record the cost of paper napkins used in January.

650 650

e. Each approach results in the same expense for January ($650) and the same asset amount ($2,950) reported on the January 31 balance sheet. P4.28. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. Cash -27,000

Rent Exp. -27,000

b. Prepaid Rent +18,000

Rent Exp. +18,000

c. Prepaid Rent +27,000 Cash -27,000 d. Prepaid Rent -9,000

Rent Exp. -9,000

e. Prepaid Rent -9,000

Rent Exp. -9,000

Journal entries: a. Dr. Rent Expense ..... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

27,000 27,000

b. Dr. Prepaid Rent ..... ........... ........... ........... ........... ........... ........... Cr. Rent Expense ......... ........... ........... ........... ........... ...........

18,000

c. Dr. Prepaid Rent ..... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

27,000

d. Dr. Rent Expense ..... ........... ........... ........... ........... ........... ........... Cr. Prepaid Rent ........... ........... ........... ........... ........... ………

9,000

4-35

18,000

27,000 9,000

Instructor’s Manual / Solutions Manual

P4.28.

(continued) e. Dr. Rent Expense .... ........... ........... ........... ........... ........... ........... Cr. Prepaid Rent ........... ........... ........... ........... ........... ...........

9,000 9,000

f. The payment should be initially recorded with a debit to Prepaid Rent (as in part c), because this would allow the bookkeeper to make the same adjusting entry every month. P4.29. Note: The key to this problem is for students to see that transactions have a direct effect on the financial statements. To answer the questions in part b, students should be thinking about how Campbell would record each of the transactions. To answer the questions in part c, solve for the missing amounts in T-accounts for inventories, accounts receivable, and “payable to suppliers and others” (i.e., accounts payable). Assets

Liabilities Revenues

Expenses

a. b.

Cash and Accounts Payable to Cash Receivable, Inven- Suppliers Equivalents net tories & Others Beginning balance . ………… 1. Net sales ............ ………… 2. Cost of products sold ......... 3. Marketing, selling, and administrative expenses….. 1. Purchases of inventory on account ......... ............... 2. Collections of accounts receivable .......... ............... 3. Payments to suppliers and others .......... ............... Ending balance ...... ………...

574 +8,691

863

Cost of Marketing, Products Selling, and Sold Administrative

814 +8,691

-5,692

-5,692 +947

+8,690

Net Sales

+5,700

$ 871

-6,412 $1,049

-947

-8,690

-6,412 $ 575

Note to Instructors: In this problem, it is assumed that Campbell runs all marketing, general, and administrative expenses through the “payable to suppliers and others” category. It may well be that some of these types of expenses were paid directly as cash payments without ever having been accrued prior to payment. It is also probable that some of these expenses were run through the “accrued liabilities” caption, as shown on Campbell’s statement of earnings. Likewise, it is possible that some of Campbell’s “research and development expenses”, “other expenses / (income)” and “restructuring charges” were run through the “payable to suppliers and others” caption. Thus, the answer for “payments to suppliers and others” in part c is a rough approximation at best. The $6,412 answer would need to be adjusted down (reduced) for any marketing, general and administrative expenses that did not go through “payable to suppliers and others” and for any of these same expenses that were run though other current liability accounts (such as the “accrued liabilities” caption mentioned above). The $6,412 answer would need to be adjusted up (increased) for any of Campbell’s research and development expenses and restructuring charges (or other types of expenses) that were run through the “payable to suppliers and others” caption. Similarly, the accounts receivable and inventory captions as shown on Campbell’s balance sheet may well have been affected by other transactions in addition to those included in this simplified model. Some accounts receivable may have been reclassified as notes receivable, others may have been written off as uncollectible accounts or factored with a finance company. Some inventory may have been lost, stolen, damaged, or written down under the lower of cost or market rule. The point being that with some basic assumptions about Campbell’s transaction processing, we can arrive at approximate—but never exact—results for the questions in part c of this problem.

4-36

Instructor’s Manual / Solutions Manual

P4.30. a. BIG BLUE RENTAL CORP. Income Statement—August 2022

Adjustments / Corrections Preliminary Debit Credit Final

Commission revenue . ........... ........... ........... $27,000 Interest revenue ......... ........... ........... ........... 5,100 Total revenues ......... ........... ........... ........... $32,100 Rent expense . ........... ........... ........... ........... $ 3,060 Wages expense .......... ........... ........... ........... 7,140 Supplies expense ....... ........... ........... ........... -Interest expense ......... ........... ........... ........... -Total expenses ......... ........... ........... ........... $10,200 Net income .... ........... ........... ........... ........... $21,900

$a)1,500 $28,500 f ) 840 5,940 $ $ 2,340 $34,440 $ $e)2,040 $ 1,020 d) 780 7,920 b)1,080 1,080 c) 120 120 $ 1,980 $ 2,040 $10,140 $ 1,980 $ 4,380 $24,300

BIG BLUE RENTAL CORP. Adjustments / Corrections . Balance Sheet—August 31, 2022 Preliminary Debit Credit Final Cash ... ........... ........... ........... ........... ........... $ 2,400 $ $ $ 2,400 Notes receivable ........ ........... ........... ........... 78,000 78,000 Commissions receivable ........ ........... ........... -a)1,500 1,500 Interest receivable ..... ........... ........... ........... -f ) 840 840 Prepaid rent ... ........... ........... ........... ........... -e)2,040 2,040 Supplies ......... ........... ........... ........... ........... 3,900 b)1,080 2,820 Total assets .... ........... ........... ........... ........... $84,300 $ 4,380 $ 1,080 $87,600 Accounts payable ...... ........... ........... ........... $ 720 Note payable .. ........... ........... ........... ........... 14,400 Interest payable ......... ........... ........... ........... 240 Wages payable ........... ........... ........... ........... -Dividend payable ....... ........... ........... ........... -Total liabilities........... ........... ........... ........... $15,360

$ 720 14,400 c) 120 360 d) 780 780 g) 8,400 8,400 $ 9,300 $24,660

Paid-in capital ........... ........... ........... ........... $14,400 Retained earnings: Balance, August 1 ..... ........... ........... ........... $32,640 Net income .... ........... ........... ........... ........... 21,900 Dividends ...... ........... ........... ........... ........... -Balance, August 31 ... ........... ........... ........... $54,540 Total stockholders' equity...... ........... ........... $68,940 Total liabilities and stockholders’ equity ...... $84,300

$14,400

$32,640 1,980 4,380 24,300 g) 8,400 (8,400) $ 10,380 $ 4,380 $48,540 $ 10,380 $ 4,380 $62,940 $ 10,380 $13,680 $87,600

Note: The net income line from the income statement is transferred down to the retained earnings section of the balance sheet. Remember, net income increases retained earnings, and net income is the link between the income statement and balance sheet.

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P4.30.

(continued) a. Calculation for item c: $14,400 Notes payable * 10% interest rate * 1/12 = $120 accrued interest, one month. Thus, the $240 preliminary balance in the Interest Payable account makes sense because it represents interest for two months on the note payable that had been accrued between the last interest payment date (May 31) and the end of last month (July 31). Calculation for item e: Too much was recorded as Rent Expense in August because the $3,060 rent payment included a prepayment of the rent for September and October. Thus, the Prepaid Rent (asset) account should be debited for $2,040 (2/3 * $3,060), and the Rent Expense account should be credited for the same amount.

b. Adjustments are made at the end of an accounting period to properly reflect accrual accounting in the financial statements. The accrual of a revenue item (i.e., an income statement account) that has been earned but not yet collected will also result in an increase to an asset account (i.e., a balance sheet account). In this problem, items (a, commissions) and (f, interest) are examples of revenue accruals that also result in increases to the related receivable accounts. Likewise, adjustments that are made to accrue expenses (i.e., income statement accounts) result in increases to liability accounts (i.e., balance sheet accounts). Items (c, interest) and (d, wages) are examples of expense accruals that also increase the related payable accounts. For reclassification-type adjustments, the same logic holds true. For example, the increase to supplies expense on the income statement in item (b) is a result of the "using up" of an asset on the balance sheet (i.e., Supplies). c. Accrual accounting recognizes revenues and expenses as they occur, even though the cash receipt from the revenue or the cash disbursement related to the expense may occur before or after the event that causes revenue or expense recognition. Another way of stating this would be to say that most adjustments are caused by either 1) the early or late receipt of cash relative to when the revenue is earned, or 2) the early or late payment of cash relative to when the expense is incurred. That is, all revenues need to be recorded in the period earned, even if the company has not yet received the cash (i.e., items (a) and (f) in this problem). The fact that cash has not yet been received is what caused the need for the adjustment to begin with — so the Cash account itself cannot be affected! Likewise, expenses must be recorded when incurred, such as items (c) and (d), even though cash has not yet been paid. The cash payments will not be recorded until the next accounting period when the interest and wages are paid.

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P4.30.

(continued) c. When cash is received before the related revenue is earned, or when cash is paid before the related expense has been incurred, reclassification-type adjustments are necessary. An example of this is item (e). In this case, too much rent expense had been recorded initially relative to the amount of rent expense actually incurred during the month. As a result, the required adjustment is to reduce the amount of rent expense to be reported on the income statement, which also results in an increase to prepaid rent on the balance sheet. Other examples of adjustments might include depreciation expense, or the accrual of advertising expense, for example.

C4.31. a. Commissions expense. Since DeBauge Realtors, Inc. is a service firm, the company would not report cost of goods sold, and the other costs of operating the business are likely to be less than the commissions expense that would be paid to Jeff and Kristi, and to any non-owner sales associates employed by the firm. b. Advertising expense is material in amount. The owners of the firm would be interested in knowing how much was spent on advertising so that an assessment could be made of the relative value received (i.e., commissions revenue per dollar spent on advertising). c. $15,000 Interest Expense / $250,000 Note Payable = 6% effective interest rate. d. Operating income ...... ........... ........... ........... ........... ........... ........... ........... $265,000 Interest expense ......... ........... ........... ........... ........... ........... ........... ........... (15,000) Earnings before taxes ........... ........... ........... ........... ........... ........... ……… $250,000 Average income tax rate = Income tax expense / Earnings before taxes = $70,000 / $250,000 = 28% e. Since there were no changes in paid-in capital during the year, beginning paid-in capital would also be $120,000. Thus, the beginning retained earnings would be $210,000 (total stockholders’ equity at December 31, 2021 of $330,000 less $120,000 paid-in capital). Retained earnings, December 31, 2021 ......... ........... ........... ........... ........... Add: Net income for the year ended December 31, 2022 ..... ........... ……… Less: Dividends declared and paid in 2022 ... ........... ........... ........... ……… Retained earnings, December 31, 2022 ......... ........... ........... ........... ...........

$210,000 180,000 (90,000) $300,000

The company’s dividend policy must be to distribute 50% of net income as dividends to its two stockholders. It is not uncommon for a closely-held corporation to distribute a high percentage of its net income as dividends (even up to 100%). In effect, this provides additional income to the owners beyond the compensation included in the “Cost of services provided” on the income statement.

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C4.31.

(continued) f. The corporate form of organization protects the owners by providing limited liability, such that their personal assets that have not been invested in the business are free from the reach of the business creditors—even in corporate bankruptcy proceedings. The primary disadvantage of the corporate form is that business profits are taxed twice--once at the corporate level, and a second time at the individual level when dividends are paid to stockholders. For DeBauge Realty, Inc., the corporation incurred $70,000 of Income Tax Expense (based on $250,000 of earnings before taxes), and Jeff and Kristi will have to pay additional individual income taxes on the $90,000 received as dividends as well as on any commissions that were paid to them personally (included in the “Cost of services provided” on the income statement). In a partnership, the income earned by the business passes through to the owners, and no taxes are paid by the partnership.

g. Businesses are often required to make quarterly tax payments based on their estimated annual taxable income, so DeBauge Realty, Inc. has probably already paid a substantial portion of its 2022 tax bill. h. Working capital = CA - CL

Current ratio = CA / CL

Cash and short-term investments ...... ........... ........... ........... ........... ........... Accounts receivable, net ....... ........... ........... ........... ........... ........... ........... Total current assets (A) ......... ........... ........... ........... ........... ........... ...........

12/31/22 $179,000 190,000 $369,000

Accounts payable ...... ........... ........... ........... ........... ........... ........... ........... Income taxes payable ........... ........... ........... ........... ........... ........... ……… Total current liabilities (B) .... ........... ........... ........... ........... ........... ………

$430,000 20,000 $450,000

Working capital (A - B) ........ ........... ........... ........... ........... ........... ........... Current ratio (A / B) .. ........... ........... ........... ........... ........... ........... ………

$(81,000) 0.82

With negative working capital and a current ratio of less than 1.0, this company is experiencing a major liquidity crisis. Money will have to be borrowed on a long-term basis in order to pay current obligations unless the owners discontinue their practices of distributing 50% of net income as dividends and paying what appear to be substantial real estate sales commissions.

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C4.31.

(continued) i.

ROI

NET INCOME AVERAGE TOTAL ASSETS

MARGIN

TURNOVER

NET INCOME SALES* . SALES* x AVERAGE TOTAL ASSETS

$180,000 = (($1,130,000 + $1,120,000) / 2) 16% =

$180,000 $750,000 24%

x x

$750,000 (($1,130,000 + $1,120,000) / 2) 0.67

* Commissions revenue is used for sales.

ROE = Net income / Average stockholders’ equity = $180,000 / (($330,000 + $420,000) / 2) = 48.0% Trend comparisons of ROI and ROE cannot be made with data for only one year. For service firms such as DeBauge Realty, Inc., ROE is more significant to analysts than ROI because the investment in assets is relatively small (as compared to that required for merchandising and manufacturing firms). Thus, the ROI measure may be distorted by the small amount of “Average total assets” in the denominator. ROE provides a better measure for closely-held service firms because the stockholders are interested in their personal return.

C4.32. a. Gerrard Construction Co. is an excavation contractor, and has invested substantially all of its resources in property, plant, and equipment (i.e., heavy, earth-moving machinery). Not surprisingly, depreciation expense is material in amount. The owners of the firm would be interested in knowing what the approximate “economic” cost of fixed asset utilization is, because a substantial portion of the firm’s profits will need to be invested in replacement machinery and equipment. Another reason for separating depreciation expense from other operating expenses is that depreciation does not result in a cash outflow. Yes, depreciation is a “cost” of doing business; although cash is not affected by the depreciation adjustment, the wear and tear of long-term assets results in a loss of their economic value. b. Depreciation expense is high because Gerrard Construction Co. is a highly capitalintensive firm. Interest expense is high because the firm has a large amount of long-term debt. Depreciation should be related to property, plant, and equipment, and interest should be related to notes payable. The effective interest rate is 8% ($11,400,000 / $142,500,000).

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C4.32. (continued) c. Operating income ...... ........... ........... ........... ........... ........... ........... ........... $42,900,000 Interest expense ......... ........... ........... ........... ........... ........... ........... ........... (11,400,000) Earnings before taxes ........... ........... ........... ........... ........... ........... ……… $31,500,000 Average income tax rate = Income tax expense / Earnings before taxes = $9,600,000 / $31,500,000 = 30.5% (rounded) d. Businesses are often required to make quarterly tax payments based on their estimated annual taxable income. Gerrard Construction Co. has probably already made payments for taxes related to 2022, but underestimated its tax due for prior quarters. e. Cash and short-term investments ...... ........... ........... ........... ........... ........... $ 8,400,000 Accounts receivable, net ....... ........... ........... ........... ........... ........... ........... 29,400,000 Total current assets .... ........... ........... ........... ........... ........... ........... ........... $37,800,000 Current assets are low, in relative terms, because construction firms are capital-intensive. f. As an excavation contractor, the firm provides services to its customers, but does not sell goods. g. Working capital = Current assets - Current liabilities Current ratio = Current assets / Current liabilities 12/31/22 Cash and short-term investments ...... ........... ........... ........... ........... ........... $ 8,400,000 Accounts receivable, net ....... ........... ........... ........... ........... ........... ........... 29,400,000 Total current assets (A) ......... ........... ........... ........... ........... ........... ........... $37,800,000 Accounts payable ...... ........... ........... ........... ........... ........... ........... ........... $ 4,500,000 Income taxes payable ........... ........... ........... ........... ........... ........... ........... 4,800,000 Total current liabilities (B) .... ........... ........... ........... ........... ........... ........... $ 9,300,000 Working capital (A - B) ........ ........... ........... ........... ........... ........... ........... $28,500,000 Current ratio (A / B) .. ........... ........... ........... ........... ........... ........... ........... 4.06 The firm shows high liquidity measures, and should not have any difficulties meeting its current obligations as they become due. However, the accounts receivable balance seems to be large relative to net revenues, and an analysis of the accounts receivable detail is certainly warranted. It may be that the firm extends credit too liberally, or that it has difficulties in collecting certain major accounts. Note also that the balance sheet does not show a liability for interest payable, which indicates that the firm has kept current on its interest payments (related to the long-term notes payable).

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C4.32. (continued) h. ROI

NET INCOME AVERAGE TOTAL ASSETS

MARGIN

TURNOVER

NET INCOME SALES* . SALES* x AVERAGE TOTAL ASSETS

$21,900,000 = (($246,000,000 + $270,000,000) / 2)

$21,900,000 $96,600,000

8.5%

22.7%

$96,600,000 (($246,000,000 + $270,000,000) / 2)

0.37

* Net revenues is used for sales. ROE = Net income / Average stockholders’ equity = $21,900,000 / (($97,800,000 + $118,200,000) / 2)

= 20.3%

Note: Ending stockholders’ equity = $30,000,000 PIC + $88,200,000

= $118,200,000

The firm’s profitability measures appear to be within the normal range of expectation. ROE is significantly higher than ROI because Gerrard Construction Co. has relied very heavily on long-term borrowings to finance the acquisition of its property, plant, and equipment. Trend data for the company and for the construction industry (or data for close competitors) are needed to increase the validity of this conclusion. Note: Although the financial leverage concept is discussed and illustrated in Chapter 11, this problem provides an opportunity to introduce students to the magnification effect on ROE that occurs when debt is added to the firm’s capital structure. At this point in the course, an appropriate explanation of the difference between ROI and ROE would be that the owners of Gerrard Construction Co. have made money through the use of other people’s money. i. Since there were no changes in paid-in capital during the year, the beginning paid-in capital would also be $30,000,000. Thus, the beginning retained earnings would be $67,800,000 (total stockholders’ equity at December 31, 2021 of $97,800,000 less $30,000,000 paid-in capital). Retained Earnings

Dividends declared and paid

???

Beginning balance Net income Ending balance

Solution: $67,800,000 + $21,900,000 - ??? = $88,200,000 Dividends declared and paid = $1,500,000

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67,800,000 21,900,000 88,200,000

Instructor’s Manual / Solutions Manual

TAKE-HOME QUIZ -- CHAPTER 4

NAME__________________________

1. Mikor has an account payable of $7,700 due to Smiley, Inc., one of its suppliers. The amount was due to be paid on October 15, 2022. Mikor only had enough cash on hand then to pay $1,700 of the amount due, so Mikor's treasurer called Smiley's treasurer and agreed to sign a note payable for the balance. The note was dated October 15, 2022, had an interest rate of 8% per annum, and was payable with interest on December 31, 2022. Use the horizontal model, or write the journal entry, to show the effect of: a. The October 15, 2022 payment of $1,700 and the creation of a note payable for the balance owed.

b. The October 31, 2022 accrual of interest expense for the month of October.

c. The December 31, 2022 payment of the note and all of the interest due. Interest for November and December had not been accrued.

2. On January 10, 2022, Jeanco paid $2,100 rent for a storage facility for the period from January 10 through May 31. The rent charge is $450 per month. Use the horizontal model, or write the journal entry, to show the effect of: a. The January 10, 2022 rent payment assuming that the disbursement was recorded as an expense.

b. The January 31, 2022 adjustment recorded to show the appropriate amount of expense in the income statement of Jeanco for the month of January.

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TAKE-HOME QUIZ -- CHAPTER 4 (continued) c. Show an alternative way of recording the disbursement of $2,100 on January 10, 2022.

d. Record the adjustment that would be appropriate at January 31, 2022 if the disbursement had been recorded as in c.

e. What is the effect of the difference between the two methods of recording these items (a and b versus c and d) on the: 1. Income statement for the month of January?

2. Balance sheet at January 31?

3. A bookkeeper prepared the year-end financial statements of Giftwrap, Inc. The income statement showed net income of $3,900, and the balance sheet showed beginning retained earnings of $39,200. No dividends were declared or paid during the year. The firm's accountant reviewed the bookkeeper's work and determined that adjusting entries should be made which would increase revenues by $2,200 and decrease expenses by $900. a. What will be the amount of net income after the above adjustments are recorded?

b. What was the ending retained earnings balance on the balance sheet prepared by the bookkeeper?

c. What is the correct ending balance in retained earnings to be reported on the balance sheet?

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TAKE-HOME QUIZ KEY -- CHAPTER 4 1. a. Dr. Accounts Payable ........... ........... ........... ........... ........... ........... Cr. Cash ... ........... ........... ........... ........... ........... ........... ........... Cr. Note payable ........... ........... ........... ........... ........... ...........

7,700 1,700 6,000

b. Dr. Interest Expense .. ........... ........... ........... ........... ........... ........... 20 Cr. Interest Payable ......... ........... ........... ........... ........... ........... Interest = Principal * Rate * Time = $6,000 * 8% * (1/2 month /12) = $20 c. Dr. Note Payable ....... ........... ........... ........... ........... ........... ........... Dr. Interest Payable ... ........... ........... ........... ........... ........... ........... Dr. Interest Expense .. ........... ........... ........... ........... ........... ........... Cr. Cash .. ........... ........... ........... ........... ........... ........... ...........

6,000 20 80 6,100

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. Cash -1,700

Accounts Payable -7,700 Note Payable +6,000

Interest Payable +20

Interest Exp. -20

c. Cash -6,100

Note Payable -6,000 Interest Payable -20

Interest Exp. -80

2. a. Dr. Rent Expense ..... ........... ........... ........... ........... ........... ........... Cr. Cash ... ........... ........... ........... ........... ........... ........... ...........

2,100

b. Dr. Prepaid Rent ($450 * 2/3 month = $300 expense. $2,100 - $300 = $1,800) .... Cr. Rent Expense . ........... ........... ........... ........... ........... ...........

1,800

c. Dr. Prepaid Rent ........ ........... ........... ........... ........... ........... ........... Cr. Cash ... ........... ........... ........... ........... ........... ........... ...........

2,100

d. Dr. Rent Expense ...... ........... ........... ........... ........... ........... ........... Cr. Prepaid Rent . ........... ........... ........... ........... ........... ...........

300

2,100

1,800

2,100

300

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY -- CHAPTER 4 (continued) 2. e. There are no differences on either the income statement or the balance sheet. After the adjusting entry is recorded at the end of January, the firm will show $300 of rent expense and $1,800 of prepaid rent. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. Cash -2,100

Rent Expense -2,100

b. Prepaid Rent +1,800

Rent Expense +1,800

c. Cash -2,100 Prepaid Rent +2,100 d. Prepaid Rent -300

Rent Expense -300

3. a. Before adjustments ...... ........... ........... ........... ........... ........... ........... ........... Revenue increase ......... ........... ........... ........... ........... ........... ........... ........... Expense decrease ........ ........... ........... ........... ........... ........... ........... ........... After adjustment .......... ........... ........... ........... ........... ........... ........... ...........

Net Income $ 3,900 2,200 900 $ 7,000

b. and c. Retained earnings, beginning balance ........... ........... ........... Net income ..... ........... ........... ........... ........... ........... ........... Dividends ....... ........... ........... ........... ........... ........... ........... Ending balance ........... ........... ........... ........... ........... ...........

Bookkeeper $39,200 3,900 -$43,100

Corrected $39,200 7,000 -$46,200

The point is that adjustments to the income statement affect retained earnings dollar for dollar, because net income is closed into retained earnings.

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CHAPTER

Accounting for and Presentation of Current Assets

CHAPTER OUTLINE: I. Preliminary topics A. Operating Cycle B. Expansion of the Horizontal Model: Statement of Cash Flows column II. Cash and Cash Equivalents A. Balance sheet valuation — amount available B. The Bank Reconciliation as a Control Over Cash 1. Timing differences a. Deposits in transit b. Outstanding checks c. Charges for bank services d. Interest added to the account e. NSF checks 2. Errors 3. Adjustments required III. Short-Term Marketable Securities A. Reasons for investing in debt and equity securities B. Balance sheet valuation C. Interest accrual IV. Accounts Receivable A. Balance sheet valuation — net realizable value B. Bad debts/uncollectible accounts 1. Expense recognition/valuation adjustment 2. Write-off of uncollectible accounts C. Cash discounts 1. Credit terms 2. Cash discounts subtracted from revenues in income statement

Instructor’s Manual / Solutions Manual V. Notes Receivable A. Comparison with accounts receivable B. Interest accrual VI. Inventories A. Alternative generally accepted practices exist B. Flow of costs from inventory to cost of goods sold C. Inventory cost flow assumptions 1. Specific identification 2. Weighted-average cost 3. FIFO 4. LIFO D. The impact of changing costs (inflation/deflation) E. Selecting an inventory cost flow assumption F. Inventory accounting system alternatives 1. Perpetual 2. Periodic G. Inventory errors H. Balance sheet valuation at the lower of cost or market VII. Prepaid Expenses and Other Current Assets A. Prepaid insurance B. Other prepaid items

Instructor’s Manual / Solutions Manual PRELIMINARY WARNING: The coverage of six current asset elements in this chapter includes descriptions of many accounting/bookkeeping procedures that enhance the student’s understanding of business and make the coverage more complete; however, these procedures do not have to be mastered by the student to achieve course objectives. These procedures include the bank reconciliation, petty cash, estimating uncollectible accounts, cash discounts, and the application of inventory cost flow assumptions. Emphasis should be placed on the financial statement impact and the "matching" results achieved by these procedures, rather than on the procedures themselves. The instructor must avoid the trap of spending so much time on the procedural details of this material that the semester plan is thrown off.

TEACHING/LEARNING OBJECTIVES: Principal: 1. To have the student understand and be able to analyze the transactions that affect current assets, and related income statement accounts, and to use the horizontal model to illustrate the effects of these transactions on the financial statements. 2. To have the student understand the application of valuation and matching concepts in accounting for accounts receivable. 3. To have the student understand the significance of inventories to many entities; to recognize the effect of the cost flow assumption and changing price levels on the balance sheet and income statement; and to understand the impact of inventory errors on both the balance sheet and income statement. 4. To have the student integrate accounting for current assets with its impact on profitability (ROI, ROE) and liquidity measurements. Supporting: 5. To continue to build the student's understanding of the double entry system and the use of journal entries to record transactions and adjustments. 6. To have the student understand the bank reconciliation process. 7. To have the student understand the reasons for, and valuation of, short-term investments. 8. To introduce the student to the concept and components of the system of internal control.

Instructor’s Manual / Solutions Manual TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. The discussion of cash provides an opportunity to explain the bank reconciliation process, which many students follow for their own checking account. Exercises 5-9 through 5-10 are straightforward illustrations. Problems 5-27 and 5-28 require more thought because the student must work backwards to determine the unadjusted Cash account and bank statement balances. 2. Students are usually interested in short-term investments issues, and this provides an opportunity to re-emphasize the risk/return relationship. 3. A key to understanding the allowance for bad debts account is to have students understand the idea of detailed accounts receivable records and an allowance account that applies to accounts receivable in total. Exercises 5-11 and 5-12 along with Problems 5-29 through 5-32 are application-oriented and focus on the impact of the allowance method on the financial statements. 4. The Business In Practice box about Internal Control should be emphasized, because students will encounter internal controls in their work, and now is the time to learn why they exist. 5. Discussion of valuation allowances is a chance to emphasize that the matching concept has as much significance as the original cost concept. 6. Inventory accounting is the first topic in the text coverage for which alternative accounting practices exist. 7. Having the student understand that FIFO and LIFO describe the flow of costs "in" to inventory and "out" to cost of goods sold is a key to understanding these alternatives. Problems 5-33 through 5-36 are straightforward “numbers” assignments. 8. The impact of changing price levels is the most important integrating concept for the student to learn in this chapter. Exercises 5-19 and 5-20 are conceptually oriented and can be used to facilitate class discussion of the impact of the firm’s LIFO-FIFO decision. 9. It is important to integrate the inventory cost flow assumption material with its impact on profitability (ROI, ROE) and liquidity measures. Emphasis should be placed on the potential problems that arise when inter-firm comparisons are made. 10. Illustrations from actual annual reports should be utilized extensively so students become more familiar with "reading" the financial statements and to illustrate the application of the ideas described in this chapter.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: NO. M5.1. M5.2. M5.3.

LEARNING OBJECTIVES 3 3 5

DIFFICULTY & TIME ESTIMATE Easy, 5-8 min. Easy, 2-3 min. Med., 7-10 min.

M5.4. M5.5. M5.6.

5 7, 8 7, 8

Med., 7-10 min. Med., 7-10 min. Med., 7-10 min.

M5.7. M5.8. E5.9. E510. E5.11. E5.12. E5.13.

10 10 3 3 3 3 5

Easy, 3-5 min. Easy, 3-5 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 2-3 min. Easy, 2-3 min. Med., 7-10 min.

E5.14. E5.15.

5 5

Med., 7-10 min. Med., 5-8 min.

E5.16. E5.17.

5 6

Easy, 4-6 min. Easy, 5-8 min.

E5.18. E5.19. E5.20. E5.21.

6 7, 8 7, 8 10

Easy, 5-8 min. Med., 5-8 min. Med., 5-8 min. Med., 7-10 min.

E5.22.

Med., 7-10 min.

E5.23. E5.24. E5.25. E5.26. P5.27.

5, 6, 8 5, 8, 10 5, 6, 7 7, 8, 10 3

Easy-Med., 5-7 min. Easy-Med., 5-7 min. Easy-Med., 5-7 min. Med., 7-10 min. Med., 7-10 min.

P5.28. P5.29.

3 5

Med., 7-10 min. Med., 7-10 min.

P5.30.

Med., 10-12 min.

P5.31. P5.32. P5.33. P5.34. P5.35.

5 5 7, 8 7, 8 7, 8

Med., 7-10 min. Med., 7-10 min. Med., 12-15 min. Med., 12-15 min. Med.-Hard, 15-20 min.

OTHER COMMENTS Basic bank reconciliation. Related to M5.1. T-account analysis of Accounts Receivable and Allowance for Bad Debts to determine ending balances. See M5.3. T-account analysis of Allowance for Bad Debts. Basic FIFO-LIFO mini-exercise using periodic. See M5.5. Basic FIFO-LIFO mini-exercise with an interesting twist to calculate number of units purchased in October. Basic prepaid insurance mini-exercise. Basic prepaid rent mini-exercise. Basic bank reconciliation. Basic bank reconciliation. Related to E5.9. Related to E5.10. Emphasize the financial statement effects of: 1) the adjustment to accrue bad debts expense, versus 2) the write-off entry. See E5.13. Good in-class demonstration exercise. Students should review the Business in Practice—Cash Discounts before attempting this problem. See E5.15. Good in-class demonstration exercise. Can use as a follow-up problem to reinforce the adjustment process introduced in Chapter 4. See E5.17. Good homework assignment. Good in-class discussion exercise. See E5.19. Can use as a follow-up problem to reinforce the adjustment process introduced in Chapter 4. See P7.29 for an integrating assignment. E5.22 covers the prepaid (asset) transactions for a tenant, while P7.29 covers the unearned rent revenue (liability) transactions for the landlord of a six-month store lease. Basic transaction analysis. Basic transaction analysis. Basic transaction analysis. Good homework assignment. Emphasize the bank reconciliation format (“book” vs. “bank”) and solve for the beginning balances. See P5.27. Group learning problem. Part b can be used to explain why the allowance method is conceptually superior to the direct write-off method. Group learning problem. Review the solution with students, focusing on “what the numbers mean” rather than on mechanics. Excellent “T-accounts” problem. See P5.31. Good homework assignment. Basic FIFO-LIFO problem using periodic. See P5.33. Good in-class demonstration problem. Students should review Business in Practice—The Perpetual Inventory System before attempting this problem. Emphasize the

Instructor’s Manual / Solutions Manual Balance Sheet—Income Statement link, and the timing of cost of goods sold recognition (periodic vs. perpetual).

ASSIGNMENT OVERVIEW (continued): NO. P5.36.

LEARNING OBJECTIVES 7, 8

P5-37.

P5-38.

C5.39.

5, 7, 8

DIFFICULTY & TIME ESTIMATE Med.-Hard, 15-20 min. Med.-Hard, 7-10 min. Med.-Hard, 12-15 min. Easy, 7-10 min.

OTHER COMMENTS See P5.35. Group learning problem. Students should review the “Inventory Errors” section before attempting this problem. Group learning problem. Excellent way to stress the importance of inventory valuation. Focus company—basic review of note disclosures. Encourage students to use Adobe Acrobat for downloading annual reports.

SOLUTIONS: M5.1. Balance per bank……… $14,900 Add: Deposit in transit… 2,100 Less: Outstanding checks. (1,500) Reconciled balance…… M5.2. a.

$15,500

Balance per books……………… Add: Interest earned……………. Less: NSF check………………... Bank service charges…………… Reconciled balance……………...

$16,200 50 (650) (100) $15,500

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash -700 Acc. Rec. +650

Int.Rev. +50

Dr. Miscellaneous Expense (for bank service charge) ....... ……… Dr. Accounts Receivable (for NSF check) .. ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ........... Cr. Interest Revenue .... ........... ........... ........... ........... ...........

Misc.Exp. -100

100 650 700 50

b. The cash amount to be shown on the balance sheet is the $15,500 reconciled amount.

Instructor’s Manual / Solutions Manual

M5.3. Accounts Receivable Beginning balance ..... ........... Sales on account ........ ........... Ending balance .......... ...........

30,000 100,000 ? .

Cash collections ......... ........... Accounts written off ... ………

94,000 1,000

Ending balance = $30,000 + $100,000 - $94,000 - $1,000 = $35,000. This makes sense because the debit to accounts receivable for sales on account of $100,000 was greater than the credits during the year for cash collections and write-offs of $95,000, so the ending balance is $5,000 more than the beginning balance. Allowance for Bad Debts Bad debt write-offs Beginning balance .......... ………. (During the year) ....... ........... 1,000 Bad debt expense ........... ………. Ending balance ... ........... ……….

1,500 2,000 ? .

Ending balance = $1,500 + $2,000 - $1,000 = $2,500. This makes sense because this company wrote-off $1,000 less accounts during the year than it added to the allowance account with the bad debts expense adjustment; thus, the ending balance of the allowance account is $1,000 more than the beginning balance. Net realizable value: Accounts receivable . ........... ........... ........... ........... ........... …… $35,000 Less: Allowance for bad debts .......... ........... ........... ........... …… (2,500)

$32,500

Allowance for Bad Debts Bad debt write-offs Beginning balance .......... ………. (During the year) ....... ........... ? Bad debt expense ........... ………. Ending balance ... ........... ……….

19,200 36,600 24,400.

M5.4.

Bad debt write-offs = $19,200 + $36,600 - $24,400 = $31,400. This makes sense because the ending balance of the Allowance for Bad Debts account was $5,200 greater than the beginning balance, so the bad debt write-offs (debits to the account) are $5,200 less than the bad debts expense for the year (credits to the account).

Instructor’s Manual / Solutions Manual

M5.5. Calculation ending inventory in units: Beginning inventory .. ........... ........... ........... ........... ........... ........... Purchase 1 ...... ........... ........... ........... ........... ........... ........... ........... Purchase 2…. . ........... ........... ........... ........... ........... ........... ........... Goods available for sale ........ ........... ........... ........... ........... ........... Sales ... ........... ........... ........... ........... ........... ........... ........... ........... Ending inventory ....... ........... ........... ........... ........... ........... ...........

400 units 200 units 100 units 700 units (500) units 200 units

Calculation of cost of goods sold amounts: a. ------- FIFO ------- b. ------- LIFO ------Beginning inventory.. 400 @ $6 = $2,400 Purchase 2 ... ……. 100 @ $8 = $ 800 Purchase 1 ...... ........... 100 @ $7 = 700 Purchase 1 ... ……. 200 @ $7 = 1,400 Cost of goods sold ..... ........... $3,100 Beginning inventory 200 @ $6 = 1,200 Cost of goods sold .. ........... $3,400 Calculation of ending inventory amounts: a. ------- FIFO ------- b. ------- LIFO ------Purchase 2 ...... ........... 100 @ $8 = $ 800 Beg. inventory….. 200 @ $6 = $1,200 Purchase 1 ...... ........... 100 @ $7 = 700 Ending inventory... $1,200 Ending inventory ....... ........... $1,500

M5.6.

Instructor’s Manual / Solutions Manual a. Beginning inventory .. ........... ........... ........... May purchases ........... ........... ........... ........... October purchases…. . ........... ........... ........... Goods available for sale ........ ........... ........... Sales ... ........... ........... ........... ........... ........... Ending inventory ....... ........... ........... ...........

900 units @ $10 per unit = $ ? 1,800 units @ ? per unit = 19,800 ? units @ ? per unit = ? 3,900 units $43,200 ? units 1,650 units

Solution approach: Use the information available to solve for the missing information. Number of units purchased in October = 3,900 – 900 – 1,800 = 1,200 units Number of units sold = 3,900 – 1,650 = 2,250 units Cost of beginning inventory = 900 units @ $10 = $9,000 Cost per unit purchased in May = $19,800 / 1,800 units = $11 per unit Cost of October purchases = $43,200 – $9,000 – $19,800 = $14,400 Cost per unit purchased in October = $14,400 / 1,200 units = $12 per unit b. Calculation of cost of goods sold amounts: -------- FIFO --------------- LIFO -------Beginning inventory.. 900 @ $10 = $ 9,000 October purchases...1,200 @ $12 = $14,400 May purchases……. 1,350 @ $11 = 14,850 May purchases.…... 1,050 @ $11= 11,550 Cost of goods sold ..... ........... $23,850 Cost of goods sold . ........... $25,950 M5.6.

(continued) b. Calculation of ending inventory amounts: -------- FIFO --------------- LIFO -------October purchases…1,200 @ $12 = $14,400 Beg. inventory……. 900 @ $10 = $ 9,000 May purchases……. 450 @ $11 = 4,950 May purchases…… .750 @ $11 = 8,250 Ending inventory ....... ........... $19,350 Ending inventory................... $17,250

M5.7. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Insurance +9,000 Cash -9,000 May 1 Dr. Prepaid Insurance .......... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

9,000

To record the payment of a one-year insurance premium.

9,000

Instructor’s Manual / Solutions Manual b.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Insurance -750

Insurance Expense -750

Each month-end: Dr. Insurance Expense ........ ........... ........... ........... ........... ........... Cr. Prepaid Insurance ... ........... ........... ........... ........... ...........

750 750

To record the expiration of prepaid insurance each month.

c. At December 31, 2022, 8 months of insurance coverage has been used, and 4 months remains unused (prepaid). Thus, 4/12 of the original premium of $9,000, or $3,000, is prepaid and will be shown on the December 31, 2022 balance sheet as a current asset.

M5.8. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Rent +18,000 Cash -18,000 September 1, 2022 Dr. Prepaid Rent ...... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

18,000 18,000

To record a six-month advance rent payment.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Rent -3,000

Rent Expense -3,000

Each month-end: Dr. Rent Expense .... ........... ........... ........... ........... ........... ........... Cr. Prepaid Rent ........... ........... ........... ........... ........... ………

3,000

To record the expiration of prepaid rent each month.

3,000

Instructor’s Manual / Solutions Manual

c. At December 31, 2022, four months of prepaid rent have expired, and two months remain unexpired. Thus, 2/6 of the original premium of $18,000, or $6,000, is prepaid rent and will be shown on the December 31, 2022 balance sheet as a current asset. E5.9. Balance per bank………… Add: Deposit in transit….. Less: Outstanding checks ($33 + $160)…………… Reconciled balance………

$1,168 800

Balance per bank………… Add: Deposit in transit…... Less: Outstanding checks...

$9,050 1,300 (1,620)

Reconciled balance………

$8,730

(193) $1,775

Balance per books…………………. Less: NSF check…………………... Error in recording check (as $27 instead of $72)…………... Reconciled balance………………..

$1,940 (120)

Balance per books…………………. Add: Interest earned………………. Error in recording payment……….. Less: Check charge………………... Reconciled balance………………...

$8,436 68 270 (44) $8,730

(45) $1,775

E5.10.

E5.11. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Accounts Accounts Receivable Payable +120 -45 Cash -165 Dr. Accounts Receivable (for NSF check) .. ........... ........... ........... Dr. Accounts Payable .......... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

120 45 165

b. The cash amount to be shown on the balance sheet is the $1,775 reconciled amount.

E5.12.

Instructor’s Manual / Solutions Manual a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash +294

Acc. Pay. +270

Int.Rev. +68

Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... Dr. Miscellaneous Expense (for check charge) ...... ........... ……… Cr. Accounts Payable ... ........... ........... ........... ........... ........... Cr. Interest Revenue .... ........... ........... ........... ........... ...........

Misc.Exp. -44 294 44 270 68

b. The cash amount to be shown on the balance sheet is the $8,730 reconciled amount.

E5.13. Allowance for Bad Debts Bad debt write-offs (from 1/1 to 11/30) ........... ……

1/1/22 balance ... ........... … Bad debt expense (from 1/1 to 11/30) ..... … 11/30/22 balance …………

$21,600 24,910 $17,440

12/31/22 balance ........... …

$14,200

Adjustment required (12/31/22)… ?

a. Solution approach: The bad debt write-offs from January through November can be determined by subtracting the November 30 balance from the total of the beginning balance and the bad debts expense recognized for the first 11 months. Bad debt write-offs = $21,600 + $24,910 - $17,440 = $29,070 E5.13. (continued) b. The adjustment required at December 31, 2022 can be determined by comparing the November 30 balance in the allowance account to the desired ending balance. Bad debt expense adjustment = $17,440 - $14,200 = $3,240 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Allowance for Bad Debts +3,240

(Note: A decrease in an expense increases net income, and a decrease in a contra-asset account increases total assets.)

Dr. Allowance for Bad Debts .......... ........... ........... ........... ........... Cr. Bad Debts Expense ........... ........... ........... ........... ...........

Bad Debts Expense +3,240 3,240

To adjust the allowance account to the appropriate balance, and to correct the overstatement of expense recorded in the January through November period.

3,240

Instructor’s Manual / Solutions Manual

The write-off will not have any effect on 2022 net income, because the write-off decreases both the accounts receivable asset and the allowance account contra-asset for equal amounts. Net income was affected when the bad debt expense was recognized.

E5.14. Allowance for Bad Debts Bad debt write-offs 1/1/22 balance ... ........... ........... $25,160 (during the year)………….. $65,700 Bad debt expense .......... ........... ? . 12/31/22 unadjusted balance ..... $30,440 Adjustment required ...... ........... ? . 12/31/22 balance, as adjusted .......... ........... ........... $61,600 a. Solution approach: The bad debt expense recognized during the year can be determined by comparing the bad debt write-offs during the year to the change in the balance of the allowance account from the beginning to the end of the year (before considering the yearend adjustment). Since the allowance account balance increased during the year, there was more bad debt expense recognized than accounts written-off during the year. Bad debt expense = $65,700 - $25,160 + $30,440 = $70,980 E5.14. (continued) b. Bad debt expense adjustment = $61,600 - $30,440 = $31,160 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Allowance for Bad Debts -31,160

Bad Debts Expense -31,160

Dr. Bad Debts Expense ....... ........... ........... ........... ........... ........... Cr. Allowance for Bad Debts ... ........... ........... ........... ...........

31,160 31,160

To adjust the allowance account to the appropriate balance.

E5.15. a. 2% * $240,000,000 * 90% = $4,320,000, or $4.32 million. b. By paying within 10 days instead of 30 days, the customers are "investing" funds for 20 days, and receiving slightly more than a 2 percent return on their investment (for a $100 obligation, the return is $2 on an investment of $98). But ROI is expressed as an annual percentage rate, and there are slightly more than 18 twenty-day periods in a year. Thus, the annual ROI is a little greater than 36 percent. (See Business in Practice—Cash Discounts.) 5-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

E5.16. a. Solution approach: The percentage discounts offered are for short-term loans of 15 days (30 -15), 50 days (60 -10), and 80 days (90 -10), respectively. Assuming the use of a 360-day year, calculate the number of 15-day, 50-day, and 80-days periods within a year, then multiply these factors by the percentage discounts offered. 1. 360 days / 15 day loan = 24 loan periods within a year * 1% discount = 24% ROI 2. 360 days / 50 day loan = 7.2 loan periods within a year * 2% discount = 14.4% ROI 3. 360 days / 80 day loan = 4.5 loan periods within a year * 1% discount = 4.5% ROI b. Customers are not likely to pay promptly with terms of 1/10, net 90 because they can earn a higher ROI elsewhere.

E5.17. a.

| 7/15/22 (date of note)

5.5 months

___ |______ 2.5 months | 12/31/22 3/15/23 (year-end) (maturity date)

Interest earned = $7,000 * 12% * 5.5/12 = $385 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Interest Receivable +385

Interest Revenue +385

Dr. Interest Receivable ........ ........... ........... ........... ........... ........... Cr. Interest Revenue ..... ........... ........... ........... ........... ...........

385 385

To accrue interest earned on a short-term note.

b. Solution approach: What accounts are affected, and how are they affected? Cash is being received for note principal and 8 month's interest. Notes receivable is reduced because the note is being paid off. Interest receivable accrued at 12/31/22 is being collected. Interest revenue for 2.5 months from 1/1/23 to 3/15/23 has been earned. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Instructor’s Manual / Solutions Manual Cash +7,560 Note Receivable -7,000 Interest Receivable -385

Interest Revenue +175

Dr. Cash ($7,000 + ($7,000 * 12% * 8/12)) ........... ........... ........... Cr. Note Receivable ..... ........... ........... ........... ........... ........... Cr. Interest Receivable (accrued at 12/31/22) .. ........... ........... Cr. Interest Revenue ($7,000 * 12% * 2.5/12). ........... ...........

7,560 7,000 385 175

To record the collection of principal and interest at the maturity date of a short-term note (for which some interest had been previously accrued).

E5.18. a. Interest earned = $525,000 principal * 4.2% rate * one-year time = $22,050 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Interest Receivable +22,050

Interest Revenue +22,050

Dr. Interest Receivable ........ ........... ........... ........... ........... ........... Cr. Interest Revenue ..... ........... ........... ........... ........... ...........

22,050

To accrue interest earned on short-term notes.

Interest Receivable

22,050

Instructor’s Manual / Solutions Manual

1/1/22 balance ......... ........... …….. $ ? Interest collected.... …….. Interest accrued ....... ........... …….. 22,050 12/31/22 balance ..... ........... …….. $ ?

Solution approach: Because the ending balance is $6,400 more than the beginning balance, the interest accrued must be $6,400 more than the interest received. Thus, $15,650 of interest receivable was collected in cash during the year. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash +15,650 Interest Receivable -15,650 Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... Cr. Interest Receivable . ........... ........... ........... ........... ...........

15,650 15,650

To record the cash collection of interest receivable on short-term notes.

E5.19. a. Under LIFO, the cost of the most recent purchases are released to cost of goods sold. If the purchase cost of inventory items is changing, the selling price of these same items is likely to be changing in the same direction. Thus, releasing the most recent purchase costs to the Cost of Goods Sold account results in better matching of revenue and expense. b. During periods of rising prices, LIFO results in a balance sheet valuation that is lower than current cost. This is considered consistent with the “original cost” concept usually used to record asset values. However, it understates the “value” of inventory items because it does not reflect the current cost of inventory items. The ending inventory under FIFO more accurately reflects the value of inventory items.

E5.20. a. ROI = Net income / Average assets Net income ... ........... ........... ........... ........... ........... / Average assets ........ ........... ........... ........... ........... = ROI ........... ........... ........... ........... ........... ...........

FIFO $ 1,500,000 10,000,000 15%

LIFO $1,200,000 9,700,000 12.4%

Analysis of results: When prices are rising, LIFO results in a higher cost of goods sold amount and a lower ending inventory amount, as compared to FIFO. Thus, net income is lower, assets are lower, and ROI is lower under LIFO.

Instructor’s Manual / Solutions Manual b. Net income .... ........... ........... ........... ........... ........... / Average assets ......... ........... ........... ........... ........... = ROI. ........... ........... ........... ........... ........... ...........

FIFO $ 1,800,000 12,000,000 15%

LIFO $ 1,900,000 11,800,000 16.1%

Analysis of results: When prices are falling, all of the above effects (from part a) are reversed. LIFO may result in a lower cost of goods sold in any given year (since the most recent, lowest costs, are treated as cost of goods sold). If a liquidation occurs, the ending inventory amount will also be lowered in that year, as compared to FIFO. Thus, net income will be higher under LIFO, and ROI will also be higher, as compared to FIFO. E5.21. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Insurance +4,800 Cash -4,800 April 1 Dr. Prepaid Insurance .......... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

4,800 4,800

To record the payment of a one-year insurance premium.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Insurance -400

Insurance Expense -400

Each month-end: Dr. Insurance Expense ........ ........... ........... ........... ........... ........... Cr. Prepaid Insurance ... ........... ........... ........... ........... ...........

400 400

To record the expiration of prepaid insurance each month.

E5.21. (continued) c. At December 31, 2022, 9 months of insurance coverage has been used, and 3 months remains unused (prepaid). Thus, 3/12 of the original premium of $4,800, or $1,200, is prepaid and will be shown on the December 31, 2022 balance sheet as a current asset. d. The prepaid amount is $6,000 for 15 months of coverage. Only $4,800 of this amount is a current asset, because of the one-year time frame for current assets. Thus, $1,200 of the prepaid amount is technically a noncurrent asset.

Instructor’s Manual / Solutions Manual

e. Accounting for prepaid expenses achieves a better matching of revenues and expenses and yields a more meaningful measure of net income. Although the expenditure of cash has been made, the item relates to the earning of revenue in a subsequent accounting period. E5.22. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Rent +31,800 Cash -31,800 November 1, 2022 Dr. Prepaid Rent ...... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

31,800 31,800

To record a six-month advance rent payment.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Prepaid Rent -5,300

Rent Expense -5,300

Each month-end: Dr. Rent Expense .... ........... ........... ........... ........... ........... ........... Cr. Prepaid Rent ........... ........... ........... ........... ........... ………

5,300 5,300

To record the expiration of prepaid rent each month.

c. At December 31, 2022, two months of prepaid rent have expired, and four months remain unexpired. Thus, 4/6 of the original premium of $31,800, or $21,200, is prepaid rent and will be shown on the December 31, 2022 balance sheet as a current asset. d. At a rate of $5,300 per month, the 18-month rent prepayment would have been $95,400. The prepaid amount at December 31, 2022 is $84,800 ($5,300 per month for the next 16 months). Only $63,600 ($5,300 * 12 months) of this amount is a current asset, because of the one-year time frame for current assets. Thus, $21,200 ($5,300 * 4 months) of the prepaid amount is technically a non-current asset.

Instructor’s Manual / Solutions Manual E5.23. b. Determined that the Allowance for Bad Debts balance should be increased by $2,700.

Current Current Stockholders' Net Assets Liabilities Equity Income Allowance for Bad Debts Bad Debts Expense -2,700 -2,700

c. Recognized bank service charges of $35 for the month.

Cash -35

d. Received $80 cash for interest receivable that had been accrued in a prior month.

Cash +80 Interest Receivable -80

e. Purchased six units of a new item of inventory on account at a cost of $90 each.

Inventory Accounts +540 Payable +540

f. Purchased 20 more units of the same item on account at a cost of $96 each.

Inventory Accounts +1,920 Payable +1,920

g. Sold eight of the items purchased Inventory (in e and f above), and recognized -732 the cost of goods sold using the FIFO (6 units @ $90, cost flow assumption. 2 units @ $96)

Service Charge Exp -35

Cost of Goods Sold -732

E5.24. Current Current Stockholders' Net Assets Liabilities Equity Income b. Determined that the Allowance for Bad Debts balance should be decreased by $7,200 because expense during the year was overestimated.

Allowance Bad Debts for Bad Debts Expense +7,200 +7,200 (A reduction of an expense increases net income, and a reduction of a contra-asset increases total assets.)

c. Wrote off an account receivable of $2,600.

Accounts Receivable -2,600 Allowance for Bad Debts +2,600

(Net realizable value of accounts receivable is not affected.)

Instructor’s Manual / Solutions Manual

E5.24.

(continued) Current Current Stockholders' Net Assets Liabilities Equity Income Cash +2,450 Accounts Receivable -2,500 Allowance for Cash Discounts +50

d. Received cash from a customer in full payment of an account receivable of $2,500 that was paid within the 2% discount period.

e. Purchased six units of a new item of inventory on account at a cost of $130 each.

Inventory Accounts +780 Payable +780

f. Purchased 14 more units of the above item on account at a cost of $140 each.

Inventory Accounts +1,960 Payable +1,960

g. Sold 16 of the items purchased (in e and f above), and recognized the cost of goods sold using the LIFO cost flow assumption.

Inventory -2,220 (14 units @ $140, 2 units @ $130)

h. Paid an insurance premium of $3,840 that applied to the next fiscal year.

Cash -3,840 Prepaid Insurance +3,840

i. Recognized insurance expense related to the above policy during the first month of the fiscal year to which it applied.

Prepaid Insurance -320

Cost of Goods Sold -2,220

Insurance Expense -320

Instructor’s Manual / Solutions Manual

E5.25. Current Current Stockholders' Net Assets Liabilities Equity Income b. Recorded estimated bad debts in the amount of $1,100.

Allowance for Bad Debts -1,100

c. Wrote off an overdue account receivable of $840.

Accounts Receivable -840 Allowance for Bad Debts +840

Bad Debts Expense -1,100

(Net realizable value of accounts receivable is not affected.)

d. Converted a customer’s $1,700 overdue account receivable into a note.

Notes Receivable +1,700 Accounts Receivable -1,700

e. Accrued $56 of interest earned on the note (in d above).

Interest Receivable +56

f. Collected the accrued interest (in e above).

Cash +56 Interest Receivable -56

g. Recorded $6,000 of sales, 60% of which were on account.

Cash +2,400 Accounts Receivable +3,600

Sales +6,000

h. Recognized cost of goods sold in the amount of $4,100.

Inventory -4,100

Cost of Goods Sold -4,100

Interest Revenue +56

E5.26.

Instructor’s Manual / Solutions Manual Current Current Stockholders' Net Assets Liabilities Equity Income b. Paid $9,300 in cash as an advance rent payment for a short-term lease that covers the next three months.

Cash -9,300 Prepaid Rent +9,300

c. Recorded an adjusting entry at the end of the first month (of b above) to show the amount of rent “used” in the month.

Prepaid Rent -3,100

d. Inventory was acquired on account and recorded for $4,810.

Inventory Accounts +4,810 Payable +4,810

e. The inventory acquired on account (in d above) should have been recorded for only $4,180.

Inventory -630

f. Purchased 12 units of inventory at a cost of $120 each, and then 4 more units of the same inventory item at $140 each. Paid cash for both transactions.

Inventory +2,000 Cash -2,000

g. Sold 13 of the items purchased (in f above) for $210 each, and received the entire amount in cash. Record the sales transaction, and the cost of goods sold using the LIFO cost of goods sold assumption.

Cash +2,730

Sales +2,730

Inventory -1,640 (4 @ $140, 9 @ $120)

Cost of Goods Sold -1,640

h. Assume the same facts (in g above) except that the company uses the FIFO cost flow assumption. Record only the cost of goods sold.

Inventory -1,580 (12 @ $120, 1 @ $140)

Cost of Goods Sold -1,580

i. Assume the same facts (in g above) except that the company uses the weighted-average cost flow assumption. Record only the cost of goods sold.

Inventory -1,625 ($2,000 / 16 units = $125 per unit)

Cost of Goods Sold -1,625

Rent Expense -3,100

Accounts Payable -630

j. The sales amount is equal to the number of units sold (13) multiplied by the selling price per unit ($210), or $2,730 in total, which is independent of the cost flow assumption used.

Instructor’s Manual / Solutions Manual

P5.27. Solution approach: Set up a bank reconciliation in the usual format, enter the known information, and then work backwards to solve for the beginning balances in the company’s Cash account and on the bank statement (these are referred to as the “Indicated balance” amounts in Exhibit 5-2 in the text). Indicated balance (per bank) . $ ? Add: Deposits in transit…….. 3,100 Less: Outstanding checks…... (4,000) Reconciled balance.... ...........

$5,800

Indicated balance (per books). Add: Check recording error… Less: NSF check……………. Bank service charge……….... Reconciled balance..... ...........

$ ? 90 (700) (100) $5,800

Key: To solve for the beginning (i.e., indicated) balances, the effects of reconciling items must be reversed out of the known ending (i.e., reconciled) balances. a. Balance per Cash account before reconciliation = $5,800 - 90 + 700 + 100 = $6,510 b. Balance per bank before reconciliation = $5,800 – 3,100 + 4,000 = $6,700

P5.28. Indicated balance (per bank) . $ ? Add: Deposits in transit......... 22,700 Less: Outstanding checks ...... (14,250)

Reconciled balance.... ........... $36,400

Indicated balance (per books). $ ? Add: Interest earned ... ........... 88 Less: Bank service charge ...... (110) Check recording error ........... (612) NSF check ...... ……… ........... (3,240) Reconciled balance..... ........... $36,400

Key: To solve for the beginning (i.e., indicated) balances, the effects of reconciling items must be reversed out of the known ending (i.e., reconciled) balances. a. Balance per Cash account before reconciliation = $36,400 - 88 + 110 + 612 + 3,240 = $40,274 b. Balance per bank before reconciliation = $36,400 – 22,700 + 14,250 = $27,950

P5.29. Allowance for Bad Debts a. Bad debt write-offs (during the year). . . . . . . .

9,100

12/31/22 balance ....... ........... Bad debt expense ...... ........... 12/31/23 balance ....... ...........

12,300 ? 8,700

Bad debt expense = $9,100 - $12,300 + $8,700 = $5,500

Instructor’s Manual / Solutions Manual

P5.29. (continued) b. 1. Working capital would not be affected because the write-off entry decreases both the accounts receivable asset and the allowance account contra-asset by equal amounts. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Accounts Receivable -1,600 Allowance for Bad Debts +1,600 Dr. Allowance for Bad Debts .......... ........... ........... ........... ........... Cr. Accounts Receivable .......... ........... ........... ........... ...........

1,600 1,600

To write off a past due account as uncollectible.

2. Net income would not be affected by the write-off entry because it does not adjust any expense or revenue accounts. ROI would not be affected because net income and total assets are not changed. c. Sales were probably lower in 2023 because the accounts receivable balance has decreased during the year—but this cannot be determined for sure without information about the cash collections of accounts receivable. P5.30. a. An analysis of an aged trial balance of accounts receivable is the most accurate way of determining the appropriate allowance account balance. b.

Allowance for Uncollectible Accounts Bad debt write-offs (during the year). . . . . . . .

12/31/22 balance .......... ........... 11,000 Bad debt expense ......... ........... 19,000 12/31/23 balance .......... ........... 23,000

Bad debt write-offs = $11,000 + $19,000 - $23,000 = $7,000 c. 1. Working capital would not be affected because the write-off entry decreases both the accounts receivable asset and the allowance account contra-asset by equal amounts. (See answer to Problem 5-29 b. above). 2. Net income would not be affected by the write-off entry because it does not affect any expense or revenue accounts. ROI would not be affected because net income and total assets are not changed.

Instructor’s Manual / Solutions Manual

P.5.30. (continued) d. Sales were probably higher in 2023 because the accounts receivable balance has increased during the year—but this cannot be determined for sure without information about the cash collections of accounts receivable. e. At 12/31/22: $11,000 allowance / $370,000 accounts receivable = 3.0% At 12/31/23: $23,000 allowance / $480,000 accounts receivable = 4.8% The ratio could have increased because: a) credit was extended to proportionately more slow-paying or high credit-risk customers during 2023, or b) proportionately fewer bad accounts were actually written off during 2023. P5.31. Solution approach: Net realizable value = Accounts receivable - Allowance for bad debts. The balance sheet presentation of this information at December 31, 2023 (ending balances) is provided with the problem information. Your task is to work backwards to determine the balances in these accounts at December 31, 2022 (beginning balances). Accounts Receivable 12/31/22 balance ....... ........... Sales on account ........ ........... 12/31/23 balance ....... ...........

? 700,000 80,000

Cash collections.......... ........... Accounts written off ... ………

725,000 35,000

December 31, 2022 balance = $725,000 + $35,000 - $700,000 + $80,000 = $140,000. This makes sense because the credits to accounts receivable during the year for cash collections and write-offs exceeded the debit for sales on account. Allowance for Bad Debts Bad debt write-offs (During the year) ....... ........... 35,000

12/31/22 balance ........... ………. Bad debt expense ........... ………. 12/31/23 balance ........... ……….

? 28,000 17,000

December 31, 2022 balance = $17,000 + $35,000 - $28,000 = $24,000. This makes sense because Carr Co. wrote-off $7,000 more accounts during the year than it added to the allowance account with the bad debts expense adjustment. Thus, the allowance account balance would decrease by $7,000 for the year. At December 31, 2022: Accounts receivable . ........... ........... ........... ........... ........... Less: Allowance for bad debts .......... ........... ........... ...........

$140,000 (24,000)

$116,000

Instructor’s Manual / Solutions Manual

P5.32. Emphasize: Net realizable value = Accounts receivable - Allowance for bad debts. Accounts Receivable 12/31/22 balance .... ........... 425,000 Sales on account ..... ........... 2,600,000 12/31/23 balance .... ........... ?

Cash collections ....... Accounts written off.

2,375,000 30,000

December 31, 2023 balance = $425,000 + $2,600,000 - $2,375,000 - $30,000 = $620,000. This makes sense because the debit to accounts receivable for sales on account exceeded the credits for cash collections and write-offs. Allowance for Bad Debts Bad debt write-offs (during the year). . . . . . . . .

30,000

12/31/22 balance ..... ........... Bad debt expense .... ........... 12/31/23 balance ..... ...........

18,000 41,000 ?

December 31, 2023 balance = $18,000 + $41,000 - $30,000 = $29,000. This makes sense because Gibbs Co. added more $11,000 to the allowance account with the bad debts expense adjustment than it wrote off as uncollectible accounts. Thus, the allowance account balance would increase by $11,000 for the year. At December 31, 2023: Accounts receivable . ........... ........... ........... ........... ........... Less: Allowance for bad debts .......... ........... ........... ...........

$620,000 (29,000)

$591,000

P5.33.

Instructor’s Manual / Solutions Manual a. Ending inventory calculations: --------- FIFO ---------Blowers ......... ........... 10 of 11/7 @ $700 = $ 7,000

---------- LIFO ---------10 of 1/21 @ $700 = $ 7,000

Mowers.......... ........... 10 of 9/20 @ $620 = $ 6,200 10 of 8/15 @ $640 = 6,400 $12,600

10 of 4/6 @ $620 = $ 6,200 10 of 5/22 @ $640 = 6,400 $12,600

Analysis of results: In this problem, there is no difference between the ending inventories amounts under FIFO and LIFO; thus there won't be any difference between cost of goods sold under either alternative. Why isn’t ending inventory affected by the inventory cost flow assumption used? Look carefully at the cost per unit of inventory items purchased during the year. Notice that the cost per unit of the blowers purchased on January 21 and November 7 were the same ($700). Likewise, the cost per unit of the mowers purchased on April 6 and September 20 were the same ($620). The mowers purchased on May 22 and August 15 also had the same cost per unit ($640). These unit costs were carefully selected to demonstrate that the differences between FIFO and LIFO are minimized, or possibly eliminated altogether, when prices rise and fall throughout the year. P5.33. (continued) b. LIFO is probably being used because the higher cost of the most recent (last-in) purchase will become part of cost of goods sold, thus decreasing the company’s profits and income tax obligation. P5.34. a. Calculation of ending inventory in units: Beginning inventory .. ........... ........... ........... ........... ........... ........... Purchases (total) ........ ........... ........... ........... ........... ........... ........... Goods available for sale ........ ........... ........... ........... ........... ........... Sales .. ........... ........... ........... ........... ........... ........... ........... ........... Ending inventory ....... ........... ........... ........... ........... ........... ...........

500 units 1,900 units 2,400 units (1,600) units 800 units

Calculation of cost of goods sold amounts: ------- FIFO ------------- LIFO ------Beginning inventory… 500 @ $4 = $ 2,000 Purchases……. 500 @ $8 = $ 4,000 Purchases ....... ........... 600 @ $5 = 3,000 800 @ $6 = 4,800 500 @ $6 = 3,000 300 @ $5 = 1,500 Cost of goods sold ..... ........... $ 8,000 Cost of goods sold ......... $10,300 Calculation of ending inventory amounts: ------- FIFO ------------- LIFO ------500 @ $8 = $ 4,000 Beg. inv . ……. 500 @ $4 = $ 2,000 300 @ $6 = 1,800 Purchases……. 300 @ $5 = 1,500 Ending inventory ....... ........... $ 5,800 Ending inventory $ 3,500 Purchases ....... ...........

Instructor’s Manual / Solutions Manual Weighted-average calculations: Beginning inventory .. ........... ........... ........... ........... ........... Purchases ....... ........... ........... ........... ........... ........... ........... Goods available for sale in units and dollars ………………

500 @ $4 = $ 2,000 600 @ $5 = 3,000 800 @ $6 = 4,800 500 @ $8 = 4,000 2,400 units $13,800

Weighted-average cost = $13,800 / 2,400 units = $5.75 per unit Cost of goods sold = 1,600 units @ $5.75 = $9,200 Ending inventory = 800 units @ $5.75 = $4,600

P5.34. (continued) b. Solution approach: The effect on net income will be the difference between the cost of goods sold as computed under the weighted-average method, versus the cost of goods sold as computed under the FIFO and LIFO methods, respectively. FIFO cost of goods sold is $1,200 lower than the weighted-average cost of goods sold ($8,000 -$9,200), so net income will be $1,200 higher under FIFO, or $81,200. LIFO cost of goods sold is $1,100 higher than weighted-average ($10,300 - $9,200), so net income will be $1,100 lower under LIFO, or $78,900. P5.35.

Instructor’s Manual / Solutions Manual Solution approach: Calculate goods available for sale in units and dollars, and ending inventory in units. These amounts are the same for both FIFO and LIFO under either a periodic or a perpetual inventory system. Beginning inventory .. ........... ........... ........... ........... ……… Purchases ....... ........... ........... ........... ........... ........... ...........

300 @ $ 90 = $ 27,000 140 @ 99 = 13,860 180 @ 105 = 18,900 280 @ 108 = 30,240 100 @ 114 = 11,400 Goods available for sale ....... ........... ........... ........... ……… 1,000 $101,400 Sales .. ........... ........... ........... ........... ........... ........... ........... (600) Ending inventory ....... ........... ........... ........... ........... ........... 400 units a. FIFO periodic cost of goods sold ..... ........... ........... ………

300 @ $ 90 = $ 27,000 140 @ 99 = 13,860 160 @ 105 = 16,800 $ 57,660

FIFO periodic ending inventory........ ........... ........... ………

20 @ $105 = $ 2,100 280 @ 108 = 30,240 100 @ 114 = 11,400 $ 43,740 $101,400

LIFO periodic cost of goods sold ..... ........... ........... ……… 100 @ $114 = $ 11,400 280 @ 108 = 30,240 180 @ 105 = 18,900 40 @ 99 = 3,960 $ 64,500 LIFO periodic ending inventory ....... ........... ........... ……… 300 @ $ 90 = $ 27,000 100 @ 99 = 9,900 $ 36,900 $101,400

P5.35.

(continued)

Instructor’s Manual / Solutions Manual b. FIFO perpetual cost of goods sold .... ........... ……… 2/22 sale 200 @ $ 90 = $ 18,000 6/11 sale 100 @ 90 = 9,000 100 @ 99 = 9,900 12/4 sale 40 @ 99 = 3,960 160 @ 105 = 16,800 $ 57,660 FIFO perpetual ending inventory...... ........... ...........

20 @ $105 = $ 2,100 280 @ 108 = 30,240 100 @ 114 = 11,400 $ 43,740 $101,400

LIFO perpetual cost of goods sold ... ........... ……… 2/22 sale 140 @ $ 99 = $ 13,860 60 @ 90 = 5,400 6/11 sale 200 @ 108 = 21,600 12/4 sale 100 @ 114 = 11,400 80 @ 108 = 8,640 20 @ 105 = 2,100 $ 63,000 LIFO perpetual ending inventory ..... ........... ...........

240 @ $ 90 = $ 21,600 160 @ 105 = 16,800 $ 38,400 $101,400

c. Under FIFO, the periodic and perpetual inventory systems always result in the same dollar amounts being assigned to ending inventory and cost of goods sold—once first-in, always first-in—and the timing of the application of the FIFO rules makes no difference. Under LIFO, the “last-in cost” changes each time another inventory item is purchased. Thus, the timing of the application of the LIFO rules is relevant, and different results will occur under the periodic and perpetual systems. These relationships are discussed in the Business in Practice—The Perpetual Inventory System. P5.36. a. FIFO periodic cost of goods sold ..... ………

FIFO periodic ending inventory........ ........... LIFO periodic cost of goods sold .... ………

LIFO periodic ending inventory ....... ...........

400 @ $13 = $ 5,200 640 @ 15 = 9,600 600 @ 16 = 9,600 200 @ 16 = 800 @ $16 = $12,800 640 @ 15 = 9,600 200 @ 13 = 2,600 200 @ 13 =

$24,400 3,200 $27,600

$25,000 2,600 $27,600

Instructor’s Manual / Solutions Manual P5.36. (continued) b. FIFO perpetual cost of goods sold: 4/10 sale 280 @ $13 = $ 3,640 6/11 sale 120 @ 13 = 1,560 480 @ 15 = 7,200 11/1 sale 160 @ 15 = 2,400 600 @ 16 = 9,600 $24,400 200 @ 16 = 3,200 $27,600

FIFO perpetual ending inventory:

LIFO perpetual cost of goods sold: 4/10 sale 280 @ $13 = $ 3,640 6/11 sale 600 @ 15 = 9,000 11/1 sale 760 @ 16 = 12,160 $24,800 120 @ 13 = 1,560 40 @ 15 = 600 40 @ 16 = 640 2,800 $27,600

LIFO perpetual ending inventory:

c. Under FIFO, the periodic and perpetual inventory systems always result in the same dollar amounts being assigned to ending inventory and cost of goods sold—once first-in, always first-in—and the timing of the application of the FIFO rules makes no difference. Under LIFO, the “last-in cost” changes each time another inventory item is purchased. Thus, the timing of the application of the LIFO rules is relevant, and different results will occur under the periodic and perpetual systems. d. The LIFO periodic calculation is made at the end of the year, and assumes that the cost of the last-in 1,640 units for the year should be released to cost of goods sold. However, the last-in 800 units were purchased on September 28, and only 760 units were actually sold after this point in the year. Thus, at least 40 of these physical units must be in ending inventory.

P5.37. Inventory

Cost of Goods Sold

a. Balance is $12,000 too high

Credit to correct error

Debit to correct inventory error

To correct the overstatement, inventory should be reduced (credited) by $12,000, and cost of goods sold should be increased (debited) by $12,000. If the error is not corrected, cost of goods sold will be understated (too low), and net income will be overstated (too high). b. If ending inventory were understated (too low), cost of goods sold would be overstated (too high), and net income would be understated (too low).

Instructor’s Manual / Solutions Manual

P5.38. a. Sales…………………………………… Cost of goods sold…………………...... Gross profit……………………………. Operating expenses………………….… Net income (ignoring income taxes)…..

2023

2022

$760,000 (556,000) $204,000 (117,000) $ 87,000

$719,000 (512,000) $207,000 (143,000) $ 64,000

b. Combined net income: Total Before correction of error…………………………… $151,000 After correction of error…………………………….. 151,000

2023 $57,000 87,000

2022 $94,000 64,000

Ending inventory errors are “self-correcting” as long as the physical inventory count is made properly at the end of the second year. By properly excluding the goods held on consignment on behalf of Kirk’s Servistar at the end of 2023, the error was “selfcorrecting” and no further action was necessary in 2024—from an accounting perspective, the physical inventory count at the end of 2023 essentially served as the point of discovery of the error. c. The error will have no effect on 2024 net income or stockholders’ equity. The error was fully corrected when the December 31, 2023 ending inventory count was made properly.

C5.39. It should be possible for most students to find the note disclosures for accounts receivable and inventory. The answers will obviously vary depending on the focus company selected by each student. With respect to accounts receivable, most companies disclose dollar amounts for the allowance for uncollectible accounts and any other valuation allowances. Ask students to calculate the percentage of accounts receivable that are expected to become bad debts and to make an assessment of that percentage relative to their expectations given the nature of their company’s business activities. With respect to inventories, most companies disclose the cost flow assumption(s) used, as well as the dollar amounts of materials, work-in-process, and finished goods inventories. Encourage students to download the Adobe Acrobat annual report files for each of the past 3 years for their focus companies; they will need to make reference to some prior year data in subsequent-chapter focus company case assignments.

Instructor’s Manual / Solutions Manual TAKE HOME QUIZ—CHAPTER 5

Name____________________________

A. Accounts Receivable 1. This question is designed to help you reason through the transactions related to accounting for accounts receivable. For each of the transactions described below (items a-d), enter the effects of the transaction on the appropriate side (debit or credit) of the T-accounts affected. Note that the Cash account is not included in the T-accounts shown below, but would be increased by transaction b. The Sales account is not included, but would be increased by transaction a. a. Credit sales. b. Collections from customers. c. Write-off of uncollectible accounts. d. Estimate of bad debts expense. ------------------------------------------------------------------ Balance Sheet / Income Statement ------Allowance for Accounts Receivable Uncollectible Accounts Bad Debts Expense Beginning Balance

Beginning Balance

Ending Balance

Total for the Period

2.. The remaining questions relate to the following presentation in the balance sheets of HiROE Co. at December 31, 2023 and 2022: 12/31/23 12/31/22 Accounts receivable, less allowance for uncollectible accounts of $12,000 and $4,000, respectively .... ........... ........... ........... ........... ........... $487,000 $406,000 a. Describe how the allowance amount at December 31, 2023 was most likely determined.

b. If the bad debt expense for 2023 totaled $14,000, what was the amount of accounts receivable written off during the year? (Hint: Using the T-account model of the allowance account, plug in the three amounts that you know and then solve for the unknown.)

Instructor’s Manual / Solutions Manual TAKE HOME QUIZ—CHAPTER 5 (continued) 2. c. The December 31, 2023 allowance account balance includes $3,500 for a past due account that is not likely to be collected. This account has not been written off. If it had been written off, what would have been the effect of the write off on: 1. Working capital at December 31, 2023?

2. Net income and ROI, for the year ended December 31, 2023?

d. What do you suppose was the level of HiROE's sales in 2023, compared to 2022?

B. Inventories 1. This question is designed to help you reason through the transactions related to accounting for inventories. For each of the transactions described below (items a and b), enter the effects of the transaction on the appropriate side (debit or credit) of the T-accounts affected. Note that the Cash and Accounts Payable accounts are not included in the T-accounts shown below, but would be credited for the expenditures involved in transaction a. a. Cost of items purchased or made. b. Cost of items sold. ------------------------ Balance Sheet / Income Statement -----------------------Inventory Cost of Goods Sold . Beginning Balance

Ending Balance

Total for the Period

Instructor’s Manual / Solutions Manual TAKE HOME QUIZ—CHAPTER 5 (continued) 2. Assume that the company does not keep track of the physical items sold and does not record the cost of an item sold at the same time that the sale is recorded. Assume also that the company does actually count (and determine the cost of) its inventory at the end of every accounting period. Construct a model (i.e., equation) that this company could use to calculate the cost of goods sold at the end of the period.

3. If the beginning balance of the inventory account and the cost of items purchased or made during the period were correct, but an error resulted in understating the firm's ending inventory balance by $4,000, would the firm's net income be affected? If your answer is "yes," explain the amount and direction (overstated—too high or understated—too low) of the effect on net income.

4. Assume that the purchase or manufacturing cost of inventory items has been rising over a period of time and that the LIFO cost flow assumption has been used. Would the firm's margin, turnover, and ROI have been higher or lower than they would have been under the FIFO cost flow assumption? Consider the impact on margin, turnover, and ROI separately, and use the equations shown below to help you think through your answer. ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN NET INCOME SALES

TURNOVER SALES AVERAGE TOTAL ASSETS

Instructor’s Manual / Solutions Manual

TAKE HOME QUIZ KEY—CHAPTER 5 A. Accounts Receivable 1. -------------------------------------------------------------- Balance Sheet / Income Statement -------Allowance for Uncollectible Accounts

Accounts Receivable Beginning Balance a. Credit Sales

b. Collections c. Write-offs

Bad Debts Expense

Beginning Balance c.

Write-offs

Ending Balance

d. Estimated bad debts

Ending Balance

Total for the Period

2. a. A detailed analysis of the accounts receivable at year-end.

Allowance for Uncollectible Accounts Bad debt write-offs 12/31/22 balance ...... ........... (during the year)………. ? Bad debt expense ..... ........... 12/31/23 balance ...... ...........

4,000 14,000 12,000

Bad debt write-offs = $4,000 + $14,000 - $12,000 = $6,000. This makes sense because HiROE Co.’s allowance account balance increased during the year, so more was added to the allowance account with the bad debts expense adjustment than was subtracted for the write-off of uncollectible accounts. c. 1. Working capital would not be affected because the write-off entry decreases both the accounts receivable asset and the allowance account contra-asset by equal amounts. 2. Net income would not be affected by the write-off entry because it does not adjust any expense or revenue accounts. ROI would not be affected because net income and total assets are not changed. d. Sales were probably higher in 2023 because the accounts receivable balance has increased by so much during the year—but this cannot be determined for sure without information about the cash collections of accounts receivable.

Instructor’s Manual / Solutions Manual TAKE HOME QUIZ KEY—CHAPTER 5 (continued) B. Inventories 1. --------------------------- Balance Sheet / Income Statement -----------------------Inventory Beginning Balance a. Cost of items Purchased or Made Ending Balance

b. Cost of items Sold

Cost of Goods Sold

b. Cost of items Sold Total for the Period

2. Beginning Balance + Purchases - Ending Balance = Cost of Goods Sold 3. Yes, net income is affected. Net income is understated (too low) by $4,000. To correct such an error, inventory should be increased (debited) by $4,000 and Cost of Goods Sold should be decreased (credited) by $4,000. 4. If cost of goods sold is overstated, net income is understated. The lower net income causes margin to be lower. Inventory will have lower costs, so the average total assets will be lower, causing turnover to be higher. The effect on ROI cannot be determined because the relative changes in margin and turnover are unknown. Chances are that margin will decrease proportionately more than turnover will increase, so ROI will probably be lower under LIFO than FIFO when prices are rising.

Instructor’s Manual / Solutions Manual

CHAPTER

Accounting for and Presentation of Property, Plant, and Equipment, and Other Noncurrent Assets

CHAPTER OUTLINE: I. Property, Plant, and Equipment A. Land 1. Capitalizing versus expensing B. Buildings and Equipment 1. Cost of assets acquired 2. Depreciation for financial accounting purposes a. An application of the matching concept b. Cash not affected by depreciation c. Depreciation calculation methods 1. Straight-line 2. Units-of-production 3. Declining-balance 4. Sum-of-the-years’-digits (not illustrated) 3. Partial-year depreciation 4. Depreciation for income tax purposes 5. Repair and maintenance expenditures 6. Disposal of depreciable assets C. Assets Acquired by Lease 1. Operating lease versus financing lease 2. Present value (see chapter appendix) D. Intangible Assets 1. Leasehold improvements 2. Patents, trademarks, and copyrights 3. Goodwill II. Natural Resources III. Other Noncurrent Assets IV. Appendix—Present Value

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To have the student understand the major accounting issues with respect to noncurrent assets including the allocation of cost to expense over time, and the significance of capitalizing versus expensing an expenditure. 2. To have the student understand the present value concept and how to use tables of present value factors of $1 and for an annuity of $1. Supporting: 3. To have the student understand the accounting depreciation process, and the balance sheet and income statement consequences of straight-line versus accelerated depreciation. 4. To have the student understand why different depreciation methods are frequently used for book and income tax purposes. 5. To have the student understand how to apply the present value concept to financing leases. 6. To have the student understand that accounting for intangible assets parallels that for tangible assets. 7. To have the student understand the nature of goodwill, the circumstances that cause goodwill to be recorded, the significance of goodwill on the balance sheet, and the impact of goodwill impairment losses on the income statement.

TEACHING OBSERVATIONS: 1. It is recommended that emphasis be placed on the "big picture" issues of accounting for noncurrent assets (see Teaching/Learning objectives) rather than on the details of depreciation calculation methods and/or accounting for asset disposals. 2. The nature of depreciation and the fact that it doesn't involve the use of cash was presented in Chapter 2; these basic concepts should be reviewed and emphasized. 3. The application of the matching concept and judgments made by the accountant in achieving matching are ideas that need to be integrated. 4. The balance sheet and income statement effects of straight-line and accelerated depreciation should be emphasized. This leads to easy development of the reasons for using different methods for book and income tax purposes.

Instructor’s Manual / Solutions Manual 5. A lot of emphasis is required on the present value concept. Present value will be used in subsequent chapters, and those applications will reinforce the concept if a good foundation is built now. 6. The discussion of goodwill integrates the following ideas:1) recording assets at cost, 2) the present value concept, and 3) the importance of future cash flows from an investment. Press reports of a contemporary business acquisition involving an amount greater than the fair market value of the assets being acquired can be used to help students understand the nature of goodwill and any subsequent impairment losses.

ASSIGNMENT OVERVIEW: NO. M6.1. M6.2. M6.3. M6.4. M6.5.

LEARNING OBJECTIVES 1,6 1 2 3 3

DIFFICULTY & TIME ESTIMATE Easy, 2-3min. Easy, 3-5 min. Easy, 2-3 min. Med., 5-8 min. Med., 7-10 min.

OTHER COMMENTS Simple illustration of the cost principle. Basic basket purchase allocation. Basic capitalizing versus expensing mini-exercise. Straightforward depreciation calculations. Demonstrates the impact of depreciation methods on ROI.Emphasize that the difference between straight line and accelerated depreciation has both a balance sheet and income statement effect. Net income and average total assets are both impacted.

M6.6. M6.7.

Easy, 3-5 min.

M6.8. E6.9. E6.10. E6.11.

10 1 1 2, 4

Easy, 3-5 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 2-3 min.

E6.12. E6.13. E6.14. E6.15.

2, 4 3 3 3

Easy, 2-3 min. Easy, 5-7 min. Easy, 3-5 min. Med., 10-12 min.

E6.16. E6.17. E6.18.

3 10 10

Med., 10-12 min. Med., 7-10 min. Easy, 7-10 min.

E6.19. E6.20. E6.21.

9 9 6,8,9

E6.22.

3,4, 6,8

P6.23.

2, 4

Easy, 5-7 min. Med., 10-12 min. Easy-Med., 12-15 min. Easy-Med., 12-15 min. Med.-Hard, 15-20 min.

Goodwill is the missing debit, or the “plug figure” that makes the journal entry balance. Fun way to introduce present value analysis. Demonstrates the need for judgment in accounting. See E6.9. Good in-class demonstration exercise. Emphasize that the nature of the expenditure, not the amount, determines whether to capitalize. The materiality concept is also applicable—but is logically separate. See E6.11. Good conceptual exercise. See E6.13. Straight-forward depreciation calculations— alternative methods. See E6.15. Good in-class demonstration exercise. Basic present value calculations. Demonstrates how to “navigate” the present value tables. Easy way to explain the concept of goodwill. See E6.19. Good in-class demonstration problem. Potpourri—basic transaction analysis.

P6.24. P6.25.

2, 4 3

Med.-Hard, 15-20 min. Med., 12-15 min.

Potpourri—basic transaction analysis. Illustrates the financial statement impact of the capitalizing versus expensing issue. See P6.23. Group learning problem. Good “demo” assignment to prepare for P6.26.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW(continued): NO. P6.26.

LEARNING OBJECTIVES 3

P6.27.

P6.28. P6.29.

3 3, 6

P6.30.

3, 6

P6.31.

7, 8, 10

P6.32. P6.33. P6.34. C6.35. C6.36. C6.37.

7, 8, 10 8, 10 10 1, 3 3 3, 6

DIFFICULTY & TIME ESTIMATE Med.-Hard, 12-15 min. Med., 10-12 min.

Med., 10-12 min. Med.-Hard, 15-20 min. Med.-Hard, 15-20 min. Med., 10-12 min. Med., 10-12 min. Med., 5-7 min. Med., 12-15 min. Med., 12-15 min. Med., 12-15 min. Med.-Hard, 20-30 min. or more

OTHER COMMENTS See P6.25. Good homework assignment for partialyear depreciation calculations. Excellent in-class demonstration problem. Reinforces the student’s understanding of basic depreciation calculations, and emphasizes the financial statement impact of alternative accounting methods. See P6.27. Group learning problem. Excellent way to demonstrate the relevance of the depreciation process. Makes students think. See P6.29. Group learning problem.Works well as a graded homework assignment. Use as an in-class demonstration of capital lease transactions. See P6.31. Basic present value calculations with a capital lease. Good homework assignment. Focus company case. Similar to C6.36. Group learning problem. Similar to C6.35. Capstone analytical review, Chapters 5-6. Sale of fixed assets and accounts receivable collection issues.

SOLUTIONS: M6.1. a. $175,000. Land is reported at its original cost to the acquiring company. b. $175,000. Land continues to be reported at its original costunless ownership of the land changes hands (i.e., if the land is sold). Appraised values of land, whether above or below the original cost of the land, are ignored for financial accounting purposes. Land is not a depreciable asset; thus, depreciation wouldnot be recorded to reduce the book value of the land beneath its original cost. c. $183,000 sales proceeds – $175,000 original cost = $8,000 gain on sale of land.

M6.2.

Allocate the purchase cost in proportion to appraised values. Cost of commercial safe = [$7,500 / ($9,000 + $13,500 + $7,500)] * $18,000 = $4,500

Instructor’s Manual / Solutions Manual M6.3.

Capitalized: •

$5,700 cost to replace the transmission in a company-owned vehicle. This cost should be added to the Vehicles account because it will extend the useful life (and possibly the salvage value) of the asset.

•

$15,100 cost to develop and register a design patent. Patent rights help companies to generate future revenues. This cost should be capitalized and amortized over the estimated useful life or legal life of the patent (20 years), whichever is shorter.

•

$25,400 cost to add a security and monitoring system to the company’s distribution center. This represents a major improvement to the distribution center and should either be added to the cost of that asset or accounted for as a separate asset.

Expensed: •

$19,300 cost of annual property insurance on the company’s production facilities. This expenditure would be recorded as Insurance Expense because the benefits of the insurance coverage only pertain to the current year.

•

$700 cost to repair paint damage on a company-owned vehicle caused by normal wear and tear. A complete “paint job” may be capitalized if it is likely to increase the salvage value (and possibly the useful life) of a company-owned vehicle. Minor paint repair work for “normal wear and tear” should not be capitalized.

M6.4. a. Amount to be depreciated = Cost - Salvage value Annual depreciation expense = Amount to be depreciated / Useful life Net book value = Cost – accumulated depreciation Annual depreciation expense = ($1,200,000 - $300,000) / 10 = $90,000 per year After 3 years, accumulated depreciation = $90,000 * 3 = $270,000 After 3 years, net book value = $1,200,000 - $270,000 = $930,000at December 31, 2024 b. Straight-line rate = 1 / 10 = 10%. Double-declining rate = 10% * 2 = 20% At End of Year . Net Book Value Depreciation Accumulated Net Book Year at Beginning of Year Expense Depreciation Value 2022 $1,200,000 $1,200,000 * 20% = $240,000 $240,000 $960,000 2023960,000 960,000 * 20% = 192,000 432,000 768,000 2024768,000 768,000 * 20% = 153,600585,600614,400

Instructor’s Manual / Solutions Manual M6.5. a. ROI = Net income / average total assets ROI for the year ended December 31, 2022 = $950,000 / $10,000,000 = 9.5% Note: Straight-line depreciation = $90,000 per year, so this amount would have already been subtracted outin the determination of the $950,000 net income for the year. b. The difference between the 2022 straight-line depreciation expense ($90,000) and the 2022double declining balance depreciation expense ($240,000) is $150,000. Net income for 2022 would have been $150,000 less or $800,000 ($950,000 - $150,000). Under double declining balance, accumulated depreciation would have been $150,000 more at December 31, 2022. Averaging this difference for the year means that the average total assets for 2022 would have been $75,000 less ($150,000 / 2), or $9,925,000 ($10,000,000 - $75,000). ROI for the year ended December 31, 2022 using double declining balance depreciation for the CAT 336 DL earth mover = $800,000 / $9,925,000 = 8.1% M6.6. a. Amount to be depreciated = Cost – Salvage value = $17,000 – $3,000 = $14,000 Annual depreciation expense = Amount to be depreciated / Useful life = $14,000 / 4 = $3,500 Accumulated Depreciation account balance on January 3, 2024 = $3,500 * 2 years = $7,000 b. Net book value = Cost – Accumulated Depreciation = $17,000 – $7,000 = $10,000 Sales price – Net book value = Gain (if positive) or Loss (if negative) = $8,200 – $10,000 = $(1,800) Loss on Sale ofEquipment

Instructor’s Manual / Solutions Manual

M6.7.

Solution approach: Goodwill results from the purchase of one firm by another firm for a price greater than the fair market value of the net assets acquired. Both elements of the goodwill definition have been met:1) Backstreets Co. acquired all of Jungleland, Inc.’s net assets, and 2) the price paid ($9,400,000) exceeds the fair market value of the net assets acquired ($6,600,000), computed as follows: $2,100,000 + $4,600,000 + 1,900,000 = $8,600,000 in assets less $2,000,000 in liabilities. Thus, Goodwill = $2,800,000 ($9,400,000 $6,600,000). The effects of this transaction on the financial statements are: Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Land Notes Payable + 2,100,000 + 2,000,000 Buildings + 4,600,000 Inventory + 1,900,000 Goodwill + 2,800,000 Cash - 9,400,000

Land………………………………………………………... 2,100,000 Buildings…………………………………………………… 4,600,000 Inventory…………………………………………………… 1,900,000 Goodwill…………………………………………………… 2,800,000 Cr. Notes Payable…………………………………………. Cr. Cash…………………………………………………… 9,400,000

Dr. Dr. Dr. Dr.

2,000,000

To record the acquisition of Jungleland, Inc. by Backstreets Co., including the recognition of goodwill.

Study suggestions: Where the two conditions for recording goodwill have been met (as described above), calculating the amount to be recorded as Goodwill becomes a simple exercise. Goodwill represents the “unexplained” difference between the purchase price (which is ordinarily recorded as a credit to Cash) and the fair market value of the net assets acquired (which are recorded as debits to the various assets accounts, and possibly as credits for liabilities assumed by the purchaser). The amount recorded as a debit to Goodwill thus becomes a “plug figure” to ensure that the debits and credits in the journal entry balance. The key is to remember that the net assets acquired must be brought forward on the purchasing company’s accounting records at their respective fair market values.Any information provided concerning the book values of the net assets as recorded in the acquired company’s accounting records is not relevant to the purchasing company. From the perspective of the purchasing company, the net assets acquired are recorded at their “historical cost” as of today, the date of the acquisition, as measured by current appraisal values. Similarly, if a company were to purchase a used vehicle, the purchase price paid today is the amount recorded as an asset, not the amount that some other company might have paid for that vehicle years ago when it was new. 6-7 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

M6.8. Today

20 years

$100,000,000 per year 13.5903Table 6-5, 4% column, 20 period row

$1,359,030,000 E6.9. a. Allocate the purchase cost in proportion to appraised values. Cost of land = ($105,000 / ($105,000 + $245,000)) * $310,000 = $93,000 b. Land is not a depreciable asset. Management would want as much of the purchase price as feasible to be assigned to assets whose cost will become a tax-deductible expense in future years—reducing taxable income and income taxes payable. c. Appraised values are to be used because they represent the current asset values (at the time of purchase by Dorsey Co.). The old original cost data represent what the relative asset values were at the time of purchase by Bibb Co., which is not relevant to Dorsey Co. d. All ordinary and necessary costs incurred by Dorsey Co. in order to get the land ready for its intended use should be added to the Land account. Thus, the cost included in the Land account is the total amount paid, plus the cost of demolishing the building. Note that with the facts as described in this situation, no costs would be added to Dorsey Co.’s Buildings account because the building was not acquired with the intent to be used as a building. Cost of land = $310,000 + $30,000 = $340,000

Instructor’s Manual / Solutions Manual

E6.10. a. The cost of the equipment ($136,200) plus the cost of moving and installation ($12,300) are allocated on the basis of the appraiser's estimate of fair value. The list price of the same items if new does not represent the value of the used items being purchased. Likewise, the net book value of the items on the selling company’s books is not relevant to their value to the purchaser.

Punch press………………… Lathe……………………….. Welder……………………… Total………………………...

Appraiser's Estimate of Fair Value $108,000 45,000 27,000 $180,000

Percent of Total 60% 25% 15%

* * *

Total Amount Allocated $148,500 148,500 148,500

Purchase Price Allocation $ 89,100 37,125 22,275 $148,500

b. 3. The remaining useful life of the asset to Crow Co. is the appropriate life to be used for Crow Co.'s depreciation calculation because depreciation is the process of spreading cost over the estimated useful life of the asset to the owner of the asset.

E6.11. a. Expense. Routine repair and maintenance costs would not increase the useful life or estimated salvage of the vehicles, so the “economic benefits” of these expenditures relate only to the current year. b. Asset. The cost of developing the coal mine should be capitalized (as a natural resource) because the extraction of coal will generate revenues in future years. The $29,000,000 cost of developing the coal mine will be recorded as depletion expense (at a cost of $29per ton extracted). c. Asset. This cost should be added to the Building account because it will extend the useful life (and possibly the salvage value) of the asset. d. Expense. Advertising costs, as well as research and development costs, are always treated as expenses for accounting purposes. e. Asset. This cost should be added to the Land account because it is an ordinary and necessary cost incurred to get the land ready for its intended use.

Instructor’s Manual / Solutions Manual E6.12. a. Expense. Actually, this cost should be recorded as a “loss” and not as an asset because it was not an ordinary andnecessary cost incurred in the acquisition (or installation) of the machine. b. Asset. The cost of developing this intangible asset should be capitalizedand amortized over its estimated useful life or legal life, whichever is shorter. c. Asset. Title search fees are ordinary and necessary costs incurred to acquire land, because the purchaser needs to be aware of any “clouds” to the title (i.e., potential adverse claims). d. Expense. This is an example of an ordinary repair and maintenance expenditure. The “patch” in the roof is necessary to restore the asset to its original condition, but it does not extend the useful life or salvage value of the asset. e. Expense. Research and development expenditures are always treated as expenses in the year incurred because it is impossible to objectively determine to what extent, if any, future period revenues will be affected by current period R & D expenditures. Advertising costs are also expensed in the year incurred, for the same reason.

E6.13. Alpha, Inc. should have a higher ROI than Beta Co. Alpha's plant is older and will be depreciated to a greater extent than Beta's. Thus, Alpha's asset base will be lower, so its ROI will be higher. The implication for Beta is that because of its lower ROI, its ability to raise capital will be reduced unless it has production and/or technological advantages or efficiencies.

E6.14. a. Accelerated depreciation expense in the first year will be higher than straight-line depreciation expense. b. After two years, the asset's net book value will be lower under accelerated depreciation than straight-line depreciation. c. Operating cash flows are not affected by the depreciation method used. (Although the depreciation method used does affect income taxes currently payable.)

Instructor’s Manual / Solutions Manual E6.15. a. Amount to be depreciated = Cost - Salvage value Annual depreciation expense = Amount to be depreciated / Useful life Annual depreciation expense = ($1,800,000 - $180,000) / 8 = $202,500 per year After 5 years, accumulated depreciation = $202,500 * 4 = $810,000 b. Straight-line rate = 1 / 8 = 12.5%. Double-declining rate = 12.5% * 2 = 25% At End of Year . Net Book Value Depreciation Accumulated Net Book Year at Beginning of Year Expense Depreciation Value 1 $1,800,000 $1,800,000 * 25% = $450,000 $450,000 $1,350,000 2 1,350,000 1,350,000 * 25% = 337,500 787,500 1,012,500 3 1,012,500 1,012,500 * 25% = 253,1251,040,625759,375 c. Net book value = Cost - Accumulated depreciation. After 8 years, the asset will have been fully depreciated to its estimated salvage value of $180,000 under each method. Accumulated depreciation will be $1,620,000, and net book value will be $180,000 ($1,800,000 - $1,620,000).

E6.16. a. and 1. Straight-line depreciation: b. Amount to be depreciated = Cost - Salvage value Annual depreciation expense = Amount to be depreciated / Useful life Annual depreciation expense = ($117,000 - $18,000) / 4 = $24,750 per year Net book value at the end of the third year = $117,000 - ($24,750 * 3) = $42,750 2. Double-declining balance depreciation: Straight-line rate = 1 / 4 = 25%. Double-declining rate = 25% * 2 = 50%

At End of Year . Net Book Value Depreciation Accumulated Net Book Year at Beginning of Year Expense Depreciation Value 1 $117,000 $117,000 * 50% = $58,500 $ 58,500 $58,500 2 58,500 58,500 * 50% = 29,250 87,750 29,250 3 29,250 29,250 * 50% = 14,625# 102,375 14,625# #This is the calculated amount, but the net book value cannot go below salvage value of $18,000; hence,depreciation expense in the third year is limited to $11,250, as follows: 3

29,250

11,250

99,000

18,000

$87,750 accumulated depreciation + $11,250 = $99,000 maximum accumulated depreciation. $117,000 - $99,000 = $18,000 net book value, limited by salvage value. 6-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual E6.16. (continued) c. The depreciation method used should not affect the decision to sell the truck because the out-of-pocket cash cost of using the truck is not affected by the depreciation method used. If the truck is no longer useful to Barefoot Industries, it should be sold; if it is still useful, it should be kept. Although the different net book values will affect the amount of gain or loss recorded on the sale, the gain or loss on the sale is, in effect,recognition in the accounting records that the estimates used in the depreciation expense calculation were not accurate, based on hindsight.

E6.17. a. Today

2 years

$ 16,000 x 0.8264 Table 6-4, 10% column, 2 period row

$13,222,40 b. Today

20 years

$1,400,000 per year x 8.5136Table 6-5, 10% column, 20 period row

$11,919,040 c. Today

20 years

$1,400,000 per year x 6.6231Table 6-5, 14% column, 20 period row

$9,272,340 d. Today

10 years

$36,000 per year x 6.7101Table 6-5, 8% column, 10 period row

$241,563.60

Instructor’s Manual / Solutions Manual E6.18.

The present value factor for a single amount for 5 periods, at a discount rate of 16% in Table 6-4 is 0.4761. Thus, $100,000 * 0.4761 = $47,610 present value.

a. Since interest will be compounded twice per year, the number of periods is 10 (5 years * 2) and the rate is 8% (16% / 2). The present factor for 10 periods at 8% from Table 6-4 is 0.4632. Thus, $100,000 * 0.4632 = $46,320 present value. b. The number of periods now becomes 20 (5 years * 4 quarters per year), and the rate becomes 4% (16% / 4 quarters per year). The present value factor for 20 periods at 4% from Table 6-4 is 0.4564. Thus, $100,000 * 0.4564 = $45,640 present value. c. The present value factor at 12% for 5 periods in Table 6-4 is 0.5674. Thus, $100,000 * 0.5674 = $56,740 present value. d. The present value factor at 20% for 5 periods in Table 6-4 is 0.4019. Thus, $100,000 * 0.4019 = $40,190 present value. e. The present value factor at 16% for 3 periods in Table 6-4 is 0.6407. Thus, $100,000 * 0.6407 = $64,070 present value. f. The present value factor at 16% for 7 periods in Table 6-4 is 0.3538. Thus, $100,000 * 0.3538 = $35,380 present value.

E6.19. a. Yes, because of the above-average ROI of 16%, I could afford to invest $300,000 more than $500,000 and still earn a 10% ROI—which is the rate I’d expect to earn from an investment in this type of business. The excess earnings offered by this investment = ($500,000 * 16%) - ($500,000 * 10%) = $80,000 - $50,000 = $30,000 per year on a $500,000 investment. At an ROI of 10%, an investment of $800,000 would be required to earn $80,000 of income, so $800,000 is the maximum price that investors should be willing to pay for the business. b. Each of the individual assets acquired would be recorded at their fair market values, and $300,000 would be recorded as "Goodwill."

E6.20. a. Goodwill is the difference between the amount invested in the company (the cost of the investment to the new owner) and the fair market value of the net assets acquired. Goodwill = $8,100,000 - $5,400,000 = $2,700,000 b. ROI = Operating income / Assets = $1,215,000 / $5,400,000 = 22.5%

Instructor’s Manual / Solutions Manual

E6.20. (continued) c. ROI = Operating income / Assets (Cost of existing net assets + goodwill) = $1,215,000 / $8,100,000 = 15% d. Takeover Co. is satisfied with a 15% ROI. The additional $2,700,000 investment represents goodwill and the expected superior earnings in future years. E6.21. Assets Liabilities Land Gain on –33,000

b. Sold land that had originally cost $33,000 for $57,000 in cash. Cash Land + 57,000 + 24,000 c. Acquired a new machine under a financing lease. The present value of future lease payments, discounted at 7%, was $48,000.

Net Income Sale of

Right-of- Lease Use Asset Liability +48,000 + 48,000

d. Recorded the first annual payment of $8,000 for the leased machine (in c above).–4,640 – 3,360

Cash –8,000

Lease Interest Liability Expense

(Interest = $48,000 * 7% = $3,360). e. Recorded a $21,000 payment for the cost of developing and registering a trademark. –21,000

Trademark + 21,000 Cash

f. Recognized the periodic amortization on the trademark (in e above) using a 40-year useful life.

Trademark –525 Expense –525

Amortization

(Amortization = $21,000 / 40 = $525). g. Sold used production equipment for $37,000 in cash. The equipment originally cost $105,000. The accumulated depreciation account has a balance of $54,000 before adjusting for a $2,000 year-to-date depreciation entry that must be recorded before the sale of the equipment is recorded.

Accumulated Depreciation Depreciation Expense –2,000, + 56,000 –2,000 Equipment Loss on – 105,000 Sale of CashEquipment + 37,000 –12,000

Instructor’s Manual / Solutions Manual

E6.22. b. Sold land that had originally cost $55,000 for $42,300 in cash. – 55,000 Sale of

Assets Liabilities Land Loss on Cash

Net Income

Land

+ 42,300 – 12,700 c. Recorded a $437,000 payment for the cost of developing and registering a patent.

Patent + 437,000 Cash

– 437,000 d. Recognized periodic amortization on the patent (in c above) using the maximum statutory useful life.–21,850 ($437,000 / 20 years)

Patent – 21,850

Amortization Expense

e. Capitalized $18,400 of cash expenditures Cash made to extend the useful life of production – 18,400 equipment. Equipment + 18,400 f. Expensed $7,100 of cash expenditures Cash Maintenance incurred for routine maintenance of – 7,100 Expense production equipment. – 7,100 g. Sold a used machine for $162,000 cash. Machine The machine originally cost $540,000, – 540,000 of Machine and had been depreciated for the first Accumulated two years of its five-year useful life Depreciation using the double-declining balance method. + 345,600 Cash + 162,000

Loss on Sale – 32,400

Double-declining rate = 20% * 2 = 40% At End of Year . Book Value Depreciation Year at Beginning of Year Expense 1 $540,000 $540,000 * 40% = $216,000 2 324,000 324,000 * 40% = 129,600

Accumulated Net Book Depreciation Value $216,000 $324,000 345,600 194,400

Instructor’s Manual / Solutions Manual

E6.22.

(continued)

h. Purchased a business for $8,000,000 in cash. The fair market value of the net assets acquired were as follows: Land, $2,200,000; Buildings $4,600,000; Equipment $2,500,000; Long-Term Debt $1,800,000. Equipment

Assets Cash – 8,000,000 Land + 2,200,000 Buildings + 4,600,000

Liabilities Long-Term Debt + 1,800,000

Net Income

+ 2,500,000 Goodwill + 500,000 P6.23. a. Repair cost capitalized in error = $30,000. Depreciation expense in current year on above amount: To be depreciated $30,000 Remaining life 5 years Depreciation expense in current year

$6,000

To correct the error: Operating income originally reported …………………………………... Increase in repair expense……………………………………………….. Decrease in depreciation expense……………………………………….. Corrected operating income……………………………………………..

$182,000 (30,000) 6,000 $158,000

Instructor’s Manual / Solutions Manual b. ROI for current year based on original data: ROI = Operating income / Average total assets = $182,000 / (($1,200,000 + 1,400,000) / 2) = 14.0% ROI for current year based on corrected data: Year-end assets originally reported …………......................... Less net book value of mistakenly capitalized repair expense: Cost…………………………………………………………… Less accumulated depreciation……………………………….. Corrected year-end assets……………………………………..

$1,400,000 $30,000 (6,000)

(24,000) $1,376,000

ROI = Operating income / Average total assets = $158,000 / (($1,200,000 + $1,376,000) / 2) = 12.3% c. In subsequent years, depreciation expense will be too high, net income will be too low, and average assets will be too high. Thus, ROI will be too low. P6.24. a. ROI = Net operating income / Average assets = $750,000 / $5,000,000 = 15.0%

Instructor’s Manual / Solutions Manual b. Net operating income would increase to $837,500, as follows: Net operating income, as reported…………………………..……. Increased by amount that should not have been expensed…..…… Decreased by depreciation for one year on the new amount added to the asset ($100,000 / 8 years)………………...………. Net operating income, as corrected.……………………………….

$750,000 100,000 (12,500) $837,500

Average total assets would increase to $5,043,750, as follows: Average total assets, as reported………...……..…….... Increase in assets for amount that should have been capitalized…………………………………….. $100,000 Decrease in assets by depreciation for one year on the amount that should have been capitalized ($100,000 / 8 years)………………………………… (12,500) Total assets at year end, as corrected…………………..

$5,000,000

87,500 $5,087,500

Average total assets, as corrected = ($5,000,000 + $5,087,500) / 2 =

$5,043,750

Note that the increase to average total assets is half of the adjustment to the net book value resulting from capitalizing and depreciating. ($100,000 - $12,750) / 2 = $43,750 ROI = Net operating income /Average assets = $837,500 / $5,043,750 = 16.7%

Instructor’s Manual / Solutions Manual P6.24. (continued) c. There are several reasons why a company may prefer to treat an expenditure as an expense immediately rather than capitalizing the expenditure. •

ROI will be lower in 2022 if the expenditure is expensed rather than capitalized (15.0% in part a as opposed to 16.7% in part b). However, if the $100,000 is expensed in 2022, ROI will be higher in 2023 and subsequent years (net operating income will not be affected but average operating assets will be lower than would be the case had the expenditure been capitalized).

•

Expensing an item immediately reduces the company’s tax expense by lowering net operating income, and thus net taxable income. Most companies would prefer to receive an immediate tax benefit (deductible expense) rather than to recover the cost of a capitalized asset over the course of several years (depreciation deductions) for tax purposes.

•

Less time, effort, and cost is spent for accounting purposes if the item is expensed (no depreciation schedules to deal with).

d. In 2023 and subsequent years, ROI will be lower because net operating income (in the numerator) will be lower by the additional $12,500 of depreciation expense recognized each year and average net assets (in the denominator) will be higher.

Instructor’s Manual / Solutions Manual P6.25. a. Estimated useful life……………………………………………………… Cost of machine ………………………………………………………….. Estimated salvage value………………………………………………….. Amount to be depreciated ………………………………………………..

5 years $198,000 (27,000) $171,000

1.Straight-line depreciation: Annual depreciation expense = $171,000 / 5 = $34,200 per year 2.Double-declining-balance depreciation: Straight-line rate = 1 / 5 = 20%. Double-declining rate = 20% * 2 = 40% At End of Year . Net Book Value Depreciation Accumulated Net Book Year at Beginning of Year Expense Depreciation Value 1 $198,000 $198,000 * 40% = $79,200 $79,200 $118,800 2 118,800 118,800 * 40% = 47,520 126,720 71,280 3 71,280 71,280 * 40% = 28,512 155,23242,768 4 42,76842,768 * 40% = 17,107# 172,33925,661# # This is the calculated amount, but the net book value cannot go below salvage value; hence, depreciation expense in the fourth year is limited to $15,768, as follows: 4 5

42,768 27,000

15,768 0

171,000 171,000

27,000 27,000

In Year 4, $155,232 accumulated depreciation at the end of Year 3 + $15,768 = $171,000 maximum accumulated depreciation. $198,000 - $171,000 = $27,000 net book value, as limited by the salvage value. Thus, $0 depreciation expense can be recorded in Year 5. b. One-half of the first year's depreciation expense should be recorded. Straight-line = $34,200 * 6/12 = $17,100 Double-declining-balance = $79,200 * 6/12 = $39,600 c. 12/31/23 (after 1.5 years): Cost Straight-line $198,000 Double-declining-balance 198,000

Accumulated Net Depreciation Book Value $51,300 $146,700 102,960# 95,040

#Accumulated depreciation isequal to the sum ofdepreciation expense for 2022 (for 6 months) and 2023 (for a full year). Depreciation expense for 2022 = $198,000 * 40% * 6/12 = $39,600. Depreciation expense for 2023 is equal to 40% of the January 1, 2023 net book value =$198,000 - $39,600 = $158,400* 40% = $63,360.The accumulated depreciation balance = $39,600 added in 2022 +$63,360added in 2023 = $102,960.

Instructor’s Manual / Solutions Manual P6.26. a. and Estimated useful life………………………………………………….. b. Cost of machine ……………………………………………………… Estimated salvage value……………………………………………… Amount to be depreciated…………………………………………….

4 years $720,000 (80,000) $640,000

a. Straight-line depreciation method: Annual depreciation expense = $640,000 / 4 = $160,000 per year Depreciation expense for 2024 = $160,000 Accumulated depreciation at December 31, 2024 = $160,000 * 2.25 years = $360,000 b. Double-declining-balance method: Straight-line rate = 1 / 4 = 25%. Double-declining rate = 25% * 2 = 50% At End of Year . Net Book Value Depreciation Year at Beginning of Year # Expense 2022 $720,000 $720,000 * 50% * 25% = $ 90,000 2023 630,000 630,000 * 50% = 315,000 2024 315,000 315,000 * 50% = 157,500

Accumulated Net Book Depreciation Value $ 90,000 $630,000 405,000 315,000 562,500 157,500

# October 1 for 2022, and January 1 for 2023 and 2024.

Instructor’s Manual / Solutions Manual P6.27.

Estimated useful life…………………………………………………….. 4 years Cost of machine…………………………………………………………. $720,000 Estimated salvage value…………………………………………………. (120,000) Amount to be depreciated……………………………………………….. $600,000

a. Year 2022 2023 2024 2025

Net Book Value at Beginning of Year $720,000 570,000 420,000 270,000

Net Book Value at End of Year $570,000 420,000 270,000 120,000

Depreciation Accumulated Expense Depreciation $150,000 $150,000 150,000300,000 150,000450,000 150,000600,000

The straight-line method is being used because an equal amount of depreciation expense is recorded each year, which represents 1/4 * $600,000. b.

Net Book Value Net Book Value Depreciation Accumulated Year at Beginning of Year at End of Year Expense Depreciation 2022 $720,000 $588,000 $132,000 $132,000 2023 588,000 396,000 192,000324,000 2024396,000 228,000 168,000492,000 2025228,000 120,000 108,000600,000 The units of production method is being used. At first glance, no clear pattern can be seen in the amount of depreciation expense recorded each year. However, based on the machine’s productive capacity of 100,000 units and the actual production data provided for 2022-2025, the depreciation expense amounts shown above can be easily verified.

Net Book Value Net Book Value Depreciation Year at Beginning of Year at End of Year Expense 2022 $720,000 $360,000 $360,000 2023360,000 180,000 180,000540,000 2024 180,000 120,000 60,000600,000 2025120,000 120,000 0600,000

Accumulated Depreciation $360,000

The double-declining-balance (200%) method is being used. Notice that the expense pattern is extremely accelerated in this case. Using the double-declining-balance method for an asset with a 4-year useful life results in an annual depreciation rate of 50% (25% straight-line rate * 2) of the asset’s net book value. In year 2024, the machine became fully depreciated after only $60,000 was recorded as depreciation expense, even though the calculated amount would have been higher (50% * $180,000 = $90,000).

Instructor’s Manual / Solutions Manual P6.28.

Solution approach:The amounts shown in the T-accounts represent the depreciation expense recorded for each year of the asset’s useful life (not the balance of the Accumulated Depreciation account as of the dates shown). Thus, patterns can be determined directly from the numbers provided, without the necessity of making any calculations.

a. The 200% declining-balance method is being used. Using this method for an asset with a 5-year useful life results in an annual depreciation rate of 40% of the asset’s net book value (20% straight-line rate * 2). The following schedule is not required to solve this problem. At End of Year . Net Book Value Depreciation Accumulated Net Book Year at Beginning of Year Expense Depreciation Value 2022 $1,500,000 $1,500,000 * 40% = $600,000 $ 600,000 $900,000 2023900,000 900,000 * 40% = 360,000960,000 540,000 2024540,000 540,000 * 40% = 216,0001,176,000 324,000 2025 324,000 324,000 * 40% = 129,600# 1,305,600# 194,400# # These are the calculated amounts, but net book value cannot go below estimated salvage value; hence, depreciation expense in 2025 is limited to $24,000, as follows: 2025 324,00024,0001,200,000 2026 300,000

300,000 1,200,000

300,000

b. The units-of-production method is being used because the depreciation expense amounts do not demonstrate a clear pattern. These amounts can be verified based on the machine’s productive capacity of 1,500,000 units and the actual production data provided for 2022-2026. c. The straight-line method is being used because an equal amount of depreciation expense is recorded each year, which represents 1/5 * ($1,500,000 - $300,000) = 1/5 * $240,000. d. The 150% declining-balance method is being used. Using this method for an asset with a 5-year useful life results in an annual depreciation rate of 30% of the asset’s net book value (20% straight-line rate * 1.5). The following schedule is not required to solve this problem but may be helpful in explaining the answer. At End of Year . Net Book Value Depreciation Accumulated Net Book Year at Beginning of Year Expense Depreciation Value 2022$1,500,000 $1,500,000 * 30% = $450,000$450,000 $1,050,000 20231,050,000 1,050,000 * 30% = 315,000765,000 735,000 2024735,000 735,000 * 30% = 220,500985,500 514,500 2025514,500 514,500 * 30% = 154,3501,139,850360,150 2026 360,150 360,150 * 30% = 108,045#1,247,895#252,105# # These are the calculated amounts, but depreciation expense in 2026 is limited to $60,150 since net book value cannot go below the $300,000 estimated salvage value. 6-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

P6.29. a. Depreciation expense for 2023 is the increase in the amount of accumulated depreciation from the beginning balance sheet to the ending balance sheet, or $110,000 ($275,000 $165,000). b. 1. The cost of the asset is the net book value plus the accumulated depreciation, or $355,000 + $275,000 = $630,000. 2. The straight-line method is being used because the annual depreciation expense would be $110,000, as was determined in part a. This is calculated as follows: ($630,000 - $80,000) / 5 years = $110,000 per year. 3. At December 31, 2023, the accumulated depreciation of $275,000 represents 2 years and 6months of depreciation expense ($275,000 / $110,000 = 2.5 years), so the acquisition date of the equipment must have been on or near July 1, 2021. c. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash +314,000 Equipment-41,000 -630,000 Accumulated (A decrease in a Depreciation contra-asset account +275,000 increases assets).

Loss on Sale of Equipment

Dr. Cash …………………………………………………………….. 314,000 Dr. Accumulated Depreciation ……………………………………… 275,000 Dr. Loss on Sale of Equipment………………………………………. 41,000 Cr. Equipment……………………………………………………..630,000 To record the sale of equipment at a loss.

P6.30. a. Depreciation expense for 2023 is the increase in the amount of accumulated depreciation from the beginning balance sheet to the ending balance sheet, or $60,750 ($212,625 $151,875).

Instructor’s Manual / Solutions Manual b. 1. The cost of the asset is the net book value plus the accumulated depreciation, or $273,375 + $212,625 = $486,000. 2. The straight-line method is being used because the annual depreciation expense would be $60,750 ($486,000 / 8 years), as was determined in part a. 3. At December 31, 2023, the accumulated depreciation of $212,625 represents 3.5 years of depreciation expense ($60,750 * 3.5 = $212,625), so the acquisition date of the equipment must have been on or near July 1, 2020. P6.30. (continued) c. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash +60,000 Equipment - 97,200 Accumulated (A decrease in a Depreciation contra-asset account + 42,525 increases assets).

Gain on Sale of Equipment + 5,325

Dr. Cash …………………………………………………………… 60,000 Dr. Accumulated Depreciation ($212,625 / 5)………...…………… 42,525 Cr. Equipment ($486,000 cost / 5)…..……………………….... Cr. Gain on Sale of Equipment………………………………..

97,200 5,325

To record the sale of equipment at a gain.

P6.31.

Instructor’s Manual / Solutions Manual a. If any of the five criteria listed in the text for classification as a financing lease are met, the lease shouldbe accounted for as a financing lease rather than an operating lease. 1. Maybe.The problem does not state that ownership of the computer system is transferred to Carey, Inc. during the term of the lease, but it does state that the system was acquired. Thus, it’s not clear whether title to the asset transferred. 2. Yes.The option to purchase the computer system for $1 at the end of four years is a “bargain purchase option” that is reasonably certain to be exercised. 3. Yes.This test is met because the lease term of 4 years is 100% of the economic life of the computer system. 4. Yes.This test is met because the present value of the annual lease payments is $61,181.70 ($21,000 * 2.9137 present value of annuity factor for 4 periods at 14% from Table 6-5),which is 100% (off due to rounding of the present value factor) of the $61,200 fair value of the asset. 5. No.No indication is given in the problem suggesting that the leased asset would have no alternative use to the lessor at the end of the lease term because of its specialized nature. P6.31. (continued) (continued) $21,000 b. Annual lease payments (paid at the end of each year)……………………… Present value factor (Table 6-5, 4 periods, 14% discount rate)…………….. x 2.9137 Present value of lease payments (amount to be capitalized)……………….. $61,187.70 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Right-of-Lease Use Asset Liability + 61,190 + 61,190

Dr. Right-of-Use Asset……………………………………………..... 61,190 Cr. Lease Liability………………………………………………. 61,190 To record a financing lease transaction at the present value of future lease payments (amount rounded to the nearest $10).

Instructor’s Manual / Solutions Manual

c. Annual lease payment…………………………………………. $21,000 Beginning balance, lease liability……....……………………… $61,190 Interest rate…………………………………………………….. x 14% Interest expense (for first year of lease term)………………….. (8,567) Payment of principal (reduction of lease liability)…………….. $12,433 Dr. Interest Expense……………………………………………….. 8,567 Dr. Lease Liability……….………………………………………… 12,433 Cr. Cash………………………………………………………… 21,000 To record the first annual lease payment on a financing lease.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash Lease Interest - 21,000 Liability - 12,433 - 8,567

Expense

d. In addition to the $8,567 of Interest Expense on the lease liability, DepreciationExpense of $15,298 ($61,190 / 4 years) on the right-of-use asset (equipment) should also be recognized in the income statement. Note that the amount of interest expense will decrease each year of the lease term because thelease liability (i.e., principal amount) is reduced each time an annual lease payment is made. e. As discussed and illustrated in the text, the economic effect of a long-term financing lease is not any different than the purchase of an asset with borrowed funds. In substance, the firm has acquired virtually all of the rights and benefits of ownership—so accounting for a financing lease should be consistent with that of an asset purchase.

P6.32. a. Balance Sheet

Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Trucks +63,450

Notes Payable +63,450

Dr. Trucks ……………………………………………………….. 63,450 Cr. Notes Payable……………………………………………

63,450

To record the purchase of a delivery truck by signing a long-term note (amount rounded to the nearest $10).

Instructor’s Manual / Solutions Manual

b. Annual lease payments (paid at the end of each year)…………………. Present value factor (Table 6-5, 6 periods, 8% discount rate)…………. Present value of lease payments (amount to be capitalized)……………

$13,725 x 4.6229 $63,449.30

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Right-of Lease Use AssetLiability + 63,450 + 63,450

Dr. Right-of-Use Asset……………………………………………. Cr. Lease Liability…………………………………………….

63,450 63,450

To record a financing lease transaction at the present value of lease payments.

c. Annual lease payment …………………………………………. $13,725 Beginning balance, lease liability……………………………… $63,450 Interest rate…………………………………………………….. x 8% Interest expense (for first year of lease term)………………….. (5,076) Payment of principal (reduction of lease liability)…………….. $ 8,649 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash Lease - 13,725Liability - 8,649- 5,076

Interest Expense

Dr. Interest Expense………………………………………………. Dr. Lease Liability……….………………………………………... Cr. Cash ………………………………………………………

5,076 8,649 13,725

To record the first annual lease payment on a financing lease.

d. In addition to the $5,076 of Interest Expense on the lease liability, DepreciationExpense of $10,575 ($63,450 / 6 years) on the truck should also be recognized in the income statement. The amount of interest expense will decrease each year of the lease term because the lease liability (i.e., principal amount) is reduced each time an annual payment is made. e. The annual payments would be $63,450 / 4.6229 (the present value factor for an annuity of 6 periods, at a discount rate of 8% in Table 6-5) = $13,725.15 P6.33. a. The cost of the machine at the beginning of the lease is the present value of the lease payments discounted at the interest rate the lessor would charge. The $7,500 annual lease payment is an annuity. The present value factor for an annuity of 10 periods at a discount rate of 12% in Table 6-5 is 5.6502. Thus, the present value of the lease payments is: $7,500 * 5.6502 = $42,376.50 6-28 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual b. The difference between the total amount paid and the present value of the lease payments is represented by interest of $32,623.50 in total ($75,000 - $42,376.50), which would be recognized as an expense over the life of the lease agreement. c. The cost to be reported in Renter's balance sheet is the present value of the lease payments, $42,376.50

P6.34. a. Today

9 years

$58,000 per year x 6.8017 Table 6-5, 6% column, 9 period row $394,498.60 b. Today

20 years

$175,000 x 0.0365 Table 6-4, 18% column, 20 period row $6,387.50 c. Today

12 years

$1,600,000 x 0.3186 Table 6-4, 10% column, 12 period row $509,760 d. Today

7 years

$620,000 x 0.4523 Table 6-4, 12% column, 7 period row $280,426 P6.34. (continued) e. 1. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Machine +210,000 Cash -40,000

Notes Payable +170,000

Dr. Machine……………………………………………………. Cr. Notes Payable…………………………………………. Cr. Cash……………………………………………………

210,000 170,000 40,000

To record the purchase of a machine with a partial payment and by signing a note for the balance.

2. ($210,000 purchase price - $40,000 cash payment) = $170,000 note payable. 6-29 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

Today $ ? x 3.3121 Table 6-5, 8% column, 4 period row $170,000

4 years payments per year

In this case, the present value is known and the payment (i.e., annuity amount) must be determined. $170,000 / 3.3121 = $51,326.95, or $51,327 annual payment. 3. ($51,327 annual payment * 4 years) = $205,308 total payments - $170,000 principal = $35,308 total interest payments.

Instructor’s Manual / Solutions Manual P6.34. (continued) 4. Solution approach:Interest expense is recorded at the end of each year based on the 8% interest rate multiplied by the outstanding principal balance on the note payable. Interest expense decreases over the life of the loan because the outstanding principal balance is reduced by each payment. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Notes Interest Cash Payable Expense Year 1 –51,327 -37,727($170,000 * 8% ) -13,600 Year 2 –51,327 -40,745($170,000 - $37,727 = $132,273 * 8%) -10,582 Year 3 –51,327 -44,005($132,273 - $40,745 = $91,528 * 8%) -7,322 Year 4 –51,327 -47,525($91,528 - $44,005 = $47,523 * 8%) -3,802

----Year 1---- ----Year 2---- ----Year 3---- ----Year 4---Dr. Interest Expense 13,600 10,582 7,3223,802 Dr. Notes Payable 37,727 40,745 44,00547,525 Cr. Cash 51,327 51,327 51,327

51,327

To record the four annual payments on a note payable.

C6.35.

It should be possible for most students to find the note disclosures concerning: 1) the depreciation method(s) used by their focus company, 2) a listing of physical properties and their locations, 3) ranges of estimated useful lives used for property, plant, and equipment, often broken down by category, 4) a statement concerning the company’s policy as to how assets are evaluated for impairments, 5) a statement to the effect that the company expenses repair and maintenance expenditures. Detailed notes and/or schedules are sometimes provided to show the composition of the company’s plant assets and accumulated depreciation by category. Encourage students to download the Adobe Acrobat annual report files for each of the past 3 years for their focus companies; they will need to make reference to some prior year data in the focus company case assignments in subsequent chapters.

Instructor’s Manual / Solutions Manual C6.36. a. Straight-line depreciation is used for financial reporting purposes because depreciation expense will be lower than under any of the accelerated depreciation methods. (page 45) Accelerated depreciation using the MACRS is probably used for tax purposes to minimize taxes payable. b. Depreciation and amortization expense for 2020 (page 43) .………. $ 328million Total cost of plant assets (page 81)…………….…………………… 5,285 million Ratio ($328 / $5,285)……………………………………………. 6.2% (rounded) Note that in Campbell’s schedule of plant assets (page 81), the cost of “Land” was listed as $75 million for 2020. Thus, land, which is not subject to depreciation, represents only a small portion (just 1.4%) of the company’s total cost of plant assets. Excluding the $75 million cost of land, the above ratio calculationstill yields a result of 6.3%(rounded).We raise this point simply to alert you to the fact that the interpretation of financial data is not a passive, spectator sport. Careful consideration of the accounting data under evaluation can lead to better information for decision-making. In this case, land (a non-depreciable) is not a significant factor and thus does not have much influence on the ratio result. c. Since Campbell uses the straight-line depreciation method, the average useful life = 1 / 6.2% = 16.1 years (rounded) d. Decrease in 2020 retained earnings = Amount of accumulated depreciation * 25% = $328 * 25% = $82 million. $82 decrease in 2020 retained earnings / $3,190“Earnings retained in the business” = (2.6)% Under the assumptions outlined in this case, the use of accelerated depreciation and amortization would not have had a material effect on the amount of Campbell’s 2020 retained earnings (see the balance sheet on page 42).

Instructor’s Manual / Solutions Manual C6.37. a. Mr. Gerrard is referring to the time value of money concept. By allowing several accounts receivable balances to become long overdue, the company has, in effect, made interest-free loans to its customers for indefinite periods of time. If these same accounts had been collected promptly, the company’s cash flow would have improved and the additional inflows of cash could have been used to pay down debt or to make investments in income-producing assets. b. Gerrard Construction Co.’s accounts receivable are being poorly and grossly inefficiently managed. As the ultimate responsibility for the stewardship of all of a company’s assets rests with top management, it is inappropriate for Mr. Gerrard to shift the blame to his daughter, Anna, who he describes as being “too nice to people.” In general, the accounts receivable need to be professionally managed. •

Invoices for all outstanding accounts should be sent out on a monthly basis, rather than quarterly.

•

Specific follow up with phone calls and/or letters that threaten further collection efforts or legal action may become necessary for long-overdue accounts.

•

It may be necessary to employ the services of a collection agency to accelerate the collection process for those customers having overdue accounts in the 121-180 days and > 180 days categories.

•

For customers who are unable or unwilling to work out an arrangement to clear their account deficiencies, all current jobs in progress should be shut down and any pending work orders for such customers should be postponed until a satisfactory arrangement has been worked out.

•

The company should consider offering cash discounts for prompt payment, especially if such discounts are commonly offered within the industry.

c. Initial efforts should be made to collect the long past due accounts receivable balances, and then a more detailed analysis should be made of those accounts that remain on the aging schedule to determine which specific accounts should be written off immediately. The Allowance for Bad Debts account should be adjusted to reflect the company’s best estimate of the total amount of uncollectible accounts receivable, including those accounts that have been identified for immediate write-off as well as percentage estimates of the uncollectible accounts within various age categories. The entry to record the adjustment would be: Dr. Bad Debts Expense * ………………………………………… Cr. Allowance for Bad Debts………………………………….

XXX XXX

Instructor’s Manual / Solutions Manual C6.37. (continued) c. * Note that if the required adjustment to the Allowance for Bad Debts includes a substantial amount of accounts that have been identified for immediate write-off, it may be appropriate to treat part of this adjustment as a “prior period adjustment” for the correction of an error in the application of an accounting principle. If this were the case, the entry above would include a debit (decrease) to the Retained Earnings account for those accounts identified for immediate write-off. In effect, although the company has an Allowance for Bad Debts account in its chart of accounts, it has not used the allowance method in practice and thus has erroneously applied generally accepted accounting principles (GAAP). As explained in Chapter 9, the correction of prior period errors does not impact the current period’s net income. In any event, the above entry would include a debit (increase) to Bad Debts Expense for the estimated amount of bad debts based on various percentages applied to the remaining accounts shown on the ageing schedule after the immediate write-offs have been dealt with. Once the Allowance for Bad Debts account has been adjusted, any specific accounts that are identified as uncollectible, would be written off with the following entry: Dr. Allowance for Bad Debts……………………………………… Cr. Accounts Receivable……………………………………….

XXX XXX

Note that the write-off entry has no impact on the net realizable value of accounts receivable but is necessary to maintain proper records of the account history for each separate customer involved. d. The adjustment to record Bad Debts Expense and to increase the Allowance for Bad Debts account (a contra asset) reduces the net realizable value of accounts receivable (a current asset account) with no corresponding effect on current liabilities. Thus, both working capital and the current ratio would decrease as a result. As noted in part c, the entry to record a write-off of an uncollectible account has no impact on the net realizable value of accounts receivable, nor does it affect working capital or the current ratio. e. Mr. Gerrard is referring to the fact that accounting records reflect the historical cost of assets based on their initial purchase prices less any depreciation that has been recorded to date. The net book value is not adjusted to reflect changes in the market value of equipment while it is owned by the company.

Instructor’s Manual / Solutions Manual C6.37. (continued) f. Balance Sheet

Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash +28,000 Equipment (Ford F550) -114,400 Accumulated Depreciation +77,200

Loss on Sale of Equipment -9,200

Cash +590,000 Equipment (Cat D11R) -1,020,000 Accumulated Depreciation +544,200

Gain on Sale of Equipment

Cash +320,000 Equipment (Cat 631G) -845,400 Accumulated Depreciation +453,000

+114,200

Loss on Sale of Equipment -72,400

------F550------ ------D11R------ ------631G------Dr. Cash ………………………… 28,000 590,000 320,000 Dr. Accumulated Depreciation….. 77,200 544,200 453,000 Dr. Loss of Sale of Equipment….. 9,200 72,400 Cr. Equipment………………. 114,400 1,020,000 845,400 Cr. Gain on Sale of Equipment 114,200 To record the sale of equipment.

Instructor’s Manual / Solutions Manual C6.35. (continued) g. Similar to the answer in part e, the net book value of equipment on the company’s accounting records is not necessarily reflective of the underlying economic value of the equipment. The relevant benchmarks for decision-making should be appropriate measures of the equipment’s market value, such as its “blue book” value or appraised value. If the selling price is greater than or equal to what the equipment is “worth” in the marketplace, then it should be sold, regardless of what the accounting consequences of the transaction may be. If the sale of equipment results in an accounting loss, this means, in effect, that the equipment had been “under” depreciated (relative to its “true” but unknown decline in economic value) while the asset was held by the company. Yet, since accounting depreciation methods do not attempt to measure the “true” economic decline in the market value of assets, a loss resulting from the sale of an asset should not be regarded as bad news, nor should a gain be regarded as good news! The gain or loss from the sale of an asset represents a correction of prior year depreciation amounts, and on balance, such gains and losses should be largely offsetting. To the extent that, over an extended period of time, either gains or losses begin to occur systematically, this would be a signal that the company should reconsider the deprecation methods in use, as well as the techniques used to estimate useful lives and salvage values.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ--CHAPTER 6

NAME___________________________

This question is designed to help you reason through the transactions related to accounting for property, plant, and equipment. For each of the transactions described below (items a-d), enter the effects the transaction on the appropriate side (debit or credit) of the T-accounts affected. Note that several accounts which would be affected by these transactions are not included in the T-accounts shown below. a. Cost of equipment purchased. b. Cost of equipment sold. c. Depreciation expense for the period. d. Accumulated depreciation on equipment sold. ------------------------------------ Balance Sheet / Income Statement -----Equipment Beginning Balance

Accumulated Depreciation

Depreciation Expense

Beginning Balance

Ending Balance

Total for the Period

2. This question relates to the following presentation in the balance sheets of Criss Co. at March 31, 2023 and 2022: 3/31/23 3/31/22 Equipment, less accumulated depreciation of $76,000 and $57,000, respectively ... ........... ........... ........... ........... ........... $104,000 $98,000 a. If the cost of new equipment purchased during the year totaled $32,000, what was the cost of equipment sold?

b. If the accumulated depreciation on equipment sold (in part a) totaled $5,000, what was the amount of depreciation expense for the year?

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ--CHAPTER 6 (continued) 2. c. If there was a gain of $1,000 from the sale of equipment (in part a), how much cash was received in the sale transaction? (Hint: Prepare the journal entry to record transaction).

3. For the month ended February 28, 2023, a company capitalized a $3,000 expenditure that should have been expensed. Depreciation expense for the full month, using the straight-line method, was recorded for $120 in February with respect to this item. Reported operating income for February was $11,700. a. Calculate the amount of net income that should have been reported for February.

b. If this error is not corrected, what will be the impact on operating income for the ten-month period from March 1, 2023 through December 31, 2023?

4. a. Calculate the present value of $10,000 to be received in 9 years, assuming that interest is compounded annually at 8%.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ--CHAPTER 6 (continued) 4. b. If the amount calculated in your answer to part a were invested in a savings account for 9 years with interest at 8% compounded annually, how much would be in the account at the end of 9 years?

5. Calculate the present value of $9,200 to be received in 7 years, assuming that interest is compounded semi-annually at an annual rate of 12%.

6. Congratulations! You have won a prize of $48,000. But, you must decide whether to receive $8,000 at the end of every year for 6 years, or to receive $4,000 at the end of every 6 months for 6 years. Assume an annual interest rate of 16%. Calculate the present value of each alternative, and indicate which alternative you would prefer.

7. You have just added a swimming pool and deck to your home, and have taken out a 10% mortgage loan on which you agreed to make 20 annual payments of $4,698.37 a. What was the amount of the mortgage?(Hint: It was the present value of the payments you will make).

b. What is the total amount of the payments you will make over the 20 years?

c. What accounts for the difference between the amounts in a and b?

Instructor’s Manual / Solutions Manual

TAKE-HOME QUIZ KEY--CHAPTER 6 1. -------------------------------- Balance Sheet / Income Statement ----Equipment

Accumulated Depreciation

Depreciation Expense

Beginning Balance a. Cost of Equipment Purchased

b. Cost of Equipment Sold or Scrapped

d. Accumulated Depreciation Sold or Scrapped

Ending Balance

c. Depreciation Expense for the period

Ending Balance

Total for the Period

2. a. Net book value, 3/31/22 (beginning) Accumulated depreciation, 3/31/22 (beginning) Cost of equipment, 3/31/22 (beginning) Cost of equipment purchased during the year Total debits in the Equipment account Debit balance, 3/31/23 (ending) $104,000 + $76,000 Credits to Equipment (i.e., cost of equipment sold or scrapped)

$98,000 57,000 $155,000 32,000 $187,000 (180,000) $ 7,000

b. Accumulated depreciation, 3/31/22 (beginning) credit balance Debit for accumulated depreciation on equipment sold or scrapped Credit balance in account before depreciation expense Depreciation expense for the year Accumulated depreciation, 3/31/23 (ending) credit balance c. Dr. Cash Dr. Accumulated Depreciation Cr. Equipment Cr. Gain on Sale of Equipment

$57,000 ( 5,000) $52,000 24,000 $76,000

? 5,000 7,000 1,000

The unknown debit is $3,000.

Instructor’s Manual / Solutions Manual 3. a. Reported operating income Less: Additional expense for item erroneously capitalized Add: Depreciation expense erroneously charged on item Corrected operating income

$11,700 (3,000) 120 $ 8,820

b. Depreciation expense for 10 months would have been recorded. Thus, operating income would be (10 months * $120 per month) = $1,200 understated. 4. a. Using the present value factor for 8% for 9 periods from Table 6-4: $10,000 * 0.5002 = $5,002 b. $10,000

TAKE-HOME QUIZ KEY--CHAPTER 6 (continued) 5. Using the present value factor for 6% and 14 periods from Table 6-4: $9,200 * 0.4423 = $4,069.16 6. The present value of $8,000 annually for 6 periods, discounted at 16% is: $8,000 * 3.6847 = $29,477.60 The present of $4,000 semi-annually for 12 periods, discounted at 8% is: $4,000 * 7.5361= $30,144.40 Your answer should be, “I would prefer to receive the money semi-annually, because the present value of that alternative is higher.” 7. a. $4,698.37 * 8.5136 (Table 6-5, 10%, 20 periods) = $40,000 b. $4,698.37 * 20 = $93,967.40 c. It is all interest ($93,967.40 - $40,000 = $53,967.40)!

Instructor’s Manual / Solutions Manual

CHAPTER

Accounting for and Presentation of Liabilities

CHAPTER OUTLINE: I. Current Liabilities A. Short-term debt 1. Used to finance working capital needs 2. Interest calculation methods (Business in Practice) 3. Interest accrual B. Current maturities of long-term debt C. Accounts payable D. Unearned revenue or deferred credits E. Payroll tax and other withholdings F. Other accrued liabilities II. Noncurrent Liabilities A. Long-term debt 1. Financial leverage illustrated 2. Accounting for bonds payable a. Original issuance b. Recognition of interest expense c. Retirements and conversions 3. Bond discount or premium 4. Bond characteristics, classifications, and terminology a. By how interest is paid b. By security c. By how principal is paid B. Deferred tax liabilities 1. An application of the accrual and matching concepts C. Other noncurrent liabilities 1. Pension plan obligations 2. Post-retirement benefits other than pensions 3. Estimated liabilities for lawsuits, warranties, etc. D. Contingent liabilities

Instructor’s Manual / Solutions Manual

TEACHING/LEARNING OBJECTIVES: Principal: 1. To have the student understand that a principal concern about the liability section of the balance sheet is to ensure that liabilities are not understated; if liabilities are understated, then expenses will probably be understated as well, and net income will be overstated, which in turn would violate the concept of conservatism. 2. To have the student understand the nature of a bond payable, and to learn why the market value of a bond moves inversely with changes in interest rates. 3. To have the student understand the concept of financial leverage. Supporting: 4. To have the student understand different interest calculation methods. 5. To reinforce the student's understanding of the accrual and matching concepts. 6. To have the student understand the characteristics of a bond. 7. To have the student understand bond premium and discount. 8. To have the student understand the nature of the liability for deferred income taxes, and to be able to relate it to the difference between book and tax depreciation.

TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. A review of the accrual and matching concepts in the context of liabilities and expenses should help students understand the first principal objective of accounting for liabilities. Exercises 7-9 through 7-12 (and Case 36) focus on the issue of accruing expenses so that liabilities are not understated and net income is not overstated. Exercises 7-13 and 7-14, and Problems 7-29 and 7-30, are concerned with the opposite issue--reducing “unearned revenue” liabilities for the revenue that has been earned.

Instructor’s Manual / Solutions Manual

TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: (continued) 2. The discussion of interest calculation methods is an opportunity to apply the present value concept introduced in the Chapter 6 Appendix. See Exercises 7-7 and 7-8. 3. Financial leverage should be put into a context that the student understands. For example, students may invest the student loan proceeds not immediately needed for tuition into a savings account. The discussion should reinforce their understanding of both ROI and ROE. 4. The coverage of bonds can be related both to students' future investment opportunities, and to current market interest rates and bond price reactions. Reference to the bond listing in The Wall Street Journal is appropriate and helpful. 5. In our opinion, present value tables should be used to explain bond premium and discount. Students are frequently confused about whether to use the stated rate or the market interest rate to calculate cash flows and present value—the distinction between these two rates must be emphasized. Exercises 7-15 through 7-20 and Problems 7-31 through 7-34 cover a variety of issues related to bonds. 6. Have students review the liability section of the balance sheet of the annual report that they obtained or were provided and determine the significance of deferred taxes. A real world example may help them to better understand this item. 7. Cases 7-36 and 7-37 can be used to help students develop an ability to read and understand financial statement data; they also reinforce a lot of terminology introduced in this chapter. 8. Problem 7-30 (optional continuation) provides an opportunity to illustrate the use of present value analysis in a management decision-making context.

Instructor’s Manual / Solutions Manual

ASSIGNMENT OVERVIEW: NO. M7.1. M7.2. M7.3. M7.4. M7.5. M7.6. E7.7 . E7.8. E7.9. E7.10. E7.11. E7.12.

LEARNING OBJECTIVES 2 3 4 5 8 8 2 2 4 5 5 5

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 5-8 min. Med., 7-10 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 3-5 min. Med., 5-8 min.

E7.13.

Med., 7-10 min.

E7.14. E7.15. E7.16. E7.17.

3 8 8 8

Easy, 3-5 min. Med., 7-10 min. Med., 7-10 min. Med., 10-12 min.

E7.18. E7.19. E7.20. E7.21. E7.22. E7.23. E7.24. E7.25.

8 8 8 9 6 3, 4, 5, 8 4, 5, 8 1, 2, 5, 8, 9

Med., 10-12 min. Easy, 3-5 min. Easy, 3-5 min. Med, 5-8 min. Med., 5-8 min. Easy-Med., 5-8 min Easy-Med., 5-8 min Easy-Med., 5-8 min.

OTHER COMMENTS Simple notes payable—discount basis calculations. Basic unearned revenues entries. Basic payroll entry. Basic warranties entries. Simple bonds payable concepts and calculations. Basic conceptual bonds payable exercise. Straight-forward notes payable—discount basis. Stress that the $60,000 discount represents only 5/12 of the year. Emphasize the matching concept. Alternative to E7.9. Straight-forward. Good in-class demonstration exercise. Emphasize the financial statement effects of the accrual and payment entries. Emphasize the liability-revenue relationship rather than the specific account titles. Good in-class demonstration exercise. Easy way to introduce bonds. See E7.15. Good homework assignment. Explain that you still have to “price” the bond with present value analysis; however, the remaining bond term is less. See E7.17. Good in-class demonstration or homework exercise. Straight-forward conceptual bonds problem. See E7.19. Good theory question. Review Exhibit 7-2. Excellent exercise for self-study/review. See E7.23. See E7.23.

E7.26.

4, 5,8

Easy-Med., 5-8 min.

See E7.23.

P7.27.

Med., 5-8 min.

Straight-forward.

P7.28.

P7.29. P7.30.

4 4

Med.-Hard, 12-15 min. Easy, 5-8 min. Med., 10-15 min.

P7.31.

Hard, 12-15 min.

P7.32. P7.33. P7.34. C7.35. C7.36. C7.37.

7 8 8 7, 9 1, 5, 7, 8 7, 8

Hard, 12-15 min. Med., 10-15 min. Med., 10-15 min. Easy, 5-10 min. Med., 10-12 min. Hard, 12-15.

Group learning problem. Generates class discussion and provides an opportunity to reinforce present value concepts. Straight-forward. Distinguish clearly between the entries for: 1) accrued payroll (i.e., gross pay to employees), versus 2) accrued payroll taxes (i.e., employer taxes). Group learning problem. Provided for instructors wishing to delve into bond details. Needs instructor support/clarification. Group learning problem. See P7.31. Have students review Exhibit 7-3 before attempting this problem. Good homework assignment. Focus company—basic review of note disclosures. Group learning problem. Good homework assignment. Group learning problem. Real world financial reporting!

Instructor’s Manual / Solutions Manual

SOLUTIONS:

M7.1. a. Discount basis means interest is paid in advance. Proceeds = Face amount of note - Interest = $100,000 - ($100,000 * 6% * 4/12) = $100,000 - $2,000 = $98,000 b. The note was dated December 1, 2022, so one month has passed from the time the note was signed until the December 31, 2022 year-end. Interest = $100,000 * 6% * 1/12 = $500 c. Current liability = Face amount less discount balance. = $100,000 - ($2,000 - $500) = $100,000 - $1,500 = $98,500 M7.2. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

a. December 1, 2022: Cash +25,800

Unearned Rent Revenue +25,800

b. Each month-end: Unearned Rent Revenue -8,600

Rent Revenue +8,600

a. December 1, 2022 1. Dr. Cash . ........... ........... ........... ........... ........... ........... ……… Cr. Unearned Rent Revenue ........... ........... ........... ………

25,800 25,800

To record the receipt a three-month advance rent payment.

b. Each month-end: 2. Dr. Unearned Rent Revenue ...... ........... ........... ........... ……... Cr. Rent Revenue .... ........... ........... ........... ........... ...........

8,600

To record a reduction in the liability account for rent earned each month.

8,600

Instructor’s Manual / Solutions Manual

M7.3. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Wages Payable +91,000 Withholding Liabilities (accounts as shown in the entry) +7,000 +17,000 +4,000

Dr. Wages Expense ........... ........... ........... ........... ……… ........... Cr. Wages Payable (or Accrued Payroll) ......... ........... ........... Cr. FICA Taxes Withheld ........ ........... ........... ........... ........... Cr. Income Taxes Withheld ..... ........... ........... ........... ........... Cr. Medical Insurance Contributions ... ........... ........... ...........

Wages Expense -119,000

119,000 91,000 7,000 17,000 4,000

To record accrued payroll.

M7.4. a. Warranty Expense = ($6,500,000 sales * 1.5% estimated warranty expense) = $97,500 b. Estimated Warranty Liability, 1/1/22 balance .......... ........... ........... ……... Less: Actual warranty costs during 2022 ...... ........... ........... ........... ........... Add: Warranty Expense accrued during 2022 .......... ........... ........... ……... Estimated Warranty Liability, 12/31/22 balance ...... ........... ........... ...........

$25,000 ( ? ) 97,500 $34,400

Solving for the missing amount, the actual costs of servicing products under warranty during the year = $25,000 + 97,500 - $34,400 = $88,100

M7.5. a. The market interest rate is lower than the stated interest rate, so the bonds will sell for more than their face amount. The lower the discount rate (i.e., market interest rate), the higher the present value of cash flows associated with the bond (for interest payments and principal) becomes. Buyers are willing to pay a premium for the right to receive more interest than they could get in the marketplace for a bond of similar risk and maturity. b. $1,030,000 bond issue proceeds - $1,000,000 face amount of bonds = $30,000 premium on bonds payable. c. Accrued interest payable ($1,000,000 * 8% * 9/12) . ........... ........... ........... Premium amortization ($30,000 / 20 years * 9/12)... ........... ………. .......... Interest expense for 9 months ........... ........... ........... ........... ……… ...........

$60,000 (1,125) $58,875

Instructor’s Manual / Solutions Manual

M7.6. a. Annual interest payment = $60 million * 7% = $4,200,000 b. The bonds were issued at a discount because market interest rates were more than the stated rate when the bonds were issued. The higher the discount rate (i.e., the market interest rate), the lower the present value of cash flows for interest payments and principal (i.e., the lower the bond’s selling price). c. Interest expense will be more than the interest paid because the amortization of bond discount will increase interest expense.

E7.7. a. Discount basis means interest is paid in advance. Proceeds = Face amount of note - Interest = $600,000 - ($600,000 * 7% * 6/12) = $600,000 - $21,000 = $579,000 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash + 579,000

Notes Payable + 600,000 Discount on Notes Payable - 21,000

(Note: The discount account is a contra liability, so the initial carrying value of the note is equal to the cash proceeds received--which is the approach taken when interest is calculated on a straight basis.)

May 15, 2022 Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... Dr. Discount on Notes Payable ....... ........... ........... ........... ........... Cr. Notes Payable ......... ........... ........... ........... ........... ...........

579,000 21,000 600,000

To record the proceeds of a short-term note payable (discount basis).

b. The note was dated May 15, 2022, so 1.5 months have passed from the time the note was signed until the June 30, 2022 fiscal year-end. Interest = $600,000 * 7% * 1.5/12 = $5,250 c. Current liability = Face amount less discount balance. = $600,000 - ($21,000 - $5,250) = $600,000 - $15,750 = $584,250

Instructor’s Manual / Solutions Manual

E7.8. a. Discount = Principal (Maturity value) – Proceeds = $2,400,000 - $2,340,000 = $60,000 Discount rate = Discount / (Principal * Time) = $60,000 / ($2,400,000 * 5/12) = 6% b. Effective rate = Discount / (Proceeds * Time) = $60,000 / ($2,340,000 * 5/12) = 6.2%

Instructor’s Manual / Solutions Manual

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses 1. On August 1, 2022 to record loan proceeds: Cash Notes Payable + 2,340,000 + 2,400,000 Discount on Notes Payable - 60,000

(Note: The discount account is a contra liability, so the initial carrying value of the note is equal to the cash proceeds received.)

2. On September 30, 2022 (and each month-end) to record interest expense: Discount Note Payable (Note: A reduction of the discount + 12,000 increases the carrying value.)

Interest Expense - 12,000

3. On December 31, 2022 to record principal repayment: Cash Notes Payable - 2,400,000 - 2,400,000

Journal entries: 1. August 1, 2022 Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... Dr. Discount on Notes Payable ....... ........... ........... ........... ........... Cr. Notes Payable ......... ........... ........... ........... ........... ...........

2,340,000 60,000 2,400,000

To record the proceeds of a short-term note payable (discount basis).

2. September 30, 2022 Dr. Interest Expense ($2,400,000 * 6% * 1/12) ...... ........... ........... Cr. Discount on Notes Payable ........... ........... ........... ………

12,000 12,000

To record interest expense and discount amortization for one month.

3. December 31, 2022 Dr. Notes Payable.... ........... ........... ........... ........... ........... ……… 2,400,000 Cr. Cash ........... ........... ........... ........... ........... ........... ……… 2,400,000 To record the repayment of a short-term note. The discount is amortized for $12,000 each month; it would be fully amortized at the maturity date.

E7.9. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Payroll Taxes Payable + 4,700

Payroll Tax Expense - 4,700

Instructor’s Manual / Solutions Manual

9/30/22 Dr. Payroll Tax Expense ..... ........... ........... ........... ........... ........... Cr. Payroll Taxes Payable ........ ........... ........... ........... ...........

4,700 4,700

To accrue payroll taxes for the year.

b. Failure to make the accrual resulted in an understatement of expense and an overstatement of net income. On the 9/30/22 balance sheet, current liabilities are understated and the retained earnings account is overstated. c.

9/30/22 X Paid taxes of prior year in October; debited expense for $4,700 this year.

9/30/23 X Should have recognized $5,000 expense this year, but neglected to do so.

Effect on the income statement for year ended 9/30/23:

Expenses are too high (overstated) by amount applicable to prior year: $4,700 Expenses are too low (understated) by accrual not made this year: $5,000 Net effect is that expenses this year are $300 too low (understated), and net income this year is $300 too high (overstated). Effect on the 9/30/23 balance sheet:

Current liabilities are $5,000 understated and the retained earnings account is $5,000 overstated.

E7.10. a. The amount is estimated based on prior year taxes or based on the known assessed valuation and expected tax rate. b.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Real Estate Taxes Payable + 44,800

Real Estate Tax Expense - 44,800

Dr. Real Estate Tax Expense ........... ........... ........... ........... ........... ……… 44,800 Cr. Real Estate Taxes Payable . ........... ........... ........... ........... ........... 44,800 To accrue real estate taxes for the year.

E7.10.

(continued)

Instructor’s Manual / Solutions Manual

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Real Estate Taxes Payable + 2,800

Real Estate Tax Expense - 2,800

Dr. Real Estate Tax Expense........... ........... ........... ........... ........... ……… Cr. Real Estate Taxes Payable . ........... ........... ........... ........... ...........

2,800 2,800

To adjust the real estate taxes accrual.

d. Current liabilities at 12/31/22 and expenses for 2022 would both be understated by $44,800. Understating expenses by $44,800 would cause net income to be overstated by $44,800 for 2022 and retained earnings to be overstated by $44,800 at 12/31/22.

E7.11. a. Warranty Expense = ($2,600,000 sales * 0.3% estimated warranty expense) = $7,800 b. Estimated Warranty Liability, 1/1/22 balance .......... ........... ........... ……... Less: Actual warranty costs during 2022 ...... ........... ........... ........... ........... Add: Warranty Expense accrued during 2022 .......... ........... ........... ……... Estimated Warranty Liability, 12/31/22 balance ...... ........... ........... ...........

$25,100 (9,300) 7,800 $23,600

E7.12. 2022 estimated warranty expense = $4,100,000 * 0.5% = $20,500 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses To accrue estimated warranty expense: Estimated Warranty Liability + 20,500

Warranty Expense - 20,500

To record the actual costs of servicing products under warranty. Cash Estimated Warranty and/or Liability Inventory - 18,700 - 18,700

Dr. Warranty Expense ......... ........... ........... ........... ........... ........... Cr. Estimated Warranty Liability ......... ........... ........... ...........

20,500 20,500

To accrue estimated warranty expense for the year.

Dr. Estimated Warranty Liability.... ........... ........... ........... ........... Cr. Cash or Inventory ... ........... ........... ........... ........... ........... To record the actual costs of servicing products under warranty .

18,700

Instructor’s Manual / Solutions Manual

a. Keg deposits are a current liability on the balance sheet because they are amounts that are likely to be paid within a year.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash - 80

Keg Deposits - 80

Dr. Keg Deposits ..... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

80 80

To record the refund of keg deposits.

c. The Keg Deposits liability for the 300 kegs (300 * $80 = $24,000) should be eliminated with a debit; an income statement account (such as Keg Deposits Revenue) should be credited. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses To eliminate the liability for unreturned kegs: Keg Deposits - 24,000

Keg Deposits Revenue +24,000

Dr. Keg Deposits ..... ........... ........... ........... ........... ........... ........... Cr. Keg Deposits Revenue ....... ........... ........... ........... ...........

24,000 24,000

To eliminate the liability for unreturned kegs.

d. The cost of kegs purchased would be capitalized in a noncurrent asset account, and then be depreciated over the kegs' estimated useful life. The net book value of kegs removed from service or lost (as in part c) would be removed from the asset and recorded as an expense (or a loss). Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses To record a loss for the net book value of unreturned kegs: - Kegs + Accumulated Depreciation

Dr. Keg Expense (or Loss on Unreturned Kegs) ... ........... ........... Dr. Accumulated Depreciation........ ........... ........... ........... ........... Cr. Kegs (or other appropriate asset account) .. ........... ...........

- Keg Expense (or Unreturned Kegs Loss)

xxx xxx

To record a loss for the net book value of unreturned kegs.

xxx

Instructor’s Manual / Solutions Manual

E7.14. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash + 453,600

Unearned Ticket Revenue + 453,600

Dr. Cash (1,200 tickets @ $ 378) ..... ........... ........... ........... ........... Cr. Unearned Ticket Revenue ... ........... ........... ........... ...........

453,600 453,600

To record the cash collection for season ticket sales made in advance.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Unearned Ticket Revenue - 75,600

Ticket Revenue + 75,600

Dr. Unearned Ticket Revenue ((1,200 tickets @ $378) / 6) ........... Cr. Ticket Revenue........ ........... ........... ........... ........... ...........

75,600

To record revenues earned for presenting an event.

c. The unearned revenues are a current liability.

75,600

Instructor’s Manual / Solutions Manual

E7.15. a. The market interest rate is lower than the stated interest rate, so the bonds will sell for more than their face amount. The lower the discount rate (i.e., market interest rate), the higher the present value of cash flows associated with the bond (for interest payments and principal) becomes. Buyers are willing to pay a premium for the right to receive more interest than they could get in the marketplace for a bond of similar risk and maturity. b.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash Bonds Payable +3,120,000 +3,000,000 Premium on Bonds Payable +120,000

Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... 3,120,000 Cr. Bonds Payable ......... ........... ........... ........... ........... ........... 3,000,000 Cr. Premium on Bonds Payable ........... ........... ........... ……… 120,000 To record the issuance of bonds payable at a premium.

| 7/1/22 Bonds issued.

| 6 months

| 12/31/22 End of year.

Accrued interest payable ($3,000,000 * 9% * 6/12) . ........... ........... ........... Premium amortization ($120,000 / 20 years * 6/12). ........... ………. .......... Interest expense for 6 months ........... ........... ........... ........... ……… ...........

$135,000 (3,000) $132,000

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Interest Payable +135,000 Premium on Bonds Payable -3,000

Interest Expense -132,000

Dr. Interest Expense ........... ........... ........... ........... ........... ........... Dr. Premium on Bonds Payable ...... ........... ........... ……… ........... Cr. Interest Payable ....... ........... ........... ........... ………. ..........

132,000 3,000

To record the accrual of interest and premium amortization for 6 months.

135,000

Instructor’s Manual / Solutions Manual

E7.16. a. The market interest rate is higher than the stated interest rate, so the bonds will sell for less than their face amount. The higher the discount rate (i.e., market interest rate), the lower the present value of cash flows associated with the bond (for interest payments and principal) becomes. b.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash Bonds Payable +74,580,000 +75,000,000 Discount on Bonds Payable -420,000

Dr. Cash ...... ........... ........... ........... ........... ........... ........... 74,580,000 Dr. Discount on Bonds Payable ....... ........... ........... ........... 420,000 Cr. Bonds Payable ......... ........... ........... ........... ...........

75,000,000

To record the issuance of bonds payable at a discount.

c. Accrued interest payable ($75,000,000 * 6% * 4/12) ........... ........... ........... Discount amortization ($420,000 / 10 years * 4/12) . ........... ……… ........... Interest expense for 4 months ........... ........... ……… ........... ........... ...........

$1,500,000 14,000 $1,514,000

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Effect of interest accrual on financial statements: Discount on Bonds Payable +14,000 Interest Payable +1,500,000

Interest Expense -1,514,000

Dr. Interest Expense ........... ........... ........... ........... ........... ........... 1,514,000 Cr. Interest Payable ...... ........... ........... ........... ……… ........... 1,500,000 Cr. Discount on Bonds Payable ........... ........... ……… ........... 14,000 To record the accrual of interest and discount amortization for 4 months.

Instructor’s Manual / Solutions Manual

E7.17. The semiannual interest on the bonds = 10% stated rate * $40,000 face amount * 6/12 = $2,000 The remaining term of the bonds is 12 years, or 24 semiannual periods. The semiannual market interest rate is = 8% * 6/12 = 4% The present value of an interest annuity of $2,000 for 24 periods at 4% = $2,000 * 15.2470 = $30,494 The present value of the maturity value of $40,000 in 24 periods at 4% = $40,000 * 0.3901 = $15,604 The market value of the bonds = PV of interest + PV of maturity value = $30,494 + $15,604 = $46,098 E7.18. The annual interest on the bonds = 10% stated rate * $450,000 face amount = $45,000 The remaining term of the bonds is 15 years. The present value of an interest annuity of $45,000 for 15 years at 12% = $45,000 * 6.8109 = $306,490.50 The present value of the maturity value of $450,000 in 15 years at 12% = $450,000 * 0.1827 = $82,215.00 The market value of the bonds = PV of interest + PV of maturity value = $306,490.50 + $82,215.00 = $388,705.50 E7.19. a. Annual interest payment = $75 million * 6% = $4,500,000 b. The bonds were issued at a premium because market interest rates were less than the stated rate when the bonds were issued. The lower the discount rate (i.e., the market interest rate), the higher the present value of cash flows for interest payments and principal (i.e., the higher the bond’s selling price). c. Interest expense will be less than the interest paid because the amortization of bond premium will decrease interest expense.

Instructor’s Manual / Solutions Manual

E7.20. a. Annual interest payment = $190 million * 6.5% = $12,350,000 b. The bonds were issued at a discount because market interest rates were more than the stated rate when the bonds were issued. The higher the discount rate (i.e., the market interest rate), the lower the present value of cash flows for interest payments and principal (i.e., the lower the bond’s selling price). c. Interest expense will be more than the interest paid because the amortization of bond discount will increase interest expense. E7.21. The amount of deferred income taxes has risen steadily because the excess of accelerated tax depreciation over straight-line book depreciation on recent asset additions exceeds the excess of book depreciation over tax depreciation for older assets. This occurs because as the company grows over time, asset additions increase and over time the cost of replacement assets rises due to inflation.

E7.22. ROE will be higher using debt. The difference between the cost of debt of 10% and ROI of 12% results in increased return to the owners/stockholders without additional stockholders' investment.

E7.23. Transaction/ Adjustment a. b. c. d. e. f.

Current Assets

Current Liabilities

Long-Term Debt

Net Income

+120

-270 -180 -2,475 -120

+270 +180 +2,475 -1,790

-1,790 +2,000

-2,000

Instructor’s Manual / Solutions Manual

E7.23.

(continued)

Journal entries: a. Dr. Wages Expense . ........... ........... ........... ........... ........... Cr. Wages Payable ...... ........... ........... ........... ...........

270 270

b. Dr. Interest Expense . ........... ........... ........... ........... ........... Cr. Interest Payable ..... ........... ........... ........... ...........

180

c. Dr. Interest Expense ($540,000 * 5.5% * 1/12) ...... ........... Cr. Interest Payable .... ........... ........... ........... ...........

2,475

d. Dr. Interest Expense ........... ........... ........... ........... ........... Cr. Discount on Bonds Payable .......... ........... ...........

120

e. Dr. Estimated Warranty Liability.... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... Cr. Parts Inventory ...... ........... ........... ........... ...........

1,790

f. Dr. Sales ..... ........... ........... ........... ........... ........... ........... Cr. Unearned Revenues ........... ........... ……… ...........

2,000

180

2,475

120

660 1,130

2,000

E7.24. Transaction/ Adjustment

Current Assets

Current Liabilities

a. b. c. d. e. f.

-4,100

-4,100 +5,500 +4,830 +2,960 +61,000

Long-Term Debt

Net Income

-310

-5,500 -4,830 +310 -2,960 -83,000

+22,000

Instructor’s Manual / Solutions Manual

E7.24.

(continued)

Journal entries: a. Dr. Wages Payable .. ........... ........... ........... ........... ........... ……… Cr. Cash ........... ........... ........... ........... ........... ........... ………

4,100 4,100

b. Dr. Real Estate Tax Expense ........... ........... ……… ........... 5,500 Cr. Real Estate Taxes Payable . ........... ........... ........... ………

5,500

c. Dr. Interest Expense ($920,000 * 6.3% * 1/12) ...... ........... ........... Cr. Interest Payable ..... ........... ........... ........... ........... ...........

4,830

d. Dr. Premium on Bonds Payable ...... ........... ........... ........... ........... Cr. Interest Expense ..... ........... ........... ........... ........... ...........

310

e. Dr. Estimated Warranty Expense ($740,000 * 0.4%) ......... ........... Cr. Estimated Warranty Liability ......... ........... ........... ...........

2,960

f. Dr. Income Tax Expense ..... ........... ........... ........... ........... ........... Cr. Income Taxes Payable........ ........... ........... ........... ........... Cr. Deferred Income Taxes ...... ........... ........... ........... ...........

83,000

4,830

310

2,960

61,000 22,000

Instructor’s Manual / Solutions Manual

E7.25. Transaction/ Current Noncurrent Current Adjustment Assets Assets Liabilities a.

Noncurrent Liabilities

Stockholders' Net Equity Income

Income Taxes Deferred Tax Payable Liabilities +800 +300

Cash +11,640

Cash -16,000

Inventory -266

Estimated Warranty Liability -266

Cash +39,300

Notes Payable +40,000 Discount on Notes Payable -700

Income Tax Expense -1,100

Bonds Payable +12,000 Discount on Bonds Payable -360 Land +16,000

Current Serial Bonds Maturities Payable of Long-term -50,000 Debt +50,000

Journal entries:

Instructor’s Manual / Solutions Manual

a. Dr. Income Tax Expense ..... ........... ........... ........... ........... ........... Cr. Income Taxes Payable........ ........... ........... ........... ........... Cr. Deferred Tax Liabilities ..... ........... ........... ........... ...........

1,100

b. Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... Dr. Discount on Bonds Payable ...... ........... ........... ........... ........... Cr. Bonds Payable ....... ........... ........... ........... ........... ...........

11,640 360

E7.25.

800 300

12,000

(continued)

c. Dr. Land ...... ........... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

16,000

d. Dr. Estimated Warranty Liability.... ........... ........... ........... ……… Cr. Inventory ... ........... ........... ........... ........... ........... ...........

266

e. Dr. Cash ($40,000 - ($40,000 * 7% * 3/12)) ........ ........... ........... Dr. Discount on Notes Payable ($40,000 * 7% * 3/12) ...... ........... Cr. Notes Payable ........ ........... ........... ........... ........... ...........

39,300 700

f. Dr. Serial Bonds Payable .... ........... ........... ........... ........... ........... Cr. Current Maturities of Long-Term Debt...... ........... ...........

50,000

16,000 266

40,000 50,000

E7.26. Transaction/ Current Noncurrent Adjustment Assets Assets

Current Noncurrent Liabilities Liabilities

Stockholders' Net Equity Income

Instructor’s Manual / Solutions Manual

Truck +110,000

Wages Payable +16,300 Withholding Liabilities +4,800 Cash +53,040

E7.26.

Capital Lease Liability +110,000 Wages Expense -21,100

Bonds Payable +52,000 Premium on Bonds Payable +1,040 Estimated Warranty Liability -7,600

Cash -43,680

Warranty Expense +7,600

Bonds Payable -42,000 Discount on Bonds Payable +400

Loss on Retirement of Bonds -2,080

(continued) Transaction/ Current Noncurrent Adjustment Assets Assets f.

Current Noncurrent Stockholders' Net Liabilities Liabilities Equity Income Estimated Estimated Liability for Liability for Retiree Retiree Health Care Health Care +62,000 +470,000

Retiree Health Care Expense -532,000

Journal entries:

Instructor’s Manual / Solutions Manual

a. Dr. Truck ..... ........... ........... ........... ........... ........... ........... ........... Cr. Capital Lease Liability ....... ........... ........... ........... ...........

110,000

b. Dr. Wages Expense . ........... ........... ........... ........... ........... ........... Cr. Wages Payable ....... ........... ........... ........... ........... ……… Cr. Withholding Liabilities (various descriptions)....... ………

21,100

c. Dr. Cash ...... ........... ........... ........... ........... ........... ........... ........... Cr. Bonds Payable ....... ........... ........... ........... ........... ........... Cr. Premium on Bonds Payable .......... ........... ........... ...........

53,040

d. Dr. Estimated Warranty Liability.... ........... ........... ........... ........... Cr. Warranty Expense . ........... ........... ........... ........... ………

7,600

e. Dr. Bonds Payable ... ........... ........... ........... ........... ........... ……… Dr. Loss on Retirement of Bonds.... ........... ........... ........... ……… Cr. Discount on Bonds Payable ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ………

42,000 2,080

f. Dr. Estimated Health Care Expense ........... ........... ........... ……… Cr. Estimated Liability for Retiree Health Care--Current...... Cr. Estimated Liability for Retiree Health Care--Noncurrent

532,000

110,000

16,300 4,800

52,000 1,040 7,600

400 43,680

62,000 470,000

P7.27.

Instructor’s Manual / Solutions Manual

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses November 1, 2022: Cash Unearned +31,800 Rent Revenue +31,800 Each month-end: Unearned Rent Revenue -5,300

Rent Revenue +5,300

November 1, 2022 1. Dr. Cash . ........... ........... ........... ........... ........... ........... ……… Cr. Unearned Rent Revenue ........... ........... ........... ………

31,800 31,800

To record the receipt a six-month advance rent payment.

Each month-end: 2. Dr. Unearned Rent Revenue ...... ........... ........... ........... ……... Cr. Rent Revenue .... ........... ........... ........... ........... ...........

5,300 5,300

To record a reduction in the liability account for rent earned each month.

b. At December 31, 2022, two months of rent has been earned, and four months remains to be earned. So 4/6 of the original receipt of $31,800, or $21,200 is unearned rent and will be shown on the December 31 balance sheet as a current liability. c. At a rate of $5,300 per month, the receipt of an 18-month rent prepayment would have been for $95,400. The unearned amount at December 31, 2022, is $84,800 ($5,300 per month for the next 16 months). Only $63,600 ($5,300 * 12 months) of this amount is a current liability, because of the one-year time frame for current liabilities. Thus, $21,200 ($5,300 * 4 months) of the unearned amount is a noncurrent liability.

Instructor’s Manual / Solutions Manual

P7.28. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses 1. To record the cash collection of subscription fees received in advance: Cash Unearned +30,000 Subscription Revenue +30,000 2. To record subscription revenue earned from delivering magazines: Unearned Subscription Revenue -1,750

Subscription Revenue +1,750

1. Dr. Cash ($60 * 500 subscriptions).. ........... ........... ……… ........... Cr. Unearned Subscription Revenue ........... ………. ..........

30,000 30,000

To record the cash collection of subscription fees received in advance.

2. Dr. Unearned Subscription Revenue ..... ........... ........... ........... Cr. Subscription Revenue ($60 * 350 subscribers * 1/12)… ......

1,750 1,750

To record subscription revenue earned from delivering magazines.

b. Revenue earned during August ($60 * 350 subscribers * 1/12) ... ........... ........... Revenue earned from September-December ($60 * 500 subscribers * 4/12) ....... Total subscription revenue earned during 2022 from August 2022 sales .....

$ 1,750 10,000 $11,750

c. Solution approach: Assuming that the “profile” of lifetime subscribers for Evans Ltd. will be similar to that of current subscribers, an average lifetime membership will last for 40 years. The present value of a lifetime subscription, discounted at 10% for 40 years = ($60 per year revenues foregone * 9.7791) = $586.75 Analysis of results: Based on the calculation above, it would be profitable for Evans Ltd. to sell lifetime subscriptions for $800 because the fee received would be $213.25 greater than the present value of an average lifetime membership achieved otherwise. Note to instructor: These results would obviously be interest rate sensitive. If the 10% average interest rate seems high, it may be appropriate for the accountants at Evans Ltd. to test some other interest rates such as 8% and 6%. At 8%, the present value of the lifetime subscription would be $715.47 ($60 * 11.9246); at 6% the present value would be $902.78 ($60 * 15.0463). Thus, if long-term interest rates were expected to be much less than 8%, the price of the lifetime subscription would need to be increased accordingly.

Instructor’s Manual / Solutions Manual

P7.28.

(continued)

d. Points for discussion: Other factors to consider include the following: •

Would the lifetime subscription offer attract younger customers, such that the average age of a life-time subscriber would become less than the current average age of 38? Yes, but even under the assumption that the average age drops to 28, the present value of the additional 10 years of annual subscription fees would be minimal. PV for 50 years, discounted at 10% = $60 * 9.9148 = $594.89, so the PV of the additional 10 years of revenues foregone would be $8.14 ($594.89 - $586.75) which is less than the cost of breakfast most days)! This provides an opportunity to have students look again at the present value factors in Tables 6-4 and 6-5 for fardistant cash flows.

•

Is the use of the company’s average interest rate for long-term debt the appropriate rate to use in the present value analysis? Yes, because the money made available from the receipt of lifetime subscription fees can be used for investment in inventories, plant and equipment, etc., and will be “repaid” on a long-term basis as newsletters are delivered. The company would otherwise have to borrow funds to finance its long-term asset growth objectives, and since the present value of the subscription “repayments” is less than the $800 fee, the ROI earned on the “borrowed” funds exceeds the “interest” cost being paid on the “loan” from subscribers.

•

What would be the impact, in present value terms, of changes in the interest rate assumption? Even if 10% represents an appropriate measure of the firm’s current interest cost on long-term debt, is it reflective of the firm’s long-term interest cost? Actually, the answer shouldn’t matter (in terms of the firm’s payment obligation) because a lifetime subscription offer is essentially the same transaction as a bond issuance. That is, the firm can lock into a fixed “interest” rate that is substantially lower than 10% (see above discussion). However, if interest rates were to fall substantially, say to 6% (and were expected to stay that low), then it would no longer be profitable to offer a lifetime subscription option for $800. PV at 6% for 40 years = $60 * 15.0463 = $902.79. In these circumstances, Evans, Ltd. should either increase the cost of a lifetime membership (to say, $1,000 since it’s a nice round number) or choose not to offer a lifetime membership.

•

Would the lifetime subscription offer help to build brand identity and customer loyalty? There is no substitute for the positive word of mouth benefits associated with happy customers.

Instructor’s Manual / Solutions Manual

P7.28. d.

(continued) •

What impact would the lifetime offer have on current subscribers? Several management issues would need to be addressed, including the possibility of offering a “grandfather” clause to current subscribers such that a portion of their past subscription fees could be counted toward the $800 fee. (Note that this is another present value problem.)

•

Is the fixed annual subscription rate of $60 per year used in the present value calculations appropriate? In other words, simply because the subscription rate is $60 per year in 2019, is it reasonable to assume that it will remain at this amount for the next 40 years? Should Evans Ltd. therefore project a modest growth rate in their annual subscription rate, based on the long-run expected inflation rate? Note that if such an adjustment were made, the PV of future cash flows expected to be received from a current subscriber who renews his/her subscription on an annual basis over the next 40 years, would increase substantially. This suggests that the lifetime subscription price of $800 should be raised substantially to compensate Evans, Ltd. for their willingness to forego any such future annual rate increases.

P7.29. a. Gross Pay - Total Deductions = Net Pay Gross Pay = (Net Pay + Total Deductions) = ($36,420 + $13,580) = $50,000 FICA Tax Withholdings = (Total Deductions - all other deductions) = ($13,580 - $8,725 - $620 - $410) = $3,825 FICA Tax Withholdings / Gross Pay = withholding percentage $3,825 / $50,000 = 7.65% b.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Wages Payable +36,420 Withholding Liabilities (accounts as shown in the entry) +3,825 +8,725 +620 +410

Wages Expense -50,000

50,000

To record accrued payroll.

36,420 3,825 8,725 620 410

Instructor’s Manual / Solutions Manual

P7.30. a. FICA Tax Withholdings (employee’s portion) = Gross Pay * 7.65% = $258,000 * 7.65% = $19,737 Employee Contributions to Pension Plans = (Total Deductions - all other deductions) = $62,475 - $19,737 - $30,960 - $3,810 = $7,968 Net Pay = Gross Pay - Total Deductions = $258,000 - $62,475 = $195,525 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Wages Payable +195,525 Withholding Liabilities (accounts as described below) +19,737 +30,960 + 3,810 + 7,968

Wages Expense -258,000

Dr. Wages Expense ........... ........... ........... ……….. ......... ........... 258,000 Cr. Wages Payable (or Accrued Payroll) ........ ........... ........... 195,525 Cr. FICA Taxes Withheld (employees’ share) ……… ........... 19,737 Cr. Income Taxes Withheld .... ........... ........... ........... ........... 30,960 Cr. Group Hospitalization Insurance... ........... ........... ........... 3,810 Cr. Employee Contributions to Pension Plan.. ........... ........... 7,968 To record accrued payroll.

b. The employer’s payroll taxes consist of the following: FICA tax withholdings ($258,000 * 7.65%) . ........... ........... ........... ........... Federal unemployment compensation taxes ($27,000 * 0.6%) ........ ........... State unemployment compensation taxes ($27,000 * 5.4%) ........... ........... Total employer payroll taxes . ........... ........... ........... ........... ........... ...........

$19,737 162 1,458 $21,357

Instructor’s Manual / Solutions Manual

P7.30. b.

(continued) Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Payroll Taxes Payable (or other descriptions) +21,357

Dr. Payroll Tax Expense .... ........... ........... ........... ........... ........... Cr. Payroll Taxes Payable (or Accrued Payroll Taxes)……….

Payroll Tax Expense -21,357

21,357 21,357

To record accrued payroll taxes.

Alternative entry: The credits in the above entry are often broken down in the chart of accounts based on the nature of the employer’s payroll tax obligations, such as: Dr. Payroll Tax Expense .... ........... ........... ........... ........... ........... Cr. FICA Taxes Withheld (employer’s share) . ……… ........... Cr. Federal Unemployment Taxes Withheld ... ........... ........... Cr. State Unemployment Taxes Withheld ....... ........... ...........

21,357 19,737 162 1,458

To record accrued payroll taxes.

Instructor’s Manual / Solutions Manual

P7.31. a. Management of Hayden Co. would be interested in calling the bonds if interest rates dropped enough so that the cost of a new borrowing to pay off the old bonds at a 2% call premium would be less than the cost of continuing to pay the 6% stated interest rate on the old bonds. b. Solution approach: The amount paid to bondholders = ($50,000,000 face amount * 102%) = $51,000,000. The bond premium was $750,000 ($50,750,000 proceeds$50,000,000 face amount), and the bonds have been outstanding for 8 years, so $300,000 (8/20 * $750,000) of the premium would have been amortized by December 31, 2022. Thus, the unamortized bond premium = $450,000 ($750,000 - $300,000), and the carrying value of the bonds = $50,450,000 ($50,000,000 + $450,000). The loss on retirement of bonds = ($51,000,000 amount paid - $50,450,000 carrying value) = $550,000.

P7.31.

(continued)

b. Balance Sheet

Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash Bonds -51,000,000 Payable -50,000,000 Premium on Bonds Payable -450,000

Loss on Early Retirement of Bonds -550,000

Dr. Bonds Payable ... ........... ........... ........... ………. .......... Dr. Premium on Bonds Payable (unamortized balance) .... Dr. Loss on Early Retirement of Bonds ..... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ………

50,000,000 450,000 550,000 51,000,000

To record the early retirement of bonds by exercise of the call feature.

P7.32. a. Management of Hurley Co. would be interested in calling the bonds if interest rates dropped enough so that the cost of a new borrowing to pay off the old bonds at a 2% call premium would be less than the cost of continuing to pay the 9% stated interest rate on the old bonds.

Instructor’s Manual / Solutions Manual

P7-32.

Solution approach: The amount paid to bondholders = ($420,000,000 face amount * 102%) = $428,400,000. The bond discount was $10,500,000 ($420,000,000 face amount- $409,500,000 proceeds), and the bonds have been outstanding for 13 years, so $6,825,000 (13/20 * $10,500,000) of the discount would have been amortized by December 31, 2022. Thus, the unamortized bond discount = $3,675,000 ($10,500,000 $6,825,000), and the carrying value of the bonds = $416,325,000 ($420,000,000 $3,675,000). The loss on retirement of bonds = ($428,400,000 amount paid $416,325,000 carrying value) = $12,075,000.

(continued) Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash Bonds -428,400,000 Payable -420,000,000 Discount on Bonds Payable +3,675,000

Loss on Early Retirement of Bonds -12,075,000

Dr. Bonds Payable ... ........... ........... ........... ………. .......... 420,000,000 Dr. Loss on Early Retirement of Bonds ..... ........... ........... 12,075,000 Cr. Cash ........... ........... ........... ........... ........... ……… 428,400,000 Cr. Discount on Bonds Payable (unamortized balance) 3,675,000 To record the early retirement of bonds by exercise of the call feature.

P7.33.

Instructor’s Manual / Solutions Manual

a. The semiannual interest payments on the bonds = 14% stated rate * $6,000,000 face amount * 6/12 = $420,000 The term of the bonds is 10 years, or 20 semiannual periods. The semiannual market interest rate is = 12% * 6/12 = 6% The present value of an annuity of $420,000 for 20 periods at 6% = $420,000 * 11.4699 = $4,817,358 The present value of the maturity value of $6,000,000 in 20 periods at 6% = $6,000,000 * 0.3118 = $1,870,800 The proceeds (issue price) of the bonds = PV of interest + PV of maturity value = $4,817,358 + $1,870,800 = $6,688,158 b. The semiannual discount amortization, straight-line basis = $220,000 / 20 periods = $11,000 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Cash -420,000

Discount on Bonds Payable +11,000

Interest Expense -431,000

Dr. Interest Expense ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... Cr. Discount on Bonds Payable .......... ........... ...........

431,000 420,000 11,000

To record the semiannual cash payment and amortization of discount.

P7.33.

(continued)

Instructor’s Manual / Solutions Manual

c. Discount on bonds payable is amortized with a credit, and thus increases interest expense. Under the straight-line basis, the amount of discount amortization is the same each period. Under the compound (or effective) interest method, the amount of discount amortization increases each period. Thus, interest expense under the compound method will be lower in the early years of the bond’s life and higher in the later years, as compared to interest expense under the straight-line method of amortization. Rationale of compound interest method: Interest expense under the compound interest method is calculated by multiplying the carrying value of the bond (face amount minus the unamortized discount) by the market rate of interest. This amount is then compared to the cash payment required (the face amount multiplied by the stated rate). Any difference between interest expense and the required cash payment represents the amortization of discount for the period. Because the carrying value of the bond increases over the life of the bond as discount is amortized, the amount of discount amortization also increases each period, causing interest expense to be higher each period. Thus, as compared to the straight-line basis, interest expense under the compound method will be lower in the first year.

P7.34. a. The semiannual interest payments on the bonds = 14% stated rate * $105,000,000 face amount * 6/12 = $7,350,000 The term of the bonds is 20 years, or 40 semiannual periods. The semiannual market interest rate is = 16% * 6/12 = 8% The present value of an annuity of $7,350,000 for 40 periods at 8% = $7,350,000 * 11.9246 = $87,645,810 The present value of the maturity value of $105,000,000 in 40 periods at 8% = $105,000,000 * 0.0460 = $4,830,000 The proceeds (issue price) of the bonds = PV of interest + PV of maturity value = $87,645,810 + $4,830,000 = $92,475,810

Instructor’s Manual / Solutions Manual

P7.34.

(continued)

b. The semiannual premium amortization, straight-line basis = $3,600,000 / 40 periods = $90,000 Balance Sheet Income Statement . Assets = Liabilities + Owners’ Equity  Net income = Revenues - Expenses Cash -7,350,000

Premium on Bonds Payable -90,000

Interest Expense -7,260,000

Dr. Interest Expense ........... ........... ........... ........... ........... Dr. Premium on Bonds Payable ...... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ...........

7,260,000 90,000 7,350,000

To record the semiannual cash payment and amortization of premium.

c. Premium on bonds payable is amortized with a debit, and thus decreases interest expense. Under the straight-line basis, the amount of premium amortization is the same each period. Under the compound (or effective) interest method, the amount of premium amortization increases each period. Thus, interest expense under the compound method will be higher in the early years of the bond’s life and lower in the later years, as compared to interest expense under the straight-line method of amortization. Rationale of compound interest method: Interest expense under the compound interest method is calculated by multiplying the carrying value of the bond (face amount plus the unamortized premium) by the market rate of interest. This amount is then compared to the cash payment required (the face amount multiplied by the stated rate). Any difference between interest expense and the required cash payment represents the amortization of premium for the period. Because the carrying value of the bond decreases over the life of the bond as premium is amortized, the amount of premium amortization increases each period, causing interest expense to be lower each period. Compared to the straight-line basis, interest expense under the compound method will be higher in the first year. d. There is usually a time lag of several weeks from the point that the stated rate of interest has been established (as part of the bond indenture) and the date that the bonds are sold (issuance date). However, because this time lag tends to be relatively short, the market interest rate usually does not change significantly before the bonds are issued.

C7.35.

Answers will vary based on the annual report of the focus company selected.

Instructor’s Manual / Solutions Manual

C7.36. a. The average-for-the-year interest rate = (7% + 8%) / 2 = 7.5% The average liability balance = ($380,000 + $500,000) / 2 = $440,000 Interest accrual = $440,000 * 7.5% = $33,000 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Interest Payable +33,000

Interest Expense -33,000

Dr. Interest Expense ($440,000 * 7.5%) ..... ……… ........... ........... Cr. Interest Payable ...... ........... ........... ........... ……… ...........

33,000 33,000

To accrue interest on working capital loans for the year.

b. No. The “current maturities of long-term debt” is related to the “serial bonds due in equal annual installments.” The current maturities owed at the end of 2022 would have been paid at some point during 2023 (at the date specified in the serial bond indenture). At the end of 2023, an entry would have been made to reclassify the 2024 installment of the long-term serial bond as a current liability. Thus, the “current maturities” account would have decreased and then increased by equal amounts during the year.

Instructor’s Manual / Solutions Manual c. Solution approach: What happens to the market value of the firm’s bonds outstanding when there is a decline in interest rates for bonds of similar risk? The bonds pay a higher than market-rate of interest, so their price will increase. That is, investors are willing to pay more for bonds offering a higher than market interest rate because such an investment will increase their ROI. Since the bonds are a liability to Corless Co. (the issuer), it is likely that the call feature will be exercised so that bonds with a lower interest rate can be issued in the near future. It would not be to the bondholders’ advantage to exercise the conversion feature at this point. Points for discussion: What other factors should Corless Co. consider before deciding to call the bonds? 1) cost of the call premium, and 2) cost of registration and issuance of a new bond issue; both factors should be considered relative to the remaining term of the outstanding bonds. Note that interest rate expectations are not terribly relevant because the new bond issue will have a fixed interest rate (at or near 7%), and if interest rates continue to drop, the call feature can be exercised on the new bonds as well.

C7.36.

(continued)

Instructor’s Manual / Solutions Manual

d. The market value would be more than the book value of $800,000 because the price of the bonds would increase, as described in item c (since the market rate of interest has fallen to 7%). This is bad news to Corless Co. because it is paying a higher than market interest rate. Points for discussion: Why doesn’t the firm adjust the book value of its liability for the change in market value caused by interest rate movements? That is, why not record the unrealized gain or loss each year as a year-end adjusting entry so that the Bonds Payable account will be marked to market? 1) This would violate the historical cost principle-bonds are initially recorded at their market value at the time of issuance, and the initial amount of discount or premium is amortized over the life of the bond issue (much like the depreciation of the historical cost of long-term assets). Accounting for liabilities should be consistent with the accounting for long-term assets. 2) The going concern concept suggests that, in the end, the bonds will be appropriately valued--the book value will be equal to the face amount at the maturity date, and this is the amount of cash the issuer must ultimately pay to satisfy its obligation. So why keep adjusting the “value” of the Bonds Payable liability up and down if the market adjustments are not going to be realized by the firm? This provides a good opportunity to discuss/reinforce alternative valuation approaches for liabilities (and assets) with emphasis on the historical cost versus fair market value debate. e. The following adjusting entry would have been made (dated December 31, 2023) to reclassify the 2024 installment of the serial bond as a current liability: Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses Serial Bonds Payable -160,000 Current Maturities of Long-Term Debt +160,000

Dr. Serial Bonds Payable .... ........... ……… ........... ........... ........... 160,000 Cr. Current Maturities of Long-Term Debt...... ........... ...........

160,000

To reclassify the 2024 installment of the serial bond as a current liability.

Note that the entries to record installment payments of principal for serial bonds would decrease the Current Maturities of Long-Term Debt account, rather than the Serial Bonds Payable account. The year-end adjusting entry for 2023 shown above sets up the $160,000 cash payment entry for 2024.

Instructor’s Manual / Solutions Manual

C7.37. Note to Instructors: This case was originally based on the 1999 annual report of Home Depot, Inc. The long-term debt note disclosures in more recent years have become less interesting from an accounting perspective (i.e., Home Depot no longer reports commercial paper, installment notes, or an unsecured bank loan, for instance). To preserve the case, we changed the name to a fictional company. a. The notes were converted into shares at a price of $15.3611, which means that approximately 71.80 million shares would have been issued in exchange for the notes ($1,103,000,000 / $15.3611). Note: Home and Office City’s footnote disclosures indicate that 72 million shares were actually issued—perhaps shares were also given in lieu of some accrued interest. b. 1. Below face: No, this is not possible. 2. Above face: Yes, this is possible. 3. Equal to face: Yes, this is possible. Discussion: The bonds are redeemable at “a redemption price… equal to the greater of (1) 100% of the principal amount of the Senior Notes to be redeemed, or (2)…” This statement indicates that the minimum amount to be paid by Home and Office City is equal to the principal amount of the notes (i.e., face value). Thus, the notes cannot be redeemed at a discount—no matter what the “present value” of the remaining principal and interest payments is. If, however, the market value of the notes is greater than their principal (i.e., face) value, then Home and Office City (at its option) may redeem the notes at a premium. The language quoted in point (2) describes the market value of the notes as the “sum of the present values of the remaining scheduled payments of principal and interest to maturity.” If the market value is equal to the face value, then the notes may be redeemed at face value. Home and Office City would most likely be prompted to redeem the notes if interest rates were expected to fall significantly below 6.5% such that the company would be able to reissue debt at a fixed interest rate of less than 6.5%.

Instructor’s Manual / Solutions Manual

C7.37.

(continued)

c. This statement means that Home and Office City has arranged to have “ready access” to $800 million of additional borrowings. As of December 31, 2023, no commercial paper debt was outstanding, which means that the company has not drawn down on this line of credit. Should the company need to do so, the terms and conditions of the debt (i.e., restrictive covenants) are unlikely to make a significant difference in terms of the company’s ability to pay its other debts (i.e., liquidity). Likewise, borrowing on this line of credit is unlikely to have a significant impact on the company’s ability to access funds through other financing sources (i.e., capital resources)—which means that borrowing on the line of credit is not likely to influence the company’s creditworthiness (i.e., debt ratings). d. You might want to know, for instance: 1. What amounts are scheduled to mature in which years; 2. What the implicit interest rate (or a range of implicit interest rates) is on the financing lease obligations; and 3. What underlying assets these borrowings relate to. e. Most installment notes are non-interest bearing on their face. Yet, if you were to add up the total of the amounts to be repaid in future years, this undiscounted sum would greatly exceed the amount initially borrowed. Thus, the interest rate charged on the loan is implicit (rather than explicit, as when it’s stated in the lending documents). The implicit interest rate must be that rate which makes the loan proceeds at the time of borrowing equal to the sum of the discounted values of all future loan repayments. As you can imagine, computers help to make these present value calculations! f. Any of a number of explanations are possible, including: 1. Lenders are inclined to require security interests. 2. Unsecured loans are more expensive to borrowers (in the form of higher interest rates). 3. Most of Home and Office City’s long-term borrowing needs relate to the construction of new stores, which provides a ready-made form of security interest. 4. Unsecured loans tend to be of relatively short duration (usually 2-4 years), which may not coincide with the borrower’s cash needs. g. Most of Home and Office City’s long-term debt has near-term maturities. The $500 million of 6.5% senior notes are due on September 15, 2027; the $15 million of unsecured bank loans are due in August 2025; the capital lease obligations and installment notes fall due over longer periods (through 2050 and 2041, respectively), but perhaps some of these amounts will mature in the next five years as well.

Instructor’s Manual / Solutions Manual

TAKE-HOME QUIZ--CHAPTER 7 Name___________________________ 1. This question relates to the following presentation in the balance sheets of Asriel, Inc. at December 31, 2023 and 2022: Current liabilities: Accounts payable . ........... ........... ........... ........... ........... ........... Accrued wages payable .... ........... ........... ........... ........... ........... Accrued property taxes payable ... ........... ........... ........... ........... Accrued interest payable .. ........... ........... ........... ........... ...........

12/31/23 $ 18,400 3,800 2,200 1,800

12/31/22 $ 16,750 4,430 2,000 0

a. If wages expense during 2023 totaled $137,600, how much cash was paid for wages?

b. If property taxes paid during 2022 totaled $27,350, how much property tax expense was accrued during 2023?

c. If the interest payable at 12/31/23 had not been accrued at that date, by how much and in what direction (too high or too low) would net income for 2023 have been misstated?

d. Why are expenses accrued?

Instructor’s Manual / Solutions Manual

TAKE-HOME QUIZ--CHAPTER 7 (continued) 2. On January 1, 2023, Simon, Inc. issued $500,000 of 9%, 10-year bonds at 101. Interest is payable every June 30 and December 31. Premium is amortized on a straight-line basis. a. Was the market interest rate on January 1, 2023 equal to, more than, or less than the stated interest rate of the bonds? Explain your answer.

b. How much interest will be paid on these bonds during 2023?

c. How much interest expense will Simon, Inc. report in its 2023 income statement with respect to these bonds?

3. a. The deferred income tax liability arises because book income is greater than taxable income. What is the principal item that causes book and taxable income to be different for most companies?

b. What concept is being applied when income taxes that won't be payable for several years are recognized in the current period's financial statements?

Instructor’s Manual / Solutions Manual

TAKE-HOME QUIZ KEY—CHAPTER 7 1. a. Analyze the wages payable account: Beginning balance of wages payable ... ........... ........... ........... ........... ........... Add: Accrual of wages expense for period ....... ........... ........... ........... ........... Total credits to wages payable account . ........... ........... ........... ........... ........... Less: Ending balance of wages payable account .......... ........... ........... ……… Debit to wages payable for wages paid during year ..... ........... ........... ........... b. Analyze the property taxes payable account: Beginning balance of property taxes payable ... ........... ........... ........... ........... Less: Property taxes paid during period ........... ........... ........... ........... ........... Net debit to property taxes payable account ..... ........... ........... ........... ........... Add: Ending balance of property tax payable account . ........... ........... ........... Credit to property tax payable for tax expense accrued during the year ...........

4,430 137,600 $142,030 (3,800) $138,230

2,000 (27,350) $ 25,350 2,200 $ 27,550

c. Net income would have been $1,800 too high. d. To match revenues and expenses, thus making the financial statements more accurate. 2. a. Less than, because the bonds were issued at a premium. b. $500,000 * 9% = $45,000 c. Interest paid ...... ........... ........... ........... ........... ........... ........... ........... ........... $45,000 Less premium amortization ($5,000 / 10 years) ......... ........... ........... ........... (500) Interest expense for year .......... ........... ........... ........... ........... ........... ........... $44,500 3. a. Depreciation expense. Accelerated depreciation is claimed for income tax purposes and straight-line depreciation is used for book purposes. b. Matching of revenues and expenses.

Instructor’s Manual / Solutions Manual

CHAPTER

Accounting for and Presentation of Stockholders’ Equity

CHAPTER OUTLINE: I. Paid-in Capital A. Common Stock 1. Rights and obligations of common stockholders 2. Par value/no par value 3. Shares authorized, issued, and outstanding B. Preferred Stock 1. Differences from common stock 2. Illustrations of dividend calculations 3. Differences from bonds C. Additional paid-in capital II. Retained Earnings A. Items that cause retained earnings to change B. Cash dividends 1. Recording transactions 2. Dividend dates C. Stock dividends and stock splits 1. Reasons for stock dividends and stock splits 2. No impact on total market value of company's stock III. Accumulated Other Comprehensive Income (Loss) A. Why included in stockholders’ equity B. Foreign Currency Translation Adjustment IV. Noncontrolling (Minority) Interest V. Reporting Changes in Stockholders' Equity Accounts VI. Owners’ Equity for Other Types of Entities A. Proprietorships and Partnerships B. Not-for-Profit and Governmental organizations VII. Appendix—Personal Investing

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To have the student understand the major differences between common and preferred stock. 2. To reinforce the student's understanding of retained earnings, and the transactions that affect this account. 3. To have the student understand the nature and characteristics of cash dividends, stock dividends, and stock splits. Supporting: 4. To expand the student's understanding of the components of paid-in capital, and to introduce preferred stock. 5. To have the student understand the rights and obligations of common and preferred stockholders. 6. To have the student understand the detailed components of a corporation's paid-in capital. 7. To expand the student's understanding of cash dividends. 8. To have the student understand the effect of stock dividends and stock splits on stockholders' equity. 9. To have the student understand that treasury stock transactions affect only stockholders' equity accounts. 10. To have the student be able to understand the statement of changes in stockholders' equity in a corporate annual report, including those with Accumulated Other Comprehensive Income and Noncontrolling Interest captions.

TEACHING OBSERVATIONS: 1. To create added incentive for learning, it is appropriate to put the material in this chapter in the context of investment activities in which the student will probably become involved. 2. The discussion of preferred stock can be used to clarify the characteristics of both common stock and bonds. 3. If the instructor is so inclined, a brief discussion of the determinants of a firm's dividend policy can help students get a better grasp of dividends (e.g., why many firms continue to pay dividends even during loss years, or why a company like Apple, Inc. paid no dividends for many years despite its extraordinary profitability). Current news items about dividend rate changes, stock dividends, and stock splits can aid understanding of these topics.

Instructor’s Manual / Solutions Manual 4. The impact of stock dividends and stock splits on per share data is discussed in Chapter 10. 5. Real-world examples of the statement of changes in stockholders' equity should be presented to illustrate the topics discussed in this chapter.

ASSIGNMENT OVERVIEW: NO. M8.1. M8.2. M8.3. M8.4. M8.5. M8.6. E8.7. E8.8. E8.9. E8.10. E8.11. E8.12. E8.13. E8.14. E8.15. E8.16. E8.17. E8.18.

LEARNING OBJECTIVES 1 1, 3 2 4 4 6 7 and review 7 and review 7 and review 7 and review 1 1, 3 2 2 2 2 3 3

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Med., 5-7 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Med., 10-15 min.

E8.19. E8.20. E8.21.

3 3 3, 4

Easy, 3-5 min. Med., 7-10 min. Easy, 5-8 min.

E8.22. E8.23. E8.24. P8.25. P8.26. P8.27. P8.28. P8.29. P8.30. P8.31. P8.32. P8.33.

3, 4 4 4 1, 2, 3 1, 2, 3 3, 6 3, 6 1, 2, 3, 4, 6 1, 2, 3, 4, 6 1, 2, 3, 4, 6 1, 2, 3, 4, 6 1, 2, 3, 6, 7

Med., 7-10 min. Easy, 3-5 min. Easy, 3-5 min. Med., 7-10 min. Med., 7-10 min. Med., 7-10 min. Med., 10-12 min. Med., 10-12 min. Med., 10-12 min. Med., 10-12 min. Med., 10-12 min. Hard, 25-35 min.

P8.34. C8.35. C8.36. C8.37.

1, 2, 3, 4, 6, 7 1, 2, 5, 6, 8, 9 1, 2, 6, 7 1, 2, 3, 4, 6, 7

Hard, 25-35 min. Easy, 5-10 min. Hard, 15-20 min. Hard, 10-15 min.

OTHER COMMENTS Basic common stock terminology. Basic common stock calculations and entries. Basic preferred dividends calculations. Basic stock split calculations. Basic stock splits and stock dividends terminology. Basic treasury stock transactions. Straight-forward review question. Good in-class demonstration exercise. Review the Statement of Retained Earnings. See E8.9. Use to clarify terminology: authorized, issued, outstanding. Good homework assignment. Straight-forward dividend calculations. See E8.13. Good in-class demonstration exercise. See E8.13. See E8.13. See Business in Practice—Dividend Dates. Group learning problem—an opportunity to have students use The Wall Street Journal to learn how to read stock quotations. Good discussion starter for “dividend policy” issues. See E8.19. See E8.19. Emphasize that stock dividend transactions do not involve a third party (i.e., the transaction is between the company and its stockholders—who, collectively, own the company). See E8.21. Good in-class demonstration or homework exercise. Straight-forward. See E8.23. Straight-forward dividend calculations and entries. Good homework assignment. Straight-forward treasury stock problem. See P8.27. Potpourri—straight-forward journal entries problem. See P8.29. Good homework assignment. Excellent problem for self-study / review. See P8.31. Good homework assignment. Emphasize terminology and the structure of the stockholders’ equity section of the balance sheet. See P8.33. Group learning problem. Focus company—basic review of note disclosures. Excellent problem for self-study / review. See C8.34. Group learning case.

Instructor’s Manual / Solutions Manual C8.38.

1, 2, 7

Med-Hard, 30 min. or more.

Capstone analytical review, Chapters 7-8. Capital lease, preferred stock and bonds payable issues.

SOLUTIONS: M8.1. a. Balance sheet amount equals number of shares issued x par value. 410,000 shares x $10 = $4,100,000 b. Cash dividends are paid on shares outstanding. 380,000 shares x $0.50 = $190,000 c. Treasury stock of 30,000 shares accounts for the difference between shares issued and shares outstanding.

M8.2. Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

January 1, 2022 to record stock issuance: Cash Common Stock + 1,870,000 + 110,000 Additional Paid-In Capital + 1,760,000

December 31, 2022 to record the declaration of dividends: Dividends Retained Payable Earnings + 330,000 - 330,000

January 24, 2023 to record the payment of dividends: Cash Dividends -330,000 Payable - 330,000

a. January 1, 2022: Dr. Cash (110,000 shares @ $17) .... ........... ........... ........... ........... 1,870,000 Cr. Common Stock (110,000 shares @ $1 per share) ... ........... Cr. Additional Paid-In Capital (110,000 @ $16)........... ...........

110,000 1,760,000

To record stock issuance.

b. December 31, 2022: Dr. Retained Earnings .......... ........... ........... ........... ........... ........... Cr. Dividends Payable ... ........... ........... ........... ........... ...........

330,000

To record the declaration of dividends.

330,000

Instructor’s Manual / Solutions Manual c. January 24, 2023: Dr. Dividends Payable ......... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

330,000 330,000

To record the payment of dividends.

M8.3. Preferred dividends for 2021, 2022, and 2023 would have to be paid before a dividend on the common stock could be paid. Annual dividend = 6.5% x $100 per share x 275,000 shares = $1,787,500 Dividends for 3 years = 3 x $1,787,500 = $5,362,500

M8.4. a. A 5-for-1 split means that for every share now owned, the stockholder will own 5 shares. Thus, the investor will own 1,900 shares x 5 = 9,500 shares. b. Because there are now 5 times as many shares of stock outstanding, and the financial condition of the company hasn't changed, the market price per share should be one-fifth (1/5) of what it was, or $108 / 5 = $21.60 per share. The total market value of the investment will not have changed. Note that 1,900 shares x $108 per share = $205,200. Likewise, 9,500 shares x $21.60 per share = $205,200. c. The par value per share is also likely to be divided by 5 (i.e., from $10 to $2), but this does not happen automatically—any changes in par value per share require action by the board of directors.

M8.5. a. 400 shares x 2 = 800 shares after the stock split b. Dividend income before the stock split = $5.00 x 400 shares = $2,000 $2,000 / 800 shares = $2.50 dividend per share after the stock split. c. A 100% stock dividend would accomplish the same result.

M8.6. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

April 10, 2022 to record the purchase of 1,800 shares of treasury stock @ $23 per share: Cash Treasury Stock - 41,400 - 41,400

Instructor’s Manual / Solutions Manual b.

M8.6.

September 28, 2022 to record the sale of 700 shares of treasury stock @ $26 per share: Cash Treasury Stock + 18,200 + 16,100 Additional Paid-in Capital + 2,100 (continued)

a. April 10, 2022: Dr. Treasury Stock ... ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

41,400 41,400

To record the purchase of 1,800 shares of treasury stock @ $23 per share.

b. September 28, 2022: Dr. Cash (700 shares @ $26) ........... ........... ........... ........... ........... Cr. Treasury Stock (700 shares @ $23) . ........... ........... ........... Cr. Additional Paid-In Capital (700 shares @ $3)......... ...........

18,200 16,100 2,100

To record the sale of 700 shares of treasury stock @ $26 per share.

E8.7. A = Beginning……..$ (4) Changes……….+160,000

L + $ (3) +17,000

PIC (1) +30,000

Ending………...

$167,000 +

$120,000

(5)

RE (2) $350,000 SE + (7) Net income -40,000 Dividends (6) .

Steps: Short-cut approach: 1. $120,000 - $30,000 = $90,000 $160,000 = + $17,000 + $30,000 2. $350,000 - $90,000 = $260,000 + Net income - $40,000 3. $167,000 - $17,000 = $150,000 4. $150,000 + $350,000 = $500,000 Net income = $153,000 5. $500,000 + $160,000 = $660,000 6. $660,000 - $167,000 - $120,000 = $373,000 7. $260,000 + Net income - $40,000 = $373,000 Net income = $153,000 E8.8. A = Beginning …… $ (5) Changes……… +231,000 Ending……….

(3)

L + $657,000 -108,000

RE (6) + (7) Net income -186,000 Dividends + $570,000 + (1) $1,137,000 SE

(2)

PIC + (4) +30,000

Instructor’s Manual / Solutions Manual Steps: Short-cut approach: 1. $1,137,000 - $570,000 = $567,000 231,000 = - $108,000 + $30,000 2. $657,000 - $108,000 = $549,000 + Net income - $186,000 3. $549,000 + $1,137,000 = $1,686,000 4. $570,000 - $30,000 = $540,000 Net income = $495,000 5. $1,686,000 - $231,000 = $1,455,000 6. $1,455,000 - $657,000 - $540,000 = $258,000 7. $258,000 + Net income - $186,000 = $567,000 Net income = $495,000 E8.9. Retained earnings, December 31, 2022 ......... ........... ........... ........... ........... Add: Net income for the year ........... ........... ........... ........... ........... ........... Less: Dividends for the year .. ........... ........... ........... ........... ........... ........... Retained earnings, December 31, 2022 ......... ........... ........... ........... ...........

$346,400 56,900 (32,500) $370,800

E8.10. Prepare the retained earnings portion of a statement of changes in stockholders’ equity for the year ended December 31, 2022: Retained earnings, December 31, 2022 ......... ........... ........... ........... Less: Net loss for the year..... ........... ........... ........... ........... ........... Less: Dividends for the year .. ........... ........... ........... ........... ........... Retained earnings, December 31, 2023 ......... ........... ........... ...........

? (34,500) (50,400) $367,800

Solving for the unknown amount, retained earnings at December 31, 2022 was $452,700. E8.11. a. Balance sheet amount equals number of shares issued x par value. 4,200,000 shares x $5 = $21,000,000 b. Cash dividends are paid on shares outstanding. 3,750,000 shares x $0.40 = $1,500,000 c. Treasury stock of 450,000 shares accounts for the difference between shares issued and shares outstanding. E8.12. a. Average price at which shares issued = Balance sheet amount / Number of shares issued = $38,250,000 / 3,000,000 = $12.75 per share b. Common stock at stated value of $1 per share; 7,500,000 shares authorized, 3,000,000 issued and 2,700,000 shares outstanding .......... ........... ........... ........... ........... Additional paid-in capital ...... ........... ........... ........... ........... ........... Total paid-in capital ........... ........... ........... ........... ........... ...........

$ 3,000,000 35,250,000 $38,250,000

Instructor’s Manual / Solutions Manual

c. Total dividend = Rate per share x Number of shares outstanding = $1.60 x 2,700,000 = $4,320,000 d. Treasury stock of 300,000 shares accounts for the difference between shares issued and shares outstanding.

E8.13. a. Number of shares issued ....... ........... ........... ........... ........... ........... Less: Number of shares in treasury.... ........... ........... ........... ........... Number of shares outstanding ........... ........... ........... ........... ........... Dividend requirement per share ......... ........... ........... ........... ........... Total annual dividends required to be paid .... ........... ........... ...........

525,000 (70,500) 454,500 x $2.25 $1,022,625

b. Dividend per share (6% x $50 par value) ...... ........... ........... ........... Number of shares outstanding ........... ........... ........... ........... ........... Total annual dividends required to be paid .... ........... ........... ...........

$3.00 206,600 $619,800

c. Dividend per share (8.1% x $100 stated value) ......... ........... ........... Number of shares outstanding ........... ........... ........... ........... ........... Total annual dividends required to be paid .... ........... ........... ...........

$8.10 37,600 $304,560

E8.14. a. Annual dividend = Dividend rate x par value x number of shares outstanding = 7% x $60 x 40,000 = $168,000 Semi-annual dividend = annual dividend / 2 = $168,000 / 2 = $84,000 b. Annual dividend = Dividend rate x number of shares outstanding = $5.20 x 171,600 = $892,320 Arrears of $892,320 are owed for last year as well, so the total dividends owed would be: $892,320 x 2 years = $1,784,640 c. Annual dividend = Dividend rate x stated value x number of shares outstanding = 4.8% x $100 x 445,000 = $2,136,000 Quarterly dividend = annual dividend / 4 = $2,136,000 /4 = $534,000 E8.15. Preferred dividends for 2021, 2022, and 2023 would have to be paid before a dividend on the common stock could be paid. Annual dividend = $3.50 x 38,000 shares = $133,000 Dividends for 3 years = 3 x $133,000 = $399,000 E8.16. 8-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual a. Annual dividend per share = Dividend rate x par value = 7.5% x $50 = $3.75 b. Preferred dividends for 2021 and 2022 must be paid first because the preferred stock is cumulative. The 2023 preferred dividend must also be paid before dividends can be paid on common stock. Preferred dividends = $3.75 x 3 years x 3,100 shares = $34,875 Common dividends = $0.40 x 29,000 shares = $11,600 Total dividends received = $34,875 + $11,600 = $46,475

Instructor’s Manual / Solutions Manual E8.17. a. February 27 is the declaration date. Because this is a regular dividend of the same amount as prior dividends, the stock price would not be significantly affected. b. March 10 is the ex-dividend date. This is 2 business days prior to the record date. On this date the market price of the stock is likely to fall by the amount of the dividend because purchasers will not receive the dividend. c. March 12 is the record date. The market price of the stock is not generally affected on the record date. It is the ex-dividends date, which is 2 business days prior to the record date, that affects who receives the divided. In this case, the market price of the stock is likely to fall by the amount of the dividend per share on March 10, since anyone who purchases shares on March 10-12 will not receive the dividend. d. March 24 is the payment date. The market price of the stock should not be affected because the corporation is merely paying a liability (dividends payable). E8.18. All other things being equal, one would expect the market price of the stock to fall by the amount of the dividend on the ex-dividend date. This is because the seller will be the owner of record and will receive the dividend from the company. E8.19. To declare a dividend, the firm must have retained earnings and enough cash to pay the dividend. Of course, the board of directors must approve a dividend. E8.20. a. Quarterly. See the Quarterly Data (unaudited) on page 84 in Campbell’s 2020 annual report. b. The “Selected Financial Data” is on page 16 in Campbell’s 2020 annual report. Dividends declared and paid increased from $1.248 in 2016 to $1.40 per share in 2017 and then remained $1.40 per share in 2018, 2019, and 2020. Basic earnings per share (EPS) based on net earnings attributable to Campbell Soup Company has shown significant variability over the 5-year period. EPS rose from 2016 to 2017, then fell substantially in 2018 and remained low in 2019 before rising dramatically in 2020. The overall range in EPS results (from a low of $0.70 in 2019 to a high of $5.39 in 2020) was quite wide, despite a strong and consistent sales growth pattern exhibited during the 5-year period. Campbell’s was in fact significantly affected by nonrecurring items on the income statement during the 5-year period; this goes a long way to explaining the anomaly noted above. In particular, more than $700 million in total losses from discontinued operations were reported in 2018 and 2019, while more than $1 billion of gains from discontinued operations were reported in 2020. Not surprisingly, basic earnings per share (EPS) based on earnings from continuing operations attributable to Campbell Soup Company showed 8-10 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual E8.20. b.

(continued) a much steadier trend over the 5-year period, with a much narrower range of reported results (from a low of $1.57 in 2019 to a high of $3.03 in 2017). There does not appear to be a direct relationship between Campbell’s fixed dividends per share (DPS) beginning in 2017 and its variable reported earnings per share (EPS). For many years prior to 2017, Campbell’s dividend policy was to gradually increase DPS. This sent a clear message that management and the board of directors feel confident in the company’s ability to sustain its earnings growth. Since 2017, however, Campbell’s dividend policy has clearly been to maintain but not increase the quarterly cash dividend of $0.35 per share (or $1.40 per year). Thus, it is likely that Campbell’s will continue to follow its zero growth-rate dividend policy until it can sustain higher dividend payments without adversely affecting its ability to finance growth opportunities.

c. Dividends per share ... ........... ........... Increase (decrease) from prior year ... Percentage increase .... ........... ...........

2016 $1.248

2017 $1.40 0.152 12.2%

2018 $1.40 0.0%

2019 $1.40 0.0%

2020 $1.40 0.0%

E8.21. If a company has demonstrated an ability to consistently reinvest retained earnings at a higher ROI than a typical investor could earn on the money paid out as dividends, then most investors would prefer that the company not pay a cash dividend (Apple, Inc. is a perfect example). If an investor needed current income from an investment, the investor would want cash dividends. A common stock investor shouldn’t care whether or not a company issues a stock dividend, because a stock dividend doesn't change that investor’s equity in the company, the total market value of his investment, or the company's ability to earn a return on his investment.

E8.22. a. 14,000 shares x 5% dividend = 700 dividend shares b. $1.68 / 1.05 = $1.60 Proof: Total dividend on 14,000 shares @ $1.68 = $23,520 Total dividend on 14,700 shares @ $1.60 = $23,520 c. Total dividend on 14,700 shares @ $1.68 = $24,696 Total dividend $24,696 / 14,000 shares = $1.764 per share d. This dividend policy would result in greater total cash dividends every year without changing the cash dividend per share.

Instructor’s Manual / Solutions Manual

E8.23. a. A 2-for-1 split means that for every share now owned, the stockholder will own 2 shares. Thus, the investor will own 1,200 shares. b. Because there are now twice as many shares of stock outstanding, and the financial condition of the company hasn't changed, the market price per share should be half of what it was, or $45 per share. The total market value of the investment will not have changed. c. The par value per share is also likely to be split in half (i.e., from $10 to $5), but this does not happen automatically—any changes in par value per share require action by the board of directors. E8.24. a. 900 shares x 3/2 = 1,350 shares after the stock split b. Dividend income before the stock split = $3.15 x 900 shares = $2,835 $2,835 / 1,350 shares = $2.10 dividend per share after the stock split c. A 50% stock dividend would accomplish the same result.

P8.25. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

1. January 1, 2022 to record stock issuances: Cash Common Stock + 10,750,000 + 3,120,000 Preferred Stock + 7,000,000 Additional Paid-In Capital + 630,000 2. December 27, 2023 to record the declaration of dividends: Dividends Retained Payable Earnings + 1,190,000 - 1,190,000 3. February 11, 2024 to record the payment of dividends: Cash Dividends - 1,190,000 Payable - 1,190,000

Instructor’s Manual / Solutions Manual

P8.25. a.

(continued) 1. January 1, 2022: Dr. Cash ((120,000 @ $26) + (70,000 @ $109)).... ........... ........... 10,750,000 Cr. Common Stock (120,000 shares @ $26 per share).. ........... 3,120,000 Cr. Preferred Stock (70,000 shares @ $100 per share).. ........... 7,000,000 Cr. Additional Paid-In Capital--Preferred (70,000 @ $9) ....... 630,000 To record stock issuances.

2. December 27, 2023: Dr. Retained Earnings .......... ........... ........... ........... ........... ........... 1,190,000 Cr. Dividends Payable ... ........... ........... ........... ........... ...........

1,190,000

To record the declaration of dividends.

3. February 11, 2024: Dr. Dividends Payable ......... ........... ........... ........... ........... ........... 1,1900,000 Cr. Cash . ........... ........... ........... ........... ........... ........... ........... 1,190,000 To record the payment of dividends.

b. Preferred shareholders are entitled to one year of dividends in arrears (for 2022), as well as their current year preference (for 2023). 70,000 shares x $100 par per share x 5.5% = $385,000 per year x 2 years = $770,000 Note: Although not required, common shareholders would receive $420,000 ($1,190,000 $770,000) in dividends, or $3.50 per share ($420,000 / 120,000 shares).

P8.26. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

1. January 1, 2022 to record stock issuances: Cash Common Stock + 82,950,000 + 26,250,000 Preferred Stock + 54,000,000 Additional Paid-In Capital + 2,700,000 2. December 22, 2024 to record the declaration of dividends: Dividends Retained Payable Earnings + 15,000,000 - 15,000,000 8-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual 3. February 12, 2025 to record the payment of dividends: Cash Dividends - 15,000,000 Payable - 15,000,000 P8.26. a.

(continued) 1. January 1, 2022: Dr. Cash ((750,000 @ $35) + (540,000 @ $105))…........... ........... 82,950,000 Cr. Common Stock (750,000 shares @ $35 per share)….......... 26,250,000 Cr. Preferred Stock (540,000 shares @ $100 per share) ........... 54,000,000 Cr. Additional Paid-In Capital--Preferred (540,000 @ $5) ..... 2,700,000 To record stock issuances.

2. December 22, 2024: Dr. Retained Earnings .......... ........... ........... ........... ........... ........... 15,000,000 Cr. Dividends Payable ... ........... ........... ........... ........... ........... 15,000,000 To record the declaration of dividends.

3. February 12, 2025: Dr. Dividends Payable ......... ........... ........... ........... ........... ........... 15,000,000 Cr. Cash . ........... ........... ........... ........... ........... ........... ........... 15,000,000 To record the payment of dividends.

b. Preferred shareholders are entitled to two years of dividends in arrears (for 2022 and 2023), as well as their current year preference (for 2024). 540,000 shares x $100 par per share x 7.5% = $4,050,000 per year x 3 years = $12,150,000 c.

$1,500,000 total dividends declared - $12,150,000 preferred stock dividends = $2,850,000 common stock dividends / 750,000 common shares = $3.80 common stock dividends per share declared in 2024

Instructor’s Manual / Solutions Manual

P8.27. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

March 3, 2022 to record the purchase of 800 shares of treasury stock @ $10.75 per share: Cash Treasury Stock - 8,600 - 8,600 b. July 2, 2022 to record the declaration and payment of a cash dividend: Cash Retained - 19,680 Earnings - 19,680 c. August 29, 2022 to record the sale of 500 shares of treasury stock @ $11.50 per share: Cash Treasury Stock + 5,750 + 5,375 Additional Paid-in Capital + 375 a. March 3, 2022: Dr. Treasury Stock ... ........... ........... ........... ........... ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

8,600 8,600

To record the purchase of 800 shares of treasury stock @ $10.75 per share.

b. July 2, 2022: Dr. Retained Earnings (33,600 – 800 = 32,800 shares x $0.60) ..... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

19,680 19,680

To record the declaration and payment of a cash dividend.

c. c. August 29, 2022: Dr. Cash (500 shares @ $11.50) ...... ........... ........... ........... ........... Cr. Treasury Stock (500 shares @ $10.75) ........ ........... ........... Cr. Additional Paid-In Capital (500 shares @ $0.75).... ...........

5,750

To record the sale of 500 shares of treasury stock @ $11.50 per share.

5,375 375

Instructor’s Manual / Solutions Manual P8.28. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash -133,200

Treasury Stock -133,200

Dr. Treasury Stock ... ........... ........... ........... ........... ........... ........... 133,200 Cr. Cash ........... ........... ........... ........... ........... ........... ...........

133,200

To record the purchase of 3,600 shares of treasury stock @ $37 per share.

b. Shares outstanding at beginning of year ........ ........... ........... ........... Shares purchased for treasury in first quarter ........... ........... ........... Shares outstanding during second quarter ..... ........... ........... ........... Cash dividend per share ......... ........... ........... ........... ........... ........... Dividend paid at end of second quarter ......... ........... ........... ........... c.

411,050 (3,600) 407,450 x $1.50 $611,175

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash + 62,350

Treasury Stock + 53,650 Additional Paid-In Capital + 8,700

Dr. Cash (1,450 shares @ $43) ........ ........... ........... ........... ........... Cr. Treasury Stock (1,450 shares @ $37) .......... ........... ........... Cr. Additional Paid-In Capital (1,450 shares @ $6)...... ...........

62,350 53,650 8,700

To record the sale of 1,450 shares of treasury stock @ $43 per share.

d. Shares outstanding during second quarter ..... ........... ........... ........... ........... Treasury shares sold during third quarter ...... ........... ........... ........... ........... Shares outstanding during fourth quarter....... ........... ........... ........... ........... Cash dividend per share ......... ........... ........... ........... ........... ........... ........... Dividend paid at end of fourth quarter........... ........... ........... ........... ...........

407,450 1,450 408,900 x $1.50 $613,350

e. Stock dividend = (4% x 411,050 shares issued) = 16,442 stock dividend shares P8.29. Cash +305,000

Other Assets

Liabilities

a. b. +18,300 c. -58,300 d. +196,000 e. +38,500 f. No entry is required for a stock split.

Paid-in Capital +305,000

Retained Earnings

Treasury Stock *

Net Income

-18,300 +58,300 +196,000 +1,400

-37,100

Instructor’s Manual / Solutions Manual

P8.29.

(continued) * Note that an increase in treasury stock (for a purchase transaction such as item c) decreases total stockholders’ equity, and a decrease in treasury stock (for a sale transaction such as item e) increases total stockholders’ equity. The effects shown are with respect to the Treasury Stock account, which is a contra stockholders’ equity account.

a. Dr. Cash ($50 par x 6,100 shares) ... ........... ........... ........... ........... 305,000 Cr. Preferred Stock ....... ........... ........... ........... ........... ........... 305,000 b. Dr. Retained Earnings ($50 par x 6% x 6,100 shares) ......... ........... Cr. Dividends Payable ... ........... ........... ........... ........... ...........

18,300

c. Dr. Treasury Stock ($53 per share x 1,100 shares) .. ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

58,300

18,300

58,300

d. Dr. Land (market value)....... ........... ........... ........... ........... ........... 196,000 Cr. Common Stock ($1 par x 3,000 shares) ....... ........... ........... 3,000 Cr. Additional Paid-In Capital (excess over par) ........... ........... 193,000 e. Dr. Cash ($55 per share x 700 shares) ......... ........... ........... ........... Cr. Treasury Stock ($53 per share x 700 shares) ........... ........... Cr. Additional Paid-In Capital ($2 excess x 700 shares) ...........

38,500 37,100 1,400

f. No entry is required for a stock split. P8.30.

a. b. c. d. e. f.

Cash +215,250

Other Assets

Liabilities

Paid-in Capital +215,250

+12,320 +432,000 -96,900 +63,800

Retained Earnings

Treasury Stock *

Net Income

-12,320 +432,000 +1,100 +29,568

+96,900 -62,700 -29,568

* Note that an increase in treasury stock (for a purchase transaction such as item d) decreases total stockholders’ equity, and a decrease in treasury stock (for a sale transaction such as item e) increases total stockholders’ equity. The effects shown are with respect to the Treasury Stock account, which is a contra stockholders’ equity account.

a. Dr. Cash ($52.50 x 4,100 shares)..... ........... ........... ........... ........... 215,250 Cr. Preferred Stock ($50 par x 4,100 shares) ..... ........... ........... 205,000 Cr. Additional Paid-In Capital ($2.50 excess x 4,100 shares) ... 10,250

Instructor’s Manual / Solutions Manual b. Dr. Retained Earnings ($2.20 per share x 5,600 shares)...... ........... Cr. Dividends Payable ... ........... ........... ........... ........... ...........

12,320 12,320

P8.30. (continued) c. Dr. Building ($54 per share x 8,000 shares) ........... ........... ........... 432,000 Cr. Preferred Stock ($50 per share x 8,000 shares) ....... ........... Cr. Additional Paid-In Capital ($4 excess x 8,000 shares) ........ d. Dr. Treasury Stock ($57 per share x 1,700 shares) .. ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

96,900

e. Dr. Cash ($58 per share x 1,100 shares) ...... ........... ........... ........... Cr. Treasury Stock ($57 per share x 1,100 shares) ........ ........... Cr. Additional Paid-In Capital ($1 excess x 1,100 shares) ........

63,800

f. Dr. Retained Earnings ($44 per share x 5,600 issued x 12%) ......... Cr. Common Stock ($1 par x 672 dividend shares) ....... ........... Cr. Additional Paid-In Capital ($43 excess x 672 shares) .........

29,568

400,000 32,000

96,900

62,700 1,100

672 28,896

P8.31. Other Paid-in Cash Assets Liabilities Capital a. + 420,000 + 420,000 b. + 210,000 + 210,000 c. - 14,000 d. - 34,500 e. + 19,625 f. + 15,000 + 1,200 g. + 41,600 h. No entry is required for a stock split.

Retained Earnings

Treasury Stock *

Net Income

- 14,000 + 34,500 - 19,625 - 13,800 - 41,600

* Note that an increase in treasury stock (for a purchase transaction such as item d) decreases total stockholders’ equity, and a decrease in treasury stock (for a sale transaction such as item f) increases total stockholders’ equity. The effects shown are with respect to the Treasury Stock account, which is a contra stockholders’ equity account.

a. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Common Stock ($1 per share x 20,000 shares) ....... ........... Cr. Additional Paid-In Capital ($20 per share x 20,000 shares)

420,000

b. Dr. Land and Building ........ ........... ........... ........... ........... ........... Cr. Preferred Stock ($50 per share x 4,000 shares) ....... ........... Cr. Additional Paid-In Capital ($210,000 - $200,000) . ...........

210,000

c. Dr. Retained Earnings ($50 per share x 7% x 4,000 shares) ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

14,000

20,000 400,000

200,000 10,000

14,000

Instructor’s Manual / Solutions Manual

P8.31. (continued) d. Dr. Treasury Stock ($34,500 / 1,500 shares = $23 per share) ......... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

34,500 34,500

e. Dr. Retained Earnings (60,000 + 20,000 – 1,500 = 78,500 shares) Cr. Dividends Payable ($0.25 x 78,500 shares outstanding) .....

19,625

f. Dr. Cash ($25 per share x 600 shares) ......... ........... ........... ........... Cr. Treasury Stock ($23 per share x 600 shares) ........... ........... Cr. Additional Paid-In Capital ($2 per share x 600 shares) .......

15,000

g. Dr. Retained Earnings (80,000 shares issued x 2% = 1,600 x $26) Cr. Common Stock ($1 per share x 1,600 dividend shares) ...... Cr. Additional Paid-In Capital ($25 per share x 1,600 shares) .

41,600

19,625

13,800 1,200

1,600 40,000

h. No entry is required for stock split. P8.32.

a. b. c. d. e. f. g.

Cash + 700,000

Other Assets + 428,400

+ 768,000 - 270,000 + 189,000

Paid-in Liabilities Capital + 700,000 + 428,400 + 768,000

Retained Earnings

+ 96,000

Net Income

+ 270,000 - 162,000

+ 27,000 + 19,600

Treasury Stock *

- 19,600 - 96,000

a. Dr. Cash ....... ........... ........... ........... ........... ........... ........... ........... Cr. Preferred Stock ($100 per share x 7,000 shares) ..... ...........

700,000

b. Dr. Land ...... ........... ........... ........... ........... ........... ........... ........... Cr. Preferred Stock ($100 per share x 4,200 shares) ..... ........... Cr. Additional Paid-In Capital ($2 per share x 4,200 shares) ...

428,400

c. Dr. Cash ($16 per share x 48,000 shares) .... ........... ........... ........... Cr. Common Stock ($5 per share x 48,000 shares) ....... ........... Cr. Additional Paid-In Capital ($11 per share x 48,000 shares)

768,000

d. Dr. Treasury Stock ($18 per share x 15,000 shares) ........... ........... Cr. Cash . ........... ........... ........... ........... ........... ........... ...........

270,000

700,000

420,000 8,400

240,000 528,000

270,000

Instructor’s Manual / Solutions Manual P8.32. (continued) e. Dr. Cash ($21 per share x 9,000 shares) ...... ........... ........... ........... 189,000 Cr. Treasury Stock ($18 per share x 9,000 shares) ........ ........... 162,000 Cr. Additional Paid-In Capital ($3 per share x 9,000 shares) .... 27,000 f. Dr. Retained Earnings (7,000 + 4,200 = 11,200 x $1.75 per share) Cr. Dividends Payable ... ........... ........... ........... ........... ...........

19,600

g. Dr. Retained Earnings (48,000 shares issued x 8% = 3,840) .......... Cr. Common Stock ($5 per share x 3,840 dividend shares) ...... Cr. Additional Paid-In Capital ($20 per share x 3,840 shares) ..

96,000

P8.33. a. Annual dividend per share (7% x $100) ........ ........... ........... ........... Number of shares outstanding ........... ........... ........... ........... ........... Annual dividend requirement ........... ........... ........... ........... ...........

19,600

19,200 76,800

7.00 2,000 $14,000

b. Balance sheet amount = ($100 par value x 2,000 shares issued) = $200,000 c. Number shares issued = ($175,000 balance sheet amount / $5 par value) = 35,000 Number shares outstanding = (35,000 shares issued - 3,000 treasury shares) = 32,000 d. November 30, 2022.... ........... ........... ........... ........... January 1, 2022 .......... ........... ........... ........... ........... Increase .......... ........... ........... ........... ........... ...........

Common Stock $175,000 (150,000) $ 25,000

Additional Paid-in Capital $420,000 (345,000) $ 75,000

Number of shares sold = ($25,000 increase in common stock / $5 par value) = 5,000 Selling price per share = (($25,000 increase in common stock + $75,000 increase in additional paid-in capital) / 5,000 shares sold) = $20 per share e. Average purchase price of treasury stock =$54,000 / 3,000 shares = $18 per share f. Treasury stock was resold at a price greater than its cost.

Instructor’s Manual / Solutions Manual g. Retained earnings, January 1, 2022 ... ........... ........... ........... ........... Add: Net income ........ ........... ........... ........... ........... ........... ........... Less: Preferred stock dividends (see answer to part a) ......... ........... Less: Common stock dividends ......... ........... ........... ........... ........... Retained earnings, November 30, 2022 ......... ........... ........... ...........

$ 80,000 72,000 (14,000) ? . $122,000

Solving for the unknown amount, common stock dividends = $16,000 Note: Although not required, dividends per share on common stock = $0.50 ($16,000 / 32,000 common shares outstanding). P8.34. a. Common stock = ($5 par value x 600,000 shares issued) = $3,000,000 b. Price per share = Increase in total paid-in capital / Number of shares issued. Increase in common stock ($3,000,000 - $2,700,000)........... ........... ........... $ 300,000 Increase in additional paid-in capital ($26,100,000 - $23,220,000) .. ........... 2,880,000 Total increase in paid-in capital ......... ........... ........... ........... ........... ........... $3,180,000 / Number of shares issued in May .... ........... ........... ........... ........... ........... 60,000 = Price per share of shares sold in May ........ ........... ........... ........... ........... $53 c. Increase in cost of treasury stock ($4,412,000 - $4,148,000) ........... ........... / Increase in number of shares of treasury stock (72,000 – 68,000) . ........... = Cost per share ........ ........... ........... ........... ........... ........... ........... ...........

$264,000 4,000 $66

d. Retained earnings, April 30, 2022 ..... ........... ........... ........... ........... ........... $34,640,000 Add: Net income ....... ........... ........... ........... ........... ........... ........... ........... ? Less: Preferred stock dividend (1/2 year x 9% x $120 par x 140,000 share) …… .. (756,000) Retained earnings, May 31, 2022 ...... ........... ........... ........... ........... ........... $36,200,000 Solving for the unknown amount, net income = $2,316,000 e. 1. Shares outstanding = (600,000 shares issued - 72,000 treasury shares) = 528,000 Total cash dividend = ($0.60 dividend per share x 528,000 outstanding) = $316,800 2. The June 30, 2022, balance sheet will reflect a reduction in retained earnings and an increase in dividends payable (a current liability) for the same amount. Dividends declared have no effect on the income statement.

Instructor’s Manual / Solutions Manual f. Number of dividend shares = (10% dividend rate x 600,000 shares issued) = 60,000 Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Retained Earnings - 4,200,000 Common Stock + 300,000 Additional Paid-In Capital + 3,900,000 Dr. Retained Earnings (60,000 shares @ $70 per share) ..... ........... 4,200,000 Cr. Common Stock (60,000 shares @ $5 per share)...... ........... 300,000 Cr. Additional Paid-In Capital (60,000 shares @ $65 per share) 3,900,000

P8.34. (continued) g. 1. New par value will be 1/2 of prior par value = ($5 / 2) = $2.50. The number of authorized shares will double (1,000,000 x 2 = 2,000,000) to accommodate the new total number of shares issued. 2. The market price will drop to about 1/2 of the pre-split market price = (1/2 x $70) = $35 3. The number of treasury shares will double = (72,000 x 2) = 144,000 shares h. Total stockholders’ equity will not change from either a stock dividend or a stock split.

Instructor’s Manual / Solutions Manual C8.35.

It should be possible for most students to find note disclosures concerning the primary stockholders’ equity items commonly found on corporate balance sheets: 1) common stock and additional paid-in capital, 2) retained earnings, including information concerning dividends, 3) accumulated other comprehensive income (or loss), 4) treasury stock, and 5) noncontrolling interest. Details concerning the changes in these items are commonly reported in the Consolidated Statement of Equity (or equivalent). Additional note disclosures are often provided concerning the company’s share repurchase programs and/or stock-based compensation plans. Students may find it interesting to compare the various descriptions found in annual reports for stockholders’ equity items.

C8.36. a. Par value per share of preferred stock = ($5,760,000 balance sheet amount / 64,000 shares issued) = $90 par value per share Preferred stock dividend percentage = ($4.50 dividend per share / $90 par value per share) = 5% b. Balance sheet amount for common stock = (1,640,000 shares issued x $5 par value per share) = $8,200,000 (shown as $8,200). c. Average issue price of common stock = (($8,200,000 common stock + $22,960,000 additional paid-in capital) / 1,640,000 shares issued) = $19 per share issued d. Treasury shares = (1,640,000 issued shares – 1,500,000 outstanding shares) = 140,000 e. Balance sheet amount for treasury shares = (140,000 shares x $21 per share) = $2,940,000 (shown as $2,940) C8.36.

(continued)

f. Preferred stock ........... ........... ........... ........... ........... ........... ........... ........... $ 5,760,000 Common stock ........... ........... ........... ........... ........... ........... ........... ........... 8,200,000 Additional paid-in capital ...... ........... ........... ........... ........... ........... ........... 22,960,000 Retained earnings ....... ........... ........... ........... ........... ........... ........... ........... ? Treasury stock ........... ........... ........... ........... ........... ........... ........... ........... (2,940,000) Total stockholders’ equity ..... ........... ........... ........... ........... ........... ........... $48,000,000 Solving for the unknown amount, retained earnings = $14,020,000 (shown as $14,020).

Instructor’s Manual / Solutions Manual g. Retained earnings, July 1, 2021 ......... ........... ........... ........... ........... ........... $13,400,000 Add: Net income ....... ........... ........... ........... ........... ........... ........... ........... 908,000 Less: Preferred stock dividends (64,000 shares outstanding x $4.50 per share) ....... (288,000) Retained earnings, June 30, 2022 ...... ........... ........... ........... ........... ........... $14,020,000

C8.37. a. Solution approach: Record the journal entries for transactions 1-6 to determine the effects of the transactions on stockholders’ equity accounts: 1. Dr. Cash (160,000 shares @ $21.25 per share) .. ........... ........... 3,400,000 Cr. Common Stock (160,000 shares @ $5 per share) ......... 800,000 Cr. Additional Paid-In Capital (160,000 @ $16.25 per share) 2,600,000 2. Dr. Cash (40,000 shares @ $21 per share) ......... ........... ........... Cr. Treasury Stock (40,000 @ $21 per share) ......... ...........

840,000 840,000

3. The credit in the closing entry process increases retained earnings by $1,480,000. 4. Dr. Retained Earnings (64,000 shares @ $4.50 per share) ......... Cr. Cash ....... ........... ........... ........... ........... ........... ...........

288,000

5. Dr. Retained Earnings (1,500,000 + 160,000 + 40,000 = 1,700,000)…. Cr. Cash (1,700,000 shares outstanding x $0.30 per share).

510,000

288,000

510,000

Instructor’s Manual / Solutions Manual C8.37.

(continued)

a. 6. No entry is required for a 2 for 1 stock split. The number of shares issued and outstanding are each doubled (i.e., multiplied by two); the par value per share and the annual dividend per share are each halved (i.e., divided by two). The market price per share is likely to settle at approximately half of its pre-split value. Note that the number of shares authorized will normally be increased to accommodate a stock split, but this requires shareholder approval. In this case, the 150,000 shares authorized would be sufficient to accommodate the post-split number of shares issued of 128,000 (64,000 x 2). However, there would not be much cushion for future share issuances. Thus, a stock split in these circumstances would not normally be affected until it is approved at the next annual shareholders’ meeting (along with the approval to increase the number of authorized shares, to 300,000). Dollar amounts reported on the June 30, 2023, balance sheet: (000 omitted) Preferred stock (No changes to the $5,760,000 amount reported last year) .. $ 5,760 Common stock ($8,200,000 + $800,000) ...... ........... ........... ........... ........... 9,000 Additional Paid-In Capital on Common Stock ($22,960,000 + $2,600,000) 25,560 Retained Earnings ($14,020,000 + $1,480,000 - $288,000 - $510,000) ..... 14,702 Treasury Stock ($2,940,000 - $840,000) ...... ........... ........... ........... ........... (2,100) Total Stockholders’ Equity………………………………………………… $52,922 b. Preferred stock, $2.25, $45 par value, cumulative, 300,000 shares authorized, 128,000 shares issued and outstanding. Common stock, $5 par value, 4,000,000 shares authorized, 1,800,000 shares issued, 1,700,000 shares outstanding. Treasury common stock, at cost, 100,000 shares. Note: No other disclosure changes would be made in the June 30, 2023 balance sheet, and no new accounts are needed to record the fiscal 2023 transactions. c. Average issue price of common stock = (($9,000,000 common stock + $25,560,000 additional paid-in capital) / 1,800,000 shares issued) = $19.20 per share issued. It makes sense that the average issue price has increased because the $21.25 issue price of the 160,000 shares sold during fiscal 2023 was higher than DeZurik Corp.’s average issue price of $19 in prior years.

Instructor’s Manual / Solutions Manual

C8.38. a. Assets acquired under financing leases are treated very much like other long-term depreciable assets, and financing lease liabilities are treated very much like long-term notes payable. The only difference is that in a financing lease transaction, the lessee company (i.e., the company having use and enjoyment of the asset during the lease term) does not have actual ownership of the leased asset. Yet, since the lessee does control the majority of economic benefits to be derived from the use of the asset, it is regarded “in substance” as being the owner of the asset. Thus, on the lessee’s books, Right of Use Asset is debited and a long-term interest-bearing liability called “Lease Liability” is credited for the present value of future lease payments (which is used as a substitute for the asset’s purchase price). The leased equipment is then depreciated in the same manner as purchased equipment would be depreciated. Likewise, the initial financing lease liability amount is amortized over the lease term as monthly, quarterly, or annual lease payments are made. Part of each lease payment is recorded as interest expense, based on the carrying value of the financing lease liability at the beginning of each payment period; the remaining part of each payment is treated as a reduction in the lease liability account (i.e., principal amount). In effect, financing leases result in the same accounting treatment as do long-term assets (such as equipment) that are purchased using 100% bank financing (i.e., notes payable). Long-term assets and long-term liabilities are recorded initially for like amounts on the balance sheet. The long-term asset is depreciated over its useful life while the long-term liability is amortized over the loan term, resulting in depreciation expense and interest expense being recorded in the company’s income statements for several years.

Instructor’s Manual / Solutions Manual

C8.38. (continued) b.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Right of Lease Use Asset Liability +6,000,000 +6,000,000 For illustration purposes only (not required): - Accumulated Depreciation

- Depreciation Expense

- Cash

- Interest Expense

- Lease Liability

Dr. Right of Use Asset ........... ........... ........... ........... ........... ........... 6,000,000 Cr. Lease Liability ........... ........... ........... ........... ........... ........... 6,000,000 To record the initial financing lease agreement.

Dr. Depreciation Expense ..... ........... ........... ........... ........... ........... Cr. Accumulated Depreciation .. ........... ........... ........... ...........

XXX XXX

To record annual depreciation on the equipment.

Dr. Interest Expense .. ........... ........... ........... ........... ........... ........... Dr. Lease Liability ..... ........... ........... ........... ........... ........... ........... Cr. Cash ........... ........... ........... ........... ........... ........... ...........

XXX XXX XXX

To record the periodic (monthly, quarterly, or annual) lease payments.

c. Retained earnings represents the company’s cumulative earnings that have been kept for use within the business rather than being distributed to stockholders as dividends. Retained earnings is increased by net income and decreased by dividends (or by net losses) and thus is not the same as cash. Net income (and thus retained earnings) is determined using the accrual basis of accounting which results in an amount that is different than operating cash flows. Most of Gerrard Construction Co.’s retained earnings have been invested in property, plant, and equipment.

Instructor’s Manual / Solutions Manual

C8.38. (continued) d. Bonds payable represents a liability to the firm and is payable at pre-specified times. Interest is a fixed claim to the company’s income and must be paid in accordance with the terms of the bond agreement. Likewise, the maturity value of bonds is a fixed claim to the company’s assets. If any interest or principal payments are missed, the company will face legal action, and could possibly be forced into bankruptcy. Bonds are usually callable and may be convertible. Interest is a deductible expense for income tax purposes. Preferred stock is a stockholders’ equity element in the firm’s balance sheet, but has many characteristics that are more similar to bonds payable than to common stock. Although preferred stock dividends represent a fixed claim to income, there is no requirement that they must be declared or paid. Thus, unlike bonds payable, it is possible to “skip” preferred dividends in any given year, or even over a number of years. Preferred dividends are usually “cumulative” which means that once declared, preferred shareholders will be entitled to their dividends “in arrears” before dividends can be paid to common stockholders. This “cumulative” feature makes preferred more bond-like than common stock-like. Preferred stock has no maturity date but normally has a redemption value that represents a fixed claim to the company’s assets after bondholders have been satisfied for their claims. Preferred is usually callable and may be convertible. Dividends are not an expense and are not deductible for income tax purposes. Common stock represents the residual ownership claim to the company’s assets and must be part of the company’s capital structure before preferred stock can be issued. Common shareholders are the ultimate risk takers in the enterprise, but also stand to receive the greatest rewards. e. As Mr. Gerrard alluded to in his conversation, the company has a substantial amount of long-term notes payable outstanding. With $142,500,000 of long-term debt, plus another $4,500,000 of accounts payable and $4,800,000 of income taxes payable, the company’s debt ratio is 56.2% ($151,800,000 / $270,000,000). The bulk of this debt is interestbearing. Raising another $30 million to $60 million of capital by issuing bonds would further increase the company’s already high debt ratio and would add more financial leverage than Mr. Gerrard may be comfortable with at this time, given his concern about not wanting to become “overextended” with debt. Since most of the company’s assets are invested in property, plant, and equipment, liquidity could become a serious problem if there were an economic downturn in the near future. By issuing preferred stock, Mr. Gerrard could better control the timing of future cash flows in the event that the company cannot afford to pay dividends in any given year. The risk, however, is that if the company fell too far behind with preferred dividend payments, then common stock dividends could not be paid to Mr. Gerrard or to his family members and employees who are common stockholders. On balance, issuing $30 to $60 million of preferred stock in this situation would be less risky than issuing the same amount of bonds payable. 8-28 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 8

NAME______________________

1. The balance sheet caption for common stock is: Common stock, $25 par value, 5,000,000 shares authorized, 3,500,000 shares issued, 3,410,000 shares outstanding……………….

a. Calculate the dollar amount that will be presented opposite of this caption.

b. Calculate the total amount of a cash dividend of $2.90 per share.

c. What accounts for the difference between issued shares and outstanding shares?

2. As of March 11, 2022, Swanson Group, Ltd. had 300,000 shares of $10 par value common stock authorized, and 185,000 shares issued. There were 6,000 shares of treasury stock that had been purchased by the firm at an average cost of $12. The market value of the stock on March 11, 2022 was $22. a. How many shares of common stock are outstanding on March 11, 2022?

b. Assume that on March 11, 2022, the board of directors declared a cash dividend of $0.15 per share, payable on April 4, 2022, to stockholders of record on March 11, 2022. What is the amount of the dividend payable that would appear on the March 31, 2022, balance sheet?

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 8 (continued) c. Assume that instead of a cash dividend, the board of directors declared a 4% stock dividend. Calculate the amount of retained earnings that would be capitalized as a result of the stock dividend.

d. Assume that instead of either the cash dividend or the stock dividend, the board of directors approve a 2-for-1 stock split. How many shares of stock will be outstanding after the stock split?

e. If you were a stockholder of the Swanson Group, Ltd., which would you prefer—a cash dividend, a stock dividend, or a stock split? Explain your answer.

f. Assume that the cash dividend was declared, and that neither the stock dividend nor the stock split had occurred. Assume that 4,000 shares of the treasury stock were sold by the Swanson Group, Ltd. on March 17, 2022, at a price of $24 per share. Record the journal entry required for the sale (or show the effect of the sale in the horizontal model).

g. Assume that Swanson's retained earnings at February 28, 2022, totaled $2,285,000, and at March 31, 2022, retained earnings were $2,320,000. Assume also that the cash dividend of part b above was declared. Calculate Swanson's net income or loss for March.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 8 (continued) 3. Barron, Inc. was incorporated on January 1, 2020, and issued the following stock, for cash: • • • •

3,000,000 shares of no-par common stock were authorized, and 1,200,000 shares were issued on January 1, 2020 at $14 per share. 200,000 shares of $100 par value, 8.3 percent cumulative, non-participating preferred stock were authorized, and 70,000 shares were issued on January 1, 2020, at $107 per share. Net income for the years ended December 31, 2020, 2021, and 2022 was $2,160,000 and $3,230,000, and $3,790,000, respectively. No dividends were declared or paid during 2020 or 2021. However, on December 23, 2022, the board of directors of Barron, Inc. declared dividends of $3,400,000, payable on February 14, 2023, to holders of record as of January 8, 2023.

a. Use the horizontal model (or record the journal entry) to show the effect of the issuances of shares of stock and the payment of dividends.

b. Of the total amount of dividends declared during 2022, how much will be received by preferred shareholders?

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 8 1. a. Balance sheet amount = 3,500,000 shares issued x $25 par value = $87,500,000 b. Cash dividends are paid on outstanding shares. 3,410,000 x $2.90 = $9,889,000 c. Treasury stock accounts for the difference in shares issued and shares outstanding. 2. a. Shares outstanding = (185,000 shares issued - 6,000 treasury shares) = 179,000 b. 179,000 shares x $0.15 = $26,850 c. 185,000 shares issued x 4% dividend rate = 7,400 stock dividend shares issued 7,400 dividend shares x $22 per share = $162,800 of retained earnings capitalized d. 179,000 shares x 2 = 358,000 shares e. Cash! I'd like the money to spend. f.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash +96,000

Treasury Stock +48,000 Additional Paid-In Capital +48,000

(Note: The sale of treasury stock reduces the contra stockholders’ equity account, which increases total stockholders’ equity.)

Dr. Cash (4,000 shares x $ 24 per share) ..... ........... ........... ........... 96,000 Cr. Treasury Stock (4,000 shares x $ 12 per share cost) ........... Cr. Additional Paid-In Capital (4,000 shares x $12 per share excess)

48,000 48,000

g. Retained earnings, beginning balance ........... ........... ........... ........... $2,285,000 Add: Net income........... ........... ........... ........... ........... ........... ? Less: Dividends ........... ........... ........... ........... ........... ........... (26,850) Retained Earnings, ending balance....... ........... ........... ........... $2,320,000 Solving for the unknown amount, net income = $61,850

Instructor’s Manual / Solutions Manual 3. a.

Balance Sheet Income Statement . Assets = Liabilities + Stockholders’ Equity  Net income = Revenues - Expenses

Cash +24,290,000

Dividends Payable +3,400,000

Common Stock +16,800,000 Preferred Stock +7,000,000 Additional Paid-In Capital—Preferred +490,000 Retained Earnings -3,400,000

3. a. (continued) Journal entries: Dr. Cash ((1,200,000 @ $14) + (70,000 @ $107)) ........... 24,290,000 Cr. Common Stock (1,200,000 shares @ $14 per share) Cr. Preferred Stock (70,000 shares @ $100 per share) Cr. APIC—Preferred (70,000 shares @ $7 per share)

16,800,000 7,000,000 490,000

Dr. Retained Earnings ......... ........... ........... ........... ........... Cr. Dividends Payable………………………………...

3,400,000

b. Preferred shareholders are entitled to two years of dividends in arrears (for 2020 and 2021), as well as their current year preference (for 2022): 70,000 shares x $100 par per share x 8.3% dividends rate = $581,000 per year x 3 years = $1,743,000

Instructor’s Manual / Solutions Manual

CHAPTER

The Income Statement and the Statement of Cash Flows

CHAPTER OUTLINE: I. Income Statement A. Revenues 1. Revenue recognition a. Realized or realizable b. Earned 2. Revenue from sales a. Sales returns and allowances b. Net sales 3. Revenue from services 4. Unusual revenue recognition methods a. Percentage of completion B. Expenses 1. Expense recognition a. Matching principle, objectivity, and conservatism applied 2. Cost of goods sold a. Under perpetual inventory system b. Under periodic inventory system c. Purchases returns and allowances C. Gross Profit or Gross Margin 1. Expressed as dollar amount and percentage of net sales 2. Effect of sales mix 3. Use of gross profit ratio to estimate ending inventory and cost of goods sold 4. Use of target gross profit ratio to set selling price D. Operating Expenses E. Income from Operations F. Other Income and Expense 1. Interest income and interest expense 2. Other gains and losses G. Income Before Income Taxes and Income Tax Expense H. Net Income and Earnings Per Share 1. Weighted-average shares outstanding 2. Net income available for common stock 3. Basic versus diluted earnings per share

Instructor’s Manual / Solutions Manual I. Summary of Income Statement Presentation Alternatives 1. Single-step format 2. Multiple-step format J. Unusual or Infrequently Occurring Items Sometimes Seen on the Income Statement 1. Discontinued operations a. Reported net of income tax effect b. Reported as a separate element of EPS disclosures 2. Extraordinary items (no longer reported under U.S. GAAP) 3. Net income attributable to noncontrolling (minority) interests II. Statement of Cash Flows A. Content and Format of the Statement 1. Cash providing/using activities a. Operations b. Investing c. Financing 2. Net income—the beginning point for cash generated from operations, but adjustments are required for non-cash elements of net income a. Depreciation and amortization expense b. Income tax expense not currently payable c. Gains or losses on sales of noncurrent assets 3. Changes in other current assets and current liabilities affect cash generated from operating activities 4. Summary of investing activities 5. Summary of financing activities 6. Statement illustrated a. Direct method b. Indirect method B. Interpreting the Statement of Cash Flows 1. Look at category totals before looking at details 2. Operating activities—should generate cash 3. Investing activities—usually use less cash than is generated by operating activities 4. Financing activities a. Debt transactions—borrowings and repayments b. Capital stock transactions—sale of stock and purchase of treasury stock c. Dividends payments

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Primary: 1. To have the student integrate the material learned during the study of the balance sheet with the impact of those issues on net income and cash flows. 2. To have the student understand the significance of the components and subtotals of the income statement and statement of cash flows. 3. To prepare the student to interpret a relatively straightforward statement of cash flows. Supporting: 4. To have the student understand that revenue recognition requires both realization and earning. 5. To have the student understand that there are some alternatives to recognizing revenue at the point of sale of a product or service, and that these alternatives must be evaluated carefully. 6. To review the concepts related to expense recognition: matching, objectivity, and conservatism. 7. To have the student understand the significance of gross profit / gross margin, and how to use an estimated gross profit / gross margin ratio to estimate net income. 8. To have the student understand why operating income is frequently used in the ROI calculation. 9. To have the student understand the basic earnings per share calculation, and the reasons for adjustments sometimes required in this calculation. 10. To have the student understand some of the unusual or infrequently occurring items reported in the income statement, and why they are reported separately. 11. To have the student understand the purpose of the statement of cash flows. 12. To have the student understand how the statement of cash flows relates to the income statement and balance sheet.

Instructor’s Manual / Solutions Manual TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. Students should be told again to study the financial statements of the annual reports that they have, and to relate the chapter material to those statements. 2. It should be emphasized that during discussion of the balance sheet components, the income statement impact of transactions was described. This chapter focuses on the presentation format of the income statement—there aren't really any significant new transactions to be studied. Thus, the student's main task is to integrate material covered in previous chapters with the income statement and statement of cash flows presentation of that material. 3. The net sales, gross profit / gross margin, and operating income amounts on the income statement are the most significant and frequently used items for identifying key relationships and trends. These elements of the income statement should be emphasized, and their use illustrated. 4. The significance of the price/earnings ratio as a common stock valuation model is explained in Chapter 11. The importance of understanding earnings per share should be stressed now, but the temptation to develop the P/E ratio should be resisted. 5. The difference between the accrual basis income statement and statement of cash flows should be emphasized and illustrated in the process of creating an understanding of the purpose and importance of each statement. Exercises 9-17 and 9-18 are excellent for in-class demonstrations. 6. Use examples of statements of cash flows to help students understand the interpretation process.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: NO. M9.1. M9.2. M9.3. M9.3. M9.5. M9.6. E9.7. E9.8. E9.9.

LEARNING OBJECTIVES 1 3 5 6 9 10 1 1 2

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 3-5 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Med., 5-8 min.

E9.10. E9.11.

2 2, 3

Med., 5-8 min. Easy, 5-8 min.

E9.12. E9.13.

2, 3 5

Easy, 5-8 min. Easy, 5-8 min.

E9.14. E9.15. E9.16.

5 6 6

Easy, 5-8 min. Easy, 5-8 min. Med., 7-10 min.

E9.17.

E9.18.

E9.19. E9.20.

6, 7 11

Med.-Hard, 10-15 min. Med.-Hard 10-15 min. Easy, 3-5 min. Med., 7-10 min.

P9.21. P9.22. P9.23.

5 5 3

P9.24. P9.25.

3 10

Med., 7-10 min. Med., 7-10 min. Med.-Hard, 10-12 min. Med., 7-10 min. Med., 5-8 min.

P9.26.

Med., 10-12 min.

P9.27.

Med., 10-12 min.

P9.28. P9.29. P9.30. P9.31.

10 10, 11 10, 11 10, 11

P9.32.

10, 11

C9.33. C9.34. C9.35.

3, 5, 7, 8 9, 10, 11 11

Med., 7-10 min. Hard, 12-15 min. Hard, 12-15 min. Med.-Hard, 20-25 min. Med.-Hard, 22-35 min. Med., 10-12 min. Med., 10-12 min. Hard, 25-35 min.

OTHER COMMENTS In-class demonstration of revenue recognition. In-class demonstration of gross profit calculations. In-class demonstration of income statement relationships. In-class demonstration of basic EPS. Review of basic statement of cash flows—"big picture” structure. In-class demonstration of cash flows from operations—indirect. Straight-forward revenue recognition exercise. Good in-class demonstration exercise. Review the cost of goods sold model, and refer students to the “inventory errors” discussion Chapter 5. See E9.9. Use to clarify relationships: sales, cost of goods sold, gross profit. Good homework assignment. Good discussion starter. Refer students to Exhibit 9.7. Part II. Emphasize the relevance of operating income as a sub-total on the multiple-step income statement. See E9.13. Good in-class demonstration exercise. Straight-forward application of the basic EPS equation. Group learning exercise. An easy way to get students to think about the EPS effects of potentially dilutive securities. Group learning exercise. Walk through the solution using T-accounts to solve for the missing amounts. Group learning exercise. Students find this exercise to be quite challenging. Good homework assignment. Straight-forward Campbell’s income statement exercise. Use this exercise as a discussion starter. Ask students, “What kinds of information does the SCF communicate that cannot be easily determined by looking at the BS and IS alone?” Straight-forward income statement “structure” problem. See P9.21. Analytical problem. Emphasize the IS/BS sheet linkage between sales, cost of goods sold, gross profit, and ending inventory. See P9.23. Good homework assignment. Straight-forward in-class demonstration of cash flows from operations using the indirect method. See P9.25. Good in-class demonstration of the Statement of Cash Flows—indirect method. Provided for instructors wishing to emphasize the direct method presentation of the Statement of Cash Flows. See P9.27. Excellent problem for self-study / review. See P9.29. Good homework assignment. Group learning problem. Be careful not to consume too much class time working through mechanical details. See P9.31. Group learning problem. Focus company case assignment. Generates class discussion. See C9.33. Group learning case. Great for MBA classes!

Instructor’s Manual / Solutions Manual

SOLUTIONS: M9.1. Annual pool cleaning service fee = $780 / 12 months = $65 per month x 5 months = $325

M9.2. a. Net sales ....... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ...........

$600,000 426,000 $174,000

100.0% 71.0%. 29.0%

$90.00 ? $ ?

100.0% 71.0%. 29.0%

Gross profit ratio = $174,000 / $600,000 = 29.0% Cost of goods sold ratio = $426,000 / $600,000 = 71.0% b. Selling price .. ........... ........... ........... ........... ........... ........... Cost to manufacture .. ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ...........

Manufacturing cost = $90.00 selling price * 71% cost of goods sold ratio = $63.90 per unit This is the maximum manufacturing cost per unit that can be incurred without reducing the company’s overall gross profit ratio, assuming that the maximum selling price of the new product is $90.00 per unit. If it cost more than $63.90 per unit to manufacture the new product, the company’s overall gross profit ratio would be reduced because of the introduction of a low-gross-margin (less than 29%) product into the sales mix. Conversely, if manufacturing costs were less than $63.90 per unit and the product could be sold for $90.00, then the company’s overall gross profit ratio would increase due to the introduction of a new high-gross-margin (more than 29%) product into the sales mix. M9.3. a. Net sales ........ ........... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses .......... ........... ........... ........... Research and development expenses ........... ........... ........... ........... ........... Operating income (or Income from operations) ....... ........... ........... ...........

$520,000 (312,000) $208,000 (78,000) (61,400) $ 68,600

Instructor’s Manual / Solutions Manual b. Operating income (or Income from operations) ....... ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... ........... Income before taxes .. ........... ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ........... ...........

$ 68,600 (11,600) $ 57,000 (17,100) $ 39,900

“Net cash provided by operating activities” does not figure in the solution, as this amount would be reported on the statement of cash flows rather than the income statement. M9.4. Net income .... ........... ........... ........... ........... ........... ........... ........... ........... Less: Dividends on preferred stock (5,000 shares * $6.50 per share) ......... Net income available for common stockholders ....... ........... ........... ........... / Number of common share outstanding ...... ........... ........... ........... ........... = Earnings per share—basic ........... ........... ........... ........... ........... ...........

$388,500 (32,500) $356,000 80,000 $4.45

M9.5. Net cash provided by operating activities ..... ........... ........... ........... Net cash used for investing activities ........... ........... ........... ........... Net cash used for financing activities ........... ........... ........... ........... Net decrease in cash for the year ...... ........... ........... ........... ........... Cash balance, January 1, 2022 .......... ........... ........... ........... ........... Cash balance, December 31, 2022 .... ........... ........... ........... ...........

$117,300 (107,100) (1) (48,200) $(38,000) 104,500 (2) $ 66,500

(1). $117,300 + $38,000 -$48,200 = $(107,100) (2). $38,000 + 66,500 = $104,500

M9.6. Cash flows from operating activities: Net income .... ........... ........... ........... ........... ........... ........... ........... ........... $ 84,200 Add (deduct) items not affecting cash: Depreciation and amortization expense ........ ........... ........... ........... ........... 31,000 Accounts receivable increase ........... ........... ........... ........... ........... ........... (17,600) Inventory decrease .... ........... ........... ........... ........... ........... ........... ........... 12,100 Accounts payable decrease ... ........... ........... ........... ........... ........... ........... (7,400) Net cash provided by operating activities ..... ........... ........... ........... ........... $102,300 “Proceeds from the issuance of common stock” and “purchase of land” do not figure in the solution, as these amounts would be reported within the statement of cash flows as financing and investing activities, respectively.

E9.7. 6/1/22

30 days

6/30/22

20 days

7/20/22

Instructor’s Manual / Solutions Manual a. For the year end June 30, 2022, recognize 30/50 of summer school tuition, because that portion of the summer session occurs within the first fiscal year. Summer session expenses will be accrued or deferred (i.e., recognized as incurred), so an appropriate matching of revenue and expense will occur in each fiscal year. Amount of revenue for the year ended June 30, 2022 = (30/50 * $152,000) = $91,200

E9.7.

(continued) b. No. Revenues and expenses would still be allocated to each fiscal year to achieve the most appropriate matching (based on when revenues are earned and when expenses are incurred). Since revenues are earned as services are provided, the critical event is the offering of classes rather than the university’s tuition refund policy. Thus, the amounts calculated in part a would still result in the most meaningful financial statements for each fiscal year.

E9.8. a. Season ticket price .... ........... ........... ........... ........... ........... ........... ........... Price of first program event .. ........... ........... ........... ........... ........... ........... Balance for 5 remaining events ......... ........... ........... ........... ........... ........... Price per remaining event ($180 / 5 events) . ........... ........... ........... ...........

$240 (60) $180 $ 36

After 3 events, $132 ($60 + $36 + $36) of revenue has been earned from each ticket. Thus, total season ticket revenue earned = ($132 * 1,800 tickets) = $237,600 b. The fact that all tickets aren't used is irrelevant to the revenue recognition process because the critical event is the delivery of the service (i.e., presentation of the program). E9.9. Solution approach: Use the cost of goods sold model with assumed amounts that are the same except for the item in error: "Error" "Correct" Beginning inventory.. ........... ........... ........... ........... ........... $100,000 $100,000 Add: Purchases .......... ........... ........... ........... ........... ........... 300,000 300,000 Goods available for sale ........ ........... ........... ........... ........... $400,000 $400,000 Less: Ending inventory ......... ........... ........... ........... ........... (150,000)  (80,000) Cost of goods sold ..... ........... ........... ........... ........... ........... $250,000  $320,000

Instructor’s Manual / Solutions Manual The overstatement of ending inventory (too high relative to the correct amount) causes cost of goods sold to be understated by $70,000 (too low relative to the correct amount). As a result, gross profit and operating income are too high, or overstated, by $70,000, as shown below with an assumed amounts:

Net sales ........ ........... ........... ........... ........... ........... ........... Less: Cost of goods sold (from above calculations) . ........... Gross profit ... ........... ........... ........... ........... ........... ........... Less: Operating expenses ...... ........... ........... ........... ........... Operating income ...... ........... ........... ........... ........... ...........

"Error" "Correct" $900,000 $900,000 250,000  320,000 $650,000  $580,000 (200,000) (200,000) $450,000  $380,000

E9.10. a. Solution approach: Use the cost of goods sold model with assumed amounts that are the same except for the item in error: "Error" "Correct" Beginning inventory.. ........... ........... ........... ........... ........... $100,000 $100,000 Add: Purchases .......... ........... ........... ........... ........... ........... 300,000 300,000 Goods available for sale ........ ........... ........... ........... ........... $400,000 $400,000 Less: Ending inventory ......... ........... ........... ........... ........... (150,000)  (180,000) Cost of goods sold ..... ........... ........... ........... ........... ........... $250,000  $220,000 The understatement of ending inventory (in Year 1) causes cost of goods sold to be too high (or overstated by $30,000 in Year 1. As a result, gross profit and operating income are too low, or understated, by $30,000 in Year 1, as shown below with an assumed amounts:

"Error" "Correct" $900,000 $900,000 250,000  220,000 $650,000  $680,000 (200,000) (200,000) $450,000  $480,000

b. The prior period's ending inventory (in Year 1) is the subsequent period's beginning inventory (in Year 2). If beginning inventory is understated in Year 2, goods available for sale will also be understated in Year 2, which causes cost of goods sold to be too low, or understated in Year 2. Thus, operating income will be too high (or overstated) in Year 2 by the amount of the understatement of ending inventory in Year 1. 9-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual c. For the two periods combined, there is no effect on operating income (or net income), in total because the errors in Year 1 and Year 2 offset each other. In other words, for the two periods combined, there was no error in either the beginning inventory (that is, at the beginning of Year 1) or in the ending inventory (that is, at the end of Year 2). E9.11. a. Net sales ........ ........... .......... ........... ........... ........... Cost of products sold ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... Gross profit ratio ....... ........... ........... ........... ...........

2020 $8,691 (5,692) $2,999 34.5%

(in millions) 2019 2018 $8,107 $6,615 (5,414) (4,241) $2,693 $2,374 33.2% 35.9%

Instructor’s Manual / Solutions Manual E9.11.

(continued)

b. Using the gross profit ratio for 2020 of 34.5%: Net sales ($ millions) ........... ........... ........... ........... ........... ........... Cost of goods sold (65.5%) ... ........... ........... ........... ........... ........... Gross profit (34.5%) . ........... ........... ........... ........... ........... ...........

$3,200 (2,096) $1,104 million

Alternative calculation: Some students may calculate a weighted-average gross profit ratio for the three-year period from 2018-2020 (from left to right below), as follows: Total gross profit ($2,374 + $2,693 + $2,999) .......... ........... ........... / Total net sales ($6,615 + $8,107 + $8,691) ........... ........... ........... Weighted-average gross profit ratio .. ........... ........... ........... ...........

$ 8,066 $23,413 34.5%

Net sales ($ millions) ........... ........... ........... ........... ........... ........... Cost of goods sold (65.5%) ... ........... ........... ........... ........... ........... Gross profit (34.5%) . ........... ........... ........... ........... ........... ...........

$ 3.200 (2,096) $ 1,014

Note that there was no difference between the single-year (2020) and three-year weighted-average estimation of gross profit; Campbell’s gross profit ratio was quite consistent over the three-year period. Had these calculations been carried out to one additional decimal place, the 2020 gross profit ratio of 34.51% would have yielded a slightly higher projected gross profit for January-April 2021 of $1,014,320 as compared to $1,102,400 using the 34.45% three-year weighted average gross profit ratio. E9.12. a. Sales (in millions) .... ........... ........... ........... ........... ........... ........... $900.0 Cost of goods sold ..... ........... ........... ........... ........... ........... ........... ? Gross profit ... ........... ........... ........... ........... ........... ........... ........... $ ?

100.0% ? . 37.5%

Gross profit = ($900.0 million sales * 37.5% gross profit ratio) = $337.5 million Cost of goods sold = ($900.0 million sales - $337.5 million gross profit) = $562.5 million Alternative computation for cost of goods sold: $900.0 million sales * (100% - 37.5%) or 62.5% cost of goods sold ratio = $562.5 million b. Selling price .. ........... ........... ........... ........... ........... ........... ........... $ ? Cost to manufacture .. ........... ........... ........... ........... ........... ........... 1,625 Gross profit ... ........... ........... ........... ........... ........... ........... ........... $ ?

100.0% ? . 37.5%

Selling price = $1,625 cost / (100% - 37.5%) or 62.5% cost of goods sold ratio = $2,600.00

Instructor’s Manual / Solutions Manual c. Management could use the $2,600.00 estimated selling price as a “target” in conducting marketing research studies to estimate the sales volume for the new product (within this general price range), thus, helping to assess its ultimate prospects for success at this price. E9.13. Most analysts would prefer to have access to operating income data, because this describes how well the company has performed in its ongoing, central, core business operations. While net income is also important, it often includes non-recurring items such as discontinued operations and other unusual or infrequently occurring items. Thus, trends in operating income data are often more likely to reflect the firm’s ability to generate future earnings than are trends in net income data. E9.14. Operating income (earnings before interest and taxes) .. ........... ........... Net income (net earnings attributable to Campbell Soup Company) .........

2020

2019

2018

2017

2016

$1,107

$ 979

$1,010

$1,431

$ 865

1,628

211

261

887

563

For Campbell’s, the trends in operating income and net income from 2016-2020 are somewhat difficult to interpret. Operating income peaked in 2017 and then declined significantly in 2018 but has remained stable since that time, with 2020 being somewhat of a bounce back year. The net income trend exhibited much more variability; it increased sharply in 2017 but then was dramatically impacted by large losses from discontinued operations in 2018 ($463 million) and 2019 ($263 million) and an even larger gain from discontinued operations in 2020 ($1,036 million) which accounted for 63.6% of the company’s earnings in 2020. Although both measures are meaningful, the operating income series is often analyzed more critically because it reflects the results of a company’s ongoing activities. Net income includes many ongoing items such as interest expense, income tax expense, and gains and losses on the sale of investments, which can vary considerably from year to year. Net income also includes non-recurring items such as discontinued operations, which often cause distortions in the trend; as noted above, this was clearly the case with respect to Campbell’s during the 5-year period from 2016-2020. Thus, trends in operating income data are more likely to better reflect and help assess a company’s ability to generate future earnings than are trends in net income data. E9.15.

Instructor’s Manual / Solutions Manual January 1, 2022 through March 31, 2022 (15,000 shares * 3 months) ....... April 1, 2022 through September 30, 2022 (25,000 shares * 6 months) ..... October 1, 2022 through December 31, 2022 (22,000 shares * 3 months). . Total shares outstanding (by month * 12)..... ........... ........... ........... ........... Weighted-average number of shares outstanding (261,000 / 12 months) ... Net income .... ........... ........... ........... ........... ........... ........... ........... ........... Less: Dividends required on preferred stock (6,000 shares * 5% * $100) .. Net income available for common stockholders ....... ........... ........... ........... / Weighted-average number of common share outstanding ........... ........... = Earnings per share—basic ........... ........... ........... ........... ........... ...........

45,000 150,000 66,000 261,000 21,750 $151,800 (30,000) $121,800 21,750 $5.60

E9.16. a. February 1, 2022 through October 31, 2022 (100,000 shares * 9 months).... November 1, 2022 through January 31, 2023 (130,000 shares * 3 months).. Total shares outstanding (by month * 12)..... ........... ........... ........... ........... Weighted-average number of shares outstanding (1,290,000 / 12 months) . Net income .... ........... ........... ........... ........... ........... ........... ........... ........... Less: Preferred dividends (40,000 shares * $50 par * 6%)... ........... ........... Net income available for common stock....... ........... ........... ........... ........... Earnings per share—basic ($453,650 / 107,500 shares) ...... ........... ...........

900,000 390,000 1,290,000 107,500 $ 573,650 (120,000) $ 453,650 $4.22

b. Diluted earnings per share, reflecting an assumed conversion of the preferred stock into common stock, would also have to be calculated. E9.17. a. ($420,000 sales on account + $17,000 decrease in accounts receivable) = $437,000 source of cash. Since accounts receivable decreased during the year, more accounts were collected in cash than were created by credit sales.

Sales on account

Accounts Receivable 420,000 Cash collections from customers

437,000

b. ($94,000 income tax expense + $23,000 decrease in income taxes payable) = $117,000 use of cash. Tax payments exceeded the current year’s income tax expense because the payable account decreased. Income Taxes Payable Cash payments for taxes 117,000 Income tax expense

94,000

c. ($291,000 cost of goods sold + $25,000 increase in inventory - $38,000 increase in accounts payable) = $278,000 use of cash. Cost of goods sold reflects inventory uses. Inventory purchases were greater than inventory uses because inventory increased during the year, but part of the inventory purchases were not paid for in cash because accounts payable also increased during the year. 9-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

Inventory purchases

Inventory 316,000 Cost of goods sold

291,000

($291,000 + $25,000)

Cash paid to suppliers

Accounts Payable 278,000 Inventory purchases

316,000

($316,000 - $38,000)

E9.17.

(continued)

d. ($180,000 increase in net book value + $64,000 depreciation expense) = $244,000 use of cash. Since depreciation is an expense that does not affect cash, the amount of cash paid to purchase new buildings exceeded the increase in net book value. (Note: In some years, a firm may spend an enormous amount of cash to acquire new buildings and equipment, yet still report a decrease in net book value.) Buildings, net of Accumulated Depreciation Purchase of buildings 244,000 Depreciation expense

64,000

E9.18. a. ($147,000 cash collected from customers + $31,000 increase in accounts receivable) = $178,000 revenues earned. Since accounts receivable increased during the year, more sales were made on account than were collected in cash during the year. Sales on account

Accounts Receivable 178,000 Cash collections from customers

147,000

b ($85,000 cash payments for income taxes + $13,000 increase in income taxes payable) = $98,000 expense incurred. Income tax expense exceeded cash payments for taxes in the current year because the payable account increased. Cash payments for taxes

Income Taxes Payable 85,000 Income tax expense

98,000

c. ($168,000 cash paid to suppliers + $14,000 decrease in inventory - $26,700 decrease in accounts payable) = $155,300 expense incurred. Inventory purchases were less than cash payments to suppliers because accounts payable decreased. Cost of goods sold reflects inventory uses. Inventory uses were greater than inventory purchases because inventory decreased during the year. Accounts Payable 9-14 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual Cash payments to suppliers (for inventory purchases)

Inventory purchases

168,000

Inventory purchases

141,300

($168,000 - $26,700) Inventory 141,300 Cost of goods sold

155,300

($141,300 + 14,000)

E8.18.

(continued)

d. ($430,000 cost of new building purchased - $275,000 increase in net book value) = $155,000 depreciation expense incurred. The cost of new buildings purchased exceeded the increase in net book value, and no buildings were sold, so the difference was the depreciation expense recorded during the year (for old buildings). Buildings, net of Accumulated Depreciation Purchase of buildings 430,000 Depreciation expense

155,000

E9.19. a. Campbell’s uses the multiple-step format. The multiple-step format is generally easier to read and interpret because it provides intermediate captions and subtotals that are useful to investors. The key line item in a multiple-step income statement is operating income, which Campbell’s shows as “earnings before interest and taxes.” Campbell’s does not show gross profit as a separate item, although many firms using the multiple step format will do so. b. The EPS disclosures (basic and diluted) are important measures to investors because they express accrual accounting income on a per share basis. For Campbell Soup Company, these disclosures are straight-forward. As discussed in the text, however, additional disclosure about the significant elements of EPS is appropriate for any years during which a company reports any discontinued operations. Knowledge about the impact of non-recurring items provides investors with a better basis for anticipating what may happen to EPS in the future. E9.20. a. Amounts in millions: Net earnings . ........... ........... ........... ........... ........... ........... ........... Net (gain) loss on sales of businesses ........... ........... ........... ........... Depreciation and amortization expense ........ ........... ........... ........... Net cash provided by the three most significant operating sources…

$1,628 (975) 328 $ 981

Instructor’s Manual / Solutions Manual

Note to Instructors: Adding back depreciation and amortization to net earnings is a reconciling adjustment to arrive at net cash provided by operations; these expenses were reported on the income statement but did not use cash. Similarly, the net gain on sales of businesses is subtracted from net earnings; although such gains did generate cash, they were nonoperating in nature. Proceeds from the sale of businesses are reported in the investing section of the statement of cash flows. b. Sales of businesses, net of cash divested ...... ........... ........... ........... Purchase of plant assets ........ ........... ........... ........... ........... ........... Net cash provided by the two most significant investing activities ..

E9.20.

$2,537 (299) $2,238

(continued)

c. Short-term borrowings .......... ........... ........... ........... ........... ........... Short-term repayments .......... ........... ........... ........... ........... ........... Payments related to extinguishment of debt . ........... ........... ........... Net cash used by the three most significant financing activities .....

$5,617 (6,909) (1,769) $(3,061)

P9.21. a. Net sales ........ ........... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ........... ........... ........... Advertising expense .. ........... ........... ........... ........... ........... ........... ........... Other selling expenses .......... ........... ........... ........... ........... ........... ........... General and administrative expenses ........... ........... ........... ........... ........... Operating income ...... ........... ........... ........... ........... ........... ........... ...........

$725,000 (464,000) $261,000 (46,000) (14,000) (105,000) $ 96,000

b. Note: Since Manahan Co. did not report any interest expense, or other income or expense, the operating income amount calculated in part a also represents the firm’s “Income from continuing operations before taxes.” Income from continuing operations before taxes (operating income) .......... Income tax expense ... ........... ........... ........... ........... ........... ........... ........... Income from continuing operations .. ........... ........... ........... ........... ........... Loss from discontinued operations, net of tax savings of $31,000 ... ........... Net loss.......... ........... ........... ........... ........... ........... ........... ........... ...........

$ 96,000 (24,000) $ 72,000 (93,000) $ (21,000)

P9.22.

Instructor’s Manual / Solutions Manual a. Net sales ........ ........... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses .......... ........... ........... ........... Research and development expenses ........... ........... ........... ........... ........... Operating income (or Income from operations) ....... ........... ........... ...........

$948,000 (521,000) $427,000 (106,000) (77,000) $244,000

b. Operating income (or Income from operations) ....... ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... ........... Income from continuing operations before taxes ...... ........... ........... ........... Provision for income taxes.... ........... ........... ........... ........... ........... ........... Income from continuing operations .. ........... ........... ........... ........... ........... Loss from discontinued operations, net of tax savings of $8,000 .... ........... Net income .... ........... ........... ........... ........... ........... ........... ........... ...........

$244,000 (97,000) $147,000 (35,000) $112,000 (24,000) $ 88,000

P9.23. Solution approach: Calculate ending inventory in the cost of goods sold model for the high (41%) and low (38%) gross profit ratios, and select the ratio that yields the highest ending inventory. Gross Profit Ratio

Calculation 41% Sales .. ........... ........... ........... $ 95,200 Cost of goods sold: Beginning inventory.. ........... $ 36,400 Add: Purchases .......... ........... 64,100 Goods available for sale ........ $100,500 Less: Ending inventory ......... (44,332) Cost of goods sold ..... ........... $(56,168) Gross profit ... ........... ........... $ 39,032

38% $ 95,200 $ 36,400 64,100 $100,500 (41,476)

Sequence Given

Given Given Add givens 3rd $(59,024) 2nd $ 36,176 1st *

* Gross profit percentage multiplied by sales. Franklin Co.’s management would argue for using a 41% gross profit ratio for 2022 to the date of the tornado, because the higher the gross profit ratio, the higher the estimated ending inventory lost in the storm, and the greater the insurance claim.

P9.24.

Instructor’s Manual / Solutions Manual Solution approach: Using the cost of goods sold model for a periodic inventory system, enter the known amounts and solve for ending inventory. The cost of goods sold amount can be determined by multiplying sales by the complement of the gross profit ratio (1 - 45%). Sales .. ........... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold: Beginning inventory.. ........... ........... ........... ........... ........... ........... Add: Purchases .......... ........... ........... ........... ........... ........... ........... Goods available for sale ........ ........... ........... ........... ........... ........... Less: Ending inventory ......... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ........... ...........

$638,400 $314,200 355,140 $669,340 ( ? ) $( ? ) $ ? .

Gross profit = (45% gross profit ratio * $638,400 sales) = $287,280 Cost of goods sold = ($638,400 sales - $287,280 gross profit) = $351,120 Alternative calculation: = (55% cost of goods sold ratio * $638,400 sales) = $351,120 Ending inventory = ($669,340 goods available - $351,120 cost of goods sold) = $318,220

P9.25. a. Cash flows from operating activities: ($000 omitted) Net income .... ........... ........... ........... ........... ........... ........... ........... $ 840 Add (deduct) items not affecting cash: Depreciation and amortization expense ........ ........... ........... ........... 640 Accounts receivable decrease ........... ........... ........... ........... ........... 90 Inventory increase ..... ........... ........... ........... ........... ........... ........... (40) Accounts payable decrease ... ........... ........... ........... ........... ........... (20) Income tax payable increase . ........... ........... ........... ........... ........... 70 Net cash provided by operating activities ..... ........... ........... ........... $1,580

Instructor’s Manual / Solutions Manual b. Net income is based on accrual accounting, and revenues may be earned before or after cash is received. Likewise, expenses may be incurred before or after cash payments are made. Thus, net income and cash flows provided by operations may differ because of the timing of cash receipts and payments versus the timing of recognition on the income statement. In addition to the timing issue, other adjustments to net income may be necessary to add back non-cash expenses (such as depreciation and amortization), or to remove the effects of non-operating transactions (such as the gains and losses from the sale of long-term assets). To adjust net income for timing differences, changes during the year in non-cash working capital items (i.e., current assets other than cash, and current liabilities) must be considered. If a current asset account increases or if a current liability account decreases during the year, the cash account balance is assumed to have decreased. If a current asset account decreases or if a current liability account increases, the cash account balance is assumed to have increased. (Note: You should review the Business in Practice— Understanding Cash Flow Relationships—Indirect Method if you are having difficulty understanding these adjustments.)

P9.26. Solution approach: Have the students review the statement of cash flows-indirect method (see Exhibit 9-9). Emphasize that investing activities relate primarily to changes in non-operating asset accounts, and that financing activities relate primarily to changes non-operating liability and stockholders’ equity accounts.

Instructor’s Manual / Solutions Manual POUCHIE CO. Statement of Cash Flows For the Year Ended December 31, 2022 Cash flows from operating activities: (in millions) Net income .... ........... ........... ........... ........... ........... ........... ........... ........... $ 192 Add (deduct) items not affecting cash: Depreciation and amortization expense ........ ........... ........... ........... ........... 130 Accounts receivable increase ........... ........... ........... ........... ........... ........... (8) Inventory decrease .... ........... ........... ........... ........... ........... ........... ........... 19 Accounts payable increase .... ........... ........... ........... ........... ........... ........... 22 Net cash provided by operating activities ..... ........... ........... ........... ........... $ 355 Cash flows from investing activities: Purchase of equipment .......... ........... ........... ........... ........... ........... ........... Sale of building (at book value) ........ ........... ........... ........... ........... ........... Net cash used for investing activities ........... ........... ........... ........... ...........

$(410) 106 $(304)

Cash flows from financing activities: Common stock issued ........... ........... ........... ........... ........... ........... ........... Cash dividends declared and paid ..... ........... ........... ........... ........... ........... Net cash used for financing activities ........... ........... ........... ........... ...........

$ 74 (165) $ (91)

Net decrease in cash for the year ...... ........... ........... ........... ........... ........... Cash balance, January 1, 2022 .......... ........... ........... ........... ........... ........... Cash balance, December 31, 2022 .... ........... ........... ........... ........... ...........

$ (40) 60 $ 20

P9.27. a. Solution approach: Prepare a statement of cash flows-direct method (see Exhibit 9-9). Cash flows from operating activities: (in millions) Cash collected from customers ......... ........... ........... ........... ........... ........... $ 3,410 Interest and taxes paid ........... ........... ........... ........... ........... ........... ........... (160) Cash paid to suppliers and employees .......... ........... ........... ........... ........... (1,970) Net cash provided by operating activities ..... ........... ........... ........... ........... $ 1,280

Instructor’s Manual / Solutions Manual P9.27.

(continued)

b. Cash flows from investing activities: (in millions) Purchase of land and buildings ......... ........... ........... ........... ........... ........... $ (460) Proceeds from the sale of equipment ........... ........... ........... ........... ........... 90 Net cash used for investing activities ........... ........... ........... ........... ........... $ (370) c. Cash flows from financing activities: Payment of long-term debt.... ........... ........... ........... ........... ........... ........... Issuance of preferred stock ... ........... ........... ........... ........... ........... ........... Cash dividends declared and paid ..... ........... ........... ........... ........... ........... Net cash used for financing activities ........... ........... ........... ........... ...........

$ (570) 750 (840) $ (660)

d. Net increase in cash for the year ....... ........... ........... ........... ........... ...........

$ 250

P9.28. a. Cash flows from operating activities: (in millions) Cash collected from customers ......... ........... ........... ........... ........... ........... $8,940 Interest and taxes paid ........... ........... ........... ........... ........... ........... ........... (440) Cash paid to suppliers and employees .......... ........... ........... ........... ........... (?) . Net cash provided by operating activities ..... ........... ........... ........... ........... $3,200 Solving for the missing amount, cash paid to suppliers and employees = $5,300 million. b. Cash flows from investing activities: Purchase of buildings and equipment ........... ........... ........... ........... ........... Proceeds from the sale of land .......... ........... ........... ........... ........... ........... Net cash used for investing activities ........... ........... ........... ........... ...........

$ (?) 500 $ (?)

Cash flows from financing activities: Retirement of bonds at maturity ....... ........... ........... ........... ........... ........... Issuance of common stock .... ........... ........... ........... ........... ........... ........... Cash dividends declared and paid ..... ........... ........... ........... ........... ........... Net cash provided (used) for financing activities ..... ........... ........... ...........

$ (600) 1,250 (950) $ (300)

Net increase in cash for the year ....... ........... ........... ........... ........... ...........

$ 800

Net cash used by investing activities = ($3,200 operating - ??? investing - $300 financing = $800 increase in cash for the year) = $(2,100) million. Cash used to purchase buildings and equipment = ($2,100 million used by investing activities +$500 million proceeds from the sale of land) = $(2,600) million.

Instructor’s Manual / Solutions Manual P9.29. a.

HOEMAN, INC. Comparative Balance Sheets December 31, 2023, and 2022 Assets: Current assets: Cash... ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... Inventory ....... ........... ........... ........... ........... ........... ........... Total current assets ........... ........... ........... ........... ........... Land . ........... ........... ........... ........... ........... ........... ........... Buildings ....... ........... ........... ........... ........... ........... ........... Less: Accumulated depreciation ....... ........... ........... ........... Total land & buildings ....... ........... ........... ........... ........... Total assets .... ........... ........... ........... ........... ........... ...........

2023 $ 26,000 (1) 62,000 78,000 (2) $166,000 (3) 70,000 (4) 207,500 (60,000) (5) $217,500 (6) $383,500

Liabilities: Current liabilities: Accounts payable ..... ........... ........... ........... ........... ........... (7) $ 83,500 Notes payable ........... ........... ........... ........... ........... ........... 77,500 Total current liabilities ....... ........... ........... ........... ........... $ 161,000 Long-term debt .......... ........... ........... ........... ........... ........... (11) $ 96,000 Stockholders' Equity: Common stock .......... ........... ........... ........... ........... ........... $ 25,000 Retained earnings ...... ........... ........... ........... ........... ........... (9) 101,500 Total stockholders' equity .. ........... ........... ........... ........... (10) $ 126,500 Total liabilities and stockholders' equity ...... ........... ........... (8) $ 383,500

2022 $ 23,000 67,000 88,000 $ 178,000 70,000 145,000 (52,500) $ 162,500 $ 340,500

$ 98,500 62,000 $ 160,500 $ 69,500 $ 22,500 88,000 $ 110,500 $ 340,500

Calculations: 1. $67,000 – $5,000 = $62,000 2. $26,000 + $62,000 + $78,000 = $166,000 3. Land is carried at historical cost = $70,000 4. $145,000 + $62,500 = $207,500 5. $70,000 + $207,500 – $60,000 = $217,500 6. $166,000 + $217,500 = $383,500 7. $161,000 – $77,500 = $83,500 8. Same as total assets = $383,500 9. $88,000 + $47,000 – $33,500 = $101,500 10. $25,000 + $101,500 = $126,500 11. $383,500 – $126,500 – $161,000 = $96,000

Instructor’s Manual / Solutions Manual P9.29. b.

(continued) HOEMAN, INC. Statement of Cash Flows For the Year Ended December 31, 2023 Cash flows from operating activities: Net income ... ........... ........... ........... ........... ........... ........... ........... ........... $ 47,000 Add (deduct) items not affecting cash: Depreciation expense ........... ........... ........... ........... ........... ........... ........... 7,500 Decrease in accounts receivable ....... ........... ........... ........... ........... ........... 5,000 Decrease in inventory ........... ........... ........... ........... ........... ........... ........... 10,000 Increase in note payable ........ ........... ........... ........... ........... ........... ........... 15,500* Decrease in accounts payable .......... ........... ........... ........... ........... ........... (15,000) Net cash provided by operating activities ..... ........... ........... ........... ........... $ 70,000 Cash flows from investing activities: Cash paid to acquire new buildings . ........... ........... ........... ........... ........... $ (62,500) Cash flows from financing activities: Cash received from issuance of long-term debt ........ ........... ........... ........... $ 26,500 Cash received from issuance of common stock ........ ........... ........... ........... 2,500 Payment of cash dividends on common stock .......... ........... ........... ........... (33,500) Net cash provided by financing activities ..... ........... ........... ........... ........... $ (4,500) Net increase in cash for the year ....... ........... ........... ........... ........... ........... $ 3,000 * Many firms treat increases/decreases in notes payable (or short-term debt) as financing activities rather than operating activities.

Instructor’s Manual / Solutions Manual P9.30. a.

HARTFORD, INC. Comparative Balance Sheets December 31, 2023, and 2022 Assets: Current assets: Cash... ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... Inventory ....... ........... ........... ........... ........... ........... ........... Total current assets .. ........... ........... ........... ........... .......... Land . ........... ........... ........... ........... ........... ........... ........... Buildings and equipment ...... ........... ........... ........... ........... Less: Accumulated depreciation ....... ........... ........... ........... Total land, buildings and equipment . ........... ........... ........... Total assets .... ........... ........... ........... ........... ........... ...........

2023 $ 318,000 300,000 336,000 $ 954,000 240,000 1,560,000 (1,008,000) $ 792,000 $1,746,000

2022 $ 528,000 438,000 294,000 $1,260,000 240,000 972,000 (738,000) $ 474,000 $1,734,000

Liabilities: Current liabilities: Accounts payable ...... ........... ........... ........... ........... ........... Short-term debt ......... ........... ........... ........... ........... ........... Notes payable ........... ........... ........... ........... ........... ........... Total current liabilities .......... ........... ........... ........... ........... Long-term debt .......... ........... ........... ........... ........... ...........

$ 138,000 192,000 288,000 $ 618,000 $ 510,000

$ 174,000 162,000 216,000 $ 552,000 $ 660,000

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

$ 240,000 378,000 $ 618,000 $1,746,000

$ 180,000 342,000 $ 522,000 $1,734,000

HARTFORD, INC. Statement of Changes in Retained Earnings For the Year Ended December 31, 2023 Retained earnings, January 1, 2023 .. ........... ........... ........... ........... Add: Net income for the year ........... ........... ........... ........... ........... Less: Cash dividends for the year ..... ........... ........... ........... ........... Retained earnings, December 31, 2023 ........ ........... ........... ...........

$342,000 54,000 (18,000) $378,000

Instructor’s Manual / Solutions Manual

P9.31. a.

HARRIS, INC. Balance Sheet December 31, 2023 Assets: Current assets: Cash .. ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... Merchandise inventory .......... ........... ........... ........... ........... Total current assets ........... ........... ........... ........... ........... Noncurrent assets: Land .. ........... ........... ........... ........... ........... ........... ........... Buildings ....... ........... ........... ........... ........... ........... ........... Less: Accumulated depreciation ...... ........... ........... ........... Total noncurrent assets ...... ........... ........... ........... ........... Total assets ... ........... ........... ........... ........... ........... ........... Liabilities and Stockholders’ Equity: Current liabilities: Accounts payable ..... ........... ........... ........... ........... ........... Short-term debt ......... ........... ........... ........... ........... ........... Notes payable ........... ........... ........... ........... ........... ........... Total current liabilities ....... ........... ........... ........... ...........

$ 18,000 201,000 138,000 $ 357,000

$ 81,000 624,000 (303,000) 402,000 $ 759,000

$ 183,000 36,000 72,000 $291,000

Long-term debt .......... ........... ........... ........... ........... ........... Stockholders’ equity: Common stock, no par ......... ........... ........... ........... ........... Retained earnings ...... ........... ........... ........... ........... ........... Total stockholders' equity . ........... ........... ........... ........... Total liabilities and stockholders' equity ...... ........... ........... b.

195,000

$ 84,000 189,000 273,000 $ 759,000

HARRIS, INC. Statement of Changes in Retained Earnings For the Year Ended December 31, 2023 Retained earnings, January 1, 2023 . ........... ........... ........... ........... Add: Net income for the year ........... ........... ........... ........... ........... Less: Dividends for the year . ........... ........... ........... ........... ........... Retained earnings balance, December 31, 2023 ...... ........... ...........

$165,000 39,000 (15,000) $ 189,000

Instructor’s Manual / Solutions Manual

P9.32. The strategy is to enter the amount of the change for each asset, liability, and stockholders' equity item between the two dates. Each of these changes will be used in the Statement of Cash Flows. (Note: Because the retained earnings section of the balance sheet is, in and of itself, an analysis of the change in the retained earnings account for the month, total net income and total dividends for the month of February are shown as changes). MILLCO, INC. Balance Sheets January 31 and February 28, 2023 Assets: Cash... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... Merchandise inventory .......... ........... ........... ........... Total current assets ........... ........... ........... ........... Plant and Equipment: Production equipment ........ ........... ........... ........... Less: Accumulated depreciation .... ........... ........... Total assets .... ........... ........... ........... ........... ...........

Feb. 28 $126,000 192,000 243,000 $561,000

Jan. 31 $111,000 159,000 282,000 $552,000

Change +15,000 +33,000 -39,000

$498,000 (72,000) $987,000

$456,000 (63,000) $945,000

+42,000 -9,000

Liabilities: Accounts payable ...... ........... ........... ........... ........... $111,000 Short-term debt ......... ........... ........... ........... ........... 132,000 Other accrued liabilities ........ ........... ........... ........... 63,000 Total current liabilities ....... ........... ........... ........... $306,000 Long-term debt .......... ........... ........... ........... ........... 99,000 Total liabilities .......... ........... ........... ........... ........... $405,000

$123,000 132,000 72,000 $327,000 138,000 $465,000

-12,000 0 - 9,000

$312,000

$288,000

+24,000

$192,000 108,000 (30,000) $ 270,000 $ 582,000 $ 987,000

$129,000 87,000 +108,000 (24,000) -30,000 $192,000 $480,000 $945,000

Stockholders’ Equity: Common stock, no par value, 80,000 shares authorized, 60,000 and 56,000 shares issued, respectively ........... ........... ........... ........... ........... Retained earnings: Beginning balance .. ........... ........... ........... ........... Net income for the month .. ........... ........... ........... Dividends ... ........... ........... ........... ........... ........... Ending balance ....... ........... ........... ........... ........... Total stockholders' equity ........... ........... ........... Total liabilities and stockholders' equity....... ...........

-39,000

Instructor’s Manual / Solutions Manual

P9.32. (continued) The statement of cash flows uses the changes between the two month-end balance sheets, as illustrated below: MILLCO, INC. Statement of Cash Flows For the Month Ended February 28, 2023 Cash flows from operating activities: Net income .... ........... ........... ........... ........... ........... ........... ........... $108,000 Add (deduct) items not affecting cash: Depreciation expense ......... ........... ........... ........... ........... ........... 9,000 Increase in accounts receivable ...... ........... ........... ........... ........... (33,000) Decrease in merchandise inventory ........... ........... ........... ........... 39,000 Decrease in accounts payable ........ ........... ........... ........... ........... (12,000) Decrease in other accrued liabilities .......... ........... ........... ........... (9,000) Net cash provided by operating activities ..... ........... ........... ........... $102,000 Cash flows from investing activities: Purchases of production equipment .. ........... ........... ........... ...........

(42,000)

Cash flows from financing activities: Payment of long-term debt. ........... ........... ........... ........... ........... $(39,000) Sale of common stock ........ ........... ........... ........... ........... ........... 24,000 Payment of dividends ......... ........... ........... ........... ........... ........... (30,000) Net cash flows used by financing activities .. ........... ........... ........... (45,000) Net increase in cash for the year ....... ........... ........... ........... ........... $15,000 Notice that the statement of cash flows has explained the +$15,000 change in cash during the year by accounting for the changes in all other balance sheet items.

C9.33.

Answers will vary based on the annual report of the focus company selected.

C9.34.

Answers will vary based on the annual report of the focus company selected.

Instructor’s Manual / Solutions Manual C9.35. a. Net cash provided by operating activities easily exceeded net cash used in investing activities for all three years, which suggests that Coca-Cola is generating enough cash to finance its growth in assets. In 2018, investing activities also generated significant positive cash flows, so much so that the net cash flows from investing activities totaled a positive $474 million for the three-year period as a whole: 2020 2019 2018 Net cash provided by operating activities ..... $ 9,844 $10,471 $ 7,627 Net cash provided (used) investing activities. (1,477) (3,976) 5,927 Excess cash available for other purposes…... $ 8,367 $ 6,495 $13,554

Total $27,942 474 $28,416

Ideally, this excess cash available for other purposes (operating cash flows after paying for investing activities) would also be sufficient each year to pay all of the company’s cash dividends. However, that was not the case in 2019: 2020 2019 2018 Net cash provided by operating activities ..... $ 9,844 $10,471 $ 7,627 Net cash provided (used) investing activities (1,477) (3,976) 5,927 Excess cash available for other purposes…... $ 8,367 $ 6,495 $13,554 Dividends paid .......... ........... ........... ........... (7,047) (6,845) (6,644) Excess (deficiency)………………………… $ 1,320 $ (350) $ 6,910

Total $27,942 474 $28,416 (20,536) $ 7,880

The net cash provided by operating activities increased significantly in 2019 and then decreased but less significantly in 2020. It would be necessary to extend the trend back to several prior years to get a more complete picture of this pattern. The steady upward trend in dividends paid suggests that Coca-Cola has taken good care of its shareholders by providing a modest increase in dividend payments each year. Net cash used in investing activities was unusually high in 2019 which may help to explain the nearly $6 billion of net positive cash flow provided by investing activities in 2018. Management certainly would have anticipated and budgeted for the nearly $4 billion of net cash investing uses in the subsequent year. Possible reasons for this pattern may be offered or hinted at elsewhere within the annual report, most likely within the management discussion and analysis section. It should also be noted that Coca-Cola’s investing activities include rather large dollar amounts each year for the “Purchases of investments” and for the “Proceeds from the disposals of investments” with nearly $7.2 billion of net investment disposals in 2018 being the major source of the company’s net cash provided by investing activities that year. These types of cash flow transactions relate to short-term investment activities that are essentially an extension of Coca-Cola’s working capital management efforts. In many ways, the purchase and sale of short-term investments are as “operating” in nature as they are “investing” in nature; yet they are classified as investing activities on the Statement of

Instructor’s Manual / Solutions Manual

C9.35.

Cash Flows. The key point here is that although the reported dollar amounts are large, they are also offsetting to a great extent in 2019 and especially in 2020; the net amount of (continued)

a. cash provided (or used) by these activities puts the reported amounts in a better perspective relative to other investing activities: 2020 2019 2018 Total Purchases of investments………………… $(13,583) $ (4,704) $(7,789) $(26,076) Proceeds from disposals of investments…. 13,835 6,973 14,977 35,785 Net (purchases) disposals of investments... $ 252 $ 2,269 $ 7,188 $ 9,709

Instructor’s Manual / Solutions Manual

Although such short-term investment transactions are properly classified within the investing activities section of the Statement of Cash Flows, many financial analysts may choose to exclude them when assessing the company’s long-term investing cash flow requirements for items such as the purchase of property, plant, and equipment, or the acquisition of businesses. Note that whether such an optional adjustment were to be made by an analyst to essentially reclassify the purchases and disposals of investments as operating cash flows rather than investing cash flows, only the subtotals in the Statement of Cash Flows would change. The “big picture” would remain that same. That is, for the three years presented, Coca-Cola generated sufficient positive net cash flows from operations to pay for all of the company’s investing activities as well as cash dividend requirements, with nearly $8 billion ($7,880 million) of excess cash remaining available for other uses. b. The following observations can be made by quickly reviewing the data for the three-year period presented: •

As illustrated in part a above, Coca-Cola was a net seller of short-term investments during all three years presented. This was an especially significant factor in the 2018 Statement of Cash Flows.

•

The amount of cash used for acquisitions, equity method investments, and nonmarketable securities was more or less offset by the cash proceeds received from these same activities in 2018. In 2019, however, more than $5 billion of net cash was spent on such acquisitions and similar investments. In 2020, nearly $1 billion more of net acquisitions were made by Coca-Cola. Given the nature of these items, it should be expected that the amount of cash used to make such acquisitions (or the amount of cash received from disposing of business units) would vary considerably from year to year depending upon the timing of transaction closings.

•

Net purchases of property, plant, and equipment were significant each year, reflecting the mature nature of a company such as Coca-Cola that is no longer in a high growth stage, but continues to grow organically at a steady pace. This would normally be regarded as a sign of financial success and stability, particularly if this trend were to generally hold true over a longer period of time such as 10 years.

Instructor’s Manual / Solutions Manual b. (continued) •

For each year presented, more cash was used for debt payments than was received from debt issuances (which can be seen by summing the first two line-items listed in the financing activities section). The net payment of debt was most substantial in 2018 when Coca-Cola also generated nearly $7.2 billion (net) in cash by selling off investments (i.e., the proceeds from disposals of investments less the purchases of investments, as shown in the investing activities); it generally makes good business sense to use a portion of such significant investment sale proceeds to reduce debt levels.

•

For the three years presented, virtually the same total amount of cash was received from issuing stock ($3,135) as was used to purchase treasury stock ($3,133).

•

The steady upward trend in dividends paid suggests that Coca-Cola has taken good care of its shareholders by providing a modest increase in dividend payments each year.

•

The negative effect caused by exchange rates in 2018 was due to a relatively strong U.S. dollar, which is Coca-Cola’s reporting currency. The impact of exchange rates was immaterial in 2019 and 2020 when the U.S. dollar was highly stable.

•

The total amount reported as restricted cash and restricted cash equivalents would not be considered material and was quite stable in dollar amount from year to year.

An effort should be made to identify the underlying reasons for the above noted trends and to understand any interrelationships in the data presented. Reference to Coca-Cola’s “Management Discussion and Analysis” and “Notes to the Consolidated Financial Statements” may provide further insights into the company’s cash flow results.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 9

NAME______________________

(Author's note: Select an appropriate annual report and distribute financial statements to students and use or adapt the following questions.) These questions relate to the accompanying Consolidated Statements of Income and Consolidated Statements of Cash Flows. 1. Study the income statement and note the captions that are used. Contrast the format of this statement with that used by Campbell Soup Company. What are the captions of the intermediate profit amounts reported by this company that are not reported by Campbell’s? 2. Assume that cost of goods sold for this company is the sum of the material, labor, and other production costs, plus 80% of the depreciation and amortization expense. Calculate the gross profit ratio for this firm for each of the past three years. (Hint: Other income should be excluded from gross profit.) 3. Assuming that this firm has experienced increases in its production costs (e.g., increases in raw material and labor costs) during each of the past three years, explain how it has managed to maintain a relatively constant gross profit ratio. 4. Assume that this firm is developing a new version of its product, and that cost analysts have estimated that the new version will cost $0.64 to make. What selling price will be set for this item if management desires to have the same gross profit ratio on the new item as on items presently being made and sold? 5. Assume that the interest rate incurred by this firm on the money it has borrowed by issuing notes and bonds payable averaged 12% for the year ended Month xx, 20xx. Calculate the average amount of debt outstanding during the year ended Month xx, 20xx. Calculate the firm's effective income tax rate for the year ended Month xx, 20xx. 6. Calculate the average number of shares of common stock outstanding during each of the past three fiscal years. 7. Calculate the dividend per share, based on the average number of shares outstanding calculated in your answer to question 6. 8. Draw a T-account for the Accounts Receivable account. Assume that the balance of accounts receivable at the end of fiscal 20xx, was $xxx,000. Using the appropriate data from the income statement and statement of cash flows, calculate the amount of the credit transaction (i.e., the principal decrease to accounts receivable). What does this decrease represent?

Instructor’s Manual / Solutions Manual

CHAPTER

Corporate Governance, Notes to the Financial Statements, and Other Disclosures

CHAPTER OUTLINE: I. Corporate Governance A. General background and perspective 1. Impact of stock market and corporate failures 2. Variety of reform measures B. Sarbanes-Oxley Act (SOX) of 2002 1. Public Company Accounting Oversight Board (PCAOB) 2. Prohibited non-audit services for audit clients 3. Management’s Report on Internal Control over Financial Reporting C. Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act) 1. Regulation of executive compensation 2. Enhanced shareholder rights D. Financial Reporting Misstatements 1. Trends in SEC filings for financial misstatements in recent years 2. Fifteen Types of Financial Shenanigans identified by Schilit, Perler and Engelhart a. Earnings Manipulation Shenanigans b. Cash Flow Shenanigans c. Key Metrics Shenanigans d. Acquisition Accounting Shenanigans II. General Organization of Notes to the Financial Statements A. Significant Accounting Policies 1. Depreciation method 2. Inventory valuation method 3. Basis of consolidation 4. Income taxes 5. Employee benefits 6. Goodwill and other acquisition-related intangibles 7. Earnings per share of common stock 8. Stock option and stock purchase plans B. Details of Other Financial Statement Amounts 1. Reporting to the Securities and Exchange Commission

Instructor’s Manual / Solutions Manual

C. Other Disclosures 1. Accounting changes 2. Business combinations 3. Contingencies and commitments 4. Events subsequent to the balance sheet date 5. Impact of inflation 6. Segment information D. Management's Statement of Responsibility 1. Financial statements are the responsibility of management—not the auditors III. Management's Discussion and Analysis (MD&A) A. Enhance public disclosure of information about the corporation B. Non-GAAP Financial Measures—reconciled to comparable GAAP measures IV. Five-Year (or Longer) Summary of Financial Data A. Adjustment of per share data for stock dividends and stock splits B. Supplemental disclosures—not part of the financial statements themselves V. Independent Auditors' Report A. Structure of the standard audit report 1. Introductory paragraph 2. Scope paragraph 3. Opinion paragraph 4. Reference to the audit of the effectiveness of internal control over financial reporting 5. Alternative presentation—combining the financial statements audit opinion and the internal controls audit opinion B. Departures from the standard audit report C. Qualified opinions D. Adverse opinions VI. Financial Statement Compilations

TEACHING/LEARNING OBJECTIVES: Principal: 1. To have students obtain a sense of the current regulatory environment and the issues of corporate governance. 2. To have students integrate the context of the notes to the financial statements with their understanding of financial reporting learned in previous chapters. 3. To have students understand that the notes to the financial statements must be reviewed if the numbers in the financial statements are to be understood. 10-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. .

Instructor’s Manual / Solutions Manual

4. To have students understand the significance and meaning of the independent auditors' report, and that it is not a guarantee of company profitability or absolute accuracy of the financial statements. Supporting: 5. To explain the general types of financial reporting misstatements that frequently occur, and how they impact the reporting entity’s financial statements. 6. To explain the general content of the notes to the financial statements, so that the notes will become less formidable to students than they seem to be at first glance. 7. To review and clarify the student's understanding of some of the more challenging facets of financial reporting by discussing accounting issues in the context of note disclosures, rather than in a transaction context. 8. To emphasize to the student that the financial statements reflect management’s assertions, and that management—not the independent auditor—is responsible for the financial statements. 9. To have the student understand the process of adjusting per share data for stock dividends and stock splits.

TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. This chapter, like Chapters 9 and 11, helps students to build on their understanding of many of the accounting issues that were introduced in the study of the balance sheet. Students should understand that the notes to the financial statements do not introduce new concepts— they describe the application of concepts already learned. 2. Use the notes to the financial statements in the annual reports that students have obtained to illustrate the summary of significant accounting policies and other disclosures. 3. Emphasize the nature of management's responsibilities, and clearly separate them from the auditors' responsibilities. 4. If time permits, introduce some recent examples of lawsuits involving public accounting firms. 5. Review the significance of trends in financial ratios and illustrate how the summary financial data are used to identify trends.

Instructor’s Manual / Solutions Manual

NO.

LEARNING OBJECTIVES

M10.1. M10.2. E10.3.

9 9 1, 2

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 3-5 min. Easy, 10-15 min.

E10.4. E10.5. E10.6. E10.7. E10.8. E10.9.

3, 8, 10 10 10 9 9 9

Easy, 10-15 min. Easy, 5-10 min. Easy, 5-10 min. Med., 10-12 min. Med., 10-12 min. Med., 10-12 min.

E10.10. P10.11.

9 4, 5, 9

Med., 10-12 min. Med., 20-30 min.

P10.12. C10.13.

4, 5, 9 4, 5

Med., 20-30 min. Med., 30-40 min.

C10.14.

Med.-Hard, 3040 min.

OTHER COMMENTS Basic EPS restatement demo. Basic EPS restatement demo, working backwards. Comment on what is and is not included in Campbell’s corporate governance disclosures. Ask students whether this information is consistent with their expectations and useful to them as investors. Give students a guided tour of Campbell’s 2020 Annual Report. Use as a discussion starter: “What is the role of the auditor?” An alternative to E10.5. Good in-class demonstration of the EPS restatement process. See E10.7. Good homework assignment. Some students may get hung up on the math. Remind them that they are working backwards to find the originally reported EPS. See E10.9. Good homework assignment. Straight-forward problem using Campbell’s financial statement data. Have students verify the answers provided. Straight-forward. Good homework assignment. Focus company case, provided for instructors wishing to follow up on E1.1. Group learning case. Provides an opportunity to explain how to read and interpret segment data. Students appreciate the importance of note disclosures as they see their “value added” beyond the financial statements. Consider giving a guided tour through the solutions to save class time.

SOLUTIONS: M10.1. Originally reported EPS for 2022 ..... ........... ........... ........... ........... ........... ........... $6.30 Divided by 3 to reflect 3-for-1 stock split = EPS for 2022 as restated in 2023 ....... $2.10 M10.2. EPS for 2022, as restated in 2023 annual report ...... ........... ........... ........... ........... $1.35 Multiply by 4 to reflect 4-for-1 stock split = originally reported EPS for 2022 ...... $5.40 Proof: Originally reported EPS for 2022 ..... ........... ........... ........... ........... ........... $5.40 Divided by 4 to reflect 4-for-1 stock split = EPS for 2022 as restated in 2023 ....... $1.35

Instructor’s Manual / Solutions Manual E10.3. Information related to the Board and executive officers: Campbell’s provides biographical information about members of the executive management team and Board of Directors, details about Board committees, information about how to communicate concerns to the Board, SEC filings regarding insider transactions, and the full text of the “Code of Ethics for the CEO and Senior Financial Officers.” Policies, Guidelines, Standards, Codes, etc.: Campbell’s provides the full text of its “Corporate Governance Standards” and “Code of Business Conduct and Ethics,”, as well as board committee charters, the company’s “Political Accountability Guidelines”. Campbell’s also provides details concerning on environmental sustainability, discrimination, harassment and retaliation prevention, human rights, responsible advertising, and full report regarding social responsibility, all of which emphasize the company’s commitment to ethical and legal business practices on a worldwide basis. Other disclosures that would be appropriate? No, the corporate governance disclosures provided by Campbell Soup Company are quite extensive. E10.4. Class discussion can focus on the importance of these items to a reader's full understanding of the company's financial statements (financial position, results of operations, and cash flows). Campbell’s financial disclosures certainly appear to be adequate. E10.5. The auditors' opinion is that the identified financial statements present fairly, in all material respects (emphasis added), the financial position, results of operations, and cash flows in conformity with U.S. generally accepted accounting principles. Thus, the auditor does not guarantee that the statements are free of immaterial errors (only that they are free of material errors) or that the statements present the financial position, results of operations, and cash flows perfectly (only that they present the statements fairly). E10.6. The standard four-paragraph independent auditors' report is not at all an indicator of a company's future financial success or future cash dividends. However, if the auditor has substantial doubt about an entity's ability to continue as a going concern, there will be an explanatory paragraph to that effect.

Instructor’s Manual / Solutions Manual

E10.7. a. Original earnings per share is $3.30. To reflect a 5-for-1 stock split, divide by 5. Adjusted EPS = $0.66 b. For 2023, 2021 earnings per share as adjusted in 2022 will have to be adjusted again by dividing by 2. Adjusted EPS for 2021, to be reported in 2023 = $0.66 / 2 = $0.33 c. To reflect a 10% stock dividend, divide unadjusted earnings per share by 1.10. Adjusted EPS = $3.30 / 1.10 = $3.00 E10.8. a. Net income for 2022 (as reported in the 2023 annual report) = $442,890. Stock dividends and stock splits that occur subsequently do not cause changes to reported earnings amounts of prior years. b. Earnings per share for 2022 (as reported in the 2022 annual report) = Net income / Weighted-average number of shares outstanding = $442,890 / 155,400 = $2.85 c. For the calculation of earnings per share for 2022 (as reported in the 2023 annual report), the weighted-average number of shares outstanding in 2022 is adjusted retroactively to reflect the 3-for-1 stock split in 2023. EPS for 2022 (as reported in 2023) = Net income / Weighted-average number of shares outstanding = $442,890 / (155,400 * 3) = $442,890 / 466,200 = $0.95 E10.9. Earnings per share, as restated .......... ........... ........... ........... ........... ........... Multiply by 2 to reflect 2 for 1 stock split .... ........... ........... ........... ........... Multiply by 1.05 to reflect 5% stock dividend ......... ........... ........... ...........

$1.80 $3.60 $3.78

Proof: Original earnings per share .... ........... ........... ........... ........... ........... Adjust for stock split (divide by 2) ... ........... ........... ........... ........... ........... Adjust for 5% stock dividend (divide by 1.05) ......... ........... ........... ...........

$3.78 $1.89 $1.80

E10.10. a. Earnings per share for 2021: As reported in 2023 ... ........... ........... ........... ........... ........... ........... ........... As reported in 2022 ($2.70 * 1.1) .... ........... ........... ........... ........... ........... As reported in 2021 ($2.97 * 1.1) .... ........... ........... ........... ........... ...........

$2.70 $2.97 $3.27

The key here is to see that the $2.70 EPS figure has already been restated, so the task is to work backwards to determine the originally reported per share amount.

Instructor’s Manual / Solutions Manual

E10.10. (continued) b. Dividends per share for 2021: As reported in 2021 ... ........... ........... ........... ........... ........... ........... ........... As reported in 2022 ($0.45 / 1.1) ...... ........... ........... ........... ........... ........... As reported in 2023 ($0.41 / 1.1) ...... ........... ........... ........... ........... ...........

$0.45 $0.41 $0.37

In this case, the originally reported amount per share is known, so the task is to make the restatements going forward. P10.11. a. Net sales in 2017 = $5,837 million (table, p. 16) b. Operating income (earnings before interest and taxes) in 2016 = $865 million (table, p. 16) c. Difference between operating income (earnings before interest and taxes) and net income (net earnings) in 2018 = $1,010 - $261 = $749 million (table, p. 16) d. Year(s) in which net income (net earnings) decreased as compared to the previous year = 2018 and 2019 (table, p. 16) e. Amount of interest paid in 2020 = $287 million (table, p. 83) f. Number of stock options exercisable at August 2, 2020 = 883 thousand (table, p. 78) g. Net sales to customers outside of the United States in 2020 = $526 million (table, p. 56, Net sales “Other countries”) h. Cost of products sold for the third quarter of 2020 = $2,238 - $772 = $1,466 million (table, p.84) P10.12. a. Dividends per share declared in 2020 = $1.40 (table, p. 16) b. Capital expenditures in 2019 = $384 million (table, p. 16) c. Year in which total equity grew by the greatest amount over the previous year = 2020, increased by $1,457 million ($2,569 - $1,112). (table, p. 16) d. Change in total debt from 2016 to 2020 = $3,533 beginning amount - $6,196 ending amount = $2,663 million increase (table, p. 16)

Instructor’s Manual / Solutions Manual P10.12. (continued) e. Amount of finished products inventory in 2020 = $574 million (table, p. 81) f. The company’s effective income tax rate in 2020 = 22.7% (table, p. 67) g. Net sales of the Snacks segment in 2020 = $4,045 million (table, p. 55) h. “Fair value at end of year” of pension plan assets in 2020 = $2,120 million (table, p. 60)

C10.13. a.- h. Answers will vary based on the annual report of the focus company selected.

C10.14. a. Significant trends in consolidated totals and specific business segments: Total assets for the company grew rapidly from 2018 to 2019 and continued to grow at an impressive rate in 2020. Despite the company’s strong asset growth, revenues and operating income were essentially flat from 2018 to 2019 and declined noticeably in 2020 for the company as a whole. There was likewise strong asset growth in 2019 across all segments, and further asset growth in 2020 for both non-U.S. segments. Depreciation and amortization expense generally increased across all segments, which is consistent with the company’s asset growth, although at a slower rate of growth than the company’s asset expansion. This suggest that depreciation and amortization growth will begin to accelerate at a faster pace in the near future. Operating income declined noticeably for the company’s two main segments in 2020.

McDonald’s Corp. 2020 ROI by Primary Geographic Segment (Dollar amounts in millions)

Revenues (A) ........ ........... ........... ........... ........... ........... Operating income (B) ....... ........... ........... ........... ........... Assets, 2019(C) .... ........... ........... ........... ........... ........... Assets, 2020 (D) ... ........... ........... ........... ........... ...........

International U.S. Operated Markets $ 7,828.5 $ 9,570.7 3,789.1 3,315.1 21,376.9 22,847.5 21,010.0 24,744.0

Average assets (E) = (C+D)/2 ...... ........... ........... ........... Margin (F) =B/A .. ........... ........... .......... ........... ........... Turnover (G) =A/E........... ........... .......... ........... ........... ROI = F*G = B/E . ........... ........... ........... ........... ...........

21,193.5 48.4% 0.37 17.9%

23,795.8 34.6% 0.40 13.9%

Instructor’s Manual / Solutions Manual C10.14. (continued) c. To the extent that past performance may be indicative of future prospects, the U.S. segment appears to offer the greatest potential for high returns in the future. Margin is strongest in this segment, reflecting the fact that McDonald’s has been in operation for a substantially longer period of time in the U.S. than in other geographic areas in the world. Although the fast food service industry in the U.S. is highly saturated for McDonald’s and thus does not offer as many growth opportunities as can be found elsewhere, the U.S. operations are much more cost effective due to McDonald’s efficient distribution system and relatively low cost of labor and capital as compared to other parts of the world. Ironically, despite what the margin results suggest, the International Operated Markets segment offers McDonald’s even greater growth opportunities than does the U.S. market, mostly because further cost efficiencies can still be achieved as the company’s corporate culture becomes further engrained. Turnover is higher in this segment than in the U.S. because the infrastructure investment is not as substantial in many such countries. There are likewise strong growth opportunities in the hybrid international development and corporate segment as reflected in the rapid asset growth from 2018-2020 in that segment. It should be noted that the reported margins the two main segments are actually quite strong relative to the level of performance you would expect from an average company. This may well be reflective of the relatively mature consumer markets for fast food services on a global basis, which suggests that the overseas segments will eventually catch up to the level of performance that McDonald’s presently enjoys in the U.S. At its present rate of profitability, the company should certainly continue to explore market expansion possibilities in all corners of the globe. d.

The “Corporate” column shown in the segment disclosures provided by most companies displays the overall level of assets and expenses that cannot be meaningfully assigned to any one particular operating segment—such as the assets and expenses associated with global corporate headquarters. The “Corporate” column does not ordinarily report any revenues, since the revenues are earned within each of the operating segments; “corporate” costs must be incurred (and thus corporate assets must be maintained) in order to provide an overall infrastructure which allows the company to operate in an efficient and consistent manner. By combining the company’s overall corporate assets and expenses with the operating results of a wide variety of emerging market countries, McDonald’s has obscured the information quality of the latter.

Instructor’s Manual / Solutions Manual

C10.14. (continued) e.

The most obvious improvement that McDonald’s Corp. could make in the company’s classification of segment data would be to create a separate “Corporate” column such that these amounts would not be combined with the results of any geographic segment. It should be noted, however, that the classification of segment data is within the control of management, but only to a limited extent. It is not appropriate under U.S. GAAP to report separate results for small segments, the results of which may be considered to be immaterial in comparison to the company’s overall results. Thus, a certain degree of aggregation of results is necessary to allow the reporting entity to appropriately define segments that are of sufficient size to meet the reporting criteria.

Instructor’s Manual / Solutions Manual

CHAPTER

Financial Statement Analysis

CHAPTER OUTLINE: I. Interpretation of Financial Condition and Results of Operations A. Liquidity Measures 1. Review of working capital, current ratio, and acid-test ratio B. Activity Measures 1. Turnover a. Significance and general model 2. Turnover calculations illustrated a. Accounts receivable b. Inventory c. Plant and equipment d. Days' sales in accounts receivable e. Days' sales in inventory C. Profitability Measures 1. Review of return on investment and return on equity 2. Price/earnings ratio (earnings multiple) a. Significance b. Illustration 3. Dividend yield 4. Dividend payout ratio a. Dividend policy 5. Preferred dividend coverage ratio D. Financial Leverage Ratios 1. Review and illustration of financial leverage 2. Debt ratio 3. Debt/equity ratio 4. Times interest earned E. Book Value Per Share of Common Stock F. Common Size Financial Statements G. Other Operating Statistics II. Summary of Financial Statement Analysis Ratios

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To complete the student's integration of financial accounting concepts and reporting practices by having the student understand the most frequently used financial ratios. 2. To add an understanding of the price/earnings ratio to the student's knowledge of factors relevant to personal financial management. 3. To provide some broad "rules of thumb" so students can form a perspective about the ratio measurements for specific companies. Supporting: 4. To emphasize that the trend of a ratio is more important than the ratio itself. 5. To have the student understand the characteristics being measured by each category of ratio. 6. To review the concept of financial leverage and the risks associated with long-term debt. 7. To introduce the idea of common size financial statements as a way of identifying trends and comparing data of different entities. 8. To acknowledge that not all judgments about an entity's operations involve financial data; other operating statistics are also a source of information.

TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. This is the third of three chapters (9, 10, and 11) that are designed to help students integrate material already learned. Although new material is presented and should be learned, the focus should be on the “big picture” of financial reporting. Students should be told this, and class discussion should support this. 2. ROI, ROE, and the liquidity measures were introduced in Chapter 3, and have been used in subsequent chapters. Problems 11-15 and 11-16 provide a review of liquidity measures in a way that students find interesting at this point in the course. Likewise, Case 11-20 can be used to demonstrate the impact of financial leverage on a firm’s ROI and ROE. 3. Students should not be expected to memorize all of the ratio formulas. Instead, try to convince them that the name of the ratio usually describes how it is calculated.

Instructor’s Manual / Solutions Manual TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: (continued) 4. For examination purposes, emphasis should be placed on interpretation of ratio results, rather than on the calculation of numbers. You may wish to distribute photocopies of some of the key ratio formulas shown in the chapter summary. When testing the material in this chapter, use copies of the financial statements of a real firm that students are likely to be familiar with. 5. To emphasize the discussion of the price/earnings ratio, use a newspaper stock listing and a recent article about the level of the P/E ratio for the broad market, or for an individual stock. 6. Refer the students to Moody's Handbook of Common Stocks or an appropriate online investment advisory service to encourage them to become more familiar with the companies whose annual reports they have obtained. Relate the statistical data in that material to the accounting and analytical concepts the students have learned. See Exercise 11-10. 7. Problem 11-18 provides a straight-forward calculations-based illustration of most of the material presented in the chapter using Campbell’s 2020 financial statement data. Problem 11-17 provides a straight-forward generic alternative. Mini-exercises 11-1 and 11-3 through 11-8 can also be used to help students learn the mechanics of calculating ratios. 8. Case 11-21 presents an interesting and challenging “puzzle” that helps students to see the relationships between various financial ratios and financial statement elements/accounts; it works especially well with MBA students. 9. Case 11-22 is the fourth and final installment of the “capstone analytical review” case series using Gerrard Construction. Although intended as a 4-part case series, it can be used effectively so long as Case 4-32 was also assigned, and solutions to that case were previously provided to students.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: Note: The primary learning objective in this chapter is to develop an understanding of how financial statement ratios can be used to facilitate the interpretation of an entity’s financial position and results of operations; the assignment materials are designed to help develop a basic understanding of financial statement analysis. NO.

LEARNING OBJECTIVES

M11.1. M11.2. M11.3.

Liquidity ratios Liquidity ratios Inventory

M11.4.

E11.9.

Accounts receivable ROI and ROE P/E ratio and divided ratios Debt and debt/equity Times interest earned General

E11.10.

General

Hard, 45-90 min.

E11.11.

Various ratios

Med., 7-10 min.

E11.12. P11.13.

Various ratios 9

Med., 7-10 min. Easy, 12-15 min.

P11.14. P11.15.

9 1

Easy, 10-12 min. Med., 7-10 min.

P11.16. P11.17. P11.18.

1 Various ratios Various ratios

Med., 10-15 min. Med., 15-25 min. Med., 25-35 min.

C11.19. C11.20.

Various ratios. Various ratios

Hard, 45-60 min. Med.-Hard, 10-15 min.

C11.21.

Various ratios

Hard, 30-45 min.

C11.22.

Various ratios

Med., 20-30 min.

M11.5. M11.6. M11.7. M11.8.

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Med., 5-8 min. Easy-Med., 5-8 min. Easy-Med., 5-8 min. Easy, 5-8 min. Easy, 3-5 min.

OTHER COMMENTS

Easy, 2-3 min.

Simple calculations exercise.

Easy, 2-3 min.

Simple calculations exercise.

Easy, 5-10 min.

Good discussion starter. Can be used to highlight some of the limitations of financial statement data. Emphasize the variety of sources of data available for investment analysis. Can be used in conjunction with C11.19. See E11.9 and E1.1. Students may wish to research the firm they have chosen in E1.1. Students should first record the appropriate journal entry, and then consider the effect on the financial ratio listed opposite of it. Good in-class demonstration problem. Straight-forward common size balance sheet problem using Campbell’s data. See P11.13. Use to reinforce liquidity measures: working capital, current ratio, and acid-test ratio. Group learning problem. Good homework assignment. Straight-forward, comprehensive ratio analysis problem. Straight-forward, comprehensive ratio analysis problem using Campbell’s data. Focus company—comprehensive ratio analysis case. Group learning case. Emphasize the magnification effect that financial leverage has on ROE, and the impact that a firm’s capital structure has on its profitability. Group learning case. Students find this case to be interesting and challenging. It can be used as a graded in-class group homework assignment. Capstone review.

Simple review exercise of liquidity measures. Math puzzle requiring a clear understanding of relationships. Students often have difficulty with these ratios, and should refer to Exhibits 11-1 and 11-2 or the chapter summary for a review. See M11.3. for review suggestions. Simple calculations exercise. Simple calculations exercise.

Instructor’s Manual / Solutions Manual SOLUTIONS: M11.1. Cash ... ........... ........... ........... ........... ........... ........... ........... ........... ........... Accounts receivable ... ........... ........... ........... ........... ........... ........... ........... Merchandise inventory .......... ........... ........... ........... ........... ........... ........... Total current assets ... ........... ........... ........... ........... ........... ........... ........... Accounts payable ....... ........... ........... ........... ........... ........... ........... ........... Wages payable ........... ........... ........... ........... ........... ........... ........... ........... Total current liabilities .......... ........... ........... ........... ........... ........... ...........

$ 12,000 33,000 55,000 $100,000 $ 17,000 8,000 $ 25,000

a. Working capital = CA $100,000 – CL $25,000 ........ ........... ........... ...........

$75,000

b. Current ratio = CA $100,000 / CL $25,000 ………......................................

4.0

c. Acid-test ratio = (CA $100,000 – Inventory $55,000) / CL $25,000............

1.8

M11.2. a. Working capital = (current assets - current liabilities) = CA - CL = $300,000 Current ratio = (current assets / current liabilities) = CA / CL = 3.0 Solution approach: 1. In the current ratio equation, multiply both sides by CL, giving: CA = 3CL 2. In the working capital equation, substitute 3CL for CA, giving: 3CL - CL = $300,000 2L = $300,000 Current liabilities = $150,000 3. Current assets can be determined as: CA = 3CL = (3 * $150,000) = $450,000 Current assets b. Current assets = (Cash + Accounts Receivable + Merchandise Inventory) = $450,000 Current liabilities = $150,000 Acid-test ratio = 1.2 Solution approach: 1. The difference between the current ratio and the acid-test ratio is that Merchandise Inventory is excluded from the numerator of the acid-test ratio. 2. The numerator of the acid test ratio = (CL * 1.2) = ($150,000 * 1.2) = $180,000, which represents Cash + Accounts Receivable. 3. $450,000 - $180,000 = $270,000 Merchandise Inventory

Instructor’s Manual / Solutions Manual

M11.3. a. Inventory turnover = Cost of goods sold / average inventories = $350,400 / $109,500 = 3.2 times b. Number of days’ sales in inventory = Inventory at year-end / Average day’s cost of goods sold* = $105,600 / $960 = 110 days *Average day’s cost of goods sold = Annual cost of goods sold / 365 = $350,400 / 365 = $960

M11.4. a. Accounts receivable turnover = Sales / average accounts receivable = $365,000 / $14,600 = 25 times b. Number of days’ sales in accounts receivable = Accounts receivable at year-end / Average day’s sales* = $16,000 / $1,000 = 16 days *Average day’s sales = Annual sales / 365 = $365,000 / 365 = $1,000

M11.5. a. Margin = Net income / Sales = $64,000 / $400,000 = 16% Turnover = Sales / Average total assets = $400,000 / $800,000 = 0.5 ROI = Margin * Turnover = 16% * 0.5 = 8%, or ROI = Net income / Average total assets = $64,000 / 800,000 = 8% b. ROE = Net income / Average total stockholders’ equity = $64,000 / $640,000 = 10%

Instructor’s Manual / Solutions Manual M11.6. a. Price/earning ratio = Market price per share / earnings per share = $84.00 / $8.00 = 10.5 b. Dividend payout ratio = Dividends per share / earnings per share = $4.20 / $8.00 = 52.5% c. Dividend yield = Dividends per share / market price per share = $4.20 / $84 = 5%

M11.7. a. Debt ratio = Total liabilities / (Total liabilities and stockholders’ equity) = $360,000 / $600,000* = 60% * Total liabilities and stockholders’ equity at year-end = Total assets at year-end, which was given as $600,000. Total stockholders’ equity at year-end = $600,000 - $360,000 = $240,000. b. Debt/equity ratio = Total liabilities / total stockholders’ equity* = $360,000 / $240,000 = 1.5, or 150% * Total stockholders’ equity at year-end = Total assets of $600,000 – total liabilities of $360,000 = $240,000.

M11.8. Times interest earned = Earnings before interest and taxes / interest expense = $180,000 / $50,000 = 3.6 times

E11.9. Key data would be the recent (3-5 year) trends in earnings per share, cash dividends per share, market price, and P/E ratio. These data would be in tabular and graphic format. Market price would be noted weekly. Quarterly and annual data to note are earnings and dividend trends. The sell/hold/buy decision is based on stock price performance relative to the price objective established from analysis of the above data.

Instructor’s Manual / Solutions Manual E11.10. Other information that students may be interested in knowing include: 1. The results of operations for the most recent quarter or for any period of time that has passed by since the last balance sheet date. 2. Significant economic events or other news items that have recently affected the company or the industry within which it operates. 3. Key qualitative factors such as employment statistics. 4. The potential impact on the company of proposed legislation or pending litigation. 5. The availability of financial information about key competitors and/or industry-wide data for comparative purposes.

E11.11. Transaction/event a. Split the common stock 2 for 1.

Financial ratio Book value per share of common stock

+/-

Explanation The denominator doubles so the book value per share will be ½ of the original.

b. Collected accounts receivable.

Number of days’ sales in accounts receivable

Decrease in accounts receivable with no effect on average days’ sales.

c. Issued common stock for cash.

Total asset turnover

Increase in average total assets with no effect on sales.

d. Sold treasury stock.

Return on equity

Increase in average stockholders’ equity with no effect on net income.

e. Accrued interest on a note receivable.

Current ratio

Increase in current assets for interest receivable.

f. Sold inventory on account.

Acid-test ratio

Numerator increases (inventory is replaced with accounts receivable but for a larger amount).

g. Wrote off an uncollectible account.

Accounts receivable turnover

Net realizable value of accounts receivable is not affected by the write-off entry.

h. Declared a cash dividend.

Dividend yield

Dividends per share increase with no determinable effect on market price per share.

Instructor’s Manual / Solutions Manual E11.11. (continued) Transaction/event Incurred operating expenses.

Financial ratio Margin

+/-

Explanation Expenses reduce net income.

j. Sold equipment at a loss.

Earnings per share

Losses reduce net income.

Transaction/event a. Purchased inventory on account.

Financial ratio Number of days’ sales in inventory

+/+

Explanation Increase in inventory causes the numerator to increase.

b. Sold inventory for cash, at a profit.

Inventory turnover

As sales volume increases, so does cost of goods sold and inventory turnover.

c. Issued a 10% stock dividend.

Earnings per share

Increase in the average number of shares outstanding in the EPS denominator.

d. Issued common stock for cash

Debt ratio

Increase in total assets with no change in liabilities.

e. Sold land at a gain.

Return on investment

Increase in net income.

f. Purchased treasury stock for cash.

Debt/equity ratio

Decrease in stockholders’ equity with no change in liabilities.

g. Accrued interest on a note payable.

Times interest earned

Increase in interest expense in the denominator.

h. Accrued wages that have been earned by employees.

Current ratio

Increase in current liabilities.

i. Equipment was purchased for cash.

Plant and equipment turnover

The greater the investment in plant and equipment, the lower the turnover.

j. Issued bonds at an interest rate that is less than the company’s ROI.

Return on equity

The company is using financial leverage to its advantage—ROE is magnified relative to ROI.

E11.12.

Instructor’s Manual / Solutions Manual P11.13. CAMPBELL SOUP COMPANY Common Size Balance Sheet July 28, 2019 Total current assets .... ........... ........... ........... ........... ........... ........... Plant assets, net of depreciation ......... ........... ........... ........... ........... Goodwill ........ ........... ........... ........... ........... ........... ........... ........... Total other long-term assets ... ........... .......... ........... ........... ........... Total assets ..... ........... ........... ........... ........... ........... ........... ...........

15.0% 18.7 30.6 35.8 100.0%*

Total current liabilities ........... ........... ........... ........... ........... ........... Total noncurrent liabilities (including deferred taxes) .......... ........... Total equity .... ........... ........... ........... ........... ........... ........... ........... Total liabilities and equity ..... ........... ........... ........... ........... ...........

25.7% 65.8 8.5 100.0%

* Adds to 100.1% due to rounding of individual items.

P11.14. CAMPBELL SOUP COMPANY Common Size Balance Sheet August 2, 2020 Total current assets .... ........... ........... ........... ........... ........... ........... Plant assets, net of depreciation ......... ........... ........... ........... ........... Goodwill ........ ........... ........... ........... ........... ........... ........... ........... Total other long-term assets ... ........... .......... ........... ........... ........... Total assets ..... ........... ........... ........... ........... ........... ........... ...........

19.3% 19.1 32.2 29.4 100.0%

24.9% 54.4 20.8 100.0%*

* Adds to 100.1% due to rounding of individual items.

Instructor’s Manual / Solutions Manual P11.15. a. Working capital = (current assets - current liabilities) = CA - CL = $900,000 Current ratio = (current assets / current liabilities) = CA / CL = 2.0 Solution approach: 1. In the current ratio equation, multiply both sides by CL, giving: CA = 2CL 2. In the working capital equation, substitute 2CL for CA, giving: 2CL - CL = $900,000 Current liabilities = $900,000 3. Current assets can be determined as: CA = 2CL = (2 * $900,000) = $1,800,000 b. Current assets = (Cash + Accounts Receivable + Merchandise Inventory) = $1,800,000 Current liabilities = $900,000 Acid-test ratio = 1.5 Solution approach: 1. The difference between the current ratio and the acid-test ratio is that Merchandise Inventory is excluded from the numerator of the acid-test ratio. 2. The numerator of the acid test ratio = (CL * 1.5) = ($900,000 * 1.5) = $1,350,000, which represents Cash + Accounts Receivable. 3. $1,800,000 - $1,350,000 = $450,000 Merchandise Inventory c. Solution approach: The journal entry for collecting an account receivable involves a debit to one current asset (Cash) and a credit to another current asset (Accounts Receivable). Thus, current assets do not change in total, and there is no effect on working capital or the current ratio. Current ratio = 2.0 Working capital = $900,000 d. Solution approach: The journal entry for the payment of an account payable involves a debit to a current liability (Accounts Payable) and a credit to a current asset (Cash). Thus, current assets and current liabilities decrease by an equal amount, and there is no effect on working capital. However, the current ratio increases because current assets become proportionately higher than current liabilities. Before After Current assets (A) ...... ........... ........... ........... ........... $1,800,000 $1,500,000 Current liabilities (B) . ........... ........... ........... ........... 900,000 600,000 Working capital (A - B) ........ ........... ........... ........... 900,000 900,000 Current ratio (A / B)... ........... ........... ........... ........... 2.0 2.5

Instructor’s Manual / Solutions Manual

P11.15. (continued) e. Solution approach: The journal entries for the sale of inventory would be: Dr. Cash (included in acid-test numerator) .. ........... ........... ........... 180,000 Cr. Sales .. ........... ........... ........... ........... ........... ........... ........... 180,000 Dr. Cost of Goods Sold ......... ........... ........... ........... ........... ........... 150,000 Cr. Merchandise Inventory (excluded from acid-test numerator) 150,000 By selling inventory for cash, Arch Company will improve its acid-test ratio to 1.7 because a current asset that is included in the acid-test numerator (Cash of $180,000) will replace a current asset that was previously excluded from the acid-test numerator (Merchandise Inventory of $150,000). Acid-test ratio = Cash (including temporary cash investments) + Accounts receivable Current liabilities Before transaction: $1,350,000 / $900,000 = 1.5

After transaction: ($1,350,000 + $180,000) / $900,000 = 1.7

Note that the $1,350,000 amount above (both before and after the sale transaction) represents the amount of cash and accounts receivable that Arch Company already had prior to the sale transaction. The additional $180,000 of cash received in place of the inventory sold increases the acid-test ratio. Additional point of discussion (not required): Note also that the current ratio would increase as a result of this sale transaction, but nearly as significantly. Current assets increase by $180,000 of cash received but also decrease by $150,000 of merchandise inventory sold. The net increase in current assets of $30,000 causes the current ratio to increase slightly. Current ratio = (current assets / current liabilities) Before transaction: $1,800,000 / $900,000 = 2.0

After transaction: ($1,800,000 + $180,000 - $150,000) / $900,000 = 2.03

Instructor’s Manual / Solutions Manual P11.16. a. Working capital = current assets - current liabilities = $480,000 - $300,000 = $180,000 Current ratio = current assets / current liabilities = $480,000 / $300,000 = 1.6 Acid-test ratio = Cash (including temporary cash investments) + Accounts receivable Current liabilities = ($54,000 + $87,000 + $129,000) / $300,000 = $270,000 / $300,000 = 0.9 b. Solution approach: Record the appropriate journal entry(ies) for each transaction described, taking note of the effects of the entry(ies) on current assets (CA) and current liabilities (CL). Keep in mind that certain current assets (i.e., inventory and prepaid expenses) are excluded from the numerator of the acid-test ratio. 1. Dr. Accounts receivable (CA) .... ........... ........... ........... ........... 320,000 Cr. Sales ......... ........... ........... ........... ........... ........... ........... 320,000 Dr. Cost of goods sold .... ........... ........... ........... ........... ........... 210,000 Cr. Merchandise inventory (CA) ....... ........... ........... ........... 210,000 2. Dr. Cash (CA) ..... ........... ........... ........... ........... ........... ........... Cr. Accounts receivable (CA) ........... ........... ........... ...........

305,000

3. Dr. Merchandise inventory (CA) ........... ........... ........... ........... Cr. Accounts payable (CL) .... ........... ........... ........... ...........

192,000

4. Dr. Cash (CA) ..... ........... ........... ........... ........... ........... ........... Cr. Common stock / Additional paid-in capital ......... ...........

5,250

5. Dr. Allowance for bad debts (CA) .......... ........... ........... ........... Cr. Accounts receivable (CA) ........... ........... ........... ...........

7,500

6. Dr. Retained earnings ..... ........... ........... ........... ........... ........... Cr. Cash (CA) ........... ........... ........... ........... ........... ...........

20,000

7. Dr. Cash (CA) ..... ........... ........... ........... ........... ........... ........... Cr. Marketable securities (CA) .......... ........... ........... ........... Cr. Realized gain on sale of marketable securities .... ...........

39,000

8. Dr. Insurance expense ..... ........... ........... ........... ........... ........... Cr. Prepaid expenses (CA)..... ........... ........... ........... ...........

14,000

9. Dr. Cash (CA) ..... ........... ........... ........... ........... ........... ........... Cr. Notes payable (CL) .......... ........... ........... ........... ...........

12,000

10. Dr. Notes payable .......... ........... ........... ........... ........... ........... Dr. Interest expense ...... ........... ........... ........... ........... ........... Cr. Cash (CA) ........... ........... ........... ........... ........... ...........

50,000 3,500

305,000

192,000

5,250

7,500

20,000

22,000 17,000

14,000

12,000

53,500

Instructor’s Manual / Solutions Manual P11.16. (continued) Working Capital +

1. Credit sales for the year amounted to $320,000. The cost of goods sold was $210,000. 2. Collected accounts receivable, $305,000. NE 3. Purchased inventory on account, $192,000. NE 4. Issued 150 shares of common stock for + $35 per share. 5. Wrote off $7,500 as uncollectible accounts NE using the allowance method. 6. Declared and paid a cash dividend, $20,000. 7. Sold marketable securities for $39,000 in cash. + 8. Recorded insurance expense for the year, $14,000. The premium for the policy was paid in June, 2022. 9. Borrowed cash on a short-term bank NE loan, $12,000. 10. Repaid principal of $50,000 and interest of $3,500 on a long-term bank loan. P11.17. a.

Current Ratio +

Acid-Test Ratio +

NE +

+ -

+ NE

ROI

MARGIN

TURNOVER

NET INCOME AVERAGE TOTAL ASSETS

NET INCOME SALES

SALES . AVERAGE TOTAL ASSETS

2023 ROI = ($300 / $3,300) * [$3,300 / (($2,950 + $3,400) / 2)] = 9.1% margin * 1.04 turnover = 9.4% 2022 ROI = ($230 / $2,900) * [$2,900 / (($2,450 + $2,950) / 2)] = 7.9% margin * 1.07 turnover = 8.5% b. ROE = Net income / Average stockholders' equity 2023 ROE = $300 / (($1,150 + $1,400) / 2) = 23.5% 2022 ROE = $230 / (($950 + $1,150) / 2) = 21.9% c. Current assets . ........... ........... ........... ........... ........... ........... Current liabilities ....... ........... ........... ........... ........... ........... Working capital.......... ........... ........... ........... ........... ........... Current ratio (current asset / current liabilities)

2023 $650 (500) $150 1.3

2022 $900 (800) $100 1.1

2021 $700 (700) $ 0 1.0

Instructor’s Manual / Solutions Manual P11.17. (continued) d. Earnings per share = Net income / Weighted-average number of shares outstanding 2023 EPS = $300 / 44 = $6.82 2022 EPS = $230 / 42 = $5.48 e. Price/Earnings ratio = Market price / Earnings per share 14 = $??? / $6.82 Market price = $95.48 f. Cash dividends per share = ($50 million total cash dividend / 44 million weighted-average number of shares outstanding) = $1.14 Dividend yield = ($1.14 cash dividend per share / $95.48 market price per share) = 1.19% g. Dividend payout ratio = ($1.14 dividend per share / $6.82 earnings per share) = 16.7% h. Average days' sales = ($3,300 sales / 365 days) = $9.041 million Number of days' sales in accounts receivable = ($310 accounts receivable / $9.041 average day's sales) = 34.3 days i. Debt ratio = Total liabilities / (Total liabilities + Total stockholders' equity) 12/31/23 Debt ratio = ($500 + $1,500) / $3,400 = 58.8% 12/31/22 Debt ratio = ($800 + $1,000) / $2,950 = 61.0% Debt/equity ratio = Total liabilities / Total stockholders' equity 12/31/23 Debt/equity ratio = ($500 + $1,500) / $1,400 = 143% 12/31/22 Debt/equity ratio = ($800 + $1,000) / $1,150 = 157% j. Times interest earned = Operating income / Interest expense For 2023: = $380 / $80 = 4.8 times For 2022: = $300 / $70 = 4.3 times

Instructor’s Manual / Solutions Manual P11.17. (continued) k. A young, single professional would probably be more interested in potential growth of capital rather than current dividend income, and would probably be willing to invest in a stock that represented a relatively risky investment. Based on these criteria, the relatively low dividend payout and dividend yield, significant growth in earnings per share, and the relatively high financial leverage could make this stock an attractive, though risky, potential investment. The liquidity of the company is relatively low, based on an "average" current ratio of about 1.2 for the three-year period, although collection efforts appear to be adequate. Without further information about the composition of the current asset and current liability accounts, it is difficult to assess the firm’s liquidity. The company's ROI is relatively low, although the two-year trend is slightly up and Wiper, Inc. is making good use of borrowed funds to significantly magnify ROE relative to ROI. Interest coverage also appears to be more than adequate with times interest earned greater than 4.0 each year, which suggests that operating income is supporting the company’s debt level adequately. The price/earnings ratio of 14 is typical for a firm with a relatively low ROI; the fact that the P/E ratio has remained within the “normal” range may indicate that future earnings prospects for this firm are fairly strong.

P11.18. a. 1. Margin = ($1,628 net earnings / $8,691 net sales) = 18.7% Turnover = Net sales / Average total assets = $8,691 / (($13,148 + $12,372) / 2) = $8,691 / $12,760 = 0.68 ROI = (18.7% margin * 0.68 turnover) = 12.7%** ** Off due to rounding. Actual ROI = $1,628 / $12,760 = 12.8% Note: Students may have also calculated margin and ROI based on “Net earnings attributable to Campbell Soup Company” rather than “Net earnings” in the numerator. However, since the results of both measures for Campbell’s in 2020 were identical ($1,628 million), these alternative calculations are not shown.

Instructor’s Manual / Solutions Manual

P11.18. (continued) a. 2. ROE = Net earnings / Average total equity = $1,628 / (($1,112 + $2,569) / 2) = $1,628 / $1,840.5 = 88.5% Alternative calculations: Students may have calculated ROE based on “Net earnings attributable to Campbell Soup Company” rather than “Net earnings” in the numerator. In that case, “Total Campbell Soup Company Shareholders’ equity” rather than “Total equity” should be used in the denominator as well: ROE = Net earnings attributable to Campbell Soup Company / Average total Campbell Soup Company shareholders’ equity = $1,628 / (($1,103 + $2,563) / 2) = $1,628 / $1,833 = 88.8% 3. Price/earnings ratio = ($49.57 market value per common share / $5.36 diluted earnings per common share outstanding) = 9.2 4. Dividend yield = ($1.40 dividends declared per share / $49.57 market value per common share) = 2.8% 5. Dividend payout ratio = ($1.40 dividends per common share / $5.36 diluted earnings per common share outstanding) = 26.1% b.

1. Working capital = ($2,385 current assets - $3,075 current liabilities) = $(690) million 2. Current ratio = ($2,385 current assets / 3,075 current liabilities) = 0.78 3. Acid-test ratio = (($859 cash and cash equivalents + $575 accounts receivable) / $3,075 current liabilities) = $1,434 / $3,075 = 0.47

Instructor’s Manual / Solutions Manual 11.18. (continued) c. 1. Average day's sales = ($8,691 annual net sales / 365 days) = $23.8111 million Number of days' sales in accounts receivable = ($575 accounts receivable / $23.811 average day's sales) = 24.1 days (Note: This result may be understated to some extent because it is based on the assumption that all of Campbell’s $8,691 net sales resulted from credit sales. To the extent that Campbell’s makes cash sales, the average days’ sales result in the denominator will decrease, thus causing the number of days’ sales in accounts receivable to increase.) 2. Average day's cost of products sold = ($5,692 annual cost of products sold / 365 days) = $15.595 million Number of days' sales in inventory = ($871 inventories / $15.595 average day's cost of products sold) = 55.9 days 3. Accounts receivable turnover = Net sales / Average accounts receivable = $8,691 / (($574 + $575) / 2) = $8,691 / $574.5 = 15.1 times 4. Inventory turnover = Cost of products sold / Average inventories = ($5,692 / (($863 + $871) /2) = $5,692 / $867 = 6.6 times 5. Net property, plant, and equipment turnover = Net sales / Average plant assets, net of depreciation = $8,691 / (($2,455 + $2,368) / 2) = $8,691 / $2,411.5 = 3.6 times d. 1. Debt ratio = (Total liabilities / Total liabilities and stockholders’ equity) = (($9,803 / $12,372 total liabilities and equity) = 79.2% 2. Debt/equity ratio = (Total liabilities / Total stockholders’ equity) = (($9,803 total liabilities) / $2,569 total equity) = 381.6% e. 1. Net sales per employee = Net sales / Number* of employees for the year = $8,691 million / 14,500 employees = $599,379 per employee 2. Operating income per employee = Earnings before interest and taxes / Number* of employees for the year = $1,107 million / 14,500 employees = $76,345 per employee * Normally, these ratios would be calculated based on the “Average number of employees for the year,” but Campbell’s only discloses the number of employees at August 2, 2020.

Instructor’s Manual / Solutions Manual C11.19. Answers will vary based on the annual report of the focus company selected.

C11.20. a. ROI = Net income / Average total assets Coca-Cola = $7,747 / (($86,381 + $87,296) / 2) = $7,747 / $86,838.5 = 8.9%

PepsiCo = $7,120 / (($78,547 + $92,918) /2) = $7,120 / $85,732.5 = 8.3%

Note: Total assets at the end of the year is equal to ending liabilities plus ending stockholders’ equity. For Coca Cola, $66,012 + $21,284 = $87,296 million. For PepsiCo, $79,366 + $13,552 = $92,918 million. ROE = Net income / Average stockholders’ equity Coca-Cola = $7,747 / (($21,098 + $21,284) / 2) = $7,747 / $21,191 = 36.6%

PepsiCo = $7,120 / (($14,868 + $13,552) /2) = $7,120 / $14,210 = 50.1%

Note: Total stockholders’ equity at the beginning of the year is equal to beginning assets minus beginning liabilities. For Coca-Cola, $86,381 - $65,283 = $21,098 million. For PepsiCo, $78,547 - $63,679 = $14,868 million. b. Yes. PepsiCo uses more financial leverage than does Coca-Cola. The magnification effect on PepsiCo’s ROE (of 50.1%) relative to its ROI (of 8.3%) is approximately 604%; that is, ROE is 604% or 6.04 times greater than ROI. For Coca Cola, the spread between ROE (of 36.6%) and ROI (of 8.9%) is much smaller relative to that of PepsiCo, although the magnification effect of financial leverage (of 411% or 4.11 times greater) is also quite significant. c. Debt ratio = Total liabilities / (Total liabilities + Total stockholders’ equity) Coca Cola = $66,012 / ($66,012 + $21,284) = $66,012 / $87,296 = 75.6%

PepsiCo = $79,366 / ($79,366 + $13,552) = $79,366 / $92,918 = 85.4%

Debt/equity ratio = Total liabilities / Total stockholders’ equity Coca Cola = $66,012 / $21,284 = 3.101, or 310.1%

PepsiCo = $79,366 / $13,552 = 5.856, or 585.6%

Instructor’s Manual / Solutions Manual C11.20. (continued) d. The debt and debt/equity ratios calculated in part c make sense relative to the student’s expectations formed in part b. As expected, PepsiCo is more leveraged than is CocaCola, but the debt ratio portrays the extent to which this is true more clearly than does the debt/equity ratio. Although PepsiCo has 9.8% more debt in its capital structure than does Coca-Cola (calculated as the difference between the two companies debt ratios, or 85.4% - 75.6%), the debt/equity ratio could give a naïve observer a false signal that PepsiCo has 72% more debt in their capital structure than does Coca-Cola (calculated inappropriately, as 585.6% / 310.1% = 1.89% as much debt for PepsiCo). What is important to note is that each ratio must be interpreted in the appropriate context. In reality, PepsiCo does use financial leverage to a greater extent than does Coca-Cola, but the differences are not as dramatic as they may appear to be. While it is true that PepsiCo has nearly $6 of debt for every dollar of equity, and Coke has slightly more than $3 of debt for every dollar of equity, such relationship can and do change over time. Thus, it would be appropriate to do a comparative analysis of each company’s debt measures over several years (a minimum of 5 years) and then assess the overall trend of each company and their relationship to each other. It is also important to note the differing operating characteristics of each company. Even two highly correlated companies like Coca-Cola and PepsiCo have their differences. For instance, PepsiCo is more diversified than Coca-Cola due to its ownership of several other beverage and food service companies (such as Frito Lay and Quaker Oats), whereas Coca-Cola is more highly concentrated in carbonated beverages. Such differences in the mix of industries served by each company may possibly impact the extent to which each company relies on debt for new capital formation. In any event, profitability analysis (using ROI and ROE) can give important signals concerning financial leverage measures (debt and debt/equity). The opposite is also true (which could easily be demonstrated by reversing the order of parts a and c in this case). That is, the more leveraged a firm is, the greater would be the expected magnification of ROE relative to ROI.

C11.21. a. Note to Instructor: Although students are quite challenged by this case, they generally prefer not to be provided any “hints” if it is assigned as an individual take-home case. If it is used as an in-class group-learning case, you should be careful to monitor the progress of each group to make sure that the “star” students don’t do all of the work—otherwise, the case may lose its effectiveness for many students. After about 10-15 minutes, walk students through the solution to part a up to a certain point, or provide some hints based on their questions, and then allow additional time for them to complete part a. Part b can be assigned as take-home work if time runs short. It may also be interesting to have each group explain the sequence of steps they used in solving the case, and to then compare the different approaches taken.

Instructor’s Manual / Solutions Manual C11.21. (continued) a.

WHITTAKER, INC. Income Statement For the Year Ended December 31, 2023 Sales……………………...…………………………………………………….. Cost of goods sold………………...…………………………………………… Gross profit………………………..…………………………………………… Operating expenses…………………..………………………………………… Income from operations ……………..………………………………………… Interest expense ……………………….………………………………….…… Income before taxes…………………………………..………………….…….. Income taxes (20%) …………………………………..……………………….. Net income …………………………………………..…………………………

$680,000 (408,000) $272,000 (183,000) $ 89,000 (20,000) $ 69,000 (13,800) $ 55,200

WHITTAKER, INC. Balance Sheet December 31, 2023 Current assets: Cash…………………………………………………………………………… $148,000 Accounts receivable, net……………………………………………………… 86,000 Inventory……………………………………………………………………… 108,000 Total current assets ………………………………………………………… $342,000 Property, plant, and equipment, net……………………………………………. 138,000 Total assets…………………………………………………………………….. $480,000 Current liabilities………………………………………………………….…… Bonds payable, 15% …………………………………………………………… Total liabilities………………………………………………………………... Stockholders’ equity: Common stock, $2 par value ………………………………………………… Additional paid-in capital………………………………………………….…. Retained earnings…………………………………………………………….. Total stockholders’ equity …………………………………………………. Total liabilities and stockholders’ equity……………………………………….

$180,000 140,000 $320,000 $ 20,000 30,000 110,000 $160,000 $480,000

Solution approach: Complete the balance sheet first. There are a variety of ways of working through the problem, but the balance sheet can be completed rather easily (except that it takes some effort to separate cash from accounts receivable). Enough information is given so that the solution can be approached from many different angles and it is not necessary to follow a lock-step pattern to get the correct results. One possible sequence of steps: 1. Current ratio = 1.9 to 1, so current assets of $342,000 / 1.9 = $180,000 current liabilities. 2. Current liabilities + Bonds payable = $180,000 + $140,000 = $320,000 total liabilities.

Instructor’s Manual / Solutions Manual C11.21. (continued, additional steps) a. 3. Inventory accounts for the difference between the current ratio of 1.9 and the acid-test ratio of 1.3, so Inventory = (0.6 * current liabilities) = 0.6 * $180,000 = $108,000. 4. Debt/equity ratio = 2.0 to 1, so total liabilities of $320,000 / 2 = $160,000 total stockholders’ equity. 5. Total liabilities + total stockholders’ equity = $320,000 + $160,000 = $480,000 total liabilities and stockholders’ equity. Thus, total assets = $480,000. 6. Retained earnings can now be determined by subtraction = $160,000 - $20,000 - $30,000 = $110,000. 7. Property, plant, and equipment, net can be determined in a similar manner = $480,000 - $342,000 = $138,000. 8. Total current assets = $342,000 - $108,000 of inventory = $234,000, which represents the sum of Cash + Accounts receivable. Using the Accounts receivable information, the beginning balance of $114,000 minus cash collections in excess of credit sales during the year of $28,000 = $86,000 ending balance. 9. Thus, Cash = $234,000 - $86,000 = $148,000. 10. Average accounts receivable = ($114,000 + $86,000) / 2 = $100,000, so Sales = $100,000 * 6.8 accounts receivable turnover = $680,000. 11. Average inventory = ($96,000 + $108,000) / 2 = $102,000, so Cost of goods sold = $102,000 * 4.0 inventory turnover = $408,000. Alternatively, cost of goods sold = Sales * (1 - 40% gross profit ratio) = $680,000 * 60% = $408,000. 12. Gross profit = Sales * 40% = $680,000 * 40% = $272,000. Alternatively, gross profit = Sales - Cost of goods sold = $680,000 - $408,000 = $272,000. 13. Interest expense can be calculated as follows: ($20,000 face amount * 15% * 8/12 = $2,000 interest expense) + ($120,000 face amount * 15% = $18,000 interest expense). Thus, total Interest expense = $2,000 + $18,000 = $20,000. 14. Times interest earned = 4.45 * $20,000 = $89,000 income from operations. 15. Operating expenses can now be determined by subtraction = $272,000 gross profit - $89,000 income from operations = $183,000. 16. Income before taxes can be determined in a similar manner = $89,000 income from operations - $20,000 interest expense = $69,000.

Instructor’s Manual / Solutions Manual C11.21. (continued, additional steps) a. 17. Income taxes = $69,000 income before taxes * 20% = $13,800. 18. Net income = $69,000 income before taxes - $13,800 income taxes = $55,200. b. Current ratio = Current assets / Current liabilities = $342,000 / $180,000 = 1.9 Acid-test ratio = (Cash + Accounts receivable) / Current liabilities = ($148,000 + 86,000) / $180,000 = 1.3 Debt/Equity ratio = Total liabilities / Total stockholders’ equity = $320,000 / $160,000 = 2.0 Inventory turnover = Cost of goods sold / Average inventories = $408,000 / (($96,000 + $108,000) / 2) = $408,000 / $102,000 = 4.0 times Accounts receivable turnover = Sales / Average accounts receivable = $680,000 / (($114,000 + $86,000) / 2) = $680,000 / $100,000 = 6.8 times Times interest earned = Earnings before interest and taxes / Interest expense = $89,000 / $20,000 = 4.45 times Gross profit ratio = Gross profit / Sales = $272,000 / $680,000 = 40% Return on investment = Net income / Average total assets = $55,200 / (($440,000 + $480,000) / 2) = $55,200 / $460,000 = 12% Note that the beginning total assets in the above calculation can be determined by solving for the missing amount in the statement of retained earnings, as follows: Beginning total assets, January 1, 2023…….…………... + Net income for the year ………………………….…… - Dividends declared and paid during the year…………. Ending total assets, December 31, 2023…….…………..

? 55,200 (15,200) $480,000

Earnings per share = Net income / Weighted-average number of common shares outstanding = $55,200 / 10,000 shares outstanding = $5.52 Note that the weighted-average number of common shares outstanding in the above calculation can be determined as follows: $20,000 common stock / $2 par value per share = 10,000 shares outstanding at December 31, 2023. Since no common stock was issued during 2023 and the company does not have any treasury stock, this also represents the January 1, 2023 shares outstanding.

Instructor’s Manual / Solutions Manual C11.22. a. The other required financial statements in addition to the income statement and balance sheet are the statement of cash flows and statement of changes in stockholders’ equity (or the statement of retained earnings). The statement of cash flows discloses the reporting entity’s cash provided (or used) by operating, investing, and financing activities. This statement provides relevant information about the cash receipts and cash payments, and shows why the Cash position on the balance sheet changed from the beginning to the end of the period. The statement of changes in stockholders’ equity explains the changes during the period in the major elements of stockholders’ equity such as common stock, preferred stock, additional paid-in capital, and retained earnings, including the impact of net income and dividends. b. The note disclosures that should be provided by Gerrard Construction Co., include the following: significant accounting policies (such as depreciation methods used, inventory valuation methods used, and basis of consolidation), as well as notes that disclose the company’s effective income tax rate, details of the company’s employee benefit, pension and post-retirement plans, earnings per share, contingencies and commitments, the effects of accounting changes, and events subsequent to the balance sheet (if any). Notes disclosures are an integral part of the financial statements because they provide relevant and reliable information to users of the financial statements to help them make informed decisions and judgments. c. 1. Accounts receivable turnover = Net revenues / Average accounts receivable = $96,600,000 / (($24,600,000 + $29,400,000) / 2) = 3.6 times 2. Average day's sales = ($96,600,000 annual net revenues / 365 days) = $264,658 Number of days' sales in accounts receivable = ($29,400,000 accounts receivable / $264,658 average day's sales) = 111.1 days d. 1. Debt ratio = Total liabilities / (Total Liabilities + Total stockholders’ equity) = ($4,500,000 + $4,800,000 + $142,500,000) / $270,000,000 = $151,800,000 / $270,000,000 = 0.562 or 56.2% 2. Debt/equity ratio = Total Liabilities / Total stockholders’ equity = ($4,500,000 + $4,800,000 + $142,500,000) / ($30,000,000 + $88,200,000) = $151,800,000 / $118,200,000 = 1.284 or 128.4%

Instructor’s Manual / Solutions Manual C11.22. (continued) e. By entering into a long-term capital lease of $12 million, Gerrard Construction Co. would be increasing its assets (capital lease assets are treated as part of property, plant, and equipment) and its liabilities by an equal amount, with no effect in stockholders’ equity. Thus, both the debt ratio and the debt/equity ratio would increase. Although not required, the debt ratio would be: ($151,800,000 + $12,000,000) / ($270,000,000 + $12,000,000) $163,800,000 / $282,000,000 = 0.581 or 58.1% The debt/equity ratio would be: ($151,800,000 + $12,000,000) / ($30,000,000 + $88,200,000) $163,800,000 / $118,200,000 = 1.386 or 138.6% f. The answer to C4.32. i. indicates that dividends declared and paid during the year ended December 31, 2023 were $1,500,000. 1. Earnings per share of common stock = Net income / Average number of common shares outstanding = $21,900,000 / 4,800,000 = $4.56 2. Price/earnings ratio = ($57.50 Market value per common share / $4.56 Earnings per share of common stock) = 12.6 3. Dividends per share of common stock = ($1,500,000 Annual dividends declared / 4,800,000 Average number of shares outstanding) = $0.31 Dividend yield = ($0.31 Dividends per share / $57.50 Market value per common = 0.5% 4. Dividend payout ratio = ($0.31 Dividends per share / $4.56 Earnings per share of common stock) = 6.8%

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 11

NAME______________________

Note to Instructor: Use or adapt these questions for an annual report or set of financial statements that you provide to students. Be sure to include information concerning dividends, earnings per share, and the year-end market price per share. Require students to prepare an investment recommendation about the company's common stock. There are attached the financial statements and ___-year summary from the 20__ Annual Report of ______________________________. Liquidity: 1. Calculate the company's working capital, current ratio, and acid-test ratio at [balance sheet dates]. 2. Based on the results of your analysis above, assess the company's overall liquidity position. Explain which ratios indicate particular strengths and/or weaknesses. Assume the following industry averages: Working capital = varies in proportion to firm size; Current ratio = 2.0; Acid-test ratio = 1.6. 3. Explain how working capital and the current ratio are related. Would you expect firms with large amounts of working capital to always have high current ratios? Profitability: 4. Calculate ROI, showing margin and turnover, for 20__, 20__, and 20__. 5. Calculate ROE for as many of the past three years as you can. 6. Calculate the price/earnings ratio for as many of the past three years as you can. 7. Calculate the dividend payout and dividend yield ratios for as many of the past three years as you can. 8. Based on the results of your analysis above, assess the company's overall profitability. Explain which ratios indicate particular strengths and/or weaknesses within the company. Assume the following industry averages: ROI = 15%; Margin = 10%; Turnover = 1.5; ROE = 20%; Price/earnings = 14.0; Dividend payout = 40%; Dividend yield = 5%. 9. As an investor in this company's stock, would you be pleased with this year's dividend yield? How would your dividend yield "expectations" change, if at all, if the company's ROI was 5% higher? Explain.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 11 (continued) Financial Leverage: 10. Calculate the debt ratio (total liabilities to total liabilities and stockholders' equity), and the debt/equity ratio (total liabilities to total stockholders' equity) at_________________, 20__ 11. Based on the results of your analysis above, assess the company's overall leverage position. What would you estimate the industry averages to be for the debt ratio and debt/equity ratio? Explain. 12. Explain the relationship between ROI and ROE, and the concept of financial leverage. Would you expect the percentage difference between ROI and ROE to be high or low for a firm that has a high degree of financial leverage? Activity measures: 13. Calculate the accounts receivable turnover and the number of days' sales in accounts receivable (based on a 365-day year) for the year ended ______________________, 20__. 14. Based on your analysis above, do you believe that the company is doing an effective job at managing accounts receivable? What would you estimate the industry averages to be for accounts receivable turnover and the number of days' sales in accounts receivable? Explain. 15. Calculate the inventory turnover and the number of days' sales in inventory (based on a 365day year) for the year ended _____________________, 20__. 16. Based on your analysis above, to what extent does the company need to be concerned about its inventory management policies? In assessing inventory management policies, would you be more interested in knowing current ratio or acid-test ratio information? Explain. Overall assessment: 17. Assume that you have $5,000 that you would like to invest in the common stock of a company. Evaluate the common stock of ____________________________ as a potential investment. From the data available on the attached financial statements, identify the five most important criteria that you would use to make your investment decision, and explain why each is important.

Instructor’s Manual / Solutions Manual

CHAPTER

Managerial Accounting and Cost-Volume-Profit Relationships

CHAPTER OUTLINE: I. Managerial Accounting Contrasted to Financial Accounting A. The Management Process 1. Variety of firm's objectives 2. Planning and Control B. Differences Between Financial and Managerial Accounting 1. Future orientation 2. Breadth of focus 3. Application of Generally Accepted Accounting Principles II. Cost Classifications A. Relationship of Cost to Volume of Activity 1. Cost behavior patterns a. Variable cost b. Fixed cost c. Mixed cost 2. Variable costs as activity changes a. Change in total as activity changes b. Constant per unit 3. Fixed costs as activity changes a. Fixed in total as activity changes b. Fixed per unit - never unitize fixed costs! III. Applications of Cost-Volume-Profit Analysis A. Cost Behavior Pattern: The Key 1. Assumptions a. Relevant range b. Linearity B. Estimating Cost Behavior Patterns 1. Scattergram 2. High-low method 3. Cost formula

Instructor’s Manual / Solutions Manual CHAPTER OUTLINE (continued) IV. Contribution Margin A. Contribution Margin Format Income Statement 1. Functional cost categories reclassified to cost behavior categories 2. Analyzing impact of volume changes on net income B. Expanded Contribution Margin Model 1. Use of model to answer "what if" questions C. Contribution Margin Ratio 1. Determine the change in contribution margin and net income for a change in revenues 2. Determine the revenue increase needed to cover an increase in fixed expenses 3. Used when per unit revenue and variable expense data are not available D. Sales Mix 1. Average contribution margin ratio E. Break-Even Point Analysis 1. Sales volume in units and/or dollars 2. Graphical presentation F. Operating Leverage 1. Indifference point

TEACHING/LEARNING OBJECTIVES: Primary: To have the student understand: 1. The differences between financial accounting and managerial accounting. 2. Some of the terminology of managerial accounting, and to emphasize that there are different costs for different purposes. 3. The difference between variable costs and fixed costs, and that unitizing fixed costs may lead to erroneous conclusions. 4. To have the student understand that a cost formula for total cost recognizes variable costs per unit of activity and fixed costs in total. 5. To have the student understand and be able to use the expanded contribution margin model to determine the impact of cost, selling price, and volume changes on operating income. Supporting: To have the student understand: 6. The management planning and control process. 7. The assumptions related to cost behavior pattern classification. 8. The definition of, and distinction between, fixed and variable cost behavior patterns.

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES (continued) 9. The simplifying assumptions of linearity and relevant range. 10. The high-low method of separating a mixed cost into its variable rate and fixed amount. 11. How to use the contribution margin ratio to make cost-volume-profit calculations. 12. The sales mix concept. 13. Break-even point analysis. 14. The concept of operating leverage.

TEACHING OBSERVATIONS: 1. This material marks a "new beginning," and this point should be emphasized to students. In addition to the new jargon, an internal planning and decision-making viewpoint is taken, rather than the external, historical reporting viewpoint of financial accounting. 2. This is the cornerstone chapter in the managerial accounting section of the text. The "big picture" perspectives of the Planning and Control Cycle and the Cost Classification models should be presented as an overview now and it will be reinforced as each new managerial accounting chapter is developed. Try to help students sort out the key ideas that must be learned now, from those that they should be acquainted with which will really be learned when subsequent material is covered. 3. To emphasize the significance of cost behavior pattern knowledge, describe a nonsense decision that did not recognize cost behavior. For example, a university established a checkcashing fee by dividing business office expenses for a week (almost all fixed) by the number of students' checks cashed in a week. If students had been aware of this study, what would they have done? They would have organized a check-cashing marathon to increase the volume of checks cashed during the week. 4. Another effective approach to emphasizing cost behavior knowledge is to compare the intuitive impact of a 10% change in sales volume on operating income using the traditional income statement format (where operating income would also change by 10%) and then the contribution margin format. In the latter approach, contribution margin changes by 10%, fixed expenses don't change, and operating income changes by more than 10%. This also illustrates the concept of operating leverage. Problem P12.22 can be used for this illustration. 5. Use the expanded contribution margin model and exercise E12.14 and problems P12.24 and P12.26 to build proficiency in using the model.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: NO. M12.1 M12.2

LEARNING OBJECTIVES 3,5 6

DIFFICULTY & TIME ESTIMATE Easy, 5-8 min. Med., 10-15 min.

M12.3

Easy, 5-8 min.

M12.4

Med., 10-15 min.

M12.5 M12.6 M12.7 M12.8

9,11 9, 10, 11 9, 10, 11 12

Easy, 5-8 min. Med., 10-15 min. Med., 10-15 min. Med., 10-15 min.

E12.9 E12.10 E12.11

3 3 3

Easy, 3-5 min. Easy, 3-5 min. Easy, 5-8 min.

E12.12 E12.13

3 7,9

Easy, 7-10 min. Hard, 7-10 min.

E12.14 E12.15

7,9 8,9

Hard, 7-10 min. Med., 5-8 min.

E12.16

8,9,10,11

Med., 10-15 min.

E12.17 E12.18

8,9 8,9

Easy, 5-8 min. Easy, 5-8 min.

P12.19 P12.20 P12.21

6 6 7,8,9

Easy, 5-8 min. Easy, 5-8 min. Med., 10-15 min.

P12.22 P12.23 P12.24 P12.25

7,8,9,12 7,8,9,11 7,8,9,11 7,8,9,10

Med., 10-15 min. Med., 10-12 min. Med., 10-12 min. Med., 15-20 min.

P12.26 P12.27

7,8,9,10,11 7,8,9,10,11

Med., 15-20 min. Med., 15-20 min.

P12.28 P12.29

8,9,10,11 8,9,11

Med., 15-20 min. Med., 12-18 min.

P12.30

8,9,11,12

Med., 12-18 min.

OTHER COMMENTS Introduction to cost behavior and use of cost formula. Uses sales compensation to illustrate high-low method and calculation of sales salary (fixed amount) and sales commission (variable rate). Straight-forward preparation of contribution format income statement. Good working example of using CVP Analysis model to solve for unknown amounts by understanding CVP relationships. Basic Break-even and Margin of safety calculations. CVP calculations using multiple products. CVP analysis of a shift in sales mix. This exercise emphasizes the indifference point and the comparative cost structure relationships of two companies. Straight-forward. Good in-class exercise. CAN BE USED LATER as a Chapter 15 assignment (Flexible Budgeting). See 12.11. Tell students to focus on the CVP relationships represented in this problem to solve for ‘missing pieces of the puzzle.’ Many students will have difficulty with the math, and should be told not to sweat the details—the purpose is to help build their understanding of CVP relationships / vocabulary. See 12.13. Group learning problem. Good in-class exercise. Emphasize the managerial benefits of using the CVP analysis in terms of cost planning and control. Emphasize the importance of understanding sales mix relationships when a company sells several of its products in related markets. Straight-forward and fun—students enjoy this problem. See 12.17. Concentrate on the qualitative factors that are so often overlooked in CVP decisions. Straight-forward. Good in-class exercise. Good in-class demonstration exercise. Walk students through the answers using the expanded contribution margin model. See 12.21. Good homework assignment. Straight-forward problem. See 12.23. Good in-class demonstration problem. Potpourri of CVP applications. Use the expanded contribution model to demonstrate how easy it is to answer “what if” questions. See 12.25. Group learning problem. Emphasize the importance of gathering appropriate information in making CVP estimates. After reviewing the answers, ask students, “How do companies estimate their selling price per unit, variable cost per unit, fixed costs, and sales volume?” Budgeting will be discussed in Chapter 14. Good homework assignment. This problem can be used to stress the importance of operating leverage. See 12.29. Group learning problem. 12-4

Instructor’s Manual / Solutions Manual C12.31 C12.32

8,9,11 5,8,9

Easy, 5-8 min. Med., 7-10 min.

C12.33 C12.34

12 12

Hard, 10-15 min. Med., 30-40 min.

C12.35

Med., 60-90 min.

Can be used to highlight corporate social responsibility issues. Group learning problem. Can be used as a short in-class writing assignment / quiz. Can be used as an in-class writing assignment. Students should review Exhibit 12.21 before attempting this problem. Internet case. Introduces students to CVP tools available on the Internet for use in breakeven analysis and CVP decisions.

SOLUTIONS: M12.1. Cost formula: Total cost = Fixed cost + Variable cost = ($1,600 + 4,000 + 2,400) + ($8.40 + 32.00 + 13.60 + 3.60 + 6.40) per unit = $8,000 + $64 per unit Total cost expected for 2,000 units of activity: Total cost = $8,000 + ($64 x 2,000 units) = $8,000 + $128,000 = $136,000 M12.2. Monthly sales compensation: Total compensation = Sales salary + Sales commission = Sales salary + (Commission rate * Volume) Commission rate = (High $ - Low $) / (High units - Low units) = ($24,000 - $18,000) / (3,000 - 2,000) = $6,000 / 1,000 = $6.00 per unit Total compensation $24,000 ? -OR$18,000 ?

= Sales salary + Sales commission = ? + ($6.00 * 3,000 units) = $6,000 = ? + ($6.00 * 2,000 units) = $6,000

Total compensation = Sales salary + Sales commission = $6,000 + $6.00 per unit Units sold for the year: $168,000 = $168,000 = $96,000 = ? = ? =

($6,000 * 12 months) + ($6.00 per unit sold) $72,000 + ($6.00 * ?) $6.00 * ? $96,000 / $6 per unit 16,000 units

Instructor’s Manual / Solutions Manual M12.3. EASTERN IMPORTS, INC. August Income Statement Contribution Margin Format Revenues ($30 * 12,000 units) ……………….… Variable expenses ($15 * 12,000 units) ………… Contribution margin …………………………….. Fixed expenses ………………………………….. Operating income …..……………………………

$360,000 180,000 $180,000 120,000 $ 60,000

M12.4. Use the model, enter the known data, and solve for the unknown.

Revenue Variable expense Contribution margin Fixed expense Operating income

Per Unit * $120.00 ? $? *

Volume

Total

? (250,000) $ 74,000

% 100% ? 30%

Solution approach: Contribution margin per unit = ($120 * 30%) = $36.00 Variable expense per unit = ($120.00 - $36.00) = $84.00 Current sales units: Total contribution margin = ($250,000 + $74,000) = $324,000 Total contribution margin divided by the contribution margin per unit = units sold $324,000 / $36.00 = 9,000 units Additional sales units to achieve $110,000 operating income: Required operating income – Current operating income = Additional operating income $110,000 – $74,000 = $36,000 Additional operating income / Contribution margin per unit = Additional units required $36,000 / $36.00 = 1,000 additional units

Instructor’s Manual / Solutions Manual M12.5. Break-even units = Fixed expenses / Contribution margin per unit = $250,000 / $36 = 6,944 units Break-even dollars = Fixed expenses / Contribution margin ratio = $250,000 / 30% = $833,333 Margin of safety = Current sales – Break-even sales = ($120 * 9,000 units) – $833,333 = $246,667 Margin of safety ratio = Margin of safety / Current sales = $246,667 / $1,080,000 = 22.8% M12.6. Operating results for May: Total contribution margin = sales volume * contribution margin ratio Product A = $400,000 * 30% Product B = $600,000 * 60% Total contribution margin Less fixed expenses Operating income

Total $120,000 360,000 $480,000 300,000 $180,000

Average CM ratio = Total contribution margin / Total sales = $480,000 / $1,000,000 = 48% Break-even volume = Fixed expenses / Average CM ratio = $300,000 / 48% = $625,000 M12.7. Operating results for June: Total contribution margin = sales volume * contribution margin ratio Product A = $500,000 * 30% Product B = $500,000 * 60% Total contribution margin Less fixed expenses Operating income

Total $150,000 300,000 $450,000 300,000 $150,000

Average CM ratio = Total contribution margin / Total sales = $450,000 / $1,000,000 = 45%

Instructor’s Manual / Solutions Manual M12.7.

(continued) Break-even volume = Fixed expenses / Average CM ratio = $300,000 / 45% = $666,667 Because of the shift in sales mix, $100,000 of sales shifting from the more profitable Product B (CM ratio = 60%) to the less profitable Product A (CM ratio = 30%), Mix Inc., experienced a $30,000 decrease in total contribution margin and operating income, as well as a 3% decrease in the Average CM ratio. Also notice the $41,667 increase in the break-even volume now required because of the shift in sales mix experienced in June.

M12.8. Cost Structure – Company X = Cost Structure – Company Z Fixed costs + (Variable cost/unit * Volume) = Fixed costs + (Variable cost/unit * Volume) $1,350,000 + ($37 per unit * Volume) $35 per unit * Volume Volume Indifference Point Volume Proof @ 15,000 units: Revenue Variable Expense Contribution margin Fixed expense Operating income

= = = =

$825,000 + ($72 per unit * Volume) $525,000 $525,000 / $35 per unit 15,000 units

Company X ($140) $2,100,000 ($37) (555,000) ($103) $1,545,000 (1,350,000) $ 195,000

Company Z ($140) $2,100,000 ($72) (1,080,000) ($68) $1,020,000 (825,000) $ 195,000

Company X has significantly more operating leverage than does Company Z because its fixed costs are much higher ($1,350,000 versus $825,000) and its contribution margin is also much higher ($103 versus $68). Thus, if sales increase by 20% over the next two years, Company X will benefit proportionately more than Company Z because Company X’s cost structure is riskier. E12.9. Wages of assembly-line workers …………………… Depreciation--office equipment …………………… Glue and fasteners…………………………………… Delivery costs.………………………….…………… Raw materials handling costs ……………………… Salary of marketing manager …….………………… Production run setup costs ………………………… Plant utilities………………………………………… Electricity cost of manufacturing plant ..…………… Research and development expenses ………………

Variable x _____ x x x _____ x x x x

Fixed _____ x _____ _____ _____ x _____ x x x

Note: The last three items are each likely to have a mixed cost behavior pattern.

Instructor’s Manual / Solutions Manual E12.10. Raw materials ……………………………………… Tape used to secure packed boxes of product ……… Plant janitors' wages………………………………… Inventory clerks' wages……...……………………… Advertising expenses ……………………………… Production workers' wages ………………………… Production supervisors' salaries …………………… Sales force commissions …………………………… Office supplies used ……...………………………… Controller’s salary …………….…………………… Electricity cost ……………………………………… Real estate taxes for plant …………………………… Real estate taxes for office building …………………

Variable x x x x _____ x _____ x x _____ x _____ _____

Fixed _____ _____ x _____ x _____ x _____ _____ x x x x

Note: Janitors' wages and electricity probably have mixed cost behavior patterns. E12.11. a. Total cost = ($580 fixed cost + ($0.40 variable cost per mile * 2,256 miles)) = $1,482.40 b. No, it would not be meaningful to calculate an average cost per mile, because that would involve unitizing the fixed expenses, and they do not behave on a per mile basis. Whatever average cost per mile was calculated would be valid only for the number of miles used in the calculation. An average cost for any other number of miles driven would be different, because the fixed expenses per mile would decrease for each additional mile driven. E12.12. a. Cost Element Raw materials ($20,800 / 4,000 = $5.20 per unit) ...… Factory depreciation expense …………… Direct labor ($49,600 / 4,000 = $12.40 per unit) ……. Production supervisor’s salary…………… Computer rental expense………………… Maintenance supplies used ($600 / 4,000 = $0.15) Total cost ($48,600 + $17.75 per unit) ……………

Probable Cost Behavior Pattern Variable Fixed Variable Fixed Fixed Variable

March 4,000 units (Actual) $ 20,800 40,500 49,600 5,000 3,100 600 $119,600

April 5,600 units (Estimated) $ 29,120 40,500 69,440 5,000 3,100 840 $148,000

b. Average total cost per unit produced in March = $119,600 / 4,000 = $29.90 per unit. It would not be meaningful to use this average total cost figure to predict the cost in subsequent months; that would involve unitizing the fixed expenses—and they do not behave on a per unit basis. Average total cost per unit calculations are only valid for the number of units used in the calculation. An average total cost for any other number of units produced would be different because the fixed expenses per unit would decrease for each additional unit produced. Using the average total cost of $29.90 to estimate the cost of producing 5,600 units in April would give an estimate of $167,440, which is significantly higher than the $148,000 shown in part a above using a cost formula: Total cost = $48,600 fixed cost + $17.75 per unit variable cost. 12-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual E12.13.

Note to Student: The purpose of this assignment is to help you to build an understanding of cost-volume-profit relationships by solving for the ‘missing pieces of the puzzles.’ In this regard, it may be helpful to insert a Contribution Margin column or to rearrange the data using the expanded contribution margin model.

Answer: Firm A Firm B Firm C Firm D

Sales $160,000 1,310,000 134,000 36,800

Variable Costs $108,800 969,400 80,400 29,440

Contribution Margin Ratio 32% 26% 40% 20%

Fixed Operating Costs Income (Loss) $32,100 $19,100 236,000 104,600 73,400 (19,800) 9,835 (2,475)

Calculations: Firm A VC = Sales * (1 - CM%) = $160,000 * 68% = $108,800 CM = Sales - VC = $160,000 - $108,800 = $51,200 or CM = Sales * CM% = $160,000 * 32% = $51,200 FC = CM - Operating Income = $51,200 - $19,100 = $32,100 or FC = (Sales * CM%) - Operating Income = ($160,000 * 32%) $19,100 = $32,100 Firm B CM = FC + Operating Income = $236,000 + $104,600 = $340,600 Sales = CM + VC = $340,600 + $969,400 = $1,310,000 CM% = CM / Sales = $340,600 / $1,310,000 = 26% Firm C VC = Sales * (1 - CM%) = $134,000 * 60% = $80,400 CM = Sales - VC = $134,000 - $80,400 = $53,600 or CM = Sales * CM% = $134,000 * 40% = $53,600 Operating Loss = CM - FC = $53,600 - $73,400 = $(19,800) Firm D Sales = VC / (1 - CM%) = $29,440 / 80% = $36,800 CM = Sales - VC = $36,800 - $29,440 = $7,360 or CM = Sales * CM% = $36,800 * 20% = $7,360 FC = CM + Operating (Loss) = $7,360 + $2,475 = $9,835

Instructor’s Manual / Solutions Manual E12.14.

Answer: Firm A Firm B Firm C Firm D

Units Sold 10,000 9,000 4,000 4,000

Selling Price $25.00 30.00 7.00 60.00

Variable Costs Per Unit $15.00 19.00 4.00 50.00

Contribution Margin $100,000 99,000 12,000 40,000

Fixed Costs $40,000 66,000 18,000 48,000

Operating Income (Loss) $60,000 33,000 (6,000) (8,000)

Calculations: Firm A Operating Income = CM - FC = $100,000 - $40,000 = $60,000 CM/unit = CM / Units Sold = $100,000 / 10,000 = $10.00 VC/unit = Selling Price - CM/unit = $25.00 - $10.00 = $15.00 Firm B CM = FC + Operating Income = $66,000 + $33,000 = $99,000 CM/unit = CM / Units Sold = $99,000 / 9,000 = $11.00 Selling Price = VC/unit + CM/unit = $19.00 + $11.00 = $30.00 Firm C CM/unit = Selling Price - VC/unit = $7.00 - $4.00 = $3.00 Units Sold = CM / CM/unit = $12,000 / $3.00 = 4,000 FC = CM + Operating (Loss) = $12,000 + $6,000 = $18,000 Firm D Operating (Loss) = CM - FC = $40,000 - $48,000 = $(8,000) CM/unit = CM / Units Sold = $40,000 / 4,000 = $10.00 Selling Price = VC/unit + CM/unit = $50.00 + $10.00 = $60.00 E12.15. a. Use the model, enter the known data, and solve for the unknown.

Revenue Variable Expense Contribution Margin

Per Unit * $ ? 9.00 $ ? *

Volume

Total

% 100% 75% 25%

Variable expenses = 75% of selling price. Selling price = $9.00 / 75% = $12.00 b. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $12.00 9.00 $ 3.00 *

Volume

Total

$ ? (18,000) $ 12,000

% 100% 75% 25%

Total contribution margin = ($18,000 + $12,000) = $30,000. Total contribution margin divided by the contribution margin per unit of $3.00 gives 10,000 units of the new product that would have to be sold to increase operating income by $12,000.

a. Revenue Variable Expense Contribution Margin

Per Unit * $ ? 9.52 $ ? *

Instructor’s Manual / Solutions Manual Volume = Total % 100% 68% ? = $ ? 32%

Variable expense ratio = 100% - 32% = 68% Selling price = Variable expenses / Variable expense ratio = $9.52 / 68% = $14.00 b. Note: The requirement is to determine the number of units of the new product that must be sold to break even on the new product.

Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $14.00 9.52 $ 4.48 *

Volume

Total

$ 26,880 (26,880) $ 0

% 100% 68% 32%

Break-even in units = Fixed expenses / Contribution margin per unit = $26,880 / $4.48 = 6,000 units

c. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income (loss)

New Product

Existing Products

Total

$15.50 * 16,000 = $248,000 9.52 $ 5.98 * 16,000 = $ 95,680 (26,880) $ 68,800

$375,000

$623,000

$120,000 = 32% (150,000) $ (30,000)

215,680 (176,880) $ 38,800

Average contribution margin ratio = Total contribution margin / Total sales = $215,680 / $623,000 = 34.62% d. The specific data for existing products, not known in this example, would have to be adjusted for the reduction due to volume "stolen" by the new product. This could result in a reduction of total revenue, contribution margin and operating income. The average contribution margin ratio would also change.

Instructor’s Manual / Solutions Manual E12.17. a.

Per Unit * Volume Revenue $2.20 Variable Expense 0.66 Contribution Margin $1.54 * 600 Fixed Expense Operating income from increased volume Variable expenses of 800 cones given away, @ $0.66 Net increase in operating income

Total

$ 924 (220) $ 704 (528) $ 176

% 100% 30% 70%

b. Yes. Not only does the promotion itself result in increased operating income, but also it is likely that customers will purchase some other products (e.g., food and/or beverages) on which additional contribution margin will be earned. E12.18. a. Revenue Variable Expense Contribution Margin

Per Unit * $11.99 4.00 $ 7.99 *

b. Revenue# Variable Expense Contribution Margin

$6.00 4.00 $2.00 *

Volume

Total

400

$3,196

(($11.99 price of one pizza + $0.01) / 2) = $6.00

Required volume = $3,196 / $2.00 = 1,598 pizzas. Keep in mind, however, that this represents only 799 orders (1,598 pizzas / 2 pizzas per order). c. Will customers buy other products such as drinks, salads, etc.? Will this promotion "steal" volume from large and small pizzas? If so, normal contribution margin from those products will be lost. Will fixed expenses really stay the same? P12.19. a. Solution approach: First, calculate variable cost per unit in June and use the same per unit cost for July. Second, fixed cost will be the same for each month. Third, with knowledge of total costs for July, and variable and fixed costs for July, solve for mixed costs for July. June July Activity ……………………………………… 10,000 units 16,000 units Costs: Variable ($20,000 / 10,000 units = $2 per unit) $ 20,000 $ 32,000 Fixed (same total amount each month) ……… 60,000 60,000 Mixed (Total costs - (Variable + Fixed)) …… 40,000 49,000 Total ….……………………………………… $120,000 $141,000

Instructor’s Manual / Solutions Manual P12.19. (continued) b. Variable rate

= (High $ - Low $) / (High units - Low units) = ($49,000 - $40,000) / (16,000 - 10,000) = $9,000 / 6,000 = $1.50 per unit

Total mixed cost = Fixed cost + Variable cost $49,000 = ? + ($1.50 * 16,000 units) ? = $25,000 Cost formula = Fixed cost + (Variable rate * Volume) = $25,000 + $1.50 per unit Proof at 10,000 units: Mixed cost = $25,000 + ($1.50 * 10,000 units) = $40,000 P12.20. a. Production level (units) ………………………… Costs: Variable ($24,000 / 10,000 units = $2.40 per unit) Fixed (same total amount each month) ………… Mixed (Total costs - (Variable + Fixed)) ……… Total …………………………………….………

February 10,000 units

August 20,000 units

$24,000 36,000 20,000 $80,000

$ 48,000 36,000 34,000 $118,000

Total mixed cost = (Fixed cost + Variable cost) Variable cost = (Variable rate * Volume) Variable rate = (High $ - Low $) / (High units - Low units) = ($34,000 - $20,000) / (20,000 - 10,000) = $14,000 / 10,000 = $1.40 per unit

At 10,000 units:

Variable cost Total mixed cost $20,000 Fixed

= = = =

($1.40 * 10,000 units) = $14,000 Fixed cost + Variable cost Fixed + $14,000 $6,000

At 20,000 units:

Variable cost Total mixed cost $34,000 Fixed

= = = =

($1.40 * 20,000 units) = $28,000 Fixed cost + Variable cost Fixed + $28,000 $6,000

Cost formula

= =

Fixed cost + (Variable rate * Volume) $6,000 + $1.40 per unit

At 16,000 units: Variable (16,000 units * $2.40 per unit) ………… Fixed (same total amount each month)…………… Mixed ($6,000 + (16,000 units * $1.40 per unit))… Total cost …………………………………………

$ 38,400 36,000 28,400 $102,800

d. Cost behavior pattern is linear. Relevant range does not change.

Instructor’s Manual / Solutions Manual P12.21. a. Revenues (10,000 units * $5 per unit) ………………… Variable expenses: Cost of goods sold (10,000 units * $2.60 per unit) ….... Selling expenses (10,000 unit * $0.15 per unit) …….… Administrative expenses (10,000 units * $0.25 per unit) Total variable expenses …………………………….… Contribution margin ….…………………………….… Fixed expenses: Cost of goods sold ….………………………………… Selling expenses ……………………………………… Administrative expenses…………………………….… Total fixed expenses ………….…………………….… Operating income ….………………………………….

$50,000 $26,000 1,500 2,500 30,000 $20,000 $9,000 2,300 4,700 16,000 $ 4,000

b. Contribution margin per unit = Total CM / Volume = $20,000 / 10,000 units = $2.00 Alternative approach: CM per unit = Selling price per unit - Variable expense per unit = $5.00 - $3.00 = $2.00 per unit Contribution margin ratio = CM / Revenues = $20,000 / $50,000 = 40% Alternative approach: CM ratio = CM per unit / Selling price per unit = $2.00 / $5.00 = 40% c. 1. Volume of 14,000 units: Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $5.00 3.00 $2.00 *

Volume

14,000 =

Total

$28,000 (16,000) $12,000

% 100% 60% 40%

Alternative approach: 4,000 more units sold @ $2.00 CM per unit = $8,000 increase in contribution margin and operating income. Present operating income is $4,000, so new operating income will be $12,000. 2. Volume of 6,000 units: Revenue Variable Expense Contribution Margin Fixed Expense (no change) Operating Loss

Per Unit * $5.00 3.00 $2.00 *

Volume

6,000 =

Total

$12,000 (16,000) $(4,000)

% 100% 60% 40%

Alternative approach: Operating income decreases by $8,000 (4,000 units * $2.00 contribution margin per unit) from present operating income of $4,000, causing an operating loss of $4,000.

Instructor’s Manual / Solutions Manual P12.21. (continued) d. 1. Use the contribution margin ratio of 40%. Revenue increase of $15,000 causes a $6,000 increase (40% * $15,000) in contribution margin and operating income. Operating income = $4,000 + $6,000 = $10,000 2. Revenue decrease of $13,000 causes a $5,200 decrease (40% * $13,000) in contribution margin and operating income. Operating income changes to a loss = $4,000 - $5,200 = $(1,200) P12.22. a. Revenues (18,000 units * $6.00 per unit) ...…………... Variable expenses: Cost of goods sold (18,000 units * $2.80 per unit) …... Selling expenses (18,000 units * $1.00 per unit) …...… Administrative expenses (18,000 units * $0.40 per unit) Total variable expenses ………..……..……………… Contribution margin……………………..…………… Fixed expenses: Cost of goods sold ………………….………………… Selling expenses ……………………………………… Administrative expenses……………………………… Total fixed expenses ………………………………… Operating income………………………………………

$108,000 $50,400 18,000 7,200 75,600 $ 32,400 $10,000 2,200 5,000 17,200 $ 15,200

b. Contribution margin per unit = Total contribution margin / Volume = $32,400 / 18,000 units = $1.80 per unit Alternative approach: Contribution margin per unit = Selling price per unit - Variable expense per unit = $6.00 - ($2.80 + $1.00 + $0.40) = $1.80 per unit Contribution margin ratio = CM / Revenues = $32,400 / $108,000 = 30% Alternative approach: CM ratio = CM per unit / Selling price per unit = $1.80 / $6.00 = 30% c. 1. Volume of 20,000 units: Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $6.00 4.20 $1.80 *

Volume

Total

20,000

$36,000 (17,200) $18,800

Alternative approach: 2,000 more units sold @ $1.80 contribution margin per unit = $3,600 increase in contribution margin and operating income. Present operating income is $15,200, so new operating income will be $18,800.

Instructor’s Manual / Solutions Manual P12.22.

(continued) 2. Volume of 10,000 units: Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $6.00 4.20 $1.80 *

Volume

Total

10,000

$18,000 (17,200) $ 800

Alternative approach: Operating income decreases by $14,400 (8,000 units * $1.80 contribution margin per unit) from present operating income of $15,200 to $800. d. 1. Use the contribution margin ratio of 30%. Revenue increase of $15,000 causes a $4,500 increase (30% * $15,000) in contribution margin and operating income. Operating income = $15,200 + $4,500 = $19,700 2. Revenue decrease of $10,000 causes a $3,000 decrease (30% * $10,000) in contribution margin and operating income. Operating income = $15,200 $3,000 = $12,200 P12.23. a. Sales …………………………………………………………………… Variable expenses (75% * $130,000) …………………………………. Contribution margin (25% * $130,000) ………………………………. Fixed expenses ………………………………………………………… Operating loss ………………………………………………………….

$130,000 (97,500) $ 32,500 (36,000) $ (3,500)

Note: Operating loss remains the same, so Fixed expenses = $36,000 ($32,500 Contribution margin + $3,500 Operating loss). b. Increase in sales (10% * $130,000) …………………………………… Contribution margin ratio ………………………………………….…. Increase in contribution margin ………………………………………. Previous operating loss ………………………………………………. Adjusted operating loss ……………………………………………….

$13,000 25% $ 3,250 (3,500) $ (250)

Operating loss = $(3,500) + $3,250 = $(250). The increase in contribution margin is also a decrease in the operating loss, because fixed expenses do not change. c. At break-even, contribution margin = fixed expenses = $36,000 Contribution margin = (25% contribution margin ratio * ??? sales) = $36,000 Sales = ($36,000 fixed expenses / 25% CM ratio) = $144,000 at break-even.

Instructor’s Manual / Solutions Manual P12.24. a. Sales …………………………………………………………………… Variable expenses (70% * $100,000) …………………………….…… Contribution margin (30% * $100,000) ……….…….………………… Fixed expenses ………………………………………………………… Operating income ………………………………………………………

$100,000 (70,000) $ 30,000 (21,000) $ 9,000

Note: Operating income remains the same, so Fixed expenses = $21,000 ($30,000 Contribution margin - $9,000 Operating income). b. Increase in sales (10% * $100,000) ...…………………………………... Contribution margin ratio …………………………………….………… Increase in contribution margin……………………………….………… Previous operating income……………………………………………… Adjusted operating income………………………………………………

$10,000 30% $ 3,000 9,000 $12,000

Operating income = $9,000 + $3,000 = $12,000. The increase in contribution margin is also the increase in operating income, because fixed expenses do not change. c. At break-even, contribution margin = fixed expenses = $21,000 Contribution margin = (30% contribution margin ratio * ??? sales) = $21,000 Sales = ($21,000 fixed expenses / 30% CM ratio) = $70,000 at break-even. P12.25. a.

Per Unit * $18 12 $ 6 *

Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Volume

Total

$ 36,000 (36,000) $ 0

At the break-even point, total contribution margin must equal total fixed expenses. Break-even volume = ($6 contribution margin per unit * ??? volume) = $36,000 Thus, break-even volume = 6,000 units Total revenue = (6,000 units * $18 per unit) = $108,000 Alternative approach: $36,000 / 33.33% contribution margin ratio = $108,000 b. Margin of safety = Total sales – Break-even sales = $120,000 - $108,000 = $12,000 Margin of safety ratio = Margin of safety / Total sales = $12,000 / $120,000 = 10%

Instructor’s Manual / Solutions Manual P12.25. (continued) c. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income d. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $18 12 $6 *

Volume

Total

7,200

$43,200 (36,000) $ 7,200

Per Unit * $16 12 $4 *

Volume

Total

12,000

$48,000 (36,000) $12,000

e. Does the increase in volume move fixed expenses into a new relevant range? Are variable expenses really linear? f.

Per Unit * $19 12 $7 *

Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Volume

Total

7,200

$50,400 (41,000) $ 9,400

Yes, the increase in advertising expense is justified by the price increase as Operating Income has increased by $2,200 (from $7,200 to $9,400). g. 1. Volume of 7,200 units per month: Revenue Variable Expense Contribution Margin Fixed Expense# Operating Income

Per Unit * $18.00 13.00 $ 5.00 *

Volume

Total

7,200

$36,000 (31,000) $ 5,000

Current fixed expenses………………………………………………… Decrease in fixed expenses (2 salespersons @ $3,000) ….…………… Increase in fixed expenses (2 salespersons @ $500) ….……………… Adjusted fixed expenses ………………………………………………

$36,000 (6,000) 1,000 $31,000

2. Volume of 8,000 units per month: Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $18.00 13.00 $ 5.00 *

Volume

Total

8,000

$40,000 (31,000) $ 9,000

Instructor’s Manual / Solutions Manual P12.25. (continued) Per Unit * $18 12 $6 *

h. Revenue Variable Expense Contribution Margin Fixed Expense ($36,000 + $1,200) Operating Income

Volume

Total

8,000

$48,000 (37,200) $10,800

The sales force compensation plan changes in part g results in $1,800 ($9,000 versus $10,800) less operating income than does the plan to increase advertising in part h. P12.26. a.

Per Unit * $42.00 27.30 $14.70 *

Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Volume

Total

4,450

$65,415 (65,415) $ 0

Break-even volume = ($65,415 fixed expenses / $14.70 CM per unit) = 4,450 units b. Margin of safety = Total sales – Break-even sales = $220,000 - $186,900 ($42 * 4,450 = $186,900) = $33,100 Margin of safety ratio = Margin of safety / Total sales = $33,100 / $220,000 = 15.05% (rounded) c. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income d. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

e. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $42.00 27.30 $14.70 *

Volume

Total

5,000

$73,500 (65,415) $ 8,085

Per Unit * $45.00 27.30 $17.70 *

Volume

Total

5,400

$95,580 (73,415) $22,165

Original $42.00 27.30 $14.70 * 5,000 = $73,500

New Product $20 14 $ 6 * 4,000 = $24,000

Total

$97,500 (83,000) $14,500

Instructor’s Manual / Solutions Manual P12.26.

(continued)

f. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Original $42.00 27.30 $14.70 * 4,000 = $58,800

New Product $20 14 $ 6 * 5,000 = $30,000

Total

$88,800 (83,000) $ 5,800

g. The contribution margin ratio for each product is different, so that changes in the sales mix result in a change in total contribution margin. Specifically, in this case, a shift occurred such that a larger proportion of the mix consisted of the newer, lower margin product. P12.27. a. & b. Current Operation: Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Large $2,000 * 1,000 = $2,000,000 800 $1,200 * 1,000 = $1,200,000

Small $1,200 * 2,000 = $2,400,000 700 $ 500 * 2,000 = $1,000,000

Total $4,400,000 ________ $2,200,000 (700,000) $1,500,000

Total contribution margin = $1,200,000 + $1,000,000 = $2,200,000 Average contribution margin ratio = $2,200,000 / $4,400,000 = 50% Operating income = $2,200,000 - $700,000 = $1,500,000 c. Break-even point in sales dollars = Fixed expenses / Contribution margin ratio = $700,000 / 50% = $1,400,000 d. Because sales mix might change. For example, if the company sold only the economy model, total contribution margin would equal the economy model contribution margin ratio ($500 / $1,200 = 41.666%) multiplied by the current break-even point in sales dollars of $1,400,000, which equals $583,333. Note that this amount is less than the $700,000 of fixed expenses, so the firm would have to generate a higher sales volume to break even. The opposite would be true if the company sold only the luxury model—with a contribution margin ratio of 60% ($1,200 / $2,000), total contribution margin would be $840,000 ($1,400,000 * 60%), and the break-even point in sales dollars would fall from $1,400,000 to $1,166,667 ($700,000 fixed expenses / 60% contribution margin ratio). e. Proposed Expansion: Large Rev. VE CM FE OI

$2,000 * 600 = $1,200,000 800 $1,200 * 600 = $ 720,000

Small

Medium

$1,200 * 1,700 = $2,040,000 700 $ 500 * 1,700 = $ 850,000

$1,500 * 800 = $1,200,000 800 $ 700 * 800 = $ 560,000

Total $4,440,000 $2,130,000 (840,000) $1,290,000

Instructor’s Manual / Solutions Manual P12.27. (continued) f. No. Based on this data analysis, adding the Medium model would result in lower total operating income by $210,000 ($1,500,000 current operation versus $1,290,000 proposed). g. No. Although 200 more units of the Medium model would increase total contribution margin and operating income by $140,000 (200 units @ $ 700 CM per unit), operating income would rise only to $1,430,000, which is still less than under the current operation. P12.28. a.

MegaMuscle $140 42 30%

PowerGym $200 77 38.5%

ProForce $290 58 20%

MegaMuscle Monthly sales volume 3,000 units Selling price per unit $ 140 Sales $420,000 Total sales = $1,110,000 Monthly sales volume 3,000 units Contribution margin per unit $ 42 Contribution margin $126,000 Total contribution margin = $338,000 Overall CM ratio = Total CM / Total sales = $338,000 / $1,110,000 = 30.5% (rounded)

PowerGym 2,000 units $ 200 $400,000

ProForce 1,000 units $ 290 $290,000

2,000 units $ 77 $154,000

1,000 units $ 58 $58,000

Selling price per unit (A) Contribution margin per unit (B) Contribution margin ratio (B / A) b.

c. Break-even point = Fixed expenses / Overall CM ratio = $320,000 / 30.5% = $1,049,180 d. Operating income = Total CM - Fixed expenses = $338,000 - $320,000 = $18,000 e. The ProForce model should not be eliminated, because the contribution margin foregone would exceed the reduction in fixed expenses, as follows: Cost: Contribution margin foregone ($58 * 1,000 units) …….…… Benefit: Reduction in fixed expenses ($320,000 - $270,000) …… Net operating income foregone by eliminating ProForce model.

(58,000) $ 50,000 $ (8,000)

f. The ProForce model should be eliminated, because the reduction in fixed expenses and the increased contribution margin for the PowerGym model would exceed the contribution margin foregone, as follows: Cost: Contribution margin foregone (ProForce: $58 * 1,000 units) ……… Benefit: Increased contribution margin (PowerGym: $77 * 500 units) ...... Benefit: Reduction in fixed expenses………...…………………….……… Net benefit of eliminating ProForce model……………….………………

$(58,000) 38,500 50,000 $ 30,500

Instructor’s Manual / Solutions Manual P12.29. a. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income b. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $16 10 $ 6 *

Volume

Total

4,100

$24,600 (21,600) $ 3,000

Per Unit * $16 10 $ 6 *

Volume

Total

$21,600 (21,600) $ 0

% 100.0% 62.5% 37.5%

Break-even volume = $21,600 / $6 per unit = 3,600 units Break-even revenues = 3,600 units * $16 per unit = $57,600 c. 1. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $16 7 $ 9 *

Volume

Total

4,100

$36,900 (33,900) $ 3,000

2. Revenue Variable Expense Contribution Margin Fixed Expense Operating Income

Per Unit * $16 7 $ 9 *

Volume

Total

$33,900 (33,900) $ 0

% 100.00% 43.75% 56.25%

Break-even volume = $33,900 / $9 = 3,767 units (rounded) Break-even revenues = 3,767 units * $16 = $60,272 (rounded) 3. As sales volume moves above the break-even point, contribution margin and operating income will increase by a relatively greater amount than under the old cost structure (positive operating leverage). 4. The new cost structure has much more risk, because if sales volume declines, the impact on contribution margin and operating income will be relatively greater than under the old cost structure (negative operating leverage).

Instructor’s Manual / Solutions Manual P12.30. a. Contribution margin ratio = $356,400 / $792,000 = 45% Break-even revenues = ($260,000 fixed expenses / 45% CM ratio) = $577,778 (rounded) b. If the new machine is leased: Sales volume = 1,200 units * 125% = 1,500 units Selling price per unit = $792,000 / 1,200 units = $660 per unit Variable expenses per unit = (($435,600 / 1,200 units) - $33) = $363 - $33 = $330 per unit Contribution margin per unit = $660 - $330 = $330 per unit Contribution margin ratio = $330 / $660 = 50% Fixed expenses = $260,000 + $29,000 = $289,000 Break-even revenues = ($289,000 fixed expenses / 50% CM ratio) = $578,000 c. Revenues (1,500 units * $660 per unit) ……………….……………… Variable expenses (1,500 units * $330 per unit) ……………………… Contribution margin (1,500 units * $330 per unit) …………………… Fixed expenses ($260,000 + $29,000) …...…………………………… Operating income ……………………………………………………

$ 990,000 (495,000) $ 495,000 (289,000) $ 206,000

Note: Increase in operating income ($206,000 - $96,400) …………… Increase in operating income due to operating leverage: Operating income at 1,200 units ((1,200 * $330 per unit) - $289,000) Current operating income at 1,200 units……………………………... Increase in operating income due to operating leverage……………...

$109,600

Increase in operating income due to additional sales: (1,500 – 1,200) * $330 per unit contribution margin…………………

$107,000 96,400 $ 10,600

$ 99,000

d. Yes, the new machine should be leased. The break-even point in sales dollars remains nearly the same under both alternatives because the increase in fixed costs is offset by a decrease in variable costs, which results in an increase in the contribution margin ratio. Yet, operating income is expected to improve dramatically due to the increases in sales volume and operating leverage. The firm is already operating at a volume well beyond the break-even point, and sales are expected to increase, so there is little risk that the additional fixed costs cannot be covered.

Instructor’s Manual / Solutions Manual C12.31. Pros: 1. The sale will still generate a positive contribution margin ratio of 14% (rounded). To illustrate, assume that the normal selling price is $1.00 — which would mean that the normal variable cost is $0.60 and the normal contribution margin is $0.40. If the discount is given, the selling price will fall to $0.70 — which would mean that the contribution margin will fall to $0.10, and the contribution margin ratio will fall to 14% ($0.10 / $0.70). 2. Sweet Tooth Candy Company will generate “goodwill” with these customers and others concerned with corporate “social responsibility” issues. 3. The candy given to the children will increase brand awareness and could lead to greater sales volume in the future. 4. The Student Government Association is a positive force in the community. Cons: 1. Sweet Tooth Candy Company incurs an opportunity cost equal to the lost contribution margin if the candy could have been sold at the regular price in the ordinary course of business. 2. When other customers learn of the discounted sale, they may ask for the same special price for other “worthy organizations.” Unless Sweet Tooth Candy Company develops a policy with some limits for this sort of special pricing, the company could easily lose control of its profitability. 3. Special pricing transactions that are not based on quantity discounts may be in violation of federal price discrimination laws. Legal counsel should be consulted before agreeing to the special price. Recommendation: An appropriate corporate policy and other safeguards concerning special order pricing arrangements should be developed, and the candy should be sold at the special price. C12.32. To: Tommy From: Your Idea Person Subject: Social Hour Proposal It is recommended that a proposal be made to the restaurant manager that hors d'oeuvre prices be set at $6.00 in exchange for our organization's special promotion of the restaurant for our meetings. With a regular price of $8.00 and a 50% contribution margin ratio, the restaurant has a contribution margin of $4.00 per hors d'oeuvre and variable costs of $4.00 per hors d'oeuvre. They will still have a contribution margin of $2.00 per hors d'oeuvre at the special $6.00 per hors d'oeuvre selling price. Our group's business should not cause the restaurant's fixed expenses to move into a new relevant range even though we represent incremental business. Therefore, the concession on the hors d'oeuvre price is a fair opportunity cost for the restaurant to incur in exchange for our business and continued support.

Instructor’s Manual / Solutions Manual C12.33. a. As a firm increases operating leverage by adding more fixed expenses to its cost structure, the break-even point in terms of units and sales dollars also increases. Thus, a principal risk associated with greater operating leverage is that a decrease in sales— which leads to decreases in contribution margin, operating income, and cash flows— may result in a relatively greater inability to cover fixed expenses. Why? Because such firms have less variable costs (as a result of investment in relatively more fixed costs) leading to higher contribution margins. Therefore, for each sale lost, these firms will be losing relatively more contribution margin toward covering an already relatively inflated fixed cost pool. This larger margin loss, as it flows through to operating income, also equates to a greater decline in operating income. So in the end, even a small drop in sales volume, which doesn’t have a very material impact on a less leveraged firm, can take on significance as it materially impacts a more leveraged firm. Another risk associated with operating leverage relates to the loss of flexibility that occurs when fixed costs (e.g., robotics) are substituted for variable costs (e.g., labor). Machines cannot be laid off during the slow season. b. 1. Financial leverage relates to a firm’s use of long-term debt in its capital structure, and operating leverage relates to a firm’s use of fixed costs in its cost structure. 2. Financial leverage reflects a financing decision on the part of management—how much money to borrow and thereby how much interest expense to take on. Operating leverage reflects an operating decision on the part of management—how much machinery and equipment to invest in and thereby how much fixed expense to take on. 3. Financial leverage magnifies ROE relative to ROI. This adds risk: ROI must exceed the cost of debt (i.e., the interest rate on borrowed funds) in order for financial leverage to “pay off” for the firm. Operating leverage magnifies operating income relative to up or down movements in sales. Thus, increasing it makes a firm’s profitability relatively more volatile/riskier with respect to given changes in sales volume and places an obligation on the firm to generate enough additional sales (and contribution margin) to cover any additional fixed expenses it takes on in order for operating leverage to “pay off.” 4. With financial leverage, the magnification on ROE works both ways; the more leveraged the firm is, the more its stockholders lose as a percentage of their investment in a loss year. With operating leverage, the relatively greater magnification effect can also be seen in loss situations; the more leveraged a firm is, the greater its operating loss in a year when sales volume falls short of the breakeven point.

Instructor’s Manual / Solutions Manual C12.34. a. Step 1: Calculate the contribution margin ratio for each firm: HighTech, Inc. Sales…………………………… $420,000 100% Variable expenses……………… 84,000 20% Contribution margin…………… $336,000 80% Fixed expenses………………… 294,000 Operating income……………… $ 42,000

OldTime Co. $420,000 100% 252,000 60% $168,000 40% 126,000 $ 42,000

Step 2: Calculate the break-even point in sales dollars for each firm: Break-even sales revenue = Fixed costs / contribution margin ratio HighTech, Inc.: Break-even sales revenue = $294,000 / .80 = $367,500 OldTime Co.: Break-even sales revenue = $126,000 / .40 = $315,000 b. The break-even point for each firm is different because each firm has a different amount of fixed costs to be recovered and a different contribution margin ratio that represents the rate at which fixed costs are being recovered for each dollar of sales revenue. While the current sales of $420,000 happens to produce an equal amount of operating income ($42,000) in each firm, the relationship of fixed and variable costs in each firm determine its break-even point. c. Solution approach: Prepare all changes relative to each assumed change in sales volume. Calculate the variable expense ratio for each firm using the income statement data provided – 20% for HighTech, Inc. and 60% for OldTime Co. 1. Increase in Sales by 20% Sales……………………………………………… Variable expenses………………………………… Contribution margin……………………………… Fixed expenses…………………………………… Operating income…………………………………

HighTech, Inc. $504,000 (100,800) $403,200 (294,000) $109,200

OldTime Co. $504,000 (302,400) $201,600 (126,000) $ 75,600

2. Decrease in Sales by 20% Sales……………………………………………… Variable expenses………………………………… Contribution margin……………………………… Fixed expenses…………………………………… Operating income (loss)..…………………………

HighTech, Inc. $336,000 (67,200) $268,800 (294,000) $ (25,200)

OldTime Co. $336,000 (201,600) $134,400 (126,000) $ 8,400

Instructor’s Manual / Solutions Manual C12.34. (continued) d. 1. Operating income reported in 2022 ……………… Expected operating income with 20% sales increase. Expected increase in operating income ……………

HighTech, Inc. $ 42,000 109,200 $ 67,200

OldTime Co. $ 42,000 75,600 $ 33,600

2. Operating income reported in 2022 ……………… Expected operating income with 20% sales decrease. Expected decrease in operating income ………….…

$ 42,000 (25,200) $ 67,200

$ 42,000 8,400 $ 33,600

e. HighTech, Inc. has significantly more operating leverage than does OldTime Co. because HighTech’s fixed costs are much higher ($294,000 versus $126,000) and its contribution margin ratio is also much higher (80% versus 40%). Thus, if sales increase/decrease by 20% in 2023, HighTech, Inc. will benefit/suffer proportionately more than OldTime Co. because HighTech’s cost structure is riskier. f. Contribution margin / operating income: HighTech, Inc.: $336,000 / $42,000 = 8 times OldTime Co.: $168,000 / $42,000 = 4 times g. Expected increase in sales * (contribution margin / operating income): HighTech, Inc.: 20% * 8 = 160% OldTime Co.: 20% * 4 = 80% h. Results from (g) above * amount of 2019 operating income: HighTech, Inc.: 160% * $42,000 = $67,200 OldTime Co.: 80% * $42,000 = $33,600 i. The answer calculated in part (h) is equal to the answer calculated in part (d). The important point is that an expected change in operating income can be computed given a percentage change in sales by knowing each firm's degree of operating leverage. The degree of operating leverage is calculated by dividing a firm's total contribution margin by its operating income. The degree of operating leverage is then used to determine how much operating income will change for a given percentage change in sales as illustrated in parts (f), (g), and (h). The comparative degree of operating leverage between HighTech, Inc. and OldTime Co. illustrates how the relationship of fixed costs to variable costs in a firm's cost structure effects the speed at which operating income increases or decreases as sales volume changes.

Instructor’s Manual / Solutions Manual C12.35. Note to instructor: The purpose of this case is to illustrate some of the problem solving tools available over the Internet for certain applications like break-even analysis. At the time we were preparing this 13th Edition of What the Numbers Mean, several examples were available on web sites as identified in the problem requirements below. Our hope is that these illustrative tools will remain available for use by your students but we certainly do not control their availability as time marches on. This solution will use screen captures of the tools as they existed in February 2021. Step 1: Calculate the contribution margin for Dominic's Italian Cafe: Per Unit Sales ……………………………………………… $ 18 Variable expenses ………………………………… 6 Contribution margin ……………………………… $ 12

Percentage 100% 33% 67%

Step 2: Calculate the break-even point: Break-even point = Fixed costs / contribution margin Break-even point = $12,000 / 12 = 1,000 units a. 1. The following solution screen is from the calculators.org site:

Instructor’s Manual / Solutions Manual C12.35. (continued) a. 2. The following solution screen is from the calcxml.com site:

Instructor’s Manual / Solutions Manual C12.35. (continued) a. 3. The following solution screen is from the bplans.com site:

C12.35. (continued) a. 4. The following solution screen is from the nase.org site: 12-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

b. Clearly there is no right or wrong answer for this comparative analysis of the four illustrated tools. All tools are very simple to use and the discussion should lead to an appreciation for the design process that focuses on the ease of use, the user interface and experience, and the presentation of the results. Several tools offered extended functionality beyond the calculation of the break-even point such as solving for a target operating income and the effect of income taxes.

Instructor’s Manual / Solutions Manual C12.35. (continued) c. The following PDF Report is from the calcxml.com site. The contribution income analysis model produces an operating income of $12,000: Selling price = $18 Variable costs = $6 Units sold = 2,000 Fixed costs = $12,000

Instructor’s Manual / Solutions Manual C12.35. (continued) d. 1. The following changes used in the contribution income analysis model to produce an operating income of $9,420: Selling price = $16.20 ($18 * .90) [NOTE: Solution PDF Report rounds to $16] Variable costs = $6 (no change) Units sold = 2,100 (2,000 * 1.05) Fixed costs = $12,000 (no change)

Instructor’s Manual / Solutions Manual C12.35. (continued) d. 2. The following changes used in the contribution income analysis model to produce an operating income of $10,400: Selling price = $20 (given) Variable costs = $6 (no change) Units sold = 1,600 (2,000 * .80) Fixed costs = $12,000 (no change)

Instructor’s Manual / Solutions Manual C12.35. (continued) d. 3. The following changes used in the contribution income analysis model to produce an operating income of $10,000: Sales Price = $18 (no change) Variable costs = $8 (given) Units sold = 2,200 (given) Fixed costs = $12,000 (no change)

Instructor’s Manual / Solutions Manual C12.35. (continued) d. 4. The following changes used in the contribution income analysis model to produce an operating income of $11,000: Selling price = $18 (no change) Variable costs = $5 (given) Units sold = 2,000 (no change) Fixed costs = $15,000 (given)

Instructor’s Manual / Solutions Manual C12.35. (continued) e. To: Dominic From: Your Cost-Volume-Profit Analysis Person Subject: Analysis Results It is recommended that you keep the selling price for the gourmet pizza line at $18 per pizza with the related cost structure of variable costs at $6 per pizza and $12,000 in fixed costs. With sales initially predicted at 2,000 pizzas per month, operating income will be $12,000. As you can see from the graphical analysis and related break-even summaries, the various options that resulted in changes to selling price, sales volume, variable costs, and fixed costs each produced different contribution margin ratios and break-even points but no option produced $12,000 or more in operating income. The key to this decision is the estimate of the monthly pizza sales because item d, option 2 actually provides an attractive cost structure with a higher contribution margin ratio and the lowest break-even point, but the estimated lower sales volume more than offsets those advantages. Item d, option 4 will provide the greatest operating leverage, but again lacks sufficient sales volume. The following table summarizes the results of my analysis. Please let me know if you have any questions.

Option: Initial expectation (Item c) Item d. Option 1 Item d. Option 2 Item d. Option 3 Item d. Option 4

Contribution Margin Ratio 67% 63% 70% 56% 72%

Monthly Break-even Point in Pizzas 1,000 1,176 857 1,200 1,153

Operating Income $12,000 $ 9,420 $10,400 $10,000 $11,000

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 12

NAME______________________

1. A university's meal plan for students provides that 40% of a student's meal fee is made available to the student to purchase food at "cost." At the end of the term, the student receives a refund for any of this amount that has not been spent. The other 60% of the meal fee is retained by the food service operation. a. What is the cost behavior pattern assumed for the food consumed by the student? b. What is the cost behavior pattern assumed for the 60% of the meal fee retained by the food service operation? c. Give an example of three costs that are probably included in the cost behavior classification you identified in part b. d. Is this meal plan more equitable to students than one in which all of the meal fee is retained by the food service operation, and students can eat as much as they want? Explain your answer.

2. The cost of cleaning supplies used in a student-housing unit is believed to have a mixed cost behavior pattern that is a function of the number of student days the unit is occupied. For this purpose, a student day is defined as the occupancy by one student for one day. Thus, if during a given two-week period, 15 students occupied the unit for 10 days, and 16 students occupied the unit for 4 days, the total student days would be 214 (10 days * 15 students plus 4 days * 16 students). During one two-week period, there were 200 student days and the total cleaning supplies cost was $48. During another two-week period, there were 260 student days and the total cleaning supplies cost was $60. a. Using the high-low method, calculate the variable cost per student day and the fixed cost per two-week period for cleaning supplies.

b. Calculate the estimated cleaning supplies cost for a six-week period during which occupancy in the housing unit would average 16 students per day.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 12 (Continued) 3. Shown below is an income statement in the traditional format for a firm that sells a single product having a sales volume of 15,000 units. Cost formulas are also shown: Sales ………………………………………………………………… Cost of goods sold ($23,000 + $3.20 per unit) ……………………… Gross profit ………………………………………………………… Operating expenses: Selling ($9,000 + $0.82 per unit) …………………………………… Administrative ($12,800 +$0.07 per unit)…………………………… Operating income ……………………………………………………

$108,000 (71,000) $ 37,000 (21,300) (13,850) $ 1,850

a. Prepare an income statement in the contribution margin format.

b. Calculate the contribution margin per unit, and the increase in operating income if sales volume increases by 3,000 units.

c. Calculate the firm's break-even point in units.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 12 (Continued) 4. Swanson Candy Co. makes a candy bar that sells for $32 per case. Variable costs are $19.20 per case, and fixed costs total $59,520 per month. a. Calculate the number of cases of candy that must be sold each month for Swanson Candy Co. to break even.

b. Calculate operating income if 5,300 cases are sold in a month.

c. Assume that the selling price is decreased by 5%, and that selling commissions are increased by $0.05 per case. Calculate operating income if sales volume increases to 6,300 cases per month.

d. Assume that Swanson makes the changes described in part c above, and then develops a different type of packaging for the same candy bar that will permit the bar to be sold in another channel of distribution. In order to generate sales in the new channel of distribution, the selling price is dropped to $29 per case. Neither variable expenses nor fixed expenses will change. Calculate operating income if 4,500 cases of the original product and 1,800 cases of the new packaging product are sold in a month.

e. Explain why the operating income changed from part c to part d even though the same total number of units were sold.

f. Assume that the part c changes in the selling price and sales commission of the original product are made, and that 4,500 cases of the original product are sold. Calculate the number of cases of the new packaging product (see part d above) that must be sold at $29 per case in order to have operating income of $10,725.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 12 1. a. Food consumed has a variable cost behavior pattern. b. The 60% charge would be for fixed costs. c. Fixed costs include the manager's salary, depreciation, and some of the utility costs. d. Yes, it is more equitable to students because it reflects the cost behavior pattern of the food service operation's costs. 2. a. Variable rate = (High $ ─ Low $) / (High Activity ─ Low Activity) = ($60 ─ $48) / (260 student days ─ 200 student days) = $0.20 / student day Total cost = Fixed expense + Variable expense $60 = Fixed expense + ($0.20 per student day * 260 student days) $8 = Fixed Expense b. Cost formula for 2-week period: Total cost = $8 + ($0.20 * student days) 16 students per day * 14 days = 224 student days For 2 weeks, total cost = $8 + ($0.20 * 224 student days) = $52.80 For 6 weeks, total cost = ($52.80 per 2-week period * 3 periods) = $158.40 3. a. Sales …………………………………………………………… Variable expenses: Cost of goods sold (15,000 units * $3.20 per unit)…………… Selling expenses (15,000 units * $0.82 per unit) …………… Administrative expenses (15,000 units * $0.07 per unit) …… Total variable expenses………………………………………… Contribution margin …………………………………………… Fixed expenses: Cost of goods sold …………………………………………… Selling expenses ……………………………………………… Administrative expenses……………………………………… Total fixed expenses…………………………………………… Operating income ………………………………………………

$108,000 $48,000 12,300 1,050 (61,350) $ 46,650 $23,000 9,000 12,800 (44,800) $ 1,850

b. Contribution margin per unit = $46,650 / 15,000 units = $3.11 Additional contribution margin from sale of 3,000 more units = (3,000 * $ 3.11) = $9,330 New operating income = $1,850 + $9,330 = $11,180 c. At break-even, contribution margin will equal fixed expenses. Break-even volume = ($44,800 fixed expenses / $3.11 CM per unit) = 14,406 units (rounded)

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 12 (continued) 4. a. Revenue Variable Expense Contribution Margin Fixed Expense Operating income

Per Unit $32.00 19.20 $12.80

Volume

Total

$ 59,520 (59,520) $ 0 ? = 4,650 cases

b. Increased volume (5,300 cases ─ 4,650 cases) Multiplied by contribution margin per case Operating income increase above break-even c. Revenue Variable Expense Contribution Margin Fixed Expense Operating income d. CM from New Packaging: Revenue Variable Expense Contribution Margin CM from Original Packaging:

650 cases $ 12.80 $ 8,320

Per Unit $30.40 19.25 $11.15

Volume

Total

6,300

$70,245 (59,520) $10,725

Per Unit $29.00 19.25 $ 9.75

Volume

Total

1,800

$17,550

$11.15

4,500

50,175

Total contribution margin Fixed Expense Operating income

$67,725 (59,520) $ 8,205

e. Operating income dropped because the contribution margin on the new packaging product is less than the contribution margin on the original packaging product. f. The difference in operating income (under part d as compared to the original packaging only in part c) = $2,520 ($10,725 ─ $8,205). To make up for this difference and thus maintain an operating income of $10,725 per month, Swanson Candy Co. must sell an additional 259 cases (rounded) of the new packaging product per month, determined as follows: $2,520 / $9.75 (CM per case of new packaging product) = 259 additional cases of new packaging product. Thus, total operating income will remain at $10,725 if sales volume remains at 4,500 cases of the original product, and increases to 2,059 (1,800 + 259) cases of the new packaging product, per month.

Instructor’s Manual / Solutions Manual

CHAPTER

Cost Accounting and Reporting

CHAPTER OUTLINE: I. Cost Management A. Value Chain Functions II. Cost Accumulation and Assignment A. Cost Objects B. Cost Pools C. Cost Assignment III. Cost Classifications A. Cost Relationship to Product or Activity 1. Direct cost 2. Indirect cost B. Costs for Cost Accounting Purposes 1. Product costs a. Raw materials b. Direct labor c. Manufacturing overhead 2. Period costs IV. Cost Accounting Systems A. Cost Accounting Systems - General 1. Inventory accounts 2. Cost of a unit of product 3. Cost flows illustrated 4. Statement of Cost of Goods Manufactured 5. Income Statement B. Cost Accounting Systems - Job Order Costing, Process Costing, and Hybrid Costing C. Cost Accounting Methods - Absorption Costing and Direct Costing D. Cost Accounting Systems in Service Organizations E. Activity-Based Costing 1. Cost distortion 2. Activity-based management

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Primary: To have the student understand: 1. The relationship of cost accounting to financial accounting and managerial accounting. 2. An awareness of the strategic role that cost management plays in the organization’s value chain functions. 3. The difference between direct and indirect costs and the process for pooling and assigning indirect costs to cost objects. Specifically, the application of manufacturing overhead to jobs. 4. The elements of product cost, and that product costs are accounted for differently than period costs. 5. The process by which costs flow through a manufacturing environment. Supporting: To have the student understand: 6. The management planning and control process. 7. The inventory accounts of the manufacturing firm and how the value of the inventory is determined. 8. How the financial statements differ for the manufacturing firm and how the statement of costs of goods manufactured measures the results of the production activity. 9. The role of activity-based costing in the analysis and assignment of costs.

TEACHING OBSERVATIONS: 1. Students will generally understand how product costs are determined if they first have a solid understanding of the direct vs. indirect cost classifications. Use several examples of different cost objects to illustrate that a certain cost may be direct to one cost object but could become indirect as the cost object changes. These examples will help the student understand the application of manufacturing overhead to jobs. 2. Use the flow of cost model to emphasize the cost accumulation process. If students can picture how costs flow through raw material, work in process, finished goods, and cost of goods sold, they will have a better appreciation for the reporting issues concerning inventory valuation and the statement of cost of goods manufactured needed for income determination for the manufacturing firm. 3. Spend time with Problems P13.28, P13.30, and/or Case C13.31 to help students understand the elements of product cost, and the flow of costs in a manufacturing environment.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: NO. M13.1 M13.2

LEARNING OBJECTIVES 3,4 5,6

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 5-7 min.

M13.3 M13.4 M13.5 M13.6 M13.7

6 7 7 8 8

Med., 7-10 min. Easy, 5-7 min. Easy, 5-7 min Easy, 5-7 min. Med., 7-10 min.

M13.8 E13.9 E13.10 E13.11 E13.12 E13.13 E13.14 E13.15 E13.16 E13.17

9 2 2 3,4 3,4 4 4 5 5 5,6

Med., 7-10 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Med., 7-10 min. Med., 7-10 min. Med., 5-8 min.

E13.18 E13.19

5,6 5,6

Med., 7-10 min. Med., 5-8 min.

E13.20 E13.21

5,6 8

Med., 7-10 min. Med., 7-10 min.

E13.22 P13.23

8 9

Med., 7-10 min. Med., 10-12 min.

P13.24

Med., 10-15 min.

P13.25 P13.26 P13.27

8 8 4,5,7

P13.28

4,5,7

P13.29 P13.30

5,7 4,5,7

C13.31 C13.32

4,5,7 4,5,7

C13.33

5,7

Med., 7-10 min. Med., 7-10 min. Med.-Hard, 20-30 min. Med.-Hard, 20-30 min. Med., 10-12 min. Med.- Hard, 20-30 min. Hard, 15-20 min. Med.-Hard, 30-40 min. Med., 50-60 min.

C13.34

Easy, 30-40 min.

OTHER COMMENTS Brief introduction to total manufacturing costs calculation. Straight-forward predetermined overhead rate and unit cost determination. Focus is on underapplied overhead and application relationships. Introduction to statement of cost of goods manufactured. Analyzes FG inventory to solve for cost of goods manufactured. Compares variable and absorption unit cost calculations. Analyzes inventory change with variable vs absolute costing and impact on operating income. Introduces and explores activity-based costing concepts. Introduces students to activities in the organizational value chain. See 13.9. Straight-forward. Good in-class exercise. Use as an opportunity to clarify cost terminology. Good in-class exercise. Straight-forward product costing problem. See 13.15. Good in-class demonstration problem. Before working through the calculations, ask students: “Why does manufacturing overhead need to be applied using a predetermined annualized rate?” See 13.17. Good in-class demonstration problem. Use as a “warm up” problem before covering activity-based costing. Emphasize the cost-benefit trade-off of developing more precise overhead application methods. Good homework assignment. Students do not generally have trouble with the absorption costing topic if they understand the distinction between product and period costs. Emphasize the balance sheet / income statement link as shown in Exhibit 13.9. See 13.21. Straight-forward problem. Emphasize the managerial benefits of using the ABC approach in terms of cost planning and control. Group learning problem. An easy way to get students to think about the advantages/disadvantages of using the ABC approach. See 13.21. See 13.21. Emphasize the flow of product costs through the accounting system, as illustrated in Exhibit 13.12. See 13.27. Good homework assignment. Good in-class demonstration problem. Good homework assignment. Group learning problem. Group learning problem. Can also be used as a self-study / review problem. Internet case. Good group assignment using Campbell's Annual Reports at campbellsoupcompany.com to investigate the differences in reporting inventories and calculating cost of goods sold for manufacturing firms. Internet case. Writing assignment that explores SAS’s Activity Based Management product solution. 13-3

Instructor’s Manual / Solutions Manual SOLUTIONS: M13.1. Total manufacturing cost = (Direct materials + Direct labor + Manufacturing overhead)

Direct materials …….…………………………………………. Direct labor………………………………..…………………… Manufacturing overhead: Factory supplies………………………………………..……… Plant depreciation……………………………………………… Indirect labor………………………………………………...… Utilities ($20,000 x 75%)....…………………………………… Total manufacturing cost………………………………………

$ 36,000 52,000 $ 5,000 12,400 16,000 15,000

48,400 $136,400

M13.2. Predetermined overhead application rate = ($1,200,000 estimated total overhead cost / 400,000 estimated machine hours) = $3.00 per machine hour Total cost for 1,000,000 units produced: Raw materials …………………………………………………………… Direct labor ……………………………………………………………… Overhead (420,000 machine hours * $3.00 predetermined rate) ………... Total manufacturing cost…………………………………………………

$1,280,000 1,620,000 1,260,000 $4,160,000

Cost per unit = ($4,160,000 total cost / 1,000,000 units produced) = $4.16 per unit. M13.3. Actual overhead incurred …………………………………………..……… Applied overhead (? direct labor hours * $8 per direct labor hour) …....… Underapplied overhead ………….…………………………………………

$176,000 (?) $ 24,000

Applied overhead = Actual overhead incurred – Underapplied overhead = $176,000 - $24,000 = $152,000 Direct labor hours = Applied overhead / Overhead rate per direct labor hour Direct labor hours = $152,000 / $8 Direct labor hours = 19,000

Instructor’s Manual / Solutions Manual M13.4. ABC Company Statement of Cost of Goods Manufactured Raw materials: Inventory, beginning ……………………………………… Purchases ……………….………………………………… Raw materials available for use…………………………… Less: Inventory, ending….………………………………… Cost of raw materials used………………………………… Direct labor cost incurred…………………………………… Manufacturing overhead applied…...……………………..… Total manufacturing costs ………….……………… Add: Work-in-process, beginning...………….……………… Less: Work-in-process, ending…..…………..……………… Cost of goods manufactured………..………..………………

$ 12,000 54,000 66,000 (15,000) $ 51,000 54,000 30,000 $135,000 30,000 (33,000) $132,000

M13.5. Cost of Goods Sold Model: Beginning finished goods inventory …………… Plus: Cost of goods manufactured ……………... Goods available for sale ………………………... Less: Ending finished goods inventory ………… Cost of goods sold ……………………………...

$168,000 ? ? 156,000 $408,000

Calculation: $168,000 + Cost of goods manufactured – $156,000 = $408,000 Cost of goods manufactured = $396,000 M13.6. Variable Costing Raw material ………...……………………………………… $ 7.00 Direct labor………………………………………………….. 10.00 Variable overhead…………………………………………… 8.00 Fixed overhead ($240,000 / 30,000 units)…………………... Unit cost…………………………………………………….. $25.00

Absorption Costing $ 7.00 10.00 8.00 8.00 $33.00

Instructor’s Manual / Solutions Manual M13.7. Variable Costing Variable overhead…………………………………………… $ 8.00 Fixed overhead ($240,000 / 30,000 units) …………………... Manufacturing overhead cost per unit ……………………… $ 8.00

Absorption Costing $ 8.00 8.00 $16.00

Difference in Operating Income = Change in Inventory * Fixed Overhead Rate = Increase of 2,000 units * $8 per unit = $16,000 higher operating income using absorption costing versus variable costing The difference is attributable to the treatment of fixed overhead costs. With absorption costing, fixed manufacturing overhead costs are “absorbed” into the number of units produced, unit-by-unit. Therefore, when units are produced and not sold, they remain on the balance sheet as ending finished goods inventory, in this example $8 for each unit. With variable costing, all fixed overhead costs will be reported as an operating expense in the period incurred. M13.8. Activity-based costing rates for each cost driver: Activity costing rate = Budgeted cost / Budgeted activity Machining rate = $280,000 / 8,000 hours Machining rate = $35/machine hour Direct labor rate = $300,000 / 15,000 hours Direct labor rate = $20/direct labor hour Inspecting rate = $50,000 / 5,000 hours Inspecting rate = $10/inspection hour

The activity-based costing approach is likely to provide better information for manufacturing managers because overhead costs are applied based on the activities (i.e., cost drivers) that cause the incurrence of cost. In this example, one activity (direct labor time) is currently used to assign overhead to all custom bicycles produced. Yet it’s clear that much of the overhead cost, slightly less than 50% of the budgeted overhead, is attributable to other activity – machining and inspection. Since it’s likely that each custom bicycle produced will require differing amounts of machining, direct labor, and inspection, depending on the unique specification of the custom designs, ABC will more accurately associate manufacturing overhead assigned to each bicycle based on required efforts of each required activity. This improved costing accuracy will lead to more informed pricing decisions for custom bicycles.

Instructor’s Manual / Solutions Manual E13.9. Business Function a. Research & Development b. Design c. Production d. Marketing e. Distribution f. Customer Service

Cost Item 1. Purchase of raw materials 2. Advertising 3. Salary of research scientists 4. Delivery expenses 5. Reengineering of product assembly process 6. Replacement labor expense for warranty repairs 7. Manufacturing supplies 8. Sales salaries 9. Purchase of CAD (Computer Aided Design) software 10. Salary of website manager

Answer __c__ __d__ __a__ __e__

Cost Item 1. Labor time to repair products under warranty 2. Radio commercials 3. Labor costs of delivering customer orders 4. Testing of competitor's product 5. Direct manufacturing labor costs 6. Development of order tracking system for online sales 7. Design cost of new product brochures 8. Hours spent designing child-proof bottles 9. Training costs for representatives to staff the customer call center 10. Installation of robotics equipment in manufacturing plant

Answer

__b__ __f__ __c__ __d__ __b__ __d__

E13.10. Business Function a. Research & Development b. Design c. Production d. Marketing e. Distribution f. Customer Service

__f__ __d__ __e__ __a__ __c__ __e__ __d__ __b__ __f__ __c__

Instructor’s Manual / Solutions Manual E13.11.

Wages of assembly-line workers ... Depreciation-plant equipment ….. Glue and nails for production ..…. Outbound delivery expense ..…… Raw materials handling costs…… Salary of marketing manager …… Production run setup costs ……… Administrative office utilities ..…. Electricity cost of retail stores…… Research and development expenses …………………………

Product Direct Indirect x _____ _____ x _____ x _____ _____ _____ x _____ _____ _____ x _____ _____ _____ _____ _____

_____

Period _____ _____ _____ x _____ x _____ x x

Variable x _____ x x x _____ x x x

Fixed _____ x _____ _____ _____ x _____ x x

Note: The last three items are each likely to have a mixed cost behavior pattern. E13.12. Raw materials ……………...…… Tape used to secure packed boxes of product …………………….… Plant janitors' wages ……………. Inventory clerks' wages ……….… Promotional expenses …………... Production workers' wages……… Production supervisors' salaries… Sales force commissions………… Maintenance supplies used……… Controller's salary………………. Electricity cost for office building………………………….. Real estate taxes for factory ……. Real estate taxes for office building …………………………

Product Direct Indirect x _____

Period _____

Variable x

Fixed _____

_____ _____ _____ _____ x _____ _____ _____ _____

x x _____ _____ _____ x _____ x __ ___

_____ _____ x x _____ _____ x _____ x

x x x _____ x _____ x x _____

_____ x _____ x _____ x _____ _____ x

_____ _____

_____ x

x _____

x x

_____

Note: Janitors' wages and electricity probably have mixed cost behavior patterns. Electricity and real estate taxes for administrative areas would be a period cost. E13.13. a. b. c. d. e. f. g.

Raw material: cotton/ wool/ rayon used for jersey or material used for team emblems. Direct labor: wages of production-line machine operator. Variable manufacturing overhead: plant utilities costs or indirect materials (i.e., thread). Fixed manufacturing overhead: depreciation of machinery or property taxes on plant. Fixed administrative expense: salaries of administrative officers. Fixed indirect selling expense: advertising costs. Variable direct selling expense: shipping costs.

Instructor’s Manual / Solutions Manual a. b. c. d. e. f. g.

Raw material: fabric, zipper, shoulder straps. Direct labor: wages of sewing machine operator. Variable manufacturing overhead: electricity for sewing machine. Fixed manufacturing overhead: depreciation of sewing machine. Fixed administrative expense: president's salary. Fixed indirect selling expense: sales manager's salary. Variable direct selling expense: sales force commissions.

E13.15. a. Predetermined overhead application rate = ($210,000 estimated total overhead cost / 28,000 estimated direct labor hours) = $7.50 per direct labor hour b. Total cost for 250 coffee mugs produced: Raw materials …………………………………………………………… Direct labor (30 direct labor hours * $9.50 per hour) …………………… Overhead (30 direct labor hours * $7.50 predetermined rate) …...……… Total manufacturing cost...……………………………………………….

$270 285 225 $780

Cost per coffee mug produced = ($780 total cost / 250 mugs) = $3.12 per coffee mug c. Cost of coffee mugs sold = (175 mugs * $3.12 per mug) = $546 Cost of coffee mugs in inventory = (75 mugs * $3.12 per mug) = $234 E13.16. a. Predetermined overhead application rate = ($487,200 estimated total overhead cost / 33,600 estimated machine hours) = $14.50 per machine hour b. Total cost for 5,860 pair of shoes produced: Raw materials …………………………………………………………… Direct labor ……………………………………………………………… Overhead (2,840 machine hours * $14.50 predetermined rate) ………… Total manufacturing cost…………………………………………………

$28,468 28,800 41,180 $98,448

Cost per pair of shoes produced = ($98,448 total cost / 5,860 pairs produced) = $16.80 per pair c. Cost of shoes in ending inventory = (1,578 pairs * $16.80 per pair) = $26,510.40 Cost of shoes sold = (4,282 pairs sold * $16.80 per pair) = $71,937.60

Instructor’s Manual / Solutions Manual E13.17. a. 5,000 machine hours * $25.40 per machine hour = $127,000 budgeted overhead b. Actual overhead incurred ………………………………………………… Applied overhead (5,100 machine hours * $25.40 per machine hour) ……. Underapplied overhead …………………………………………………

$132,650 (129,540) $ 3,110

c. The overapplied or underapplied overhead for the year is normally transferred to cost of goods sold in the income statement. Since most products made during the year are sold during the same year, manufacturing overhead costs are assumed to relate primarily to the products sold. However, if the over- or underapplied overhead is material in dollar amount, then it may be allocated between work-in-process, finished goods, and cost of goods sold, based on the respective overhead amount included in the year-end balances. E13.18. a. $110,880 overhead applied = (Direct labor hours used * $12.00 predetermined manufacturing overhead application rate) = 9,240 direct labor hours b. Actual overhead incurred Overhead applied Overhead was overapplied by

$106,680 (110,880) $ 4,200

c. 1) Actual costs were less than anticipated when the predetermined overhead application rate was calculated, and/or 2) more hours were worked (and thus more overhead was applied) than was anticipated. d. At the end of the month, the overapplied overhead balance will be left in the manufacturing overhead account because it will probably be offset by underapplied overhead in a subsequent month. Note: The overapplied or underapplied overhead for the year is normally transferred to cost of goods sold in the income statement. See answer to E13.15 part c. E13.19. Total cost for 1,100 ties produced: Raw materials …………………………………………………………… Direct labor (150 direct labor hours)..…………………………………… Overhead applied based on raw materials ($3,900 * 150%) ……………. Overhead applied based on direct labor hours (150 hours * $6.50)...…… Total manufacturing cost…………………………………………………

$ 3,900 1,680 5,850 975 $12,405

Cost per tie produced = $12,405 / 1,100 units = $11.28 per unit (rounded)

Instructor’s Manual / Solutions Manual E13.20. a. Total cost for 1,420 toy flutes produced: Raw materials …………………………………………………………… Direct labor (36 direct labor hours) ...…...………………………………. Overhead applied based on machine hours (60 hours * $7.20) ...………. Overhead applied based on direct labor cost ($612 * 250%)……………. Total manufacturing cost…………………………………………………

$960 612 432 1,530 $3,534

Cost per toy flute produced = $3,534 / 1,420 units = $2.49 per unit (rounded) b. Ending inventory quantity = (1,420 quantity produced - 1,310 sold) = 110 units Ending inventory value = (110 units * $2.49 cost per unit) = $273.90 E13.21. a. Absorption cost per sweater ……………………………………………… Less: Fixed manufacturing overhead per sweater ($180,000 / 45,000)…… Variable cost per sweater …………………………………………………

$34.80 (4.00) $30.80

b. 6,400 sweaters * $4.00 = $25,600 more cost released to the income statement this month under absorption costing than under variable costing. Thus, cost of goods sold under variable costing will be $25,600 lower than under absorption costing. c. Total cost = Fixed cost + (variable rate * activity) = $180,000 + ($30.80 * number of sweaters) E13.22. a. Absorption cost per calculator …………………………………………… Less: Fixed manufacturing overhead per calculator ($42,500 / 12,500) …. Variable cost per calculator ………………………………………………

$11.75 (3.40) $ 8.35

b. 925 calculators * $3.40 = $3,145 less cost released to the income statement this month under absorption costing than under variable costing. Thus, operating income under variable costing will be $3,145 lower than under absorption costing. c. Total cost = Fixed cost + (variable rate * activity) = $42,500 + ($8.35/calculator * number of calculators)

Instructor’s Manual / Solutions Manual P13.23. a. Total manufacturing cost = (Direct materials + Direct labor + Manufacturing overhead) Direct materials ………………………………………………. Direct labor (120,000 hours * $22 per hour).…………………. Manufacturing overhead: Materials handling ($3.00 per part * 137,500 parts used) ……. Milling and grinding ($22.00 per machine hour * 47,500 hours) .. Assembly and inspection ($10.00 per labor hour * 120,000 hours) Testing ($6.00 per unit * 25,000 units tested) ………………… Total manufacturing cost………………………………………

$2,700,000 2,640,000 $ 412,500 1,045,000 1,200,000 150,000

2,807,500 $8,147,500

Cost per unit produced and tested = $8,147,500 / 25,000 units = $325.90 per unit b. The activity-based costing approach is likely to provide better information for manufacturing managers because overhead costs are applied based on the activities (i.e., cost drivers) that cause the incurrence of cost. Thus, management attention will be directed to the critical activities that can be controlled to improve the firm’s operating performance. ABC systems also produce more accurate product costing information, which can lead to better decision-making. P13.24. a. Total manufacturing cost = (Direct materials + Direct labor + Manufacturing overhead) Direct materials ……………….……………………………… Direct labor (14,320 hours * $18 per hour) …...……………… Manufacturing overhead: Materials handling ($0.18 per part * 74,800 parts used) …...… Cutting and lathe work ($1.50 per part * 74,800 parts used) … Assembly and inspection ($22.00 per hour * 14,320 labor hours). Total manufacturing cost………………………………………

$126,240 257,760 $ 13,464 112,200 315,040

440,704 $824,704

Cost per unit produced = $824,704 / 3,400 units = $242.56 per unit b. Predetermined overhead application rate = ($6,500,000 total budgeted overhead / 200,000 total budgeted direct labor hours) = $32.50 per direct labor hour. Based on a production level of 50,000 units, the total budgeted overhead cost was $6,500,000 (sum of the budgeted amounts for each of the three cost drivers). Total budgeted direct labor hours for the year were given as 200,000 (or divide $4,400,000 by $22.00 per direct labor hour for assembly and inspection). Manufacturing overhead applied = ($32.50 per direct labor hour * 14,320 hours) = $465,400

Instructor’s Manual / Solutions Manual P13.24.

(continued) Total manufacturing cost = (Direct materials + Direct labor + Manufacturing overhead) = $126,240 + $257,760 + $465,400 = $849,400 Cost per unit produced = $849,400 / 3,400 units = $249.82 per unit (rounded)

c. The activity-based costing approach is likely to provide better information for manufacturing managers because overhead costs are applied based on the activities that cause the incurrence of each cost. Even in this simplified situation, the advantages of an ABC system are easy to see. At 50,000 units of production, budgeted labor hours are 200,000. Thus, direct labor is expected to be 4 hours per unit produced. In the month of July, the actual results were 4.21 (rounded) labor hours per unit produced (14,320 / 3,400 units). This direct labor inefficiency caused more overhead costs to be applied in part b than were applied using the ABC approach in part a. The results of part a make more sense, because the number of parts used during July were less than budgeted. The budgeted number of parts per unit produced is 25(1), but only 22(2) parts per unit were used during the month of July (ask students to verify these parts-per-unit calculations). The results of the ABC approach in part a reflect this efficiency because overhead costs for the parts-related activities were applied based on the actual number of parts used during the month. (1) (2)

$225,000 / $0.18 = 1,250,000 parts / 50,000 units = 25 parts per unit budgeted $74,800 / 3,400 units = 22 parts per unit actual

P13.25. a. Variable manufacturing costs: Raw materials ……………………………………………………………. Direct labor ………………………………………………………………. Variable manufacturing overhead………………………………………… Total variable costs ……………………………………………………. Fixed manufacturing overhead…………………………………………… Total manufacturing costs………………………………………………

$124,200 33,000 22,500 $179,700 36,000 $215,700

Variable cost per rod = $179,700 / 30,000 = $5.99 each Absorption cost per rod = $215,700 / 30,000 = $7.19 each b. The fixed cost per rod is $7.19 - $5.99 = $1.20. This can also be computed as: $36,000 / 30,000 = $1.20. The total fixed cost associated with the 600 fishing rods in inventory is: 600 * $1.20 = $720. This amount would be included in ending inventory under absorption costing, but would be reported as an operating expense under variable costing. Thus, under variable costing, operating income would be $720 less than under absorption costing. c. Total cost = $36,000 + $5.99 per fishing rod produced. The cost of making 400 more units = 400 * $5.99 = $2,396

Instructor’s Manual / Solutions Manual

P13.26. a. Variable manufacturing costs: Raw materials ………………………….……………………………… Direct labor ………………………….………………………………… Variable manufacturing overhead…….………………………………… Total variable costs …………….….………………………………… Fixed manufacturing overhead…….….………………………………… Total manufacturing costs……….….…………………………………

$ 447,200 738,400 187,200 $1,372,800 176,800 $1,549,600

Variable cost per recorder = $1,372,800 / 52,000 = $26.40 each Absorption cost per recorder = $1,549,600 / 52,000 = $29.80 each b. The fixed cost per recorder is $29.80 - $26.40 = $3.40. This can also be computed as: $176,800 / 52,000 = $3.40. This amount would be included in ending inventory under absorption costing, but would be included as an operating expense under variable costing. Absorption Variable Cost of Goods Sold (52,000 produced – 6,800 inventory): Costing Costing 45,200 units sold * $29.80 each $1,346,960 45,200 units sold * $26.40 each $1,193,280 Operating Expense: Fixed manufacturing overhead 176,800 Total cost $1,346,960 $1,370,080 Therefore, under variable costing cost of goods sold ($1,346,960 - $1,193,280) is $153,680 lower than under absorption costing and operating income ($1,370,080 $1,346,960) would then be $23,120 lower than under absorption costing. This difference in operating income under variable costing can be identified as the fixed manufacturing overhead that remains on the balance sheet as finished goods inventory under absorption costing. The fixed manufacturing overhead associated with the 6,800 recorders in inventory is 6,800 * $3.40 = $23,120. c. Total cost = $176,800 + $26.40 per digital voice recorder produced. The cost of making 825 more recorders = 825 * $26.40 = $21,780

Instructor’s Manual / Solutions Manual P13.27. a. Raw materials ……………………………………………………………. Direct labor ………………………………………………………………. Manufacturing overhead ………………………………………………… Cost of goods manufactured ………………………………………………

$ 331,000 652,000 448,000 $1,431,000

Cost per unit = $1,431,000 / 53,000 = $27 b. Cost of goods sold = $27 * 48,000 = $1,296,000 c. The difference between cost of goods manufactured and cost of goods sold is in the finished goods inventory account on the balance sheet. Since more units were produced (53,000) than sold (48,000), the finished goods account will increase by $135,000 ($27 per unit * 5,000 units), and cost of goods sold will be $135,000 less than cost of goods manufactured. d.

MARYVILLE, INC. Absorption Income Statement For the month of June Sales …………………………………………………………………… Cost of goods sold……………………………………………………… Gross profit ……………………………………………………………. Selling and administrative expenses …………………………………… Operating income ……………………………………………………… Interest expense………………………………………………………… Income before taxes …………………………………………………… Income tax expense ……………………………………………………. Net income ……………………………………………………………..

$2,448,000 (1,296,000) $1,152,000 (461,000) $ 691,000 (91,000) $ 600,000 (180,000) $ 420,000

P13.28. a. Raw materials …………………………………………………………... Direct labor …………………………………………………………….. Manufacturing overhead ………………………………………………. Cost of goods manufactured …………………………………………….

$ 92,196 56,628 40,950 $189,774

Cost per unit = $189,774 / 3,900 = $48.66 b. Cost of goods sold = $48.66 * 2,200 = $107,052 c. The difference between cost of goods manufactured and cost of goods sold is in the finished goods inventory account on the balance sheet. Since more units were produced (3,900) than sold (2,200), the finished goods account will increase by $82,722 ($48.66 per unit * 1,700 units), and cost of goods sold will be $82,722 less than cost of goods manufactured.

Instructor’s Manual / Solutions Manual P13.28. (continued) d. GRANDSLAM, INC. Absorption Income Statement For the month of March Sales …………………………………………………………………… Cost of goods sold……………………………………………………… Gross profit ………………………………..…………………………… Selling and administrative expenses …………………………………… Operating income ……………………………………………………… Interest expense………………………………………………………… Income before taxes …….……………………………………………… Income tax expense (35%)……….………….……….………………… Net income …………...…………………………………………………

$207,060 (107,052) $ 100,008 (56,275) $ 43,733 (8,213) $ 35,520 (12,432) $ 23,088

P13.29. a. Note: This problem does not require a formal statement of cost of goods manufactured; the requirements can be solved using a "T" account approach. Raw materials: Inventory, Aug. 31 ………………………………………… Purchases during September ………………………………. Raw materials available for use …………………………… Less: Inventory, Sept. 30 ..………………………………… Cost of raw materials used………………………………… Direct labor cost incurred…………………………………… Manufacturing overhead applied …………………………… Total manufacturing costs, September ……………………… Add: Work-in-process, Aug. 31 .……………………………. Less: Work-in-process, Sept. 30 ……………………………. Cost of goods manufactured, September …………………… b. Finished goods, Aug. 31 .…………………………………… Cost of goods manufactured………………………………… Cost of goods available for sale.…………………………….. Less: Finished goods, Sept. 30 ……………………………… Cost of goods sold …………………………………………..

$ 67,000 247,800 314,800 (55,200) $ 259,600 624,400 384,600 $1,268,600 142,600 (129,600) $1,281,600 $ 94,400 1,281,600 $1,376,000 (83,800) $1,292,200

Instructor’s Manual / Solutions Manual P13.30. a.

MORRISON & COMPANY Statement of Cost of Goods Manufactured For the month of August Raw materials: Inventory, August 1 ……………………………………… Purchases during August ………………………………… Raw materials available for use…………………………… Less: Inventory, August 31………………………………… Cost of raw materials used………………………………… Direct labor cost incurred…………………………………… Manufacturing overhead applied (1)...……………………..… Total manufacturing costs, August ………….……………… Add: Work-in-process, August 1…………….……………… Less: Work-in-process, August 31 …………..……………… Cost of goods manufactured, August ………..………………

$ 27,440 66,150 93,590 (25,060) $ 68,530 82,500 137,500 $288,530 74,480 (79,760) $283,250

Cost per unit = $283,250 / 5,000 = $56.65 (1)

$82,500 / $15 = 5,500 DL hours; MOH applied = $25 * 5,500 DL hours = $137,500 b. Finished goods, August 1 ………………………………………………… Cost of goods manufactured ……………………………………………… Cost of goods available for sale…………………………………………… Less: Finished goods, August 31……..…………………………………… Cost of goods sold…………………………………………………………

$ 58,520 283,250 $341,770 (41,525) $300,245

c. The difference between cost of goods manufactured and cost of goods sold is in the finished goods inventory account on the balance sheet. Since fewer units were produced (5,000) than sold (5,300), the finished goods account will decrease by $16,995 ($56.65 per unit * 300 units), and cost of goods sold will be $16,995 more than cost of goods manufactured. d.

MORRISON & COMPANY Absorption Income Statement For the month of August Sales ……………………………………………………………………… Cost of goods sold………………………………………………………… Gross profit ……………………………..………………………………… Selling and administrative expenses ……………………………………… Operating income ………………………………………………………… Interest expense…………………………………………………………… Income before taxes ……………………….……………………………… Income tax expense (40%) ……….……..………………………………… Net income…………………………………………………………………

$413,400 (300,245) $113,155 (66,750) $ 46,405 (7,660) $ 38,745 (15,498) $ 23,247

Instructor’s Manual / Solutions Manual C13.31. Answer: Beginning raw materials inventory ………......... + Purchases of raw materials during the year……. = Raw materials available for use………………... - Ending raw materials inventory………………... = Cost of raw materials used……………………... + Direct labor costs incurred……………………... + Variable manufacturing overhead applied……... + Fixed manufacturing overhead applied ………. = Total manufacturing costs incurred …………… + Beginning work in process……………………. - Ending work in process ………………………. = Cost of goods manufactured …………………. Sales ……………………………………………. Less: Cost of goods sold: Beginning finished goods inventory……….…. + Cost of goods manufactured…………………. = Cost of goods available for sale………………. - Ending finished goods inventory……………. = Cost of goods sold……………………………. = Gross profit…………………………………… - Selling, general, and administrative expenses... = Income from operations……………………….

Firm A $ 34,000 170,000 204,000 24,000 180,000 260,000 100,000 200,000 740,000 30,000 50,000 $720,000

Firm B $ 11,500 48,000 59,500 9,000 50,500 37,500 17,000 30,000 135,000 3,500 5,500 $133,000

Firm C $ 126,000 678,000 804,000 153,000 651,000 954,000 216,000 270,000 2,091,000 57,000 48,000 $2,100,000

Firm A $960,000

Firm B $205,000

Firm C $2,733,000

60,000 720,000 780,000 100,000 680,000 280,000 136,000 $144,000

18,500 133,000 151,500 15,000 136,500 68,500 52,500 $ 16,000

183,000 2,100,000 2,283,000 144,000 2,139,000 594,000 327,000 $ 267,000

Calculations: Firm A 1) $180,000 + $24,000 = $204,000 2) $204,000 - $34,000 = $170,000 3) $740,000 - $180,000 - $260,000 - $200,000 = $100,000 4) $740,000 + $30,000 - $50,000 = $720,000 5) $60,000 + $720,000 = $780,000 6) $780,000 - $100,000 = $680,000 7) $280,000 - $136,000 = $144,000 8) $680,000 + $280,000 = $960,000

Instructor’s Manual / Solutions Manual C13.31.

(continued) Firm B 1) $59,500 - $48,000 = $11,500 2) $59,500 - $50,500 = $9,000 3) $133,000 + 5,500 - $3,500 = $135,000 4) $135,000 - $50,500 - $17,000 - $30,000 = $37,500 5) $151,500 - $133,000 = $18,500 6) $151,500 - $136,500 = $15,000 7) $205,000 - $136,500 = $68,500 8) $68,500 - $16,000 = $52,500 Firm C 1) $126,000 + $678,000 = $804,000 2) $804,000 - $153,000 = $651,000 3) $2,283,000 - $183,000 = $2,100,000 4) $2,100,000 + 48,000 - $57,000 = $2,091,000 5) $2,091,000 - $651,000 - $954,000 - $216,000 = $270,000 6) $2,283,000 - $144,000 = $2,139,000 7) $594,000 - $267,000 = $327,000 8) $594,000 + $2,139,000 = $2,733,000

C13.32. a. Predetermined fixed manufacturing overhead application rate = $312,000 / 96,000 machine hours = $3.25 per machine hour The predetermined overhead rate will be used to apply fixed manufacturing overhead to each unit produced during the year at the rate of $3.25 for each machine hour incurred. b. Graph of fixed manufacturing overhead relationships: $'s Fixed overhead assigned to production at the rate of $3.25 per machine hour $312,000

Expected fixed overhead costs

96,000 Machine Hours

Instructor’s Manual / Solutions Manual C13.32. (continued) The graph illustrates that fixed overhead costs are treated differently for planning and control purposes than for product costing purposes. For planning purposes, fixed costs are expected to total $312,000, but for product costing purposes fixed costs are unitized over some level of activity in order to allow each unit produced to absorb a share of the total fixed costs. Note that only if Custom Granite generates exactly 96,000 machine hours will the units produced exactly absorb total fixed costs of $312,000. Also notice that overhead costs are expected to be incurred even if zero machine hours are used (i.e., no production). c. Graph of variable manufacturing overhead relationships: $'s Variable overhead expected and assigned to production at the rate of $6.00 per direct labor hour

Direct Labor Hours The graph illustrates that variable overhead costs are treated similarly for planning and control purposes and for product costing purposes. Variable overhead costs are expected to be incurred at the rate of $6.00 per direct labor hour and they will also be assigned to each unit produced at the rate of $6.00 per direct labor hour. d.

Raw Materials Inventory BI 39,000 Purchases 240,000 ? Raw materials used during the year EI

27,000

Solving for the missing amount, raw materials used = $252,000 Raw material purchases and usage will differ by the amount of change in the inventory of raw material. Materials purchased in addition to any beginning inventory of raw material will represent the raw material available for use. The amount of raw materials used is determined by subtracting any ending inventory of raw material from the raw material available for use. e. Direct labor hours worked during the year = ($480,000 direct labor costs incurred / $16.00 per hour direct labor rate) = 30,000 direct labor hours Variable manufacturing overhead applied to work in process = (30,000 direct labor hours * $6 per hour) = $180,000

Instructor’s Manual / Solutions Manual C13.32. (continued) e. Yes, the applied amount of variable overhead for the year could differ from the actual amount incurred for several reasons. The cost category of variable overhead is comprised of many individual cost items such as indirect materials, some indirect labor, electricity, shop supplies, etc. The variable overhead rate of $6.00 per direct labor hour was based on an expectation of using a certain amount of each variable overhead item per direct labor hour and paying a certain amount to acquire each variable overhead item. It is possible that more or less of any variable overhead item could be used during the year compared to the quantity planned and it is also possible that Custom Granite could have paid more or less to acquire any particular variable overhead item. It is also likely that the items comprising variable overhead are not as directly associated with the use of direct labor as the overhead rate implies. f. Fixed manufacturing overhead applied to work in process = (88,000 machine hours * $3.25 per hour) = $286,000 Yes, the amount of fixed overhead applied to work in process during the year could be different from the amount actually incurred for two reasons. The cost category of fixed overhead is comprised of many individual cost items such as supervisor salaries, depreciation, property taxes, maintenance, etc. It is possible that Custom Granite could have paid more or less to acquire any particular fixed overhead item during the year. In addition, Custom Granite planned to spread fixed overhead to the units produced based on working 96,000 machine hours, and if the company incurs more or less than 96,000 machines hours, too much or too little fixed overhead will be applied to work in process. g. Analysis of the Work in Process Inventory account: Beginning balance ……………………………………………………… Add: Raw materials used ………………………..……………………… Direct labor ……………………………..………………………… Fixed manufacturing overhead applied….………………………… Variable manufacturing overhead applied………………………… Total manufacturing costs ………………….…………………………… Less: Cost of goods manufactured ……………………………………… Ending balance ………………………..…………………………………

33,000 252,000 480,000 286,000 180,000 1,231,000 ( ? ) $ 51,500

Solving for the missing amount, cost of goods manufactured = $1,179,500 h. Analysis of the Finished Goods Inventory account: Beginning balance Add: Cost of goods manufactured Less: Cost of goods sold Ending balance

$ 104,000 1,179,500 ( ? ) $ 122,000

Solving for the missing amount, cost of goods sold = $1,161,500 The cost of goods manufactured and not sold is represented by the ending balance of the finished goods inventory = $122,000 13-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual C13.32. (continued) h. "T" accounts for requirements (g) and (h): Work in Process Inventory Finished Goods Inventory BI 33,000 BI 104,000 Raw Material Used 252,000 ? 1,179,500 ? Direct Labor 480,000 Cost of Goods Manufactured Cost of Goods Sold Variable OH Applied 180,000 Fixed OH Applied 286,000 EI 122,000 EI 51,500 i. Observing the graph in requirement (b) illustrates that when Custom Granite generates less than 96,000 machine hours, it will not apply the $312,000 amount of expected fixed overhead for the year. Conversely, if Custom Granite generates more that 96,000 machine hours it will apply more than the $312,000 expected fixed overhead for the year. By generating 8,000 less machine hours than planned, Custom Granite underapplied fixed overhead costs in the amount of (8,000 MH x $3.25/MH) $26,000 to the units produced. Therefore, work in process and finished goods inventories would be understated on the balance sheet and cost of goods sold would be understated on the income statement.

Instructor’s Manual / Solutions Manual C13.33. For requirements a and b, the following information is used from the 2020, 2019, and 2018 annual reports for Campbell Soup Company (dollar amounts are expressed in millions). The student will need to recognize the relationship of the inventory amounts for work in process (which does not exist for Campbell) and finished goods and think backwards through the flow of costs model, beginning with cost of goods sold, to arrive at the answer. In addition the student will need to recognize that the ending inventory in one year becomes the beginning inventory in the next year.

Raw Material Inventory Work in Process Inventory Finished Goods Inventory Total Inventory

2020 297 0 574 871

2019 271 0 592 863

2018 478 0 721 1,199

Cost of Goods Sold

5,692

5,414

4,241

2017 377 0 525 902

a. Analysis of the Finished Goods Inventory account (working backwards): 2020 592 ? 5,692 574

Beginning balance Add: Cost of goods manufactured Less: Cost of goods sold Ending balance

2019 721 ? 5,414 592

2018 525 ? 4,241 721

Solving for the missing amount, 2020 cost of goods manufactured = $5,674 Solving for the missing amount, 2019 cost of goods manufactured = $5,285 Solving for the missing amount, 2018 cost of goods manufactured = $4,437 b. Analysis of the Work in Process Inventory account (working backwards):

Beginning balance Add: Cost of raw material + direct labor + manufacturing overhead Less: Cost of goods manufactured Ending balance

2020 0

2019 0

2018 0

? 5,674 0

? 5,285 0

? 4,437 0

Solving for the missing amount, 2020 total manufacturing cost = $5,674 Solving for the missing amount, 2019 total manufacturing cost = $5,285 Solving for the missing amount, 2018 total manufacturing cost = $4,437 Note: Campbell carries no WIP inventory and therefore, Total Manufacturing cost will always equal Cost of Goods Manufactured. Nevertheless, the solution model is illustrated here to emphasize the cost flow relationships.

Instructor’s Manual / Solutions Manual C13.33. (continued) c. The 2020 financial highlights and management discussion and analysis of financial condition and results of operations sections provide the following amounts and ratios for gross profit (Net Sales – Cost of products sold) as a percentage of net revenue for the years 2020, 2019, and 2018. Cost of sales can therefore be calculated as: 2020 2019 2018 Net sales $8,691 $8,107 $8,685 Gross profit 2,999 2,693 2,816 Net sales Cost of products sold Gross profit

100.0% 65.5% 34.5%

100.0% 66.8% 33.2%

100.0% 67.6% 32.4%

Overall trend: Overall trend: The overall trend for the three-year period of review shows ratios for cost of sales have significantly decreased and related gross profit ratios have increased in 2020 relative to 2019 and 2018. Campbell described a 1.3% increase in the gross profit ratio for 2020, while the amount of gross profit actually increased by $306 million in 2020 over 2019. It is interesting to note that for the three year period from 2018 to 2020, Campbell's sales only increased by $6 million and yet gross profit improved by $183 million indicating how powerful seemingly small increases in the gross profit ratio (0.8% in 2019 and 1.3% in 2020) can have such a dramatic dollar impact on overall gross profit performance. Campbell explains the 2020 increase in the gross profit ratio as follows: "The increase was primarily due to supply chain productivity improvements, cost savings initiatives, favorable product mix and operating leverage, partly offset by cost inflation and other supply chain costs, including the impact of COVID-19". d. Overall trend: The swing in inventory levels over the three-year period is trending downward where both raw material and finished goods inventories have decreased rather significantly. This result is very favorable especially given the declining to effectively flat sales which grew by only $6 million from 2018 to 2020. Calculating the three-year inventory turnover trend indicates impressive improvement in each year from 2018 through 2020. Calculating the day's sales in inventory for the three-year period reinforces that same pattern, an improvement in each year from 2018 through 2020. Calculations are as follows: 2020 $871 867

2019 $ 863 1,031

2018 $1,199 1,051

$5,674

$5,285

$4,437

6.54 times

5.13 times

4.22 times

$15.55

$14.48

$12.16

56.03 days

59.60 days

98.63 days

Total Inventory (above) Average Inventory [(BI + EI) / 2] Cost of Goods Sold (above) Inventory Turnover (CGS / Avg. Inv.) Average Day's CGS (CGS / 365) Days Sales in Inventory (Ending Inv. / Avg. day's CGS)

2017 $902

Instructor’s Manual / Solutions Manual

C13-34. Note to instructor: The purpose of the case is to make students aware of the practical applications of activity-based costing by having them read, summarize, compare, and communicate the results of their findings. SAS presents information about their software solution and testimonials from companies in the several industries who have successfully implemented activity-based costing. This case also serves as an excellent classroom discussion activity that allows students to share their findings and reinforce the application of activity-based costing. The following screen captures, as of February 2021, identify the source of information for required activities in parts a and b of this case. a. Activity-Based Management solution information can be found at:

Instructor’s Manual / Solutions Manual

C13.34.

(continued) Activity-Based Management solution - Fact Sheet:

Activity-Based Management solution - Product Brief:

Instructor’s Manual / Solutions Manual

C13.34.

(continued) Activity-Based Management solution – the Real Cost of Doing Business:

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 13

NAME______________________

1. Gears, Inc., manufactures a single product. During March, 6,700 units of product were manufactured, and 6,350 units of the product were sold. There were no beginning inventories. During March, the following costs were incurred: Raw Materials Direct Labor Manufacturing Overhead Selling Expenses Administrative Expenses Interest Expense

$ 76,900 132,600 64,800 46,700 19,300 9,300

a. Calculate the total cost of goods manufactured during March, and the average cost of a single unit of the product.

b. Calculate the cost of goods sold during March.

c. Calculate the ending finished goods inventory for March.

d. Where in the financial statements will the difference between the total cost of goods manufactured and cost of goods sold be classified?

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 13 1. a. Total manufacturing cost = (Direct materials + Direct labor + Manufacturing overhead) Direct materials ………………………………………………………… Direct labor ……………………………………………………………… Manufacturing overhead ………………………………………………… Total manufacturing cost# ………………………………………………

$ 76,900 132,600 64,800 $274,300

# Since there was no information about the Work in Process Inventory account, it can be assumed that there was no change in the balance of this account. Thus, the cost of goods manufactured is equal to the total manufacturing cost incurred during March. Cost per unit produced = $274,300 / 6,700 units = $40.94 per unit (rounded) b. (6,350 units sold @ $ 40.94 each) = $259,969 c. Units produced Less units sold Ending inventory

6,700 6,350 350 @ $ 40.94 each = $14,329 (rounded)

d. The difference between cost of goods manufactured and cost of goods sold will be in the Finished Goods Inventory account on the balance sheet. Since more units were produced (6,700) than sold (6,350), the Finished Goods account increased by $14,329 ($40.94 per unit * 350 units), and cost of goods sold was $14,329 less than cost of goods manufactured.

Instructor’s Manual / Solutions Manual

CHAPTER

Cost Planning

CHAPTER OUTLINE: I. Introduction A. Why Budgets are Useful B. Definition of Performance Reporting II. Cost Classifications A. Relationship of Cost to Volume of Activity 1. Variable cost 2. Fixed cost 3. Mixed cost B. According to a Time-Frame Perspective 1. Committed cost 2. Discretionary cost III. Budgeting A. The Budgeting Process in General 1. Usefulness of budgets-A function of management philosophy a. Budget as a guide to action b. Top management dictated, or participative approach 2. Starting point for budget a. Actual performance of current period b. Zero-based budgeting approach B. The Budget Time Frame 1. Single period 2. Multi-period, rolling budget 3. Different periods for different budgets C. The Budgeting Process 1. Broad assumptions about the economy, industry, and company 2. Operating budget a. Sales/revenue forecast b. Purchases/production budget c. Operating expense budget(s) d. Income statement budget

Instructor’s Manual / Solutions Manual CHAPTER OUTLINE (continued) e. Cash budget and the timing of cash receipts and cash payments f. Balance sheet budget 3. Sales forecast is the key D. Illustration of the Purchases/Production Budget 1. Using the cost of goods sold model 2. Based on gross profit ratio E. Cost of Goods Sold Budget Discussion F. Operating Expense Budget Challenges G. Budgeted Income Statement Discussion H. Illustration of the Cash Budget I. Budgeted Balance Sheet Discussion IV. Standard Costs A. Standards Defined - A Unit Budget Allowance B. Using Standard Costs 1. For planning and control 2. Focus may be on dollar amounts and/or quantities C. Developing Standards 1. Ideal (also referred to as engineered) standards 2. Attainable standards 3. Past experience standards D. Costing Products with Standard Costs 1. A budget for each component 2. Illustration of product cost development E. Other Uses of Standards V. Budgeting for Other Analytical Purposes A. Other Important Resources 1. Personnel time 2. Utilization of productive capacity B. Other Functional Areas

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Primary: To have the student understand: 1. That the sales/activity forecast is the starting point – and the key – to the entire budgeting process. 2. How knowledge of the financial accounting model integrates with the management process of budgeting. 3. That standard costs are unit budgets, and in turn, to appreciate how standards can be used in the planning and control process. Supporting: To have the student understand: 4. The significance of top management's attitude toward the budgeting process, and the impact that this attitude has on the usefulness of the budget as a tool for planning and controlling the entity's activities. 5. That different time periods may be appropriate for different budgets. 6. How individual budgets interrelate to make up the overall operating budget.

TEACHING OBSERVATIONS: 1. The reasons for and advantages of budgeting for an entity can be related to the personal budgeting that students may have done. 2. Emphasis should be placed on the usefulness of the budgeting process for planning and control, and the ways in which various component budgets are interrelated. 3. Be careful not to get caught up in the “how to” aspects of preparing budgets, or students may resort to rote memorization and fail to grasp the significance of the budgeting process and the uses of budgeted data. 4. Emphasize that standards are budgets for a single unit, and can be used to accomplish all of the objectives associated with budgets. 5. Call attention to the behavioral implications that result from the standard setting process and emphasize the importance of the perception that standards are attainable by those whose performance will be measured.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: NO. M14.1 M14.2 M14.3 M14.4 M14.5 M14.6 M14.7

LEARNING OBJECTIVES 4 4,5 4,5 6 7 7 7

DIFFICULTY & TIME ESTIMATE Easy, 7-10 min. Easy, 7-10 min. Med., 10-12 min. Med., 12-15 min. Easy, 7-10 min. Easy, 7-10 min. Easy, 10-12 min.

M14.8 E14.9

9 4,5

Easy, 7-10 min. Easy, 7-10 min.

E14.10 E14.11

4,5 5

Easy, 7-10 min. Easy, 7-10 min.

E14.12 E14.13 E14.14 E14.15

4,5 4,7 4,7 8,9

Med., 12-15 min. Easy, 5-8 min. Easy, 7-10 min. Easy, 5-8 min.

E14.16 E14.17

8,9 9,10

Med., 7-10 min. Easy, 5-8 min.

E14.18 P14.19

9,10 4,5

Med., 10-12 min. Med., 10-12 min.

P14.20

4,5

Hard, 15-20 min.

P14.21

4,7

Med., 10-15 min.

P14.22

4,7

Hard, 25-35 min.

P14.23

Med.-Hard, 20-25 min.

P14.24 P14.25

7 4,5,7

Hard, 45-60 min. Hard, 45-60 min.

P14.26

4,5,7

Hard, 45-60 min.

C14.27

Med., 15-20 min.

C14.28

Med., 30-40 min.

C14.29

Med., 30-45 min.

OTHER COMMENTS Simple forecast to create a sales budget. Basic introduction to a production budget. Purchases budget requires analysis of beginning inventory. Uses flexible budget idea to create operating expense budget. Straight-forward analysis of cash receipts. Straight-forward analysis of cash disbursements. Uses cash receipt amount determined in M14.5 and continues to complete preparation of a cash budget. Basic introduction to standard cost per unit determination. Stress that the Finished Goods account must be analyzed to prepare a production budget, and the Raw Materials account must be analyzed to prepare a purchases budget. See 14.9. Good in-class exercise. Emphasize the importance of management planning in the development of appropriate ending inventory policies. Good homework assignment. Straight-forward cash receipts budget. See 14.13. Good in-class demonstration problem. Emphasize that standards must be appropriate and fair if they are to be useful for managerial planning and control purposes. See 14.15. Good in-class exercise. Emphasize the importance of management planning and data gathering in the development of appropriate standards. Good homework assignment. The key is to calculate budgeted cost of sales for each month, using: Sales * (1 - Gross profit ratio). Group learning problem. Students have difficulty converting the “markup on cost” figures into gross profit ratios. Review the solution for possible hints/suggestions to provide them with. Walk students through the solution in class—make sure they understand the rhythm of this problem before assigning 14.22. Group learning problem. Students should review the answers to 14.21 before attempting this problem. Explain to students that the purpose of this problem is to help them to understand cash budgeting relationships—not to test their math skills. Good self-study/review problem. Group learning problem. Good homework assignment. Students should review the solution to this problem before attempting 14.26. Group learning problem. Emphasize the inter-relationships among the budgets. Good class discussion case. Students consider the challenges in the process of setting standards of performance. Internet case. This case is intended to introduce the student to the federal budget process and how it compares to the master budget process described in the chapter. Internet case. Group learning case. Good information gathering exercise and introduction to various budgeting software products.

Instructor’s Manual / Solutions Manual M14.1. Current sales (units) ......……………. Budgeted volume increase ....……… Budgeted sales (units) ....…………... Budgeted selling price ($20 * 1.05) ... Budgeted total sales ….….………….

January February 20,000 17,000 10% 10% 22,000 18,700 $ 21 $ 21 $462,000 $392,700

March 23,000 10% 25,300 $ 21 $531,300

Q1 Total 60,000 10% 66,000 $ 21 $1,386,000

M14.2. Use the cost of goods sold model, and work from the bottom up and then top down to calculate production: June July Beginning inventory…………………………..……………… 3,600 4,800 Add: Production……………………………..……………….. ? ? Goods available for sale ……………………..……………..… ? ? Less: Ending inventory (16,000 * 30%) ……..……………… (4,800) (14,000 * 30%) …..………………… (4,200) Units sold………...…………………………………………… 12,000 16,000 June: Goods available for sale = 12,000 + 4,800 = 16,800 units Production = 16,800 – 3,600 = 13,200 units July: Goods available for sale = 16,000 + 4,200 = 20,200 units Production = 20,200 – 4,800 = 15,400 units M14.3. Use the same approach as M14.2, but notice that raw material used is a function of quantity produced from the production budget. Each unit requires 3 pounds of raw material. June Beginning inventory (13,200 * 4 pounds * 20%) …….……….…… 10,560 Purchases ……………………………………………………...…… ? Raw materials available for use ………………………...…….…… ? Less: Ending inventory (15,400 * 4 pounds * 20%) …….........…… (12,320) Raw materials used in production (13,200 * 4 pounds) …….……... 52,800 Raw materials available for use = 52,800 + 12,320 = 65,120 pounds Purchases = 65,120 – 10,560 = 54,560 pounds

Instructor’s Manual / Solutions Manual M14.4. Variable Rate Budgeted sales (units)…..……………. Variable operating expenses: Sales commissions…….………….. Marketing promotions…………….. Supplies……………………………. Bad debt expense………………….. Utilities…………………………….. Total variable expense………….…... Fixed operating expenses: Salaries…………………………….. Rent………………………………... Depreciation……………………….. Advertising………………………… Utilities…………………………….. Total fixed expense……….…….…... Budgeted operating expense………….

$2.00/unit $1.00/unit $0.75/unit $0.25/unit $0.50/unit

June 12,000

July 16,000

August 14,000

$24,000 12,000 9,000 3,000 6,000 $54,000

$32,000 16,000 12,000 4,000 8,000 $72,000

$28,000 14,000 10,500 3,500 7,000 $63,000

$ 2,000 5,000 2,400 3,200 3,000 $15,600 $69,600

$ 2,000 5,000 2,400 3,200 3,000 $15,600 $87,600

$ 2,000 5,000 2,400 3,200 3,000 $15,600 $78,600

M14.5. Budgeted sales units...…..………………………. Unit selling price………………………………... Budgeted sales revenue…………………………. August collections: 35% of current month’s sales…………………. 53% of prior month’s sales……………………. 10% of second prior month’s sales……………. Total collections………………………………… M14.6 Budgeted raw material purchases ………………. August cash payments: 60% of current month’s purchases ……………. 40% of prior month’s purchases ………………. Total cash payments ...…………………………..

June 12,000 $21 $252,000

July 16,000 $21 $336,000

August 14,000 $21 $294,000 $102,900 178,080 25,200 $306,180

June $35,000

July $25,000

August $50,000 $30,000 10,000 $40,000

Instructor’s Manual / Solutions Manual M14.7. Beginning cash balance....……………………...……….……. Cash Receipts: Cash collections from sales……….………………………. Total cash available…………………………………………... Cash Disbursements: For payment of inventory purchases………………………. For payment of other manufacturing expenses………...…. For payment of operating expenses……...………………... For payment to retire bond………………………………… For payment of dividends…………………………………. Total cash disbursements……………………………………. Excess of available cash over disbursements………………… Borrowings…………………………………………………… Ending cash balance………………………………………….

August $ 22,000 306,180 $328,180 40,000 92,000 78,600 50,000 15,000 $275,600 $ 52,580 0 $ 52,580

M14.8. Raw materials (4 pounds per unit * $2 per pound) ....………….... Direct labor (0.25 hours per unit * $16 per hour) ………………… Manufacturing overhead (0.25 hours per unit * $20 per hour) …... Standard cost per unit

Cost per unit $ 8.00 4.00 5.00 $17.00

Instructor’s Manual / Solutions Manual E14.9. a. Use the cost of goods sold model, and work from the bottom up and then top down to calculate production: Beginning inventory………………………………………… Add: Production……………………………………………... Goods available for sale...…………………………………… Less: Ending inventory……………………………………… Quantity sold…………………………………………………

medallions 2,000 ? ? (1,600) 4,000

Goods available for sale = 4,000 + 1,600 = 5,600 medallions Production = 5,600 - 2,000 = 3,600 medallions b. Use the same approach but notice that quantity used is a function of quantity produced from the production budget. Each medallion requires 1/2 of a yard of ribbon. Beginning inventory………………………………………… Purchases …………………………………………………… Raw materials available for use ……………………………. Less: Ending inventory……………………………………… Raw materials used in production (1/2 * 3,600 medallions)…

yards 100 ? ? (40) 1,800

Raw materials available for use = 1,800 + 40 = 1,840 yards Purchases = 1,840 - 100 = 1,740 yards Use the cost of goods sold model, and work from the bottom up and then top down to calculate production. E14.10. a. Use the "Cost of Goods Sold" model: Beginning inventory, Finished Goods………………………. Add: Production……………………………………………... Goods available for sale……………………………………... Less: Ending inventory, Finished Goods……………………. Units sold…………………………………………………….

7,700 83,700 91,400 (10,800) 80,600

Steps: (1) Units sold based on sales forecast. (2) Ending inventory is given. (3) Goods available for sale = units sold (based on sales forecast) + ending inventory. (4) Beginning inventory is given. (5) Production = goods available - beginning inventory.

Instructor’s Manual / Solutions Manual E14.10. (continued) b. Beginning inventory, Raw Materials …………………..…… Add: Purchases……………………………………………… Raw materials available for use …………………….……… Less: Ending inventory, Raw Materials …………….……… Raw materials used in production ……………………...……

97,100 410,000 507,100 (88,600) 418,500

Steps: (1) Raw materials used in production = units produced * pounds per unit = 83,700 * 5 = 418,500 pounds (2) Ending inventory is given (3) Raw materials available for use = raw materials used in production + ending inventory (4) Beginning inventory is given (5) Purchases = raw materials available for use - beginning inventory E14.11. a. Use the raw material inventory/usage model: Beginning inventory ………………………………………… Add: Purchases ……………………………………………… Raw materials available for use …………………………….. Less: Ending inventory (25% of next quarter’s usage)……… Usage (3 ounces * number of gallons of product to be produced)...

Quarter I Quarter II 10,000 27,000 ? ? ? ? (27,000) (16,500) 60,000 108,000

Working backwards (up the model): Raw materials available for use …………………………….. Purchases (subtract beginning inventory)……………………

Quarter I Quarter II 87,000 124,500 77,000 97,500

b. Inventory provides a "cushion" for delivery delays or production needs in excess of the production forecast. E14.12. a.

July 8,400

August 9,500

September 7,800

Production forecast (analysis of finished goods inventory): Beginning inv. (80% of current month’s sales) …. 6,600 a Add: Production…………………...…………….. ? . Goods available for sale………………………..... ? Less: Ending inv. (80% of next month’s sales) .... (7,600) Number of units sold…………………………….. 8,400

7, 600 ? . ? (6,240) 9,500

6,240 ? . ? (5,920) 7,800

Sales forecast (units)

Instructor’s Manual / Solutions Manual E14.12.

(continued) Working backwards (up the model): Goods available for sale......………...…………… Production (subtract beginning inventory)…….… (a)

July 16,000 9,400

August September 15,740 13,720 8,140 7,480

Estimated beginning inventory of 6,600 units for July was given.

b. For raw materials purchases, the model is similar, but keys on the production forecast and raw materials inventory instead of the sales forecast and finished goods inventory. July 9,400 37,600

August 8,140 32,560

Purchases forecast (analysis of raw materials inventory): Beginning inv. (70% of current month’s usage) ... 26,000 b Purchases (in pounds)….………………………... ? . Raw materials available for use...……………..… ? Less: Ending inv. (70% of next month’s usage) ... (22,792) Raw materials used (in pounds)...……………..… 37,600

22,792 ? . ? (20,944) 32,560

Working backwards (up the model): Raw materials available for use...……………..… Purchases (subtract beginning inventory)...…...…

53,504 30,712

Production forecast (units)...…………….....…… Raw materials used (4 pounds per unit) ...…....…

(b)

60,392 34,392

September 7,480 29,920

Estimated beginning inventory of 26,000 pounds for July was given.

E14.13. September October November December Sales forecast………………………… $120,000 $140,000 $150,000 $175,000 Cash collections: 25% of current month’s sales ………………………………… $ 37,500 $43,750 60% of prior month’s sales …………………………………… 84,000 90,000 14% of second prior month’s sales …………………………… 16,800 19,600 Total cash collections budget ………………………………… $138,300 $153,350 E14.14. Actual sales Sales forecast

July $294,000

August $315,000

Cash collections: 40% of sales made in the current month...… 50% of prior month's sale...…………...…… 9% of second prior month's sales……….... Total cash collections…………...….………

September

October

November

$342,000

$282,000

$366,000

$136,800 157,500 26,460 $320,760

$112,800 171,000 28,350 $312,150

$146,400 141,000 30,780 $318,180

Instructor’s Manual / Solutions Manual E14.15. a. Worktype 1 (0.12 hours @ $14.70 per hour) Worktype 2 (0.24 hours @ $13.10 per hour) Worktype 3 (0.48 hours @ $23.40 per hour) Total direct labor cost per pedestal

$ 1.764 3.144 11.232 $16.140

b. No, because the engineer developed ideal standards. It is unlikely that the standards would be met in practice, and they would not provide positive motivation or result in accurate costing. E14.16. a. Costs for a "batch" of 12 quarts: Triphate solution (15 quarts @ $0.40 per quart) ……………………… Sobase granules (6 pounds @ $0.86 per pound) ……………………… Methage (3 ounces @ $1.30 per ounce) …………………...…...……... Bottles (12 @ $0.18 each) ………………………...…………………... Total cost for 12 quarts………………………………………………… Cost per quart ($17.22 / 12 quarts) ...………...……………...…………

$ 6.00 5.16 3.90 2.16 $17.22 $1.435

b. Other factors to be considered: 1. Possible cost increases during coming year. 2. Spillage / spoilage / waste in the manufacturing process. c. Expected labor costs (labor rate x estimated hours) for the most likely (or economical) production quantity would be determined, and then expressed on a per unit basis. E14.17. a. Raw material cost……………………………………………… Direct labor and variable overhead …………………………… Fixed overhead………………………………………………… Total absorption cost……………………………………………

$3.78 per bushel 0.50 per bushel 0.40 per bushel $4.68 per bushel

Each bushel yields 15 pounds of product. Cost per pound = $4.68 / 15 = $0.312 per pound b. This cost per pound is not very useful for management planning and control because it includes unitized fixed expenses, which do not behave on a per unit basis. E14.18. a. Raw materials: Sheet metal cost for 12 pads (1.5 * $0.18 cost of sheet metal for 8 pads) ... Foam pad cost for 12 pads (12 pads * $0.05 cost per pad) ...……………… Direct labor: Direct labor cost per shift: 2 workers * 8 hours each * $14 per hour = $ 224 Direct labor cost for 12 pads (($224 / 2,000 pads) * 12) ....…………………

$0.270 0.600

1.344

Instructor’s Manual / Solutions Manual E14.18.

(continued) Manufacturing overhead: Overhead cost for 12 pads (16 direct labor hours * $18 per hour / 2,000 pads) * 12. Standard absorption cost for a package of 12 pads………………………

1.728 $3.942

b. The relevant cost would exclude the fixed manufacturing overhead, which is incurred whether or not the extra pads are made. Fixed overhead from above: ((16 direct labor hours * $8 per hour) / 2,000 pads) * 12) = $0.768

Relevant cost for a package of 12 pads = $3.942 - $0.768 = $3.174 P14.19. Sales forecast ………………………………… Cost of sales @ 52% ………………………… Purchases budget: Beginning inventory ………………………… Purchases……………………………………… Cost of merchandise available for sale Less: Ending inventory (200% * next month’s cost of goods sold) …………… Cost of goods sold …………………………… Cost of merchandise available for sale = (Cost of goods sold + Ending inventory) …… Purchases = (Cost of merchandise available for sale - Beginning inventory) ….…………

March $125,000 65,000

April $110,000 57,200

$140,000 ? . ?

$114,400 ? . ?

(114,400) $ 65,000

(161,200) $ 57,200

$179,400

$218,400

$ 39,400

$104,000

May $155,000 80,600

P14.20. a. Sales – Cost of goods sold = Gross profit, or Cost of goods sold = Sales * (1 - gross profit ratio) Jewelry: Cost of goods sold = Sales * (1 – 70%) = Sales * 30% Watches: Cost of goods sold = Sales * (1 – 40%) = Sales * 60% Sales: May……..……………… June…......……………… Cost of goods sold: May……..……………… June…......………………

Jewelry $186,000 144,000

Watches $90,000 76,500

$186,000 * 0.30 = $55,800 $144,000 * 0.30 = $43,200

$90,000 * 0.60 = $54,000 $76,500 * 0.60 = $45,900

Instructor’s Manual / Solutions Manual P14.20. (continued) b. Purchases budget for May: Beginning inventory (150% of current month’s CGS) Add: Purchases……………………………………… Goods available for sale...…………………………… Less: Ending inventory (150% of next month’s CGS) Cost of goods sold ...………………………………… P14.21. a.

Jewelry $ 83,700 ? = 36,900 $120,600 (64,800) $ 55,800

Sales forecast …………………….……………………… Purchases budget………………………………………… Operating expense budget ……….………………………

July $84,000 75,600 21,000

Beginning cash ……..……………………………………

$75,000

Cash receipts: June 30 accounts receivable…...………………………… July sales…………..…………………………………….. Total cash receipts...………………...……………………

40,000 0 $40,000

Cash disbursements: June 30 accounts payable and accrued expenses...……… July purchases (70% * $75,600)…..…………………….. July operating expenses (70% * $21,000) ……..……….. Total cash disbursements ………………...………………

$ 48,000 52,920 14,700 $115,620

Ending cash………………………………………………

Watches $ 81,000 ? = 41,850 $122,850 (68,850) $ 54,000

August $108,000 88,000 25,600

(620)

b. PrimeTime Sportswear's management should try to accelerate the collection of accounts receivable, slow down the payment of accounts payable and accrued expenses, and/or negotiate a bank loan. If sales growth continues at a very high rate, the company will probably need to secure some permanent financing through sale of bonds or stock.

Instructor’s Manual / Solutions Manual P14.22. a. Sales forecast …………………………… Purchases budget………………………… Operating expense budget …..……………

August $108,000 88,000 25,600

September $136,000 97,800 28,600

Beginning cash …………..………………

(620)

$(28,720)

Cash receipts: June 30 accounts receivable …..……… July sales …….…………………… August sales ………..…………………… September sales….….…………………… Total cash receipts ….……………………

30,000 50,400 0 0 $ 80,400

0 29,400 64,800 0 $ 94,200

Cash disbursements: July purchases …………….…………….. August purchases ……..………………… September purchases .....………………… July operating expenses ……...………….. August operating expenses ….…..………. September operating expenses …...……… Total cash disbursements ………...……… Ending cash……………………...………..

$ 22,680 61,600 0 6,300 17,920 0 $108,500 $ (28,720)

October $118,000 66,200 32,200

0 26,400 68,460 0 7,680 20,020 $122,560 $ (57,080)

PrimeTime Sportswear’s prospects are not good, and it appears as though the company will soon have to declare bankruptcy because there is not enough cash being generated to pay the bills. b. Sales forecast …………………….……… Purchases budget………………………… Operating expense budget …………..……

October $118,000 66,200 32,200

November $118,000 66,200 32,200

December $118,000 66,200 32,200

Beginning cash……………………………

$(57,080)

$(44,480)

$(24,480)

Cash receipts: August sales ……………….……………. September sales …….…………………… October sales …………………….……… November sales ………………….……… Total cash receipts ……………………….

37,800 81,600 0 0 $119,400

0 47,600 70,800 0 $118,400

0 0 41,300 70,800 $112,100

Instructor’s Manual / Solutions Manual P14.22.

(continued) Cash disbursements: September purchases ……..…………… October purchases …..………………… November purchases …..……………… December purchases ..…..……………… September operating expenses ………… October operating expenses …………… November operating expenses ………… December operating expenses .………… Total cash disbursements ……………… Ending cash ……………………………

October $ 29,340 46,340 0 0 8,580 22,540 0 0 $106,800 $ (44,480)

November $ 0 19,860 46,340 0 0 9,660 22,540 0 $ 98,400 $(24,480)

December $ 0 0 19,860 46,340 0 0 9,660 22,540 $ 98,400 $(10,780)

By reviewing the summarized cash budget results shown below for the six-month budget period from July-December, it becomes clear that PrimeTime Sportswear must obtain a seasonal bank loan during July to help finance the additional cost of building up inventory levels to meet peak sales. Perhaps PrimeTime should apply for an open line of credit. Obviously, it would not be possible to actually have a negative balance in the cash account (as suggested by the budget results). Jul. Beginning cash ………… Total cash receipts …….. Total cash disbursements. Ending cash ……………

Aug.

Sep.

Oct.

Nov.

$ 75,000 $ (620) $ (28,720) $ (57,080) 40,000 78,600 94,200 119,400 (115,620) (108,500) (122,560) (106,800) $ (620) $ (28,720) $ (57,080) $ (44,480)

Dec.

$ (44,480) $ (24,480) 118,400 112,100 (98,400) (98,400) $ (24,480) $ (10,780)

Additional funds might also be sought during August and September, because budgeted cash disbursements exceed budgeted cash receipts during these months. The loan(s) could then be repaid during October, November, and December (and during subsequent months), when cash receipts are likely to exceed cash disbursements. The cash budget information would thus make it clear that: 1) a seasonal bank loan (or loans) should be taken out, and 2) the loan(s) could be repaid after the season has ended and cash receipts return to levels in excess of cash disbursements. P14.23.

Answer (and one possible numbered sequence of solving the problem): Cash balance, beginning ………… Add collections from customers … Total cash available……………

January $ 13 1. 34 47

February 9. $ 15 54 8. 69

March 10. $ 15 11. 68 83

Total $ 13 17. 156 169

Instructor’s Manual / Solutions Manual P14.23.

(continued) Less disbursements: Purchase of inventory ………… Operating expenses …………… Capital additions ………………. Payment of dividends …………. Total disbursements ………….. Excess (deficiency) of cash available over disbursements …. Borrowings …………………….. Repayments (including interest)... Cash balance, ending …………….

January 3.

25 15 17 57

(10) 25 4. $ 15 5.

February

March

Total

30 20 4 54

24 16. 12 15. 1 14. 4 41

18. 19.

79 47 22 4 152

6. 15 $ 15

42 13. 26 12. $ 16

20. 21. 22.

17 25 26 $ 16

Solution approach: 1. $47 - $13 = $34 2. $47 + 10 (deficiency of cash available) = $57 3. $57 - $15 - $17 = $25 4. Minimum month-end balance 5. $15 +10 (deficiency of cash available) = $25 6. Equal to ending cash balance for February because there were no borrowings or repayments during the month. 7. $54 - $30 - $4 = $20 8. $54 + $15 (excess of cash available) = $69 9. $69 - 54 = $15 (or $15 ending balance from January carried forward) 10. Ending cash balance from February is carried forward to beginning cash balance of March = $15 11. $83 - $15 = $68 12. Ending cash balance for the third quarter is the ending cash balance for March = $16 13. $42 - $16 = $26 (or $25,000 * .16 * 3/12 = $1,000 Interest) 14. Total dividends = $4, and no dividends were paid in January and February 15. $22 total capital additions - $17 - $4 = $1 16. $41 - $24 - $1 - $4 = $12 17. $169 - $13 = $156 18. Total purchases (across) = $25 + $30 + $24 = $79 19. Total operating, expenses (across) = $15 + $20 + $12 = $47 or $152 - $79 - $22 - $4 = $47 20. $169 - $152 = $17 21. Borrowings from January 22. Repayments in March

Instructor’s Manual / Solutions Manual P14.24. a.

SEATECH, INC. Cash Budget For the months of April, May, and June, 2022 April $ 11,200

Beginning cash balance……………………… Cash Receipts: From cash sales made in current month …..… 44,800 From credit sales made in: February …………………………….……… 35,840 March ……………………………….……… 54,600 April………………………………………… May……………………………….………… Total cash available ……………….………… $146,440 Cash Disbursements: For cost of goods sold/operating expenses incurred in: March ……………………………………… $ 18,080 April………………………………………… 70,560 May ………………………………………… June ………………………………………… For payment of note payable and interest …… 39,520 For capital expenditures……………………… 13,760 For payment of income taxes………………… For payment of dividends …………………… Total disbursements ………………………… $141,920 Ending cash balance ………………………… $ 4,520

May $ 4,520

June $ 2,480

54,400

60,800

29,400 43,680 $132,000

23,520 53,040 $139,840

$ 7,840 85,680

9,520 95,760

36,000 $129,520 $ 2,480

12,800 $118,080 $ 21,760

b. The $10,000 minimum cash balance requirement would cause the need to borrow $5,480 at the end of April and $2,040 at the end of May. Repayment of $7,520 principal and $108.33 interest would be expected to occur in June. Interest calculations are as follows: ($5,480 * 10% * 60/360 = $91.33) and ($2,040 * 10% * 30/360 = $17). The monthly cash budgets would appear as follows (revisions shown in bold): Beginning cash balance……………………… Cash Receipts: From cash sales made in current month …… From credit sales made in: February …………………………………… March ……………………………………… April………………………………………… May ………………………………………… Total cash available …………………………

April $ 11,200

May $ 10,000

June $ 10,000

44,800

54,400

60,080

35,840 54,600

$146,440

29,400 43,680 $137,480

23,520 53,040 $146,640

Instructor’s Manual / Solutions Manual P14.24.

(continued) April Cash Disbursements: For cost of goods sold/operating expenses incurred in: March ……………………………………… $ 18,080 April………………………………………… 70,560 May ………………………………………… June ………………………………………… For payment of note payable and interest …… 39,520 For capital expenditures……………………… 13,760 For payment of income taxes………………… For payment of dividends …………………… Total disbursements ………………………… $141,920 Excess (deficiency) of cash available over disbursements ……………………… Borrowings ………………………………… Repayments………………………………… Interest……………………………………… Ending cash balance ………………………

P14.25. a. Expected sales in units Selling price per unit Total sales b. Cash collections from: March sales April sales May sales June sales Total cash collections

4,520 5,480 --$ 10,000

May

June

$ 7,840 85,680

9,520 95,760

36,000 $129,520

7,960 2,040 --$ 10,000

12,800 $118,080

$ 28,560 -7,520 108 $ 20,932

April May 14,000 20,000 $50 $50 $700,000 $1,000,000

June Total 16,000 50,000 $50 $50 $800,000 $2,500,000

April $330,000a 280,000

June

$610,000

May $385,000 400,000 $785,000

Total $330,000 665,000 $550,000 950,000 320,000 320,000 $870,000 $2,265,000

(a) Sales from February and all prior months would have been fully collected (or

written off) by the end of March. Thus, the $330,000 net realizable value of accounts receivable represents the 55% of March sales that will be collected in April (12,000 units sold in March * $50 * 55% = $330,000).

Instructor’s Manual / Solutions Manual P14.25. (continued) c. Beginning inventory of finished goods …………… Units to be produced………… Goods available for sale ……. Desired ending inventory of finished goods (50% of next month’s budgeted sales) …… Quantity of goods sold ………

April

May

June

Total

7,000 17,000 24,000

10,000 18,000 28,000

8,000 17,000 25,000

7,000 52,000 59,000

(10,000) 14,000

(8,000) 20,000

(9,000) 16,000

(9,000) 50,000

Note: In the total column, the beginning and ending inventory figures represent the number of units on hand at April 1, 2022 and June 30, 2022, respectively. Thus, the “goods available for sale” line does not add across. d. Beginning inventory of raw materials ………………… Purchases of raw materials …… Raw materials available for use. Desired ending inventory of raw materials (40% of next month’s estimated usage)b …… Quantity of raw materials to be used in production d …………

April

May

June

Total

20,400 52,200 72,600

21,600 52,800 74,400

20,400 48,600 69,000

20,400 153,600 174,000

(21,600)

(20,400)

(18,000)c

(18,000)

51,000

54,000

51,000

156,000

(b) Next month’s “units to be produced” (see answer to part c) is multiplied by three

pounds to determine raw material requirements, which is then multiplied by 40%. (c) To determine the desired ending inventory of raw materials for June, the “units to be

produced” in July must be determined. This is done in the same manner as shown in the answer to part c for April, May, and June: July Beginning inventory of finished goods (carried over from June) ……… 9,000 Units to be produced …………………………………………………… 15,000 Goods available for sale………………………………………………… 24,000 Desired ending inventory of finished goods (50% of August’s sales) … (6,000) Quantity of goods sold ………………………………………………… 18,000 15,000 * 3 pounds * 40% = 18,000 (d) “Units to be produced” each month (see answer to part c) * 3 pounds per unit.

Note: In the total column, the beginning and ending inventory figures represent the number of pounds on hand at April 1, 2022 and June 30, 2022, respectively. Thus, the “raw materials available for use” line does not add across.

Instructor’s Manual / Solutions Manual P14.25. (continued) e. Cash payments for: March purchases ……………. April purchases ……………… May purchases ……………… June purchases ……………… Total cash payments …………

April $ 65,700e 313,200

$378,900

May

June

Total 65,700 391,500 $ 79,200 396,000 291,600 291,600 $370,800 $1,144,800 $

$ 78,300 316,800 $395,100

(e) Purchases from February and all prior months would have been fully paid by the end

of March. Thus, the $65,700 of expected accounts payable at March 31, 2022, represents the 20% of March purchases that will be paid for in April. Note: Each month’s “purchases of raw materials” in pounds (see answer to part d) is multiplied by $7.50 to determine the dollar amount of raw material purchases, which is then multiplied by 80% in the month of purchase and 20% in the following month to determine cash payments. P14.26. a.

October November December Total Expected sales in units ……… 24,000 28,000 40,000 92,000 Selling price per unit………… $50 $50 $50 $50 Total sales …………………… $1,200,000 $1,400,000 $2,000,000 $4,600,000

b. Cash collections from: September sales……………… October sales………………… November sales……………… December sales……………… Total cash collections ………

October November $845,000a 396,000 $780,000 462,000

December

Total $ 845,000 1,176,000 $910,000 1,372,000 660,000 660,000 $1,241,000 $1,242,000 $1,570,000 $4,053,000

(a) Sales from August and all prior months would have been fully collected (or

written off) by the end of September. Thus, the $845,000 net realizable value of accounts receivable represents the 65% of September sales that will be collected in October (26,000 units sold in September * $50 * 65% = $845,000). c. Beginning inventory of finished goods……………… Units to be produced………… Goods available for sale …… Desired ending inventory of finished goods (40% of next month’s budgeted sales) …… Quantity of goods sold ………

October

November

December

Total

9,600 25,600 35,200

11,200 32,800 44,000

16,000 31,200 47,200

9,600 89,600 99,200

(11,200) 24,000

(16,000) 28,000

(7,200) 40,000

(7,200) 92,000

Instructor’s Manual / Solutions Manual P14.26.

(continued) Note: In the total column, the beginning and ending inventory figures represent the number of units on hand at October 1, 2022 and December 31, 2022, respectively. Thus, the “goods available for sale” line does not add across.

d. Beginning inventory of raw materials …………………. Purchases of raw materials ……. Raw materials available for use... Desired ending inventory of raw materials (30% of next month’s estimated usage)b…… Quantity of raw materials to be used in production d ………….

October

November

December

Total

38,400 138,800 177,200

49,200 161,600 210,800

46,800 137,400 184,200

38,400 437,800 476,200

(49,200)

(46,800)

(28,200)c

(28,200)

128,000

164,000

156,000

448,000

(b) Next month’s “units to be produced” (see answer to part c) is multiplied by five

pounds to determine raw material requirements, which is then multiplied by 30%. (c) To determine the desired ending inventory of raw materials for December, the

“units to be produced” in January must be determined. This is done in the same manner as shown in the answer to part c for October, November, and December: Beginning inventory of finished goods (carried over from December)… Units to be produced …………………………………………………… Goods available for sale………………………………………………… Desired ending inventory of finished goods (40% of February’s sales)... Quantity of goods sold ………………………………………….………

January 7,200 18,800 26,000 (8,000) 18,000

18,800 * 5 pounds * 30% = 28,200 (d) “Units to be produced” each month (see answer to part c) * 5 pounds per unit.

Note: In the total column, the beginning and ending inventory figures represent the number of pounds on hand at October 1, 2022 and December 31, 2022, respectively. Thus, the “raw materials available for use” line does not add across. e. Cash payments for: September purchases………… October purchases…………… November purchases………… December purchases………… Total cash payments…………

October November $126,600e 416,400 $138,800 484,800 $543,000

$623,600

December

Total $ 126,600 555,200 $161,600 646,400 412,200 412,200 $573,800 $1,740,400

Instructor’s Manual / Solutions Manual P14.26.

(continued) (e) Purchases from August and all prior months would have been fully paid by the end of September. Thus, the $126,600 of expected accounts payable at September 30, 2022, represents the 25% of September purchases that will be paid for in October. Note: Each month’s “purchases of raw materials” in pounds (see answer to part d) is multiplied by $4.00 to determine the dollar amount of raw material purchases, which is then multiplied by 75% in the month of purchase and 25% in the following month to determine cash payments.

C14.27. a. 10,000 impressions per hour: This level of activity represents an ideal standard, sometimes referred to as an "engineering" standard, and assumes that operating conditions will be ideal and that material and labor inputs will be at maximum levels of efficiency at all times. • Pro: would result in the lowest standard cost per impression and any resulting unfavorable variance would indicate the cost of not achieving ideal conditions. • Con: the standard is unrealistic and the unfavorable variances generated will not motivate supervisors and employees to achieve the performance target. 9,000 impressions per hour: This level of activity represents an attainable standard recognizing that there will be some operating inefficiencies relative to ideal conditions that exist in general throughout CPGI's printing operations. • Pro: represents a more legitimate goal as actual performance could result in favorable as well as unfavorable variances. Employees are more likely to be motivated to achieve this standard than the ideal standard. • Con: while the standard is used realistically throughout CPGI's printing operation, it does not consider the unique differences in the nature of work and quality results that Pierre must provide his customers. Running jobs at this faster speed could result in more job waste, lower overall job quality, and dissatisfied customers. 8,000 impressions per hour: This level of activity also represents an attainable standard recognizing that there will be some operating inefficiencies relative to ideal conditions that exist in general throughout CPGI's printing operations in addition to the more specialized work that Pierre's jobs require. • Pro: represents a more legitimate goal for Pierre's employees because it considers the unique differences in the nature of work and quality results that Pierre must provide his customers. Actual performance could result in favorable as well as unfavorable variances and press operators are more likely to be motivated to achieve this standard than the ideal standard or the companywide attainable standard of 9,000 impressions per hour. • Con: none of Pierre's press operators are currently producing at this level of activity and may view this standard as challenging but still unattainable. Eventual changes in worker efficiency and/or changes in the nature of the work may call for the need to change the standard. This standard will also make it difficult for CPGI to make press comparisons across all printing plants.

Instructor’s Manual / Solutions Manual C14.27. (continued) a. 7,400 impressions per hour: This level of activity would represent a past experience standard for Pierre's most productive press operator. • Pro: this standard will be viewed by all press operators as being attainable and should motivate those who currently produce below this level because of the best press operator. • Con: this standard will provide no incentive for improvement for Pierre's best operator as it represents only an average of his performance over the past six months. It is likely that his average performance in the coming months will drop as he "tops-out" his performance around this level. 6,500 impressions per hour: This level of activity would represent a past experience standard based on the average performance of all press operators over the past six months. • Pro: this standard would be viewed as a very attainable standard because it reflects current performance levels. • Con: this standard includes all the inefficiencies that have crept into the operations over the years. Press operators will not be challenged and performance is not likely to improve over time. b. Qualitative factors that should be considered when setting standards for the same press model at other sites across Canada would include, but not be limited to, the age and general operating condition of each press, the skill and availability of an appropriately trained labor force, the maintenance programs used by each company for the operating care of the presses, the general availability of technical support from the press manufacturer, whether the press runs 1, 2, or 3 shifts a day, the product mix and technical requirements of the jobs, the quality focus of the customers, etc. c. A standard of 8,000 impressions per hour seems to provide the necessary balance between having useful management information from the standard costing system and the behavioral implications of motivating press operators to work toward achieving the goals that they perceive as challenging but attainable.

Instructor’s Manual / Solutions Manual C14.28. Note to Instructors: At the time we were preparing this 13th Edition of What the Numbers Mean, the most current version of The Citizen's Guide to the Federal Budget available at the www.govinfo.gov website was for FY 2002. The guide was a useful tool for helping students appreciate the differences between the organizational budget model described here in Chapter 14 and something as comprehensive as the Budget of the United States Government. Our hope is that these links will remain available for use by your students and perhaps someday new additional years will be provided again, but we certainly do not control availability as time marches on. This solution provides a response based on FY 2002 but it can easily be adapted if new fiscal years become available.

a. The Citizen's Guide to the Federal Budget is designed to give the reader a walking tour of the budget. The guide outlines for you how the Government raises revenues and spends money, how the President and Congress enact the budget, how the country has been able to move from deficit to surplus to deficit, and what the President hopes to accomplish with his budget. 14-24 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual C14.28. (continued) b. The Federal budget is: • a plan for how the Government spends your money. • a plan for how the Government pays for its activities. • a plan for Government borrowing or repayment of borrowing. • something that affects the Nation's economy. • something that is affected by the Nation's economy. • a historical record. The 2002 Budget is a document that embodies the President's budget proposal to Congress for the fiscal year and it reflects the President's priorities. c. The Federal budget, of course, is not the only budget that affects the economy or the American people. The budgets of state and local governments have an impact as well. While Federal Government spending was a little less than 18 percent of the Gross Domestic Product (or GDP, which measures the size of the economy), state and local government spending was about another 9 percent (see Chart 1-1). d. The money that the Federal Government uses to pay its bills--its revenues or receipts-comes mostly from taxes. Revenues come from these sources: • Individual income taxes. • Social insurance payroll taxes including Social Security taxes, Medicare taxes, unemployment insurance taxes, and Federal employee retirement payments. • Corporate income taxes. • Excise taxes applying to various products, including alcohol, tobacco, transportation fuels, and telephone services. • The Government also collects estate and gift taxes, customs duties, and miscellaneous revenues--e.g., Federal Reserve earnings, fines, penalties, and forfeitures. e. The Federal Government will spend over $2.0 trillion and have a surplus of $231 billion in 2002, which is divided into nine large categories (as shown in Chart 2-6). • Social Security accounts for 23 percent of all Federal spending. • Medicare will comprise 12 percent of all Federal spending. • Medicaid accounts for seven percent of the budget. • The means-tested entitlements category will account for an estimated six percent of the budget. • The remaining mandatory spending comprises seven percent of the budget. • National defense discretionary spending will comprise 16 percent of the budget. • Non-defense discretionary spending shrunk as a share of the budget from 23 percent in 1966 to less than 19 percent in 2002. • Interest payments are estimated to be at 10 percent of the budget in 2002. • Slightly less than eleven percent of your Federal dollar (the budget surplus) will not be spent and will instead be used to reduce the Federal debt.

Instructor’s Manual / Solutions Manual C14.28. (continued) f. Through the budget process, the President and Congress decide how much to spend and tax in any one fiscal year. More specifically, they decide how much to spend on each activity, ensure that the Government spends no more and spends it only for that activity, and report on that spending at the end of each budget cycle. The President's budget is his plan for the next year. But it's just a proposal. After receiving it, Congress has its own budget process to follow. Only after the Congress passes, and the President signs, the required spending bills has the Government created its actual budget. g. Once the President and Congress approve spending, the Government monitors the budget through: • agency program managers and budget officials, including the Inspectors General, or IGs; • OMB; • congressional committees; and • the General Accounting Office(1), an auditing arm of Congress. This oversight is designed to: • ensure that agencies comply with legal limits on spending, and that they use budget authority only for the purposes intended; • see that programs are operating consistently with legal requirements and existing policy; and, finally, • ensure that programs are well managed and achieving the intended results. The GAO’s name was changed in July 2004 to “General Accountability Office.” The change “better reflects the modern professional services organization the GAO has become…” (1)

h. A surplus occurs when revenues exceed spending in any year - just as a deficit occurs when spending exceeds revenues. Generally, to finance past deficits, the Treasury has borrowed money. With certain exceptions, the debt is the sum total of our deficits, minus our surpluses, over the years. i. Budget deficits force the Government to borrow money in the private capital markets. That borrowing competes with (1) borrowing by businesses that want to build factories and machines that make workers more productive and raise incomes, and (2) borrowing by families who hope to buy new homes, cars, and other goods. The competition for funds tends to produce higher interest rates. Deficits increase the Federal debt and, with it, the Government's obligation to pay interest. The more it must pay in interest, the less it has available to spend on education, law enforcement, and other important services, or the more it must collect in taxes. If the Government incurs a surplus, it generally repays debt held by the public.

Instructor’s Manual / Solutions Manual C14.28. (continued) j. The government's budget process outlines a plan for revenues and expenditures just as the operating budget in Chapter 14 describes for a business entity. They both start with an analysis of revenue sources and ultimately prescribe how those revenues will be spent. Certain spending in the budget is required (programs and entitlements) or is a function of activity (purchases and manufacturing). Other spending is discretionary such as employee training and the new computer system for the business vs. national defense for the country. The bottom line is still the bottom line - profits for the business vs. a budget surplus for the government and the profit/surplus can be reinvested in the business/government or given back to stockholders as a dividend (business) or to the public in the form of tax cuts (government). The major difference lies in the legal framework that defines the budget process and its oversight for the government vs. the discretionary use of budgets by business to apply sound management planning and control principles. C14.29. Note to instructor: At the time we were preparing this 13th Edition of What the Numbers Mean, the links to the numerous planning/budgeting products were available on websites as identified in the problem requirements. Our hope is that these illustrative examples will remain available for use by your students, but we certainly do not control their availability as time marches on. The purpose of the case is to make students aware of the many software solutions that are available to address an organization's planning and control information needs. You might choose to define a specific set of questions or tasks that you want students to apply to each of the software solutions that they review, as well as a specific format that you prefer for their report. Otherwise, the case requirements as they are defined in the text will give students an appreciation for the things to look for as they review each product. This case also serves as an excellent classroom discussion activity that allows students to share their findings and reinforce the importance of well-conceived planning, analysis, and design of software solutions prior to their implementation and use.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 14

NAME______________________

1. Actual sales for the past two months, and the sales forecast for the next four months, in dollars and units, are presented below:

Dollars … Units ……

Actual March April $196,074 $181,251 7,262 6,713

May $164,700 6,100

Forecast June July $148,500 $153,900 5,500 5,700

August $175,500 6,500

a. The firm's policy is to have finished goods inventory on hand at the end of each month equal to 40% of the next month's sales. It is currently estimated that there will be 2,640 units on hand at the end of April. Calculate the number of units to be produced in each of the next three months (May, June, and July).

b. Each unit of finished product requires 4 gallons of raw material A. The firm's policy is to have raw material inventory on hand at the end of each month equal to 80% of the next month's estimated usage. It is currently estimated that 15,200 gallons of raw material A will be on hand at the end of April. Calculate the number of gallons of raw material A to be purchased in each of the next two months (May and June).

c. Based on an analysis of accounts receivable made near the end of April, it is estimated that collections of accounts receivable at April 30 will amount to $160,000 in May and $40,000 in June. Based on past experience, it is estimated that 15% of a month's sales are collected in the month of sale, 60% are collected in the month following the sale, and 24% are collected in the second month following the sale. Calculate the estimated cash receipts for May, June, and July.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 14 1. a. Beginning inventory …………… Production ……………………… Goods available for sale………… Less: Ending inventory ………… Quantity sold ……………………

May 2,640 5,660 8,300 (2,200) 6,100

June 2,200 5,580 7,780 (2,280) 5,500

July August 2,280 6,020 8,300 (2,600) 5,700 6,500

June 17,856 23,728 41,584 (19,264) 22,320

July

Beginning inventory …………… Add: Purchases ………………… Raw materials available for use … Less: Ending inventory ………… Quantity used in production ……

May 15,200 25,296 40,496 (17,856) 22,640

c. Cash Receipts from: April 30 accounts receivable …… Current month's sales …………… Prior month's sales ……………… 2nd prior month's sales ………… Total collections …………………

24,080

May $160,000 24,705

June July $ 40,000 22,275 $ 23,085 98,820 89,100 _______ _______ 39,528 $184,705 $161,095 $151,713

Instructor’s Manual / Solutions Manual

CHAPTER

Cost Control

CHAPTER OUTLINE: I. Cost Classifications A. Relationship of Cost to Volume of Activity 1. Variable cost 2. Fixed cost 3. Mixed cost B. According to a Time-Frame Perspective 1. Controllable cost 2. Noncontrollable cost II. Performance Reporting A. Characteristics of the Performance Report 1. Column headings 2. Variances a. Reasons for reporting variances b. Management by exception principle 3. Issues in the design of performance reports B. The Flexible Budget 1. Required to have a meaningful performance report III. Analysis of Standard Cost Variances A. Components 1. Quantity variance 2. Cost per unit of input variance B. Favorable/Unfavorable Label 1. Arithmetic difference relative to budget 2. Label not necessarily synonymous with "good" or "bad" C. Name of Variance Related to the Input 1. Raw materials--usage and price 2. Direct labor--efficiency and rate 3. Variable overhead--efficiency and spending D. General Model for Calculating Variances E. Variance Calculations Illustrated F. Analysis of Fixed Overhead Variance 1. Budget variance 2. Volume variance

Instructor’s Manual / Solutions Manual CHAPTER OUTLINE (continued) G. Accounting for Variances IV. Reporting for Segments of an Organization A. Segments are responsibility centers 1. Cost center 2. Profit center 3. Investment center B. Hazards of arbitrary allocation of common costs C. Direct and common fixed expenses D. Segment margin V. Analysis of Investment Centers A. Return on Investment 1. Using the Dupont Model for ROI a. Margin b. Turnover B. Residual Income 1. To eliminate dysfunctional behavior and suboptimization C. The Balanced Scorecard 1. Financial perspective 2. Customer perspective 3. Internal business process perspective 4. Learning and growth perspective

TEACHING/LEARNING OBJECTIVES: Primary: To have the student understand: 1. The reasons for and method of flexing a budget. 2. That for control purposes, variances from standards can be calculated and used to encourage those responsible for costs to have control awareness - but using variances to coerce performance is dysfunctional. 3. That segments of an organization must be carefully considered in order to structure effective performance evaluation techniques. Supporting: To have the student understand: 4. The format and content of a performance report. 5. That arbitrary allocation of common fixed expenses is inappropriate when evaluating performance of segments of an organization. 6. That quantity variances are sometimes more useful than dollar variances. 7. How standards can be established, and why attainable standards are most appropriate. 15-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES (continued) 8. How standards can be used to build up product cost. 9. That budget variances are made up of two components: price/rate and usage/efficiency. 10. That variances are analyzed to permit managers to better control the activities for which they are responsible. 11. The method of calculating variances. 12. How ROI, residual income, and balanced scorecards are used to measure and communicate organizational performance.

TEACHING OBSERVATIONS: 1. Emphasize that the reason for calculating variances is to communicate to the person responsible, so that favorable variances can be captured and unfavorable variances can be eliminated. Because different persons are usually responsible for the quantity used (raw material foreman or production supervisor) and the price paid (purchasing agent or personnel supervisor) for any input, the variance must be separated into the part caused by usage and the part cause by price. 2. There may be some confusion about the use of the term "price" in connection with a cost variance. It can be explained that cost is a more generic term, and in the context of variance analysis, price generally refers to the price paid for a material, labor, or overhead inputs. 3. Students can identify with the desirability of prompt reporting of variances by having them think about the feedback they want from a quiz or exam. A parallel can also be drawn to the behavioral objectives of variance reporting. 4. The basic variance analysis equations can be covered quickly with problems such as P15.21 and P15.22. Students will then enjoy solving variance analysis “puzzles” such as E15.13, E15.14, and E15.15. Walk them through the solution to one of these problems, and then assign the others as in-class group work. You will find that they can explain it among themselves quite well.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: NO. M15.1 M15.2 M15.3 M15.4 M15.5 M15.6 M15.7 M15.8 E15.9 E15.10 E15.11 E15.12 E15.13

LEARNING OBJECTIVES 3 3,4 4,5 4,5 4,5,6 4,5,6 8 9 3 3 4,5 4,5 4,5

DIFFICULTY & TIME ESTIMATE Easy, 5-8 min. Easy, 5-10 min. Med., 10-15 min. Med., 10-15 min. Med., 10-15 min. Med., 10-15 min. Med., 10-15 min. Med., 10-15 min. Easy, 5-8 min. Med., 10-12 min. Easy, 7-10 min. Easy, 7-10 min. Med., 10-12 min.

E15.14

4,5

Med., 10-12 min.

E15.15

4,5

Med., 10-15 min.

E15.16

4,5

Med., 10-15 min.

E15.17

Easy, 7-10 min.

E15.18 E15.19 E15.20

8 9 9

Med., 10-12 min. Med., 10-15 min. Med., 18-20 min.

P15.21 P15.22 P15.23 P15.24 P15.25 P15.26

4,5 4,5 4,5 4,5 5,6 5,6

Med., 12-18 min. Med., 12-18 min. Med., 7-10 min. Med., 7-10 min. Med., 10-12 min. Med., 10-12 min.

C15.27

Easy, 3-5 min.

C15.28 C15.29 C15.30

3 4 5

Easy, 5-8 min. Easy, 3-5 min. Med., 7-10 min.

C15.31

4,5

Easy, 5-8 min.

C15.32

Med., 7-10 min.

C15.33

Med., 7-10 min.

C15.34

Med., 30-45 min.

OTHER COMMENTS Basic introduction to the flexible budget. Expands M15-1 to include basic performance report. Basic calculations for the direct material variances. Basic calculations for the direct labor variances. Basic calculations for the variable overhead variances. Basic calculations for the fixed overhead variances. Straight-forward presentation of a segmented income statement Straight-forward calculation of ROI and residual income Straight-forward example of flexible budgeting. Straight-forward example of flexible budgeting. Straight-forward way to introduce flexible budgeting. Good in-class demonstration problem. Group learning problem. Students enjoy solving the puzzle. Help them get started by filling in the known data on the board. See 15.13. Group learning problem. Good in-class demonstration problem. Group learning problem. Walk students through the solution in class. Straight-forward exercise that focuses on the calculation of material variances. Emphasize the importance of understanding cost behavior patterns when analyzing segmented income statements. See 15.9. Never arbitrarily allocate fixed expenses! Good in-class demonstration problem to compare ROI and RI. Provides an opportunity to evaluate the use of ROI vs. RI as performance measures and their effect on decision making. Straight-forward calculation of variances. Good in-class exercise or homework assignment. Straight-forward non-manufacturing application of standards. See 15.23. Straight-forward. Straight-forward numbers-oriented problem. This problem requires careful reading because of its precise use of terminology. Can be used as a discussion starter when introducing the concept of flexible budgeting. Straight-forward. Use as a discussion starter. Group learning problem. Stress the importance of the raw material usage and direct labor efficiency variances. Can be used as a discussion starter to introduce “behavioral aspects” of standard costing systems. Students tend to make this problem too difficult—the point is that these standards are way off, and need to be revised. Provides an opportunity to discuss the use of standard costs in accounting systems. Internet case. Research case to familiarize students with the Consortium for Advanced Manufacturing - International and the organization's role in assisting companies with the advancement of their planning and control systems.

Instructor’s Manual / Solutions Manual SOLUTIONS: M15.1.

Direct materials……… Direct labor………….. Variable overhead…… Fixed overhead………. Total budgeted cost…

Cost Formula $8.00 per unit $10.00 per unit $6.00 per unit $35,000 per month

Original Budget (17,500 units) $140,000 175,000 105,000 35,000 $455,000

Flexed Budget (17,000 units) $136,000 170,000 102,000 35,000 $443,000

M15.2.

Cost Component Direct materials…… Direct labor……….. Variable overhead… Fixed overhead……. Total budgeted cost

Original Budget (17,500 units) $140,000 175,000 105,000 35,000 $455,000

Flexed Budget (17,000 units) $136,000 170,000 102,000 35,000 $443,000

Actual Cost(1) (17,000 units) $140,250 160,650 115,940 33,500 $450,340

Budget Variance $4,250 U 9,350 F 13,940 U 1,500 F $7,340 U

(1) Variable cost calculations for actual unit costs incurred:

Direct materials = $8.25 * 17,000 units = $140,250 Direct labor = $9.45 * 17,000 units = $160,650 Variable overhead = $6.82 * 17,000 units = $115,940 M15.3. Direct materials.…...

Original Budget $140,000

Flexed Budget $136,000

Actual $140,250

Variance $4,250 U

Note: Budget variance = (Standard unit cost – Actual unit cost) * Units produced = ($8.00 - $8.25) * 17,000 units = $4,250 U Material price variance = (Standard cost/lb - Actual cost/lb) * Actual lbs used = ($0.80 - $0.75) * 187,000 = $9,350 F Material usage variance = (Standard lbs allowed - Actual lbs used) * Standard cost/lb = ((17,000 * 10) – 187,000) * $0.80 = $13,600 U

Instructor’s Manual / Solutions Manual M15.4. Direct labor…...…...

Original Budget $175,000

Flexed Budget $170,000

Actual $160,650

Variance $9,350 F

Note: Budget variance = (Standard unit cost – Actual unit cost) * Units produced = ($10.00 - $9.45) * 17,000 units = $9,350 F Labor rate variance = (Standard rate/DLH - Actual rate/DLH) * Actual DLHs worked = ($20 – ($160,650/7,650 DLHs)) * 7,650 = ($20 – $21) * 7,650 = $7,650 U Labor efficiency variance = (Standard DLHs allowed - Actual DLHs worked) * Standard rate/DLH = ((17,000 * 0.5) – 7,650) * $20.00 = $17,000 F M15.5. Variable overhead....

Original Budget $105,000

Flexed Budget $102,000

Actual $115,940

Variance $13,940 U

Note: Budget variance = (Standard unit cost – Actual unit cost) * Units produced = ($6.00 - $6.82) * 17,000 units = $13,940 U Variable overhead spending variance = (Standard rate/MH - Actual rate/MH) * Actual MHs incurred = ($6.00 – ($115,940/18,700 MHs)) * 18,700 = ($6.00 – $6.20) * 18,700 = $3,740 U Variable overhead efficiency variance = (Standard MHs allowed - Actual MHs incurred) * Standard rate/MH = ((17,000 * 1) – 18,700) * $6.00 = $10,200 U M15.6. Fixed overhead….....

Original Budget $35,000

Flexed Budget $35,000

Actual $33,500

Variance $1,500 F

Note: Budget variance = (Budgeted fixed overhead – Actual fixed overhead) = $35,000 - $33,500 = $1,500 F Fixed overhead volume variance = Budgeted fixed overhead – Applied fixed overhead = Budgeted fixed overhead – (Budgeted fixed overhead rate * Standard MHs allowed) = ($35,000 – ($2.00 * 17,000 MHs)) = $1,000 U

Instructor’s Manual / Solutions Manual M15.7. Sales …...…………………………………... Variable expenses (50% / 30%) ...………… Contribution margin (50% / 70%) ………… Direct fixed expenses ……………...……… Segment margin …………………...………. Common fixed expenses ……………...…... Operating income ……………………….… M15.8. a. DuPont Performance Analysis: Revenues…………………………………... Operating Income…………………………. Operating Assets…………………………… Margin (Operating income / Sales)...……… Turnover (Sales / Operating assets)………... ROI (Operating income / Operating asset)… or (Margin x Turnover) Residual Income Analysis: Operating Income……………………….… Required ROI (Operating assets x 10%)…... Residual Income……………………………

Total Company $400,000 168,000 $232,000 80,000 $152,000 120,000 $ 32,000

Division 1 $240,000 120,000 $120,000 48,000 $ 72,000

Division 1 $240,000 $ 72,000 $600,000 30% 0.4 turns 12%

Division 2 $160,000 $ 80,000 $800,000 50% 0.2 turns 10%

$72,000 60,000 $12,000

$80,000 80,000 $ 0

Division 2 $160,000 48,000 $112,000 32,000 $ 80,000

E15.9. a. Cost formula = $9,700 + $3.85 per machine hour Budget = $9,700 + ($3.85 * 13,400 machine hours) = $61,290 b. Total maintenance cost. (a)

Original Budget (13,400 MH) $61,290

Flexed Budget (14,120 MH) $64,062 a

Actual Cost $66,840

Variance $2,778 U

Flexed budget = $9,700 + ($3.85 * 14,120 machine hours) = $64,062

E15.10. Item Direct Materials……… Direct Labor ………… Variable Overhead…… Fixed Overhead……… Total …………………

Original Budget (17,500 units) $275,625 213,500 107,625 85,000 $681,750

Flexed Budget (16,600 units) $261,450 202,520 102,090 85,000 $651,060

Actual Cost $270,750 206,750 97,625 86,250 $661,375

Variance $9,300 U 4,230 U 4,465 F 1,250 U $10,315 U

Instructor’s Manual / Solutions Manual E15.10. (continued) Note: The flexed budget amounts for variable expenses are calculated by multiplying the original budget amounts by 0.95 (16,600 units / 17,500 units). An alternative approach would be to compute the variable costs per unit based on original budget amounts (i.e., DM = $15.75, DL = $12.20, and VOH = $6.15). Per unit costs are then applied to actual activity to determine flexible budget amounts. Fixed expenses do not change as activity changes, so the fixed overhead amount is not flexed. E15.11. a. Direct labor …………

Original Budget $2,400

Flexed Budget $2,280 a

Actual $2,378

Variance $98 U

(a)

3,800 books / 25 books per hour = 152 standard hours allowed * $15 per hour = $2,280 flexed budget. b. Direct labor efficiency variance = (152 Standard hours - 164 Actual hours) = 12 hours U. Note: if calculating DL efficiency variance in $ the calculation would be: 12 hours * $15.00 = $180 U c. Direct labor rate variance = (Standard rate - Actual rate) * Actual hours = ($15 - ($2,378 / 164 hours)) * 164 hours = ($15 - $14.50) * 164 = $82 F E15.12. a. Direct labor…………………………………

Flexed Budget $2,790 a

Actual $3,168

Variance $378 U

(a)

(186,000 stampings / 1,000 stampings per hour) * $15 per hour = $2,790 flexible budget b. Direct labor efficiency variance: (Standard hours - Actual hours) * Standard rate ((186,000 stampings / 1,000 stampings per hour) - 198 hours) * $15 = $180 U Direct labor rate variance: (Standard rate - Actual rate) * Actual hours ($15 - $16 b) * 198 hours = $198 U (b)

Actual rate: $3,168 / 198 hours = $16

c. The budget variance of $378 should be broken down so that the $180 U efficiency variance and the $198 U rate variance would be reported to the appropriate managers who are in the best position to take corrective action to control these amounts in the future.

Instructor’s Manual / Solutions Manual E15.13. a. Standard hours allowed = 4 hours * 36 tune-ups = 144 hours Efficiency variance was 12 hours unfavorable, therefore actual hours = 144 hours + 12 hours = 156 hours Standard labor cost allowed for actual hours ($20 per hour * 156 hours) ... Less: Favorable labor rate variance ……………………………………….. Actual total labor cost………………………………………………………

$3,120 (156) $2,964

Actual labor rate per hour = $2,964 / 156 hours = $19 per hour b. Direct labor efficiency variance: (Standard hours - Actual hours) * Standard rate (144 hours - 156 hours) * $20 = $240 U c. Less skilled, lower paid workers took longer than standard to get the work done. Net variance is $84 U ($240 U - $156 F). This was not a good trade-off based on the variance. From a Qualitatively viewpoint, it indicates less skilled workers may not do as good of a job. E15.14. a. Favorable direct labor rate variance Divided by: Actual direct labor hours worked Favorable direct labor rate variance per hour Standard direct labor rate per hour Actual direct labor rate per hour

$ 3,600 3,000 $ (1.20) 15.00 $ 13.80

b. Direct labor efficiency variance = ($900 U budget variance - $3,600 F rate variance) = $4,500 U c. Direct labor efficiency variance = (Standard hours - Actual hours) * Standard rate = ((2,700 standard hours - 3,000 hours) * $15.00) = $4,500 U. At a rate of $15 per hour, using 300 more actual hours than allowed at standard caused the $4,500 U variance. E15.15. a. Purchase price variance = (Standard price - Actual price) * Actual quantity purchased = ($10.00 per board foot - ??? actual price) * 22,000 board feet purchased = $5,500 U. Thus, the purchase price per board foot was more by $0.25 U ($5,500 U / 22,000), or $10.25. b. 2,000 units produced * 10 board feet per unit = 20,000 standard board feet allowed. c. Direct material usage variance = (Standard usage - Actual usage) * Standard price = (20,000 board feet allowed - 19,250 issued into production) * $10.00 per board foot = $7,500 F

Instructor’s Manual / Solutions Manual d. The purchasing manager may have purchased higher-than-standard quality raw material inputs. This may have allowed Oakton, Inc., to reduce waste and spoilage, resulting in a favorable raw materials usage variance that more than offset the $0.25 per board foot unfavorable price variance. Based on the variances during November, this is a good trade-off for the management of Oakton, Inc., to make. E15.16. a. Cost per pound = Cost of fiberglass purchased / pounds purchased Cost per pound = $312,500 / 50,000 = $6.25 per pound b. Purchase price variance = (Standard price - Actual price) * Actual quantity purchased = ($6.50 per pound - $6.25 per pound) * 50,000 pounds purchased = $12,500 F c. Direct materials usage variance = (Standard usage - Actual usage) * Standard price = ((1.5 pounds allowed * 25,000 units produced) - 40,000 pounds issued into production) * $6.50 per pound = $16,250 U d. Generally, it is appropriate to isolate variances as soon as possible so that immediate feedback can be provided to the manager responsible for controlling the cost. In the case of raw materials, the control point for the price variance is at the time of purchase rather than when the raw materials are issued into production. Managers responsible for reviewing raw material purchases should have the timeliest information possible about purchase variances in order to take corrective action when necessary. E15.17. a. The president's remark ignores the misleading result of arbitrarily allocated fixed expenses. b. Current net income of company ………………..…………… Less: Lost contribution margin of Division Y ……………… Add: Division Y direct fixed expenses that would be eliminated: Total Division Y fixed expenses per report ………..……… $22,000 Less: Allocated corporate ($42,000 / 3 divisions) ………… (14,000) Company net income without Division Y……………………

$20,000 (20,000)

8,000 $ 8,000

c. Never arbitrarily allocate fixed expenses! E15.18. a. The exercise presentation shows allocated fixed expenses, which can cause an erroneous conclusion because these expenses apply to the company as a whole (not to the individual segments). The $10,000 of company fixed expenses is apparently being allocated based on the number of units of each model sold. A total of 6,000 units were sold, and 50% of these were MV12 models, 33.33% were BV19 models and 16.67% were HV41 models. To resolve this problem, a “Total Company” column should be added, and the $10,000 of common fixed expenses should be subtracted out of the total column, rather than being allocated.

Instructor’s Manual / Solutions Manual b. If the MV12 model were discontinued, total company net income would decrease by $3,900 (the segment margin of the MV12 model). The $5,000 of fixed expenses that were allocated to the MV12 model would not be eliminated.

Instructor’s Manual / Solutions Manual E15.18. (continued) c. Contribution margin ratio = contribution margin / selling price BV19: $8 / $24 = 33.3% HV41: $12 / $40 = 30% MV12: $4 / $20 = 20% d. To achieve the greatest increase in contribution margin from an increase in the quantity sold, the product with the greatest contribution margin per unit should be advertised, which is the HV41 model. e. To achieve the greatest increase in contribution margin from an increase in revenues, the product with the greatest contribution margin ratio should be advertised, which is the BV19 model. E15.19. a. DuPont Performance Analysis: Margin (Operating income / Sales)………... ($32,000 / $320,000)

Central Division 10%

Turnover (Sales / Operating assets)……...… ($320,000 / $160,000)

2 turns

ROI (Operating income / Operating assets). ($32,000 / $160,000 or (Margin x Turnover) = (.10 x 2) ...

20%

b. Residual Income Analysis: Operating Income…………………………. Required ROI (Operating assets x 15%)….. ($160,000 x 15%) Residual Income…………………………... E15.20. a. DuPont Performance Analysis: Revenues…………………………………... Operating Income………………………….. Operating Assets…………………………… Margin (Operating income / Sales)...……… Turnover (Sales / Operating assets)……….. ROI (Operating income / Operating asset)… or (Margin x Turnover) Residual Income Analysis: Operating Income……………………….… Required ROI (Operating assets x 12%)…. Residual Income……………………………

$32,000 24,000 $ 8,000

Division X $ 750,000 $ 90,000 $ 375,000 12% 2 turns 24%

Division Y $ 225,000 $ 27,000 $ 225,000 12% 1 turn 12%

Division Z $ 937,500 $ 75,000 $ 468,750 8% 2 turns 16%

$ 90,000 45,000 $ 45,000

$ 27,000 27,000 $ 0

$ 75,000 56,250 $ 18,750

Instructor’s Manual / Solutions Manual E15.20. (continued) b. The DuPont model provides an excellent basis of comparison between the three divisions and illustrates the importance of managing both profit margin and turnover. Division X combines the best margin and turnover to yield an ROI of 24%. Division Y is generating the same margin as Division X but falls short on the turnover measure. Division Z achieves the same turnover as Division X but falls short on the margin measure. By looking at margin and turnover as components of ROI, the managers of these divisions can focus their attention on improving their shortcomings. Also note that Division Y is only generating the minimum required ROI as evidenced by its $0 residual income. c. If Division X were presented with an opportunity to bring on a new product line that would generate an ROI of 18%, the manager would not invest in the product line if his performance were being evaluated by ROI. With residual income, the manager will be pleased to add a product line that earns 18% because any return over the 12% minimum requirement will improve his or her division’s residual income. P15.21. a. Raw material purchase price variance: (Standard price - Actual price) * Actual quantity purchased ($3.00 - $2.97) * 14,800 pounds = $444 F Raw material usage variance: b. (Standard usage - Actual usage) * Standard price ((2,000 cases * 8 pounds) - 16,600 pounds) * $3.00 per pound = $1,800 U c. Direct labor rate variance: (Standard rate - Actual rate) * Actual hours ($10.00 - $10.50 #) * 11,600 hours = $5,800 U # Actual rate: $121,800 / 11,600 hours = $10.50 d. Direct labor efficiency variance: (Standard hours - Actual hours) * Standard rate ((2,000 cases * 6 hours) - 11,600 hours) * $10.00 = $4,000 F e. Variable overhead spending variance: (Standard rate - Actual rate) * Actual hours ($5.00 - $5.25 #) * 11,600 hours = $2,900 U # Actual rate: $60,900 / 11,600 hours = $5.25 f. Variable overhead efficiency variance: (Standard hours - Actual hours) * Standard rate ((2,000 cases * 6 hours) - 11,600 hours) * $5.00 = $2,000 F Variance Summary: Total raw materials variance Total direct labor variance Total variable overhead variance Total variance

$1,356 U 1,800 U 900 U $4,056 U 15-13

Instructor’s Manual / Solutions Manual E15.21.

(continued) Explanation of results: In order to create a favorable purchase price variance, the purchasing manager may have purchased lower-than-standard quality raw material inputs. This may have caused an excess amount of waste and spoilage, resulting in an unfavorable raw materials usage variance that by far exceeded the cost savings of $0.03 per pound. The unfavorable labor rate variance of $0.50 per hour may have been caused by using a more skilled and/or experienced workforce than was anticipated. However, this cost was largely offset by increased labor efficiency (i.e., less downtime, re-work). The favorable labor efficiency variance caused a favorable variable overhead efficiency variance because variable overhead is applied on the basis of direct labor hours.

P15.22. a. Raw materials purchase price variance: (Standard price - Actual price) * Actual quantity purchased ($7.50 - ($174,420 / 22,800 pounds)) * 22,800 pounds = ($7.50 - $7.65) * 22,800 = $3,420 U b. Raw materials usage variance: (Standard usage - Actual usage) * Standard price ((3,800 cases * 6 pounds) - 22,580 pounds) * $7.50 per pound = (22,800 pounds - 22,580 pounds) * $7.50 = $1,650 F c. Direct labor rate variance: (Standard rate - Actual rate) * Actual hours ($16.00 - $16.25) * 13,440 hours = $3,360 U d. Direct labor efficiency variance: (Standard hours - Actual hours) * Standard rate ((3,800 cases * 3.6 hours) - 13,440 hours) * $16.00 = (13,680 hours - 13,440 hours) * $16.00 = $3,840 F e. Variable overhead spending variance: (Standard rate - Actual rate) * Actual hours ($5.50 per MH - ($23,108 / 4,360 MH)) * 4,360 MH = ($5.50 - $5.30) * 4,360 MH = $872 F f. Variable overhead efficiency variance: (Standard hours - Actual hours) * Standard rate ((3,800 cases * 1.2 MH) – 4,360 MH) * $5.50 per MH = (4,560 MH - 4,360 MH) * $5.50 per MH = $1,100 F

Instructor’s Manual / Solutions Manual E15.22.

(continued) Variance Summary: Total raw materials variance Total direct labor variance Total variable overhead variance Total variance

$1,770 U 480 F 1,972 F $ 682 F

Explanation of results: The unfavorable purchase price variance sometimes indicates that higher-than-standard quality raw material inputs were purchased—and the favorable raw materials usage variance suggests that this was probably the case. However, the practice of purchasing higher-than-standard-quality inputs should only be encouraged if the favorable usage variances exceed the unfavorable price variances month after month. In this case, the overall raw materials budget variance was unfavorable, suggesting that this was not a good trade-off to make. Employing workers with more skill and/or experience than is necessary to perform the work may have caused the unfavorable direct labor variance of $0.25 per hour. However, this cost was more than offset by increased labor efficiency. It may be possible to identify certain workers and/or workstations that are causing this efficiency. Direct labor efficiency may have impacted in some capacity the variable overhead variances. P15.23. a. Work hours per day …………………………………………. Divided by: Standard processing time per claim (in hours) … Standard number of claims processed (per day per worker)… Multiplied by: Number of days in the month ……………….. Standard claims processed (per month per worker) ………… Claims processed …………………………………………… Standard number of workers required for the month ………..

Simple 7.5 0.5 15.0 20.0 300.0 3,600 12

Complex 7.5 1.5 5.0 20.0 100.0 800 8

Thus, a total of 20 workers should have been available to process the April claims. b. Actual number of workers ……………………………………………. Standard number of workers required for the month …………………. Efficiency variance, in number of workers …………………………… Efficiency variance, in dollars (2 workers * $120 per day * 20 days) …

22 20 2U $4,800 U

Instructor’s Manual / Solutions Manual P15.24. a. Teller staffing analysis: Number of customers per hour ...……………………………… Divided by: Standard number of customers per hour per teller... Number of tellers required per hour, at standard ……………… Number of tellers available per hour...………………………… Efficiency variance, tellers per hour…………………………… Efficiency variance, cost per hour (1.67 * $12 per hour) ………

50 15 3.33 5 1.67 U $20.04 U

Cost for the month: 1.67 tellers * 8 hours/day * 21 days * $12 per hour = $3,367 U b. Teller staffing analysis: 1 & 2 Average number of customers per hour…………… Standard customers served per teller per hour ……. Standard number of tellers required per hour ……... Number of tellers available per hour ……………… Efficiency variance (tellers per hour) ……………... Cost for the month a ……………………………….

11:00-1:00 80 15 5.33 5 0.33 F $166 F

Other hours 40 15 2.67 5 2.33 U $3,523 U

(a)

11:00-1:00 (0.33 tellers * 2 hours * 21 days * $12 per hour) = $166 F Other hours (2.33 tellers * 6 hours * 21 days * $12 per hour) = $3,523 U 3 A net overstaffing results from using 5 tellers per hour for the entire day. The teller supervisor would argue that the workflow and number of customers is uneven, and the variance incurred is a cost of providing a high level of customer service. The bank’s overall efficiency could be increased if tellers could be assigned other tasks when they were not busy with customers. P15.25. a. Predetermined overhead application rate: =

$54,000 Estimated Overhead $ = = $1.80 per machine hour (60,000 units ∗ 0.5 hours) Estimated Activity

b. 58,500 units produced * 0.5 machine hours per unit = 29,250 machine hours allowed. c. Applied overhead = $1.80 * 29,250 hours = $52,650. d. ($55,500 actual overhead incurred - $52,650 overhead applied) = $2,850 underapplied. e. ($54,000 budgeted overhead - $55,500 actual overhead) = $1,500 U budget variance. ((30,000 budgeted hours - 29,250 standard hours allowed for units produced) * $1.80 predetermined overhead application rate) = $1,350 U volume variance.

Instructor’s Manual / Solutions Manual P15.26. a. Original budget ……………………………………… Budgeted production, in units ……………………..… Budget per unit ……………………………………… Actual production, in units …………..……………… Flexed budget ……………………..…………………

Variable $30,000 20,000 $ 1.50 21,600 $32,400

Fixed $36,000 not appropriate $36,000

b. Standard units per hour (based on budget): 20,000 units / 4,000 hours = 5 units/hour. Actual production was 21,600 units, so 21,600 / 5 units per hour = 4,320 standard hours allowed. Actual hours = 4,500. Thus, direct labor efficiency variance = 180 hours U. (c & d) Original budget ……………………………………… Budgeted activity (direct labor hours) ……………… c. Predetermined overhead application rate per hour … Standard hours allowed……………………………… d. Overhead applied ……………………………………

Variable $30,000 4,000 $ 7.50 4,320 $32,400

Fixed $36,000 4,000 $ 9.00 4,320 $38,880

e. ($36,000 budgeted fixed overhead - $37,600 actual fixed overhead) = $1,600 U budget variance. ((4,000 budgeted hours - 4,320 standard hours allowed for units produced) * $9.00 predetermined fixed overhead application rate) = $2,880 F volume variance. f. ($37,600 actual fixed overhead - $38,880 applied fixed overhead) = $1,280 overapplied. Note: Overapplied or underapplied is the sum of the budget variance and the volume variance. C15.27. a. Supplies are a variable expense. The supplies budget should be flexed (i.e., it should be increased to provide funds for the additional 36 students above the number anticipated when the original budget was established). b. No. The budget should still be flexed, but in this case it would be reduced. c. Salary for the lab assistant is a fixed expense. The salary amount budgeted will not change as the number of students enrolled changes. At some point of activity (number of students), the need for a second lab assistant may be necessitated by significantly larger enrollments.

Instructor’s Manual / Solutions Manual C15.28. The gifts and grants budget should be flexed. In other words, it should be increased in total to attract more students. The average aid award is a variable expense. Each student who receives financial aid from the college will pay tuition, and generate revenue in excess of the aid award. Most of the other expenses of the college are fixed, so given the available capacity of 200 students, the added students will generate additional contribution margin to help cover the fixed expenses of the college. C15.29. No. For example, management might be able to control results better if the labor efficiency variance is reported daily, in hours. The labor rate variance might be reported only weekly or monthly because labor rates are likely to be governed by contractual provisions that are not subject to short-term control. The reason for calculating variances is to encourage action to eliminate unfavorable variances and to capture favorable variances - not simply to assess blame. Thus, performancereporting systems should be designed to provide the timeliest information (i.e., hourly, daily, weekly, or monthly) in the most appropriate manner (i.e., dollar amounts, quantities used, or hours worked) to the individuals within the organization who are in the best position to achieve the organization’s objectives. C15.30. a. Most Useful 1,2

Least Useful 3

5,6

7,8

1 - Raw material usage variance 2 - Direct labor efficiency variance 3 - Raw material price variance 4 - Direct labor rate variance 5 - Variable overhead efficiency variance 6 - Variable overhead spending variance 7 - Fixed overhead budget variance 8 - Fixed overhead volume variance Explanation of ranking: Raw material usage and direct labor efficiency are controllable in the current period by supervisors and managers. Raw material price and direct labor rate variances are usually less controllable in the short run. The price paid for materials tends to be easier to control than the direct labor rate per hour because labor contracts are usually negotiated for periods of one-year or longer, but raw material prices change frequently. The variable overhead efficiency variance, if the standard is based on a rate per direct labor hour, is controlled by controlling direct labor. In most circumstances, the variable overhead spending variance and the fixed overhead variances are not controllable at all in the short run.

Instructor’s Manual / Solutions Manual C15.30. (continued) b. Raw material usage and direct labor efficiency should be reported in physical quantities as frequently and promptly as feasible to facilitate cost control. The raw material price and direct labor rate variances might best be reported monthly. Unless the overhead variances are controllable, there isn't much sense in reporting them more frequently than monthly or quarterly. However, in an activity-based costing system, variances for some of the overhead cost drivers are subject to short-term control, and may be worth reporting more frequently. C15.31. a. The purchasing manager is probably taking advantage of some large-volume quantity discounts offered by suppliers of lower-grade raw materials input items. More items are being purchased than are needed for current period production. Because raw material inventory quantities are increasing at a rapid rate, the carrying cost to Williamson, Inc., will soon get out of control. Moreover, the inferior quality of these raw material inputs has led to consistently unfavorable usage variances, canceled purchase orders (lost sales), and unpleasant working conditions (unfavorable labor efficiency variances). b. Generally, it is appropriate to isolate variances as soon as possible so that immediate feedback can be provided to the manager responsible for controlling the cost. However, efforts must be made to harmonize the purchasing activities with production needs. The purchasing manager should be encouraged to find the most favorable price for materials that meet appropriate quality standards (as established by top management with the help of production managers). Minimum and maximum inventory quantity limits should be placed on each item of raw material, such that reordering does not occur until the quantity on hand is near the pre-specified minimum quantity limit. In addition to the responsibility of controlling purchase price variances, the purchasing manager should also receive feedback concerning quality of raw materials used in production (i.e., raw material usage variances and/or complaints from direct laborers and customers).

C15.32. a. Raw material usage, and direct labor and variable overhead efficiency variances are, in the aggregate, about 15% of the total standard cost of goods manufactured. This indicates that the standards are not a very effective tool for controlling raw material, direct labor, and variable overhead costs. b. The variances were favorable, so the standards are higher than actual costs incurred. Therefore, ending inventory values at standard costs will be higher than actual cost. c. Use the 15% difference between standard and actual. Ending inventory should be reduced to 85% of standard cost to adjust it to actual cost. 85% * $158,780 = $134,963. The adjustment would be a $23,817 (15% * $158,780) reduction in ending inventory.

Instructor’s Manual / Solutions Manual C15.33. a. This is the raw materials purchase price variance and it will be recorded in the income statement as it is incurred. b. When actual cost is the same as standard cost. c. It doesn't differ at all. The predetermined overhead application rate calculation originally discussed in Chapter 13 is really a standard rate. At the end of the fiscal year, the balance of overapplied or underapplied overhead will be closed to cost of goods sold. C15.34. a. Following are various points among many that students may emphasize from their CAM-I review. CAM-I describes themselves in a “Who We Are” slide as follows: • CAM-I (Consortium for Advanced Management-International) is a NonProfit 501c3 collaborative international consortium of manufacturing companies, service companies, government organizations, state, consultancies, academic and professional bodies who have elected to work cooperatively in a precompetitive environment to solve management problems and critical business issues that are common to the group. • CAM-I, working with its membership, has created innovative models and approach which have improved cost management, target costing methods through the application of process-based management Risk Management and performance management tools driving operational excellence nationally and internationally. • CAM-I is here to put all this business knowledge and experience into a form that allows our members to benefit quantitatively. • CAM-I was founded with Department of Commerce support in 1972. • Our mission - To serve as a collaborative forum of thought leaders who develop practical and effective management tools, techniques, and methods to advance the way organizations manage costs, processes, and performance. CAM-I describes in great detail their efforts and progress in multiple complementary projects and focus areas which include: • Cost and Profitability Management, • Integrated Risk and Value Management Special Interest Group • Performance Management Interest Group • Forecasting for procurement of complex acquisition and support projects Interest Group • CAM-I Higher Education Center of Excellence in Cost Management (CoE)

Instructor’s Manual / Solutions Manual C15.34. (continued) b. The purpose of this writing assignment is to have the student assess big-picture initiatives from the CAM-I interest group projects. The work in progress described for each interest group will help students better understand the scope and purpose of the organization. c. Student opinion will vary as to perceived benefits in relation to their estimation of the most useful CAM-I membership program. The important learning outcome here is to have the student try to assess membership benefits with membership costs and be able to articulate the result of that comparison, from their perspective. d. Again, students should be logically creative with their choices of two publications from the CAM-I body of knowledge that they perceive will help them with their new responsibilities. The library is plentiful and includes many good choices. e. Again, the purpose of this writing assignment is to have the student integrate information from an issue of interest on the CAM-I Wiki to the development of a planning and control system. This requirement also serves as an excellent classroom discussion activity that allows students to share their findings.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 15

NAME______________________

1. You have been employed as a customer relations representative for a firm. Your firm encourages the employees of customers to visit your firm's plant to see how products are made. One of your responsibilities is to take customer-employee visitors to lunch. The budget allowance for these lunches is $6 per visitor. When the budget for November was prepared, it was estimated that 60 customer-employees would visit your plant that month. Early in December, the following information appeared in the performance report for your department:

Customer lunches

Budget $360

Actual $430

Variance $70 U

Variance % 19.4% U

Your records indicate that during November you actually took 72 visitors to lunch. a. Explain how the budget amount was determined.

b. Evaluate the above performance report.

c. Prepare a more appropriate performance report.

2. The following income statement was prepared to provide a basis for evaluating the performance of three territories in the Midwest Division of a company.

Sales……………………… Cost Goods Sold ………… Gross Profit ……………… Operating Expenses……… Operating Income (Loss)…

Total Division $452,000 (203,400) $248,600 (213,200) $ 35,400

Chicago Kansas City Territory Territory $203,000 $122,000 (94,400) (52,500) $108,600 $ 69,500 (110,500) (61,700) $ (1,900) $ 7,800

St. Louis Territory $127,000 (56,500) $ 70,500 (41,000) $ 29,500

Comment about the usefulness of the above income statement. What specific changes would you recommend?

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 15 (continued) 3. The direct material and direct labor standards for one case of SpringBreak Tonic are: Direct Materials (5 quarts @ $8 per quart) …………………… $40 Direct Labor (2 hours @ $12 per hour) ……………………….. 24 During the week ended March 7, the following activity took place: • 16,000 quarts of raw materials were purchased for inventory at a cost of $8.10 per quart. • 3,000 cases of finished product were produced. • 14,700 quarts of raw material were used. • 6,300 hours of direct labor were incurred at a cost of $76,860. Calculate the total dollar amount of each of the following variances (show your work in detail): a. Raw materials purchase price variance.

b. Raw materials usage variance.

c. Direct labor efficiency variance.

d. Direct labor rate variance.

e. If you were the raw materials supervisor, how might you have preferred having the raw materials usage variance reported?

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 15 1. a. The budget amount is $6 per visitor * 60 visitors expected. b. The performance report is faulty because the budget was not flexed. c. Customer lunches …

Budget $432

Actual $430

Variance $2 F

Variance % 0.5% F

2. The statement appears to have arbitrarily allocated common fixed expenses of the division to the territories. For this reason, the statement is not very useful. If the statement were recast on a segment margin basis, it is likely that the Chicago territory would show a positive segment margin. Common fixed expenses should not be arbitrarily allocated to the territories. 3. a. Raw materials purchase price variance: (Standard price - Actual price) * Actual quantity purchased ($8.00 - $8.10) * 16,000 quarts = $1,600 U b. Raw materials usage variance: (Standard usage - Actual usage) * Standard price ((3,000 cases * 5 quarts) - 14,700 quarts) * $8.00 per quart = $2,400 F c. Direct labor efficiency variance: (Standard hours - Actual hours) * Standard rate ((3,000 cases * 2 hours) - 6,300) * $12.00 = $3,600 U d. Direct labor rate variance: (Standard rate - Actual rate) * Actual hours ($12.00 - $12.20 #) * 6,300 hours = $1,260 U # Actual rate: $76,860 / 6,300 hours = $12.20 per hour. e. The raw materials supervisor might prefer to have the usage variance reported in physical units (i.e., 300 quarts favorable).

Instructor’s Manual / Solutions Manual

CHAPTER

Costs for Decision Making

CHAPTER OUTLINE: I. Cost Classifications A. Classifications for Other Analytical Purposes 1. Differential cost 2. Allocated cost 3. Sunk cost 4. Opportunity cost II. Short Run Decision Analysis A. Relevant Costs B. Irrelevant Costs C. The Sell or Process Further Decision D. The Special Pricing Decision 1. Under Conditions of Idle Capacity 2. When Operating at Full capacity E. The Target Costing Question F. The Make or Buy Decision G. The Continue or Discontinue a Segment Decision H. Short-Term Allocation of Scarce Resources III. Capital Budgeting A. Investment Decision Special Considerations 1. Time Value of Money 2. Involvement of Board of Directors B. Cost of Capital C. Capital Budgeting Techniques 1. Methods that use present value analysis a. Net present value b. Internal rate of return 2. Some analytical considerations a. Estimates b. Cash flows far into the future c. Timing of cash flows within the year d. Investments made over a period of time e. Income tax effect of cash flows from the project f. Working capital investment g. Least cost projects 16-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual CHAPTER OUTLINE: (continued) 3. Methods that do not use present value analysis a. Payback b. Accounting rate of return D. The Investment Decision E. Integration of Capital Budget with Operating Budgets

TEACHING/LEARNING OBJECTIVES: Primary: To have the student understand: 1. And appreciate the difference in relevant cost analysis for short-run decisions, such as the special pricing decision, and discounted cash flow analysis to support long-run decisions, such as capital budgeting decisions. 2. That capital budgeting deals with cash flows from activities that extend relatively far into the future, and that the application of present value techniques is necessary and appropriate. 3. The net present value method of evaluating capital expenditure proposals, and the profitability index approach to ranking proposals. 4. That in addition to quantitative approaches to decision-making, management is also influenced by qualitative factors. Supporting: To have the student understand: 5. That whether the firm is operating at full capacity or idle capacity will affect the special pricing decision. 6. That a number of short-term decisions are a function of relevant cost analysis such as the sell or process further decision, make or buy decision, continue or discontinue a segment decision, or the decision to allocate scarce resources. 7. That the cost of capital used in the capital budgeting process is related to ROI expectations. 8. That the internal rate of return analytical method is really a special case of the NPV method that solves for a discount rate at which NPV is equal to zero. 9. That both the payback and accounting rate of return methods are fatally flawed because they do not consider the time value of money. 10. Some of the analytical considerations involved in capital budgeting. 11. How capital budgeting is integrated with operational budgeting discussed in Chapter 14.

Instructor’s Manual / Solutions Manual TEACHING OBSERVATIONS: 1. It is important that students understand that relevant cost analysis used to support short run decisions is a "way of thinking" that focuses only on the incremental revenues and incremental costs to be provided by the decision alternatives. The chapter illustrates the variety of “Relevant costs in Action” examples to emphasize this way of thinking and to help students better understand the key concepts to consider in short-term decision analysis. 2. Emphasize that capital budgeting deals with time periods that can extend far into the future, and that time value of money (present value analysis) should be used to evaluate the desirability of a proposed investment. 3. An interesting way of illustrating capital budgeting, and adding some of the qualitative issues involved, is to develop an analysis based on a student's investment in his/her college education, and the expected incremental income to be earned over what could have been earned without a college education. The selection of the discount rate to be used permits a discussion of the sensitivity of interest rates in present value analysis. The example should be kept simple, and should yield a positive net present value. 4. It is recommended that a time-line format be used for explaining and illustrating the cash flows related to an investment, because this emphasizes the appropriateness of present value analysis.

ASSIGNMENT OVERVIEW: NO. M16.1 M16.2 M16.3 M16.4 M16.5 M16.6 M16.7 M16.8

LEARNING OBJECTIVES 2,3 2,3 2,3 2,3 2,3 7 7 9,10

DIFFICULTY & TIME ESTIMATE Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Easy, 5-8 min. Med., 10-12 min. Easy, 5-8 min. Med., 12-18 min.

E16.9 E16.10 E16.11 E16.12 E16.13

1 1 2,3 2,3 2,3

Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Med., 12-18 min. Med., 10-12 min.

E16.14 E16.15

2,3 2,3

Med., 10-12 min. Med., 10-12 min.

E16.16 E16.17 E16.18 E16.19 E16.20

2,3 2,3 2,3 2,3 2,3

Med., 12-18 min. Med., 10-12 min. Med., 12-18 min. Med., 10-12 min. Med., 12-18 min.

OTHER COMMENTS Basic introduction to the sell or process further decision. Basic introduction to the special pricing decision. Basic introduction to the make or buy decision. Basic introduction to target costing. Basic introduction to the product mix decision. Introduction to net present value calculation. Extends M16.6 for present value ratio and IRR relationship. Introduction to payback period and accounting rate of return calculations. Use as an opportunity to clarify cost terminology. Good in-class exercise. Simple exercise that illustrates incremental analysis. Similar to 16.21 and extends the incremental analysis concept. Can be used to illustrate one of the potential pitfalls of unitizing fixed costs. See 16.13. Straight-forward exercise can be used to introduce the concept of target costing. Expands target costing questions introduced in 16.9. Good in-class exercise. Similar to 16.17 and extends the make or buy analysis. Good in-class exercise. Similar to 16.19 and extends the scarce resource allocation decision. 16-3

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: (continued) DIFFICULTY & TIME ESTIMATE Med., 7-10 min.

OTHER COMMENTS Good self-study/review problem.

Med., 7-10 min.

See 16.21. Good in-class exercise.

E16.23

LEARNING OBJECTIVES Time Value of Money Review Time Value of Money Review 7

Easy, 5-8 min.

E16.24 E16.25 E16.26 E16.27 E16.28

6 7 7,9 6,7,9 6,7

Easy, 5-8 min. Med., 7-10 min. Med., 12-18 min. Easy, 3-5 min. Med., 12-18 min.

P16.29

2,3

Med., 20-25 min.

P16.30 P16.31

2,3 2,3

Med., 30-45 min. Med., 25-30 min.

P16.32

2,3

Med., 30-40 min.

P16.33 P16.34

7,9 7,8,9

Med., 10-12 min. Med., 12-18 min.

P16.35

Easy, 5-8 min.

P16.36

P16.37

6,7,10,11

Med.-Hard 15-20 min. Med., 20-30 min.

P16.38 C16.39

7,9,10,11 7

Med., 20-30 min. Hard, 75-90 min.

C16.40

6,7,8,9,11

Med.-Hard 25-35 min. Med.-Hard 60-75 min.

Ask students to review the solution and then to explain the answer to each part “in your own words”. Use to clarify the “cost of capital” concept. Straight-forward numbers-oriented problem. Good in-class exercise or homework assignment. Simple conceptual problem. Group learning problem. Students find it difficult to come up with a plan of attack for solving this problem. They may benefit from a helpful hint. Review the solution before assigning this one. Stress that relevant cost analysis for short-run decisions is a "way of thinking" about the incremental revenues vs. the incremental costs. See 16.29. Straight-forward introduction to the continue or discontinue a segment decision by determining which costs are relevant to the situation. Similar to 16.31 but includes the analysis of a segmented income statement and considers how to improve the presentation of fixed costs. Straight-forward numbers-oriented problem. Group learning problem. Good in-class demonstration problem. Students should review solution to this problem before attempting 16.36. Group learning problem. Parts c and d should be emphasized. Stress the importance of using present value analysis in capital budgeting decisions. See 16.37. Group learning problem. Perhaps the most complex and challenging problem in the text. Can be used effectively as a group project. Students should review the solution to part a before proceeding. Group learning problem. Comprehensive numbers-oriented problem. Internet case. Group learning problem. Can be used effectively as group project to analyze Campbell’s annual reports for a period of three years in terms of their strategy for capital expenditures and company growth.

NO. E16.21 E16.22

C16.41

Instructor’s Manual / Solutions Manual SOLUTIONS: M16.1. Relevant cost analysis: Incremental selling price ($80 - $72)……………..…………………….… Incremental costs of further processing for material and labor ….…….… [($20 + $24) * 20%] Incremental Loss…………………………………..…………………....…

$ 8.00 (8.80) $ (0.80)

No, the new production changes should not be implemented and the product should be produced and sold as it is currently. M16.2. Relevant cost analysis: Revenue………………………………………..……………… Direct materials……………………………………….……… Direct labor…………………………………………………... Variable overhead……………………………………………. Fixed overhead……………………………………………….. Contribution margin per unit………………………………..… Additional units sold if special order is accepted………..……. Increase in contribution margin and operating income……

$ 56.00 $ 20.00 24.00 10.00 0.00

(54.00) $ 2.00 6,000 $12,000

Yes, the offer should be accepted because the "relevant cost" of $54 is less than the $56 selling price for the special order, thus increasing both contribution margin and operating income by $2.00 per unit. Fixed overhead cost is not relevant because Lakeside has current unused capacity. However, pertinent qualitative factors should also be considered. M16.3.

Relevant cost analysis: Manufacturing costs: Direct material…………………… Direct labor………………………. Variable overhead……………….. Fixed overhead…………………... Total cost per unit …….…………… Purchase costs: Conversion processing…....……… Advantage to buy….………………

Current Production Costs

Avoidable Cost if Purchased

$20.00 24.00 10.00 10.00 $64.00

$ 0.00 7.20 3.00 0.00 $10.20

(30%) (30%)

Cost to Buy

$8.00 $2.20

Lakeside should consider outsourcing this part of the conversion processing because contribution margin and operating would increase by the $2.20 per unit savings. However, pertinent qualitative factors should also be considered.

Instructor’s Manual / Solutions Manual M16.4. Target cost = Selling price – Desired profit Target cost = $300 – ($300* .25) Target cost = $300 – $75 Target cost per unit = $225 M16.5. Estimated demand for April…………………………....

Product A 6,000 units

Product B 4,000 units

Contribution margin per unit…………………………... Machine hours required per unit……………………….

$300 3

$250 2

Contribution margin per machine hour………………...

$100

$125

Machine hours required at estimated demand………….

18,000 hours

8,000 hours

Since product B generates a higher contribution margin per machine hour, Lakeside should prioritize April demand for Product B first with any remaining machine hours in April used to produce Product A as follows: Machine hour capacity (20,000) prioritization………… Machine hours required per unit………………………. Product mix for April production……………………

12,000 hours 3 4,000 units

8,000 hours 2 4,000 units

M16.6. 0 1 2 3 4 5 Investment………… $(320,000) Annual cash savings…...………….… $90,000 per year Salvage value…………………………………………………….. $20,000 3.6048 (Table 6-5 0.5674 (Table 6-4 $(320,000) 5 period row, 5 period row, 324,432 12% column) 12% column) 11,348 $ 15,780 net present value M16.7. Present Value Ratio = Present value of cash inflows / Investment = $335,780 / $320,000 = 1.05 Because the net present value is positive (see M16.6), as well as the resulting present value ratio being greater than 1, the internal rate of return on this project will be greater than the cost of capital of 12%. Note: Solving for the IRR indicates a return of approximately 14%.

Instructor’s Manual / Solutions Manual M16.8. Payback period = 3.56 years Investment...………………………...…………………………………… Total return in years 1-3 ($90,000 annual cash flow * 3 years) ...……… Return required in year 4 ($50,000 / $90,000 = 0.56 years) …………… Total return in 3.56 years ……………………………………………….

$(320,000) 270,000 50,000 $ 320,000

Accounting rate of return = $90,000−$60,000 # Net Income = = 10.34% ($320,000+$260,000) ## / 2 Average Investment # Straight line depreciation expense = (Cost - Salvage) / Life = ($320,000 - $20,000) / 5 = $60,000 per year ## Investment at end of the year = Investment at beginning of the year, less Accumulated depreciation = $320,000 - $60,000 = $260,000 E16.9. a. Differential cost: What costs will differ if a friend comes along? b. Allocated cost: How to allocate? Based on number of people, weight, number of suitcases, or what? c. Sunk cost: What costs have already been incurred and cannot be recovered, even if you don't make the trip? For example, the cost of the car is a sunk cost. d. Opportunity cost: What are other opportunities for you to earn revenue? What is the cost of alternative travel for your classmate? E16.10. a. b. c. d. e. f.

Sunk cost: tuition for prior semesters. Discretionary cost: social organization dues. Committed cost: cost of books. Opportunity cost: wages foregone while a student. Differential cost: cost of attending one college versus another. Allocated cost: tuition cost per course for a full-time student, or cost per meal for a student on the college’s meal plan.

E16.11. Differential cost analysis: Incremental selling price ($72 - $58)……… Incremental costs of further processing…… ($72,800 / 5,600 gallons) Incremental Profit…………………………..

$ 14 (13) $ 1

Yes, the National should produce the new compound variant and sold it for $72 per gallon. Further processing will result in an increase in profits of $5,600 (5,600 gallons x $1 incremental profit).

Instructor’s Manual / Solutions Manual E16.12. a.

Tons Alpha production: Delta product yield (350,000 x 60%)……... Pi product yield (350,000 x 40%)…………

350,000

Differential cost analysis – Super Delta: Incremental selling price ($12 - $6) .........… Incremental costs of further processing…… ($1,680,000 / 210,000 tons) Incremental Profit…………………………..

210,000 140,000

$ 6 (8) $(2)

Differential cost analysis – Precision Pi: Incremental selling price ($25 - $15) …...… Incremental costs of further processing…… ($1,120,000 / 140,000 tons) Incremental Profit…………………………..

$10 (8) $2

Delta should be sold as is for $6 per ton and Pi should be processed further and sold as Precision Pi for $25 per ton. b. The $675,000 cost incurred to produce the Alpha ore is a sunk cost and is not relevant to the decision to sell Delta or Pi as is or process either product further. c. Sales: Delta ($6 x 210,000 tons) ...……….……………...…... Precision Pi ($25 x 140,000 tons) ……………………. Production costs: Alpha ore mining costs………………………………… Processing Pi into Precision Pi………………………… Maximum profit………………………………………….

$1,260,000 3,500,000 $ 675,000 1,120,000

E16.13. Raw materials per unit …………………………………………………… a. Direct labor per unit ……………………………………………………… Variable overhead per unit………………………………………………… Fixed overhead per unit …………………………………………………… Total cost per unit …………………………………………………………

$4,760,000

1,795,000 $2,965,000 $ 6.00 6.00 8.00 4.00 a $24.00

(a)

The fixed overhead per unit is based on the total fixed overhead for the year of $480,000 divided by the current output of 120,000 units per year. b. The above calculation includes an inappropriate unitization of fixed expenses. Unless the additional production of 20,000 units results in a movement to a new relevant range, total fixed expenses will not change. c. The offer should be accepted because it would generate a contribution margin of $4 per unit (revenue of $24 per unit less variable cost of $20 per unit). 16-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual E16.14. a. Revenue……………………………………………………………………. Variable expense…………………………………………………………... Contribution margin per unit………………………………………………. Additional units sold if special order is accepted………………………….. Increase in contribution margin and operating income………………..

$ 16.25 (13.40) $ 2.85 12,000 $34,200

b. No, the order would probably have been refused because the "total cost" of $23.25 is more than the selling price for the special order. c. Will the additional production move the operation into a new relevant range? Would this transaction be in violation of federal price discrimination laws? E16.15. a. EagleEye Ltd., would consider the following costs as relevant to the decision to enter the digital binocular market: design and engineering costs, new equipment, raw materials, direct labor, variable overhead, any possible new fixed overhead costs such as a production supervisor that may be dedicated to this product line. Note that no new facility costs are required for this product line since the current plant has enough square footage to accommodate the new product line. b. Target cost = Selling price – Desired profit Target cost = ($49 * 20,000) – ($2,500,000 * .10) Target cost = $980,000 – $250,000 Target cost = $730,000 Target cost per unit = 730,000 / 20,000 units Target cost per unit = $36.50 E16.16. a. Current profit margin = Selling price – current cost per cabin Current profit margin = $1,500 – $1,200 = $300 Current profit margin % = Current profit margin / Selling price Current profit margin % = $300 / $1,500 Current profit margin % = 20% Target cost = Selling price – Desired profit Target cost = $1,250 – ($1,250 * 20%) Target cost = $1,250 – $250 Target cost = $1,000 b. Target cost reduction = Current cost – Target cost Target cost reduction = $1,200 – $1,000 Target cost reduction = $200

Instructor’s Manual / Solutions Manual E16.16. (continued) c. Rainbow must find ways to reduce its current cost per two-person cabin by $200 in order to compete at a selling price of $1,250 and earn a 20% profit margin. Rainbow should look to identify any non-essential activities and eliminate them – if customers do not perceive value in such activities, then they are not necessary. Rainbow should also review operations to make sure processes are efficient. Food and beverage services should be reviewed to reduce waste, and entertainment activities might be reviewed for cost savings opportunities. Many other detailed examples of specific cost reduction activities could also illustrate the challenge at hand of finding $200 of current cost to eliminate. E16.17. Current Production Costs Manufacturing costs: Direct material…………………… Direct labor………………………. Variable overhead ($180 x 30%)... Fixed overhead ($180 x 70%)…… Total cost per unit ………………… Purchase costs: Engine assembly part sets...……… Disadvantage to purchase………………

$ 360 180 54 126 $ 720

Avoidable Cost if Purchased

Cost to Buy

$ 360 180 54 0 $ 594 $ 620 $ 26

Waterway Engine, Inc. should continue to produce the engine part sets because the costs they can avoid by buying the part sets are less than the outside purchase cost. E16.18. a. The relevant costs to make the part internally would be the costs that could be avoided if the part were continued to be purchased from the outside. Avoidable costs would include direct material, direct labor, variable overhead, and the new manager’s salary. b.

Estimated Production Costs Manufacturing costs: Direct material…………………… Direct labor………………………. Variable overhead……………….. Fixed overhead…………………... Total cost per unit ………………… Purchase costs: Outside purchase cost………..…… Shipping and other costs…………. Total purchase cost…………………

$ 23 10 5 8 $ 46

Avoidable Cost if Purchased

Cost to Buy

$ 23 10 5 3 $ 41 $ 36 5 $ 41

Instructor’s Manual / Solutions Manual E16.18. (continued) b. From a quantitative standpoint, Redbud Company is indifferent about the decision because it incurs the same out of pocket costs to produce the parts internally or purchase them from the outside. c. Other factors that Redbud Company should consider in deciding whether to make this part internally include the potential for improved control over the availability of the parts by having it when needed and the potential for improved quality of the parts. Additionally, since Redbud Company is considering the use of currently available capacity, it should evaluate any relevant opportunity costs of using this capacity for more profitable activities. E16.19. Contribution margin per unit………………………….. Machine hours required per unit……………………….

Product X $ 150 3

Product Y $ 200 4

Contribution margin per machine hour………………...

$ 50

Since both products generate the same amount of contribution margin per machine hour, any production mix combination of Product X or Product Y will yield $30,000, the maximum amount of contribution margin available on 600 machine hours ($50 contribution margin per machine hour x 600 machine hours). E16.20. Selling price………………………………... Variable costs……………………………… Contribution margin per unit……………….

Product X $150 105 $ 45

Product Y $120 60 $ 60

Product Z $ 38 30 $ 8

Machine hours per unit……………………..

Contribution margin per machine hour…….

$ 15

$ 30

$ 8

Monthly demand (units)…………………… Machine hours per unit…………………….. Total machine hours required………………

450 3 1,350

300 2 600

750 1 750

Instructor’s Manual / Solutions Manual To assign the 1,800 available machine hours to achieve the most profitable mix of products, start by producing the product with the highest contribution per machine hour, then the next highest, and so on. Step 1: Use 600 machine hours to produce Product Y generating contribution margin in the amount of ($30 per machine hour x 600 machine hours) $18,000. Step 2: Use the remaining 1,200 machine hours to produce Product X generating contribution margin in the amount of ($15 per machine hour x 1,200 machine hours) $18,000.

E16.20.

(continued) Note that with only 1,800 machine hours available, given the current demand for each product, Product Z would not be included in the production mix.

E16.21. a.

5 $50,000 0.6806 (Table 6-4, 5 period row, 8% column)

$34,030 b. This is a future value problem, the opposite of present value. As shown in the diagram, $34,030 invested today at 8% interest compounded annually would grow to $50,000 in five years. c. Less could be invested today because at a higher interest rate, more interest would be earned. This can be seen by calculating the present value of $50,000 in five years at an interest rate greater than 8%. As can be seen in Table 6-4, the present value factors are smaller as interest rates get higher. E16.22. a.

0 Dividend = $5 per year 5.6502 (Table 6-5, 10 period row, $28.25 12% column) 39.93 $68.18

10 Market price = $124 0.3220 (Table 6-4, 10 period row, 12% column)

The maximum price to pay for the stock is the present value of the future cash flows expected from the stock, or $68.18. b.

5 Interest = $ 80 per year Maturity value = $1,000 3.7908 (Table 6-5, 0.6209 (Table 6-4, 5 period row, 5 period row, $ 303.26 10% column) 10% column) 16-12

Instructor’s Manual / Solutions Manual 620.90 $924.16 is the market value today. c.

8 $159.38 ???

$100.00 The present value factor = $100 / $159.38 = 0.6274 In Table 6-4, on the 8 period row, 0.6274 is found in the 6% column. Alexis’s average annual return on investment is 6%. E16.23. a. b. c. d.

If the investment is too high, the net present value will be too low. If the cost of capital is too low, the net present value will be too high. If the cash flows from the project are too high, the net present value will be too high. If the number of years over which the project will generate cash flows is too low, the net present value will be too low.

E16.24. a. ROI of 10%, because that rate of return reflects the composite expectation of all providers of capital - both debt and equity. ROE is not appropriate because the firm would continue to have a mix of debt and equity in its capital structure. The short-term borrowing rate is not appropriate because cost of capital is a long-term concept. b. A higher cost of capital might be used for evaluating capital expenditure opportunities to provide for a margin of error in the estimates used in the capital budgeting calculations, and to recognize the risk associated with proposed capital expenditures. E16.25. a.

0 1 2 3 4 5 6 7 8 Investment………… $(230,000) Annual cash flow……………………$40,000 per year Salvage value……………………………………………… $26,000 5.3349 (Table 6-5 0.4665 (Table 6-4 $(230,000) 8 period row, 8 period row, 213,396 10% column) 10% column) 12,129 $ (4,475) net present value

b. Because the net present value is negative, the internal rate of return on this project will be lower than the cost of capital of 10%. E16.26. a. Investment in machinery and equipment……………………………… Investment in working capital ………………………………………… Annual cash inflows, by year: ………………………………………… 2022 = $1,600,000 * 0.8929 ………………………………………… 2023 = 2,880,000 * 0.7972 …………………………………………

$(4,900,000) (960,000) 1,428,640 2,295,936

Instructor’s Manual / Solutions Manual 2024 = 1,360,000 * 0.7118 ………………………………………… 968,048 Salvage value = $800,000 * 0.7118 ………………………………… 569,440 Release of working capital = $960,000 * 0.7118.…………………… 683,328 Net present value ……………………………………………………… $ 85,392 b. Because the net present value is positive, the internal rate of return will be higher than the cost of capital which is 12%.

Instructor’s Manual / Solutions Manual E16.26. (continued) c. Estimate: Investment cost ………………… Annual cash inflows …………… Cost of capital……………………

Effect if estimate is less than actual: Actual NPV and ROI will be less than indicated. Actual NPV and ROI will be more than indicated. Actual NPV and ROI will be less than indicated.

E16.27. a. The net present value is positive $4,650 (present value of inflows of $52,650 less the investment of $48,000). Therefore, the return on investment is greater than 12%. b. The payback period should not carry much weight at all, because it does not recognize the time value of money. E16.28. a. The present value of an annuity = (Annuity amount * present value factor). If the present value of the annuity equals the investment, the IRR will equal the discount rate. (Annuity required * 3.7908 present value factor a) = $1,895,000 Annuity required = $499,894.48 (a) Table 6-5, 10%, 5 periods. b. Annual net cash flow required………………………………………… Annual direct cash costs (50%) ……………………………………..… Annual total revenues required………………………………………… Procedures capacity …………………………………………………… Utilization factor ……………………………………………………… Number of procedures per year …………………………..…………… Fee per procedure ($749,841.72 / 6,000 procedures) …………….……….

$499,894.48 249,947.24 $749,841.72 8,000 75% 6,000 $ 124.97

P16.29. a. Relevant costs for the special sales order include the following: Per Gallon Raw materials.………………………….…………… $3.20 Direct labor ……………………………….………… 1.60 Variable overhead…………………………………… 1.00 Distribution ………………………………………… .70 Total relevant costs per gallon ……………………… $6.50 b. Sales price …………………………………………… Less: relevant costs ………………..………………… Contribution margin per gallon……………………… Daily sales in gallons………………………………… Daily increase in operating income ….………………

Per Gallon $7.70 6.50 $ 1.20 600 $720.00

Instructor’s Manual / Solutions Manual P16.29. (continued) c. Since Delmar is now operating at full capacity, relevant costs for the special sales order would include any forgone contribution margin (opportunity cost) on regular sales given up by Delmar to fulfill the special sales order: Per Gallon Current sales ………………………………………… $10.00 Less variable costs…………………………………… Raw materials ……………………………………… 3.20 Direct labor………………………………………… 1.60 Variable overhead ………………………………… 1.00 Distribution (on current sales)……………………… .50 6.30 Current contribution margin ………………………… $ 3.70 Current contribution margin ………………………… Contribution margin from special order...…………… Decrease in contribution margin …………………… Daily sales in gallons………………………………… Daily decrease in operating income …………………

Per Gallon $ 3.70 1.20 $ 2.50 600 $1,500.00

d. When Delmar is operating under conditions of idle capacity, the only relevant costs incurred in producing the gallons of root beer needed to fulfill the special order are the incremental variable costs - Delmar would not be giving up any of their current sales. Conversely, when Delmar is producing and selling root at full capacity there is no reason to accept any offer for an amount less than the current selling price, and thereby accepting less contribution than is currently being earned, unless more cost can be avoided than the drop in selling price. P16.30. a. Step 1: Calculate total amount of fixed costs before the addition of plant capacity: Current total cost per unit …………………………………… $ 60 Less: Variable cost per unit ……………………….………… 48 Fixed cost per unit…………………………………………… $ 12 Units at full capacity………………………………………… * 60,000 Total fixed costs …………………………..………………… $720,000 Step 2: Calculate fixed costs per unit after the addition of plant capacity: Original total fixed cost……………………………………… $720,000 Annual increase in fixed costs ($7,800,000 / 10 years) …...... 780,000 Total fixed costs ………………………..…………………… $1,500,000 Fixed costs per unit at full capacity: $1,500,000 / 100,000 = $15

Instructor’s Manual / Solutions Manual P16.30. (continued) a. Step 3: Calculate cost per unit after the addition of plant capacity: Variable cost per unit ……………………………..………… Fixed cost per unit…………………………………………… Cost per unit …………………………………………………

$ 48 15 $ 63

b. Relevant costs associated with the special order from LawnPro.com would include variable manufacturing costs per motor ($48) and the costs associated with storing the motors in the PMI warehouse to await shipment. Fixed costs are not relevant because the capacity has already been added (sunk cost) and the commissions and freight are not relevant because they will not be paid (avoidable cost) on the special order. c. Yes, assuming no other option currently exists to provide more than $12 contribution margin per motor or that the costs associated with storing each motor in the PMI warehouse will not exceed $12 per motor. Selling price per unit………………………………………… Less variable cost per unit…………………………………… Contribution margin per unit…………………………………

$ 60 48 $ 12

d. No, because the full absorption cost per unit will indicate a loss on the sale. Selling price per unit………………………………………… Less full cost per unit ……………………..………………… Loss per unit …………………………………………………

$ 60 (63) $ (3)

e. Key qualitative factors to consider would include whether PMI's current customers would expect the same $60 price if they became aware of the sale, whether PMI's current customers would stop doing business with them if they became aware of the sale, will LawnPro.com expect this price of future additional orders if the Web site sales prove to be successful, whether there are there more profitable opportunities on the horizon for the use of the new additional capacity, or whether the sale at this discounted price is in violation of the Robinson-Patman Act.

Instructor’s Manual / Solutions Manual P16.30. (continued) f. PMI will no longer have enough idle capacity to produce the motors needed to fulfill the LawnPro.com special order without sacrificing sales to existing customers at the normal selling price. Therefore, relevant costs, in addition to the relevant costs described in part b, will now include an opportunity cost equal to the amount of contribution foregone if PMI were to accept the special order: Current sales in units………………………………………… Expected increase in sales (60,000 * 33 1/3%) …….………. Expected sales to current customers …………………………

60,000 20,000 80,000

Plant capacity in units ……………………….……………… Expected sales to current customers ………………………… Idle capacity in units…………………………………………

100,000 80,000 20,000

Selling price per unit………………………………………… Less: Variable cost per unit ……….………………………… Commission ($80 * 5%) ……………………………… Contribution margin per unit…………………………………

48 4

Sales to LawnPro.com in units ……………………………… Idle capacity in units………………………………………… Lost sales to existing customers in units ….………………… Contribution margin per unit………………………………… Opportunity cost of lost sales …………......…………………

35,000 20,000 15,000 $ 28 $ 420,000

$ 80

g. Calculation of operating income without the special order: Sales (80,000 * $80) …………………………………… Less variable costs: Manufacturing costs (80,000 * $48)…………………… $3,840,000 Commission (80,000 * $4) ……………………………. 320,000 Contribution margin ………………………..…………… Less fixed costs …………………….…………………… Operating income ……………………………..…………

52 $ 28

$6,400,000

4,160,000 $2,240,000 1,500,000 $ 740,000

Instructor’s Manual / Solutions Manual P16.30. (continued) g. Calculation of operating income with the special order: Sales (65,000 * $80)……………………………………... (35,000 * $60)……………………………………... Less variable costs: Manufacturing costs (100,000 * $48)…………………. Commission (65,000 * $4)……………………………... Contribution margin……………………………………... Less fixed costs………………………………………….. Operating income………………………………………...

$5,200,000 2,100,000 $4,800,000 260,000

$7,300,000

5,060,000 $2,240,000 1,500,000 $ 740,000

The analysis of operating income with and without the special order indicates that PMI would be indifferent to accepting the special order because each option produces exactly the same operating income of $740,000. This result provides another opportunity to stress how important it is to consider the key qualitative factors (see requirement e) associated with the special pricing decision. P16.31. a. Sales……………………………………………………... Variable operating expenses: Cost of sales (food, beverages, and snack items @ 50%) Food service items (spoons, napkins, etc.).…………….. Wages for part time employees..……………………….. Contribution Margin.…………………………………….. Fixed operating expenses: Utilities….……………………………………………… Convenience operation manager’s salary………………. General manager’s salary………………………………. Advertising...…………………………………………… Insurance……………………………………………….. Property taxes…………………………………………... Food equipment depreciation...………………………… Building depreciation...………………………………… Operating loss…..………………………………………...

$250,000 125,000 3,600 48,000

$ 7,200 60,000 18,000 20,000 12,000 3,000 5,000 15,000

176,600 $ 73,400

140,200 $ (66,800)

Instructor’s Manual / Solutions Manual P16.31. (continued) b. Note – relevant revenues and costs are those items that would be eliminated if the segment is discontinued: Relevant Amount Sales……………………………………………………... 250,000 Cost of sales (food, beverages, and snack items @ 50%).. 125,000 Food service items (spoons, napkins, etc.)………………. 3,600 Wages for part time employees………………………….. 48,000 Utilities (50% of total)…………………………………... 3,600 Convenience operation manager’s salary………………... 60,000 General manager’s salary………………………………... Not relevant Advertising………………………………………………. 3,000 Insurance………………………………………………… 3,000 Property taxes……………………………………………. Not relevant Food equipment depreciation……………………………. Not relevant Building depreciation……………………………………. Not relevant c. Loss of contribution margin……………………………... Less direct fixed costs: Utilities (50% of total)………………………………… Convenience operation manager’s salary……………... Advertising……………………………………………. Insurance……………………………………………… Decrease in operating income……………………………

$(73,400) 3,600 60,000 3,000 3,000

69,600 $ (3,800)

d. MMV should continue the convenience operation. The quantitative results of the relevant cost analysis indicate that if MMV discontinued the convenience operation it would see overall profits for this location decrease by $3,800 because the company would lose more contribution margin than the amount of fixed costs he would be able to eliminate. However, MMV should investigate whether there is a more profitable use of this space if the convenience operation were discontinued. For example, would it be more profitable to replace the convenience operation with an additional service bay? P16.32. a. Loss of contribution margin……………………………... Less direct fixed expenses……………………………….. Decrease in operating income……………………………

$(150,000) 74,000 $ (76,000)

Operating income will decrease by $76,000 for the XYZ Company if it discontinues Product A.

Instructor’s Manual / Solutions Manual P16.32. (continued) b.

XYZ COMPANY Segmented Income Statement For the Year Ended December 31, 2022

Sales………………….…. Variable expenses…….… Contribution margin….… Direct fixed expenses…... Common fixed expenses... Operating income….……

Total Company $300,000 126,000 $174,000 28,000 180,000 $(34,000)

Product A $ $ -

Product B $120,000 54,000 $ 66,000 10,000 72,000* $(16,000)

Product C $180,000 72,000 $108,000 18,000 108,000* $(18,000)

* Calculation for allocation of corporate-wide expenses based on sales revenue: Product B = $120,000 / $300,000 = 40% * $180,000 = $72,000 Product C = $180,000 / $300,000 = 60% * $180,000 = $108,000 Note: The decrease in operating income for XYZ Company is $76,000, decreasing from an operating income of $42,000 to an operating loss of $(34,000). c.

XYZ COMPANY Segmented Income Statement For the Year Ended December 31, 2022

Sales……………………. Variable expenses………. Contribution margin……. Direct fixed expenses…... Segment margin………… Common fixed expenses... Operating income……….

Total Company $600,000 276,000 $324,000 102,000 $222,000 180,000 $ 42,000

Product A $300,000 150,000 $150,000 74,000 $ 76,000

Product B $120,000 54,000 $ 66,000 10,000 $ 56,000

Product C $180,000 72,000 $108,000 18,000 $ 90,000

d. As explained in Chapter 15, a key feature of this more appropriately designed segmented income statement is that common fixed expenses have not been arbitrarily allocated to the segments. This approach more clearly illustrates that when a segment is covering its direct expenses, it should not be discontinued. By comparing the results of the relevant cost analysis in part a, which indicated that operating income would decrease by $76,000 if Product A were discontinued, with the revised segmented income statement in part c that calculates a segment margin of $76,000 for Product A, it becomes apparent that a relevant cost analysis demonstrates the importance of a properly designed segmented income statement.

Instructor’s Manual / Solutions Manual P16.33. a.

0 1 2 3 4 5 6 7 8 9 10 11 12 Investment $(140,000) Annual cash flow……………………………. $21,000 per year ……………………….. Salvage value………………………………………………………….……….…$15,000 6.1944 (Table 6-5 0.2567 (Table 6-4 $(140,000) 12 periods, 12 periods, 130,082 12%) 12%) 3,851 $ (6,067) net present value

b. Present Value Ratio = ($133,933 present value of inflows / $140,000 investment) = 0.96 c. Internal rate of return (actual rate of return) is considerably less than the cost of capital of 12% because the net present value is negative, and the present value ratio is relatively low. d. Payback period = 6.67 years Investment...…………………………………………………...………… Total return in years 1-6 ($21,000 annual cash flow * 6 years) ………… Return required in year 7 ($14,000 / $21,000 = 0.67 years)……..……… Total return in 6.67 years ……………………………………..………… P16.34 a.

Contribution Margin Present Value Factor Year Volume @ $ 5.00 per dozen (Table 6-2, 16%) 2022 3,600 dozen $18,000 0.8621 2023 5,600 dozen 28,000 0.7432 2024 8,500 dozen 42,500 0.6407 2025 11,300 dozen 56,500 0.5523 2026 12,000 dozen 60,000 0.4761 Total present value of inflows ………………………..…………………… Investment (machine cost, plus delivery and installation costs) ………..… Net present value …………………………………..………………………

$(140,000) 126,000 14,000 $ 140,000

Present Value $ 15,518 20,810 27,230 31,205 28,566 $123,329 (103,000) $ 20,329

b. Profitability index = ($123,329 present value of inflows / $103,000 investment) = 1.197 c. Because the net present value is positive and the profitability index is rather high, the IRR is significantly greater than the 16% discount rate used to calculate the NPV. d. 1. 2. 3. 4. 5.

Year 2022 2023 2024 2025 2026

Cash Flow $18,000 28,000 42,500 56,500 60,000

Cumulative Cash Flow $ 18,000 46,000 88,500 145,000 205,000

Instructor’s Manual / Solutions Manual P16.34. (continued) d. The investment of $103,000 will be recovered in the 4th year, after $14,500 of that year's $56,500 has been received. The proportion of the year is .26 ($14,500 / $56,500), so the payback period is 3.26 years. P16.35. a. Proposal 1 2 3 4

Investment $60,000 24,000 72,000 72,000

Net PV $36,000 9,600 36,000 14,400

PV of Inflows (Investment + Net PV) $96,000 33,600 108,000 86,400

Profitability Index (PV of Inflows / Outflows) $96,000 / $60,000 = 1.6 33,600 / 24,000 = 1.4 108,000 / 72,000 = 1.5 86,400 / 72,000 = 1.2

Proposal 1 is most desirable because its profitability index is the highest. P16.36. a. Project B: Initial investment………………………………………………………… Present value of net cash return, by year(s): Years 3-5 = $10,000 * (0.6750 + 0.5921 + 0.5194) …………………… Year 6-10 = $ 6,000 * (5.2161 - 3.4331) …………………………...… Net present value………………………………………………………… Project C: Initial investment………………………………………………………… Present value of net cash return, by year(s): Years 1-5 = $16,000 * 3.4331 ………………………………………… Net present value………………………………………………………… Project D: Initial investment………………………………………………………… Present value of net cash return, by year(s): Year 1 = $ 5,000 * 0.8772 …………………………………….……… Year 2 = $10,000 * 0.7695 …………………………….……………… Year 3 = $15,000 * 0.6750 ………………………….………………… Year 4 = $20,000 * 0.5921 ……………………….…………………… Year 5 = $25,000 * 0.5194 ………………………………….………… Net present value………………………………………………………… b. Initial investment ……………..…… + Net present value………………… = PV of inflows….………………… / PV of outflows (initial investment) = Profitability index

B $25,000 3,563 $28,563 25,000 1.14

Project C D $50,000 $50,000 4,930 (2,967) $54,930 $47,033 50,000 50,000 1.10 0.94

$(25,000) 17,865 10,698 $ 3,563

$(50,000) 54,930 $ 4,930

$(50,000) 4,386 7,695 10,125 11,842 12,985 $ (2,967)

E $100,000 2,942 $102,942 100,000 1.03

Instructor’s Manual / Solutions Manual P16.36. (continued) b. Based on the profitability index computed for each project, Project B would rank first followed by Project C, then Project E. Note that Project D would not be considered as it has a profitability index of less than 1. c. 1. Based on quantitative analysis only, Project C should be invested in because the $4,930 net present value of this project is expected to exceed the total net present value of Projects A and B of $4,644 ($1,081 + $3,563). Project D is automatically eliminated because of its negative net present value. Project E cannot be considered because of its $100,000 initial investment cost. 2. Projects A, B, and C should be invested in—even though this would mean that only $100,000 has been invested. The total net present value of projects A, B, and C is $9,574 ($1,081 + $3,563 + $4,930), which exceeds the amount that could be earned by investing in projects C and E ($4,930 + $2,942 = $7,872). 3. Projects A, B, C, and E should be invested in—even though this would mean that only $200,000 has been invested. Project D has a negative net present value. d. The analysis above represents only quantitative factors. Management of Scott, Inc., should also take a number of qualitative factors into account, such as: 1) the possibility of estimation errors with respect to net cash return projections, 2) an assessment of non-financial risks involved with each project, 3) the relative importance of each project in terms of marketing and competitive pressures, and 4) whether it is feasible to wait until Year 3 to begin receiving cash returns on Project B. Management of Scott, Inc., should also re-evaluate its 14% cost of capital periodically to determine whether this represents a conservative estimate of the firm’s long-run cost of acquiring funds. If not, what is the incremental cost of borrowing? Would the net present value for Project D be positive at some lower discount rate?

Instructor’s Manual / Solutions Manual P16.37. a. Accounting rate of return = $87,000−$30,000 # Net Income = = 20% Average Investment ($300,000+$270,000 ##)/ 2 # Depreciation expense = (Cost - Salvage) / Life = ($240,000 - $150,000) / 3 = $30,000 ## Investment at end of the year = Investment at beginning of the year, less Accumulated depreciation = $300,000 - $30,000 = $270,000 Since the accounting rate of return of 20% exceeds the company’s desired rate of return of 18%, the investment would be made. b. Investment: Machine Working Capital Cash returns: Operations Salvage Working Capital Totals PV Factor for 18% Present value Sum of present values Net present value

Year 1

Year 2

Year 3

Year 4

$42,000

$72,000

$87,000

$42,000 0.8475 $35,595

$72,000 0.7182 $51,710

$87,000 0.6086 $50,948

$ 60,000 150,000 60,000 $270,000 0.5158 $139,266

$(240,000) (60,000)

$(300,000)

277,519 $ (20,481)

Based on this analysis, the investment would not be made because the net present value is negative, indicating that the ROI on the project is less than the discount rate of 18%. c. The net present value analytical approach is the best technique to use because it recognizes the time value of money.

Instructor’s Manual / Solutions Manual P16.38. a. Accounting rate of return = $30,000−$16,000 # Net Income = = 15.2% Average Investment ($100,000+$84,000 ##)/ 2 The investment would probably not be made because the indicated ARR of 15.2% is less than the 16% desired rate of return. # Depreciation expense = (Cost - Salvage) / Life = ($100,000 - $20,000) / 5 = $16,000 ## Investment at end of the year = Investment at beginning of the year, less Accumulated depreciation = $100,000 - $16,000 = $84,000 b. ($100,000 investment / $30,000 cash flows per year) = 3.33 years The investment would probably not be made because the payback period of 3.33 years is longer than the desired 3-year payback period. c. Investment: Machine Cash returns: Operations Salvage Totals PV Factor for 16% Present value Sum of present values Net present value

Year 1

Year 2

Year 3

Year 4

Year 5

$30,000 _________ ______ $(100,000) $30,000 0.8621 $25,863 107,754

$30,000 ______ $30,000 0.7432 $22,296

$30,000 ______ $30,000 0.6407 $19,221

$30,000 ______ $30,000 0.5523 $16,569

$30,000 20,000 $50,000 0.4761 $23,805

$(100,000)

7,754

The investment probably would be made because the net present value is positive, indicating that the ROI on the project is more than the cost of capital of 16%. d. The net present value analytical approach is the best technique to use because it recognizes the time value of money.

Instructor’s Manual / Solutions Manual C16.39. a. Notes: All amounts are rounded to the nearest US$1.00 psf = per square foot, sf = square feet, 1.25 = conversion factor, PV = present value factor (10 years, 12% = 0.3220), PVa = present value of an annuity factor (10 years, 12% = 5.6502). Initial investment: Real estate (CI$150 psf * 1,000 sf * 1.25) ……………………… Equipment for health spa …………………………………… Inventory of cosmetics and skin care products ……………… Annual operating costs: Cleaning (CI$0.10 psf * 1,000 sf * 12 months * 1.25 * 5.6502 PVa) .. Utilities (CI$0.40 psf * 1,000 sf * 12 months * 1.25 * 5.6502 PVa) … Health spa assistant (US$25,000 * 5.6502 PVa)………………… Advertising (US$3,000 * 5.6502 PVa) ………………………… Maintenance and insurance (US$4,500 * 5.6502 PVa) ………… Annual cash inflows (CI$8,000 * 12 months * 1.25 * 5.6502 PVa) … Future sale of real estate (CI$300 psf * 1,000 sf * 1.25 * 0.3220 PV).. Net present value………………………………………………

US$ (187,500) (35,000) (8,000)

b. Initial investment: Real estate (CI$150 psf * 2,500 sf * 1.25) ……………………… Equipment for fitness center ………………………………… Equipment for health spa …………………………………… Inventory of cosmetics and skin care products ……………… Annual operating costs: Cleaning (CI$0.10 psf * 2,500 sf * 12 months * 1.25 * 5.6502 PVa) .. Utilities (CI$0.60 psf * 2,500 sf * 12 months * 1.25 * 5.6502 PVa) … Health spa assistant (US$25,000 * 5.6502 PVa)………………… Aerobics instructors (2 * US$20,000 * 5.6502 PVa) …………… Physical trainer (US$30,000 * 5.6502 PVa) …………………… Advertising (US$3,000 * 5.6502 PVa) ………………………… Maintenance and insurance (US$4,500 * 5.6502 PVa) ………… Annual cash inflows: Fitness center (CI$300 * 500 members * 1.25 * 5.6502 PVa) …… Health spa (CI$8,000 * 12 months * 1.25 * 5.6502 PVa) ………… Future sale of real estate (CI$300 psf * 2,500 sf * 1.25 * 0.3220 PV) . Net present value………………………………………………

US$ (468,750) (50,000) (35,000) (8,000)

(561,750)

(21,188) (127,130) (141,255) (226,008) (169,506) (16,951) (25,426)

(727,464)

(8,475) (33,901) (141,255) (16,951) (25,426)

1,059,413 678,024

US$

(230,500)

(226,008) 678,024 120,750 $342,266 US$

1,737,437 301,875 $ 750,098

Instructor’s Manual / Solutions Manual C16.39. (continued) c. Note: Changes from the solution to part b are shown in bold. Initial investment: Real estate (CI$150 psf * 2,500 sf * 1.25) ……………………… Equipment for fitness center ………………………………… Equipment for health spa …………………………………… Inventory of cosmetics and skin care products ……………… Annual operating costs: Cleaning (CI$0.10 psf * 2,500 sf * 12 months * 1.25 * 5.6502 PVa) .. Utilities (CI$0.60 psf * 2,500 sf * 12 months * 1.25 * 5.6502 PVa) … Health spa assistant (US$25,000 * 5.6502 PVa)………………… Aerobics instructors (2 * US$20,000 * 5.6502 PVa) …………… Physical trainer (US$30,000 * 5.6502 PVa) …………………… Advertising (US$3,000 * 5.6502 PVa) ………………………… Maintenance and insurance (US$4,500 * 5.6502 PVa) ………… Annual cash inflows: Fitness center (CI$300 * 300 members * 1.25 * 5.6502 PVa) …… Health spa (CI$6,000 * 12 months * 1.25 * 5.6502 PVa) ………… Future sale of real estate (CI$200 psf * 2,500 sf * 1.25 * 0.3220 PV).. Net present value………………………………………………

US$ (468,750) (50,000) (35,000) (8,000)

(561,750)

(21,188) (127,130) (141,255) (226,008) (169,506) (16,951) (25,426)

(727,464)

635,648 508,518

US$

1,144,166 201,250 $ 56,202

d. If Jinny initially decides to open the health spa only, she should consider leasing (rather than purchasing) the 1,000 square foot unit for the following reasons: • By leasing, her initial investment cost would be reduced to only US$43,000 because the real estate cost of CI$150,000 would be eliminated. This would allow her to get started with less business risk and she would maintain flexibility in terms of her desire to open the fitness center / health spa in one location in the future. • Leasing would eliminate the hassle and possible business interruption of having to sell the 1,000 square foot unit before she could afford to purchase the 2,500 square foot unit. By leasing on an annual basis, she will have plenty of time to search for the most suitable location for the combined business, and will not face the possibility of having to run her business out of two locations (or to make two mortgage payments). • Although the nominal value of real estate in Grand Cayman is likely to double over the next 10 years (from CI$150 to CI$300 per square foot), the present value of the future selling price of Jinny’s unit (US$120,750) is less than the cost of purchasing it today (US$187,500). Because the present value of $1 to be received in 10 years at 12% is only 0.3220, real estate values would have to triple (rather than double) for the investment to yield an acceptable payoff. • One possible drawback to leasing is the loss of collateral for borrowing purposes.

Instructor’s Manual / Solutions Manual C16.39. (continued) e. Analysis: 1. Without considering the cost of Jinny’s salary, the net present value calculations in parts a and b adequately support either alternative. The profitability index for each of these alternatives would be extremely high, calculated as follows: 1,000 sf unit 2,500 sf unit (see part a) (see part b) PV of annual cash inflows ………………………… $678,024 $1,737,437 + PV of future sale of real estate……………………… 120,750 301,875 - PV of annual operating costs ……………………… (226,008) (727,464) = PV of net cash inflows……………………………… $572,766 $1,311,848 / PV of net cash outflows (i.e., initial investment)…… 230,500 561,750 = Profitability index…………………………………… 2.48 2.34 2. One additional line should now be added to the solutions presented for parts a and b. Without adjusting Jinny’s “reasonably comfortable salary” of CI$4,000 for inflation over the next 10 years, the following results would occur (changes in bold): 1,000 sf unit 2,500 sf unit (see part a) (see part b) PV of annual cash inflows ………………………… $678,024 $1,737,437 + PV of future sale of real estate……………………… 120,750 301,875 - PV of annual operating costs ……………………… (226,008) (727,464) - PV of Jinny’s salary (CI$4,000 * 12 months (339,012) (339,012) * 1.25 * 5.6502 PVa) ………………………… = PV of net cash inflows……………………………… $ 233,754 $ 972,836 / PV of net cash outflows (i.e., initial investment)…… 230,500 561,750 = Profitability index…………………………………… 1.01 1.73 3. It now becomes clear that the real money to be made is in the full-scale operation. The combined fitness center / health spa allows Jinny to pay herself a reasonably comfortable salary and still earn an excess return! This makes intuitive sense—by operating a small personal service business (i.e., health spa only) with the help of one personal assistant, Jinny would be taking a low risk, low return strategy. The combined business has more risk, but it also offers higher potential returns. 4. The analysis above represents only quantitative factors. Jinny should also take a number of qualitative factors into account, such as: 1) the possibility of estimation errors with respect to her projections, 2) an assessment of non-financial risks involved with each aspect of her business, 3) any possible synergistic effects of operating the combined business in terms of attracting fitness center members by offering them discounts to health spa services, and 4) whether Jinny’s 12% cost of capital represents a conservative estimate of her long-run cost of acquiring funds. If not, what is her incremental cost of borrowing? Would the net present value of either alternative change significantly if the discount rate were changed?

Instructor’s Manual / Solutions Manual C16.39. (continued) e. Recommendation: After consulting with Jinny in terms of how she perceives the various risks involved, I would recommend that she either: 1) consider purchasing the 2,500 square foot unit immediately and begin pre-selling the fitness center memberships to ensure its success, or 2) lease the 1,000 square foot unit for one year and begin to build her business reputation by operating the health spa—with a target of opening the combined operation at the end of the initial one-year lease term. C16.40. a. Investment...……………………………………………………………… Investment in working capital…………………………………………… Annual cash inflows, by year: 2022 = $126,000 * 0.8929……………………………………………… 2023 = 162,000 * 0.7972……………………………………………… 2024 = 195,000 * 0.7118……………………………………………… 2025 = 144,000 * 0.6355……………………………………………… Salvage value = $75,000 * 0.6355.……………………………………… Release of working capital = $80,000 * 0.6355.………………………… Net present value…………………………………………………………

$(500,000) (80,000) 112,505 129,146 138,801 91,512 47,663 50,840 $ (9,533)

b. Profitability index = ($570,467 present value of inflows / $580,000 outflows) = 0.984 c. Because the net present value is negative, the IRR will be lower than the cost of capital. d. Payback period = 3.67 years Initial investment Return in year 1 …………………………………………… Return in year 2 …………………………………………… Return in year 3 …………………………………………… Total return in 3 years ……………………………………… Return required in year 4 ($97,000 / $144,000 = 0.67 years). Total return in 3.67 years……………………………………

$(580,000) $126,000 162,000 195,000 $483,000 97,000 $ 580,000

e. No. The ROI is expected to be lower than the cost of capital. f. What are the probabilities of exceeding the annual cash flow estimates? Is the 12% cost of capital used by Sunset Beach, Inc., a conservative estimate of the firm’s longrun cost of acquiring funds? If not, what is the firm’s incremental cost of borrowing? Is the NPV positive at this lower discount rate? Would this product line expansion open any additional market opportunities for the firm that could not be entered into at a later date without making this initial investment? Are there ways to reduce the initial investment cost by expanding the product line on a multi-phase basis, rather than all at once?

Instructor’s Manual / Solutions Manual C16.41.

Note to Instructor: The purpose of this case is to familiarize students with information about an organization’s capital expenditures that may appear in its annual report. This solution uses Campbell Soup Company’s 2020 annual report, which was the most recent annual report available at the time we were preparing the 13th edition of Accounting: What the Numbers Mean. Over the years, Campbell Soup has been very consistent in the structure of its annual report and the location sequence of information presented. Hence, it should be fairly easy to update this solution for annual reports issued after 2020.

For the year 2020: (Note: Dollar amounts in millions) a. 1. Additions to plant assets amounted to $299 and new businesses acquired amounted to $11. Sales of plant assets amounted to $0 and businesses sold amounted to $2,548. Other net investing activities provided $34 cash. (Campbell’s Annual Report p. 43). 2. Additions to plant and assets were $304 and $407 in 2019 and 2018, respectively, and business acquisitions were $47 for 2019 and $6,781 for 2018. Sales of plant assets amounted to $0 and $0 in 2019 and 2018 respectively, and business sales were $570 in 2019 and $10 in 2018. And other net investing activities provided cash of $14 in 2019 and used cash of $19 in 2018. The trend indicates that Campbell Soup has been consistently investing in plant assets but clearly the amount is decreasing over the three years reported. In addition, expansion through business acquisitions has been significantly erratic over the three years as compared to other net investments which have remained relatively steady over the three years. (Campbell’s Annual Report p. 43). Campbell’s end of year cash amount was $859, $31, and $49 in 2020, 2019, and 2018, respectively. This trend indicates that over the three periods, the general cash position has been positive but with a significant positive increase in 2020. Notice not only the very steady cash provided by operating activities, but also the annual relationship of cash used/provided by investing and financing activities. (Campbell’s Annual Report p. 43). b.

During 2020, our aggregate capital expenditures were $299 million. We expect to spend approximately $350 million for capital projects in 2021. Major capital projects based on planned spend in 2021 include implementation of an SAP enterprise resource planning system for Snyder's-Lance, which was delayed from 2020 due to the COVID-19 pandemic, and a new manufacturing line for our snacks business. (Campbell’s Annual Report p. 5).

Instructor’s Manual / Solutions Manual C16.41. c.

(continued) We have historically made strategic acquisition of brands and businesses and we may undertake additional acquisitions or other strategic transactions in the future. Our ability to meet our objectives with respect to acquisitions and other strategic transactions may depend in part on our ability to identify suitable counterparties, negotiate favorable financial and other contractual terms, obtain all necessary regulatory approvals on the terms expected and complete those transactions. Potential risks also include: • the inability to integrate acquired businesses into our existing operations in a timely and cost-efficient manner, including implementation of enterprise-resource planning systems; • diversion of management's attention from other business concerns; • potential loss of key employees, suppliers and/or customers of acquired businesses; • assumption of unknown risks and liabilities; • the inability to achieve anticipated benefits, including revenues or other operating results; • operating costs of acquired businesses may be greater than expected; • the inability to promptly implement an effective control environment; and • the risks inherent in entering markets or lines of business with which we have limited or no prior experience. In addition, during the first half of 2020, we completed the sale of our Kelsen business and the Arnott’s and other international operations, and we may undertake other divestitures in the future. Any other businesses we decide to divest in the future may depend in part on our ability to identify suitable buyers, negotiate favorable financial and other contractual terms and obtain all necessary regulatory approvals on the terms expected. Potential risks of divestitures may also include: • diversion of management's attention from other business concerns; • loss of key suppliers and/or customers of divested businesses; • the inability to separate divested businesses or business units effectively and efficiently from our existing business operations; and • the inability to reduce or eliminate associated overhead costs. If we are unable to complete or realize the projected benefits of future acquisitions, divestitures or other strategic transactions, our business or financial results may be adversely impacted. (Campbell’s Annual Report p. 10-11).

1. Capital expenditures were $299 million in 2020, $384 million in 2019 and $407 million in 2018. Capital expenditures in 2020 were lower than 2019 reflecting delays in certain projects impacted by the spread of the COVID-19 pandemic. Capital expenditures are expected to total approximately $350 million in 2021. Capital expenditures in 2020 included the implementation of an SAP enterprise-resource planning system for Snyder's-Lance, a Milano cookie 16-32

Instructor’s Manual / Solutions Manual C16.41. d.

(continued) 1. capacity expansion project, chip capacity expansion projects, and a Goldfish cracker capacity expansion project. Capital expenditures in 2019 included a U.S. warehouse optimization project, replacement of a Pepperidge Farm refrigeration system, transition of production of the Toronto manufacturing facility to our U.S. thermal plants, a Snyder's-Lance regional distribution center, a Milano cookie capacity expansion project, and a Goldfish cracker capacity expansion project. Capital expenditures in 2018 included a U.S. warehouse optimization project; transition of production of the Toronto manufacturing facility to our U.S. thermal plants; insourcing manufacturing for certain simple meal products; replacement of a Pepperidge Farm refrigeration system; and an Australian multi-pack biscuit capacity expansion project. (Campbell’s Annual Report p. 32).

2. Fixed assets and amortizable intangible assets are reviewed for impairment as events or changes in circumstances occur indicating that the carrying value of the asset may not be recoverable. Undiscounted cash flow analyses are used to determine if impairment exists. If impairment is determined to exist, the loss is calculated based on estimated fair value. (Campbell’s Annual Report pp. 3536). The estimates of future cash flows involve considerable management judgment and are based upon assumptions about expected future operating performance, economic conditions, market conditions, and cost of capital. Inherent in estimating the future cash flows are uncertainties beyond our control, such as changes in capital markets. The actual cash flows could differ materially from management’s estimates due to changes in business conditions, operating performance, and economic conditions. If assumptions are not achieved or market conditions decline, potential additional impairment charges could result. We will continue to monitor the valuation of our long-lived assets. (Campbell’s Annual Report p. 37).

1. Property, plant and equipment are recorded at historical cost and are depreciated over estimated useful lives using the straight-line method. Buildings and machinery and equipment are depreciated over periods not exceeding 45 years and 20 years, respectively. Assets are evaluated for impairment when conditions indicate that the carrying value may not be recoverable. Such conditions include significant adverse changes in business climate or a plan of disposal. Repairs and maintenance are charged to expense as incurred. (Campbell’s Annual Report p. 45).

Instructor’s Manual / Solutions Manual C16.41. e.

(continued) 2. Acquisitions On March 26, 2018, we completed the acquisition of Snyder's-Lance, Inc. (Snyder's-Lance) for $50.00 per share. Total consideration was $6,112, which included the payoff of approximately $1,100 of Snyder's-Lance indebtedness. The acquisition was financed through a single draw 3-year senior unsecured term loan facility and the issuance of senior notes. Snyder's-Lance is a snack food company that manufactures, distributes, markets and sells snack food products in North America and Europe. Its primary brands include Snyder’s of Hanover and Lance, as well as Kettle Brand, Cape Cod, Snack Factory Pretzel Crisps, Pop Secret, Emerald and Late July. The excess of the purchase price over the estimated fair values of identifiable net assets was recorded as $3,006 of goodwill. The goodwill is included in the Snacks segment. In the first quarter of 2019, we made measurement period adjustments to reflect facts and circumstances in existence as of the date of the Snyder's-Lance acquisition. These adjustments included a $134 decrease to indefinite-lived trademarks, a $52 decrease to customer relationships, a $43 decrease to Deferred taxes and a $140 increase to Goodwill. On December 12, 2017, we completed the acquisition of Pacific Foods of Oregon, LLC (Pacific Foods). The purchase price was $688. Pacific Foods produces broth, soups and non-dairy beverages. The excess of the purchase price over the estimated fair values of identifiable net assets was recorded as $202 of goodwill. The goodwill is included in the Meals & Beverages segment. In 2019, the acquisition of Snyder's-Lance contributed $2,192 to Net sales. The contribution to Earnings from continuing operations was a loss of $36 including expenses associated with restructuring charges and cost savings initiatives, as well as interest expense on the debt to finance the acquisition. In 2018, we recognized transaction costs and integration costs of $102, associated with the Snyder's-Lance acquisition. Approximately $53 represented transactions costs, including bridge financing costs and outside advisory costs, and were recorded in Other expenses / (income). Integration costs included the following: • amortization of the acquisition date fair value adjustment to inventories of $42 that was recorded in Cost of products sold; • $13 of Restructuring charges; • $12 of Administrative expenses; and • $18 gain in Interest expense on treasury rate lock contracts used to hedge the planned financing of the acquisition. The acquisition of Snyder's-Lance contributed $772 to Net sales from March 26, 2018, through July 29, 2018. The contribution to Earnings from continuing operations was a loss of $84 from March 26, 2018, through July 29, 2018, including the effect of the transaction and integration costs, and interest expense on the debt to finance the acquisition. 16-34

Instructor’s Manual / Solutions Manual C16.41. e.

(continued) 2. In 2019, the acquisition of Pacific Foods contributed $222 to Net sales. The contribution to Earnings from continuing operations was a loss of $12. The acquisition of Pacific Foods contributed $123 to Net sales from December 12, 2017, through July 29, 2018. The contribution to Earnings from continuing operations was a loss of $13 from December 12, 2017, through July 29, 2018. The following unaudited summary information is presented on a consolidated pro forma basis as if the Snyder's-Lance and Pacific Foods acquisitions had occurred on August 1, 2016:

The pro forma amounts include additional interest expense on the debt issued to finance the purchases, amortization and depreciation expense based on the estimated fair value and useful lives of intangible assets and plant assets, and related tax effects. The pro forma results are not necessarily indicative of the combined results had the Snyder's-Lance and Pacific Foods acquisitions been completed on August 1, 2016, nor are they indicative of future combined results. With the acquisition of Snyder's-Lance, we acquired an investment in Yellow Chips Holdings B.V. (Yellow Chips) and accounted for the investment under the equity method of accounting. On October 30, 2018, we purchased the remaining ownership interest in Yellow Chips, and began consolidating the business. The purchase price was $18. The pro forma results for 2019 and 2018 were not material. This business was subsequently sold on October 11, 2019. See Note 3 for additional information. (Campbell’s Annual Report p. 51). e.

3. Divestures Discontinued Operations On February 25, 2019, we sold our U.S. refrigerated soup business, and on April 25, 2019, we sold our Garden Fresh Gourmet business. Proceeds were $55. On June 16, 2019, we sold our Bolthouse Farms business. Proceeds were $500. Beginning in the third quarter of 2019, we have reflected the results of these businesses as discontinued operations in the Consolidated Statements of Earnings for all periods presented. These businesses were historically included in the Campbell Fresh reportable segment. We completed the sale of our Kelsen business on September 23, 2019, for $322. We also completed the sale of our Arnott’s business and certain other international operations, including the simple meals and shelf-stable beverages businesses in Australia and Asia Pacific (the Arnott's and other international operations), on December 23, 2019, for $2,286. The purchase price was subject to certain post-closing adjustments, which resulted in $4 of additional proceeds in the third quarter of 2020. Beginning in the fourth quarter of 2019, we have 16-35

Instructor’s Manual / Solutions Manual C16.41. e.

(continued) 3. reflected the results of operations of the Kelsen business and the Arnott’s and other international operations (collectively referred to as Campbell International) as discontinued operations in the Consolidated Statements of Earnings for all periods presented. These businesses were historically included in the Snacks reportable segment. (Campbell’s Annual Report p. 49). 4. Business Segments

(Campbell’s Annual Report p. 55). f.

1. (Millions)

2020 2019 2018 2017 2016

Net Sales $8,691 $8,107 $6,615 $5,837 $5,868

Capital Expenditures $299 $384 $407 $338 $341

Annual % Change 2020 2019 2018 2017 2016

Net Sales 107% 123% 113% 99% 100%

Capital Expenditures 78% 94% 120% 99% 100%

Ratio 3.44% 4.74% 6.15% 5.79% 5.81%

(Campbell’s Annual Report p.16)

Instructor’s Manual / Solutions Manual C16.41.

(continued) 3. The data indicate that net sales have increased steadily from 2016 to 2020, the most recent five-year period, but clearly more significantly in 2019 and 2020. Over that same time period capital expenditures have remained relatively constant; however, the pattern shows larger investment growth in 2018 and 2019, and then significantly less investment in 2020. Ironically in 2020, the year of COVID 19, Campbell’s saw its highest level of net sales while at the same time its smallest amount of investment in capital expenditures. The ratio of capital expenditures to net sales was virtually identical in 2016 and 2017, then peaked in 2018 at 6.15% as net sales and capital expenditures both grew significantly, then finally the ratio declined dramatically in 2019 and 2020 as net sales and capital expenditures moved in opposite directions. From 20182020, net sales grew from $6,615 to $8,691 (31%) while capital expenditures declined from $407 to $299 (27%). Looking side-by-side over the five-rear period at the annual percentage change in net sales and capital expenditures clearly illustrates this movement in opposite directions. What does it mean? Standing alone, 2020 may logically be explained as a byproduct of a global pandemic; consumer demand for food products explode as people retreat to their homes full time while similarly, companies are suddenly faced with uncertain operating conditions and forced to reassess strategic plans in place. But over the five-year period, certainly other factors are in play as perhaps illustrated in the demonstrated trends. One relationship related to the net sales and capital expenditures outcomes you might consider is the impact on Campbell’s profitability and ROI. If you notice in Campbell’s five-year Selected Financial Data, net earnings in 2020 at $1,628 almost doubled its second most profitable year in 2017 at $887. You may also recall from studying the DuPont model for analyzing ROI that by improving asset turnover, Net Sales/Operating Assets, by either increasing net sales or decreasing operating assets, ROI would be improved. In 2020, Campbell’s accomplished both. Finally, a closer examination of management’s discussion and analysis of financial conditions should provide more comprehensive detail as to Campbell’s strategic direction and this changing business environment.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ: CHAPTER 16

NAME______________________

1. Management of Lakeside, Inc. is considering an investment in an expansion of the company's product line. The estimated investment required will be $162,500. You can assume that the full amount will be invested at the beginning of 2022. The estimated cash returns from the new product line are shown in the following table. You should assume that the returns are received at the end of each of the years indicated, and that Lakeside, Inc.’s cost of capital is 12%. Year 2022 2023 2024 2025

Estimated Cash Return $36,000 48,000 60,000 72,000

a. Calculate the present value of the cash returns. Show the present value factors and amounts in the space to the right of the cash returns in the above table. b. Calculate the net present value of the investment.

c. Calculate the profitability index of the investment.

d. Estimate, but do not calculate, the Internal Rate of Return of the product line expansion.

e. Calculate the payback period of the investment.

f. Based on your quantitative analyses, would you recommend that the product line expansion project be undertaken?

g. Identify some qualitative factors that you would want to consider with respect to this investment.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY: CHAPTER 16 a.

Year 2022 2023 2024 2025

Cash Return $36,000 48,000 60,000 72,000

12% PV Factor 0.8929 0.7972 0.7118 0.6355

b. Investment ……………………………………………………… Present value of inflows ………………………………………… Net present value………………………………………………… c.

Present Value $ 32,144 38,266 42,708 45,756 $158,874 $(162,500) 158,874 $ (3,626)

$158,874 Present value of inflows = = 0.978 Profitability Index $162,500 Investment

d. The internal rate of return will be less than the cost of capital - about 11%. e. Year 2022 2023 2024 2025

Cumulative Cash Flow $36,000 84,000 144,000 216,000

Cash Flow $36,000 48,000 60,000 72,000

In the fourth year, $18,500 of cash flow is required to bring the cumulative cash flow to $162,500. $18,500 / 72,000 = 25.7% of the year, so the payback period is 3.26 years. f. No, because the return on investment does not equal or exceed the cost of capital. g. What are the probabilities of achieving the estimates? Could the expansion of this product line increase profits from other product lines? What is the firm’s incremental cost of borrowing, and is the NPV positive at this discount rate? Would this product line expansion open any additional market opportunities for the firm that could not be entered into at a later date without making this initial investment? Are there ways to reduce the initial investment cost by expanding the product line on a multi-phase basis, rather than all at once?